Estimating the Number of Damaged Shares in Securities Fraud Litigation: An Introduction to Stock Trading Models
Dean Furbush and Jeffrey W. Smith, 49(2): 527–43 (Feb. 1994)
Calculating damages in class action securities fraud litigation requires estimating the number of affected shares. The authors describe a trading model that has been used extensively for such purposes. They analyze its properties and highlight its weaknesses, showing that it is unbiased only under the assumption that all shares are equally likely to trade on any given day. Under more realistic assumptions, the model overestimates the number of damaged shares and thus overestimates damages. An alternative model is suggested.
Auctioning Class Actions: Turning the Tables on Plaintiffs' Lawyers' Abuse or Stripping the Plaintiff Wizards of Their Curtain
Julie Rubin, 52(4): 1441–63 (Aug. 1997)
This Article offers a critical analysis of the concept of auctioning the merits of class action suits to the highest bidder as an alternative to the present method of class actions, which has proven inadequate on many fronts. Problems currently associated with class actions, such as attorneys' fees, selection of class counsel, and the divergent interests of class counsel and class members, are discussed as areas upon which auctioning may improve. The Article applies the auction theory and model to securities class actions. In doing so, the author examines Federal Rule of Civil Procedure 23 and the Private Securities Litigation Reform Act of 1995 to determine if class action auctions comport or conflict with their purposes and aims.
In Search of Bargained-For Fees for Class Action Plaintiffs' Lawyers: The Promise and Pitfalls of Auctioning the Position of Lead Counsel
Andrew K. Niebler, 54(2): 763–834 (Feb. 1999)
This Article examines the economic fundamentals of auctions held for the purpose of selecting lead counsel in class action lawsuits. As presently implemented, these auctions sometimes exacerbate the agency costs inherent in the relationship between class counsel and class plaintiffs. Redesigning the auction utilizing option principles can help produce a more optimal resolution of the class claim through a reduction of agency costs.
Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
Henry T. C. Hu and Bernard Black, 61(3):1011–1070 (May 2006)
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This structure gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' "separation of ownership and control" suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers from straying too far from the goal of shareholder wealth maximization.
In the past few years, the derivatives revolution, hedge fund growth, and other capital market developments have come to threaten this familiar pattern throughout the world. Both outside investors and corporate insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling—which we call "the new vote buying"—is often hidden from public view and is largely untouched by current law and regulation. Hedge funds, sophisticated and largely unfettered by legal rules or conflicts of interest, have been especially aggressive in decoupling. Sometimes they hold more votes than economic ownership, a pattern we call "empty voting." That is, they may have substantial voting power while having limited, zero, or even negative economic ownership. In the extreme situation of negative economic ownership, the empty voter has an incentive to vote in ways that reduce the company's share price. Sometimes hedge funds hold more economic ownership than votes, though often with "morphable" voting rights—the de facto ability to acquire the votes if needed. We call this "hidden (morphable) ownership" because under current disclosure rules, the economic ownership and (de facto) voting ownership are often not disclosed. Corporate insiders, too, can use new vote buying techniques.
This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other forms of shareholder oversight, and the circumstances in which decoupling could be beneficial or harmful to corporate governance. We also propose a near-term disclosure-based response and sketch longer-term regulatory possibilities. Our disclosure proposal would simplify and partially integrate five existing, inconsistent share-ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed; we briefly discuss possible strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.
Independent Directors as Securities Monitors
Hillary A. Sale, 61(4):1375-1412 (August 2006)
This paper considers the role of independent directors of public companies as securities monitors. Rather than engaging in the debate about whether independent directors are good or bad, important or unimportant, the paper takes their existence and basic governance role as a given, focusing instead on what recent statements from Securities and Exchange Commission officials indicating an increased focus on independent directors and their role in preventing securities fraud. The paper notes that the SEC believes that independent directors are on the board to act, at least in part, as securities monitors. This securities monitor role is another aspect of the information-forcing-substance disclosure model that the SEC has used to achieve improved corporate governance. Although directors face heightened risk when they draft or sign disclosure documents, they also have an ongoing responsibility to be informed of developments within the company, ensure good processes for accurate disclosures, and make reasonable efforts to assure that disclosures are adequate. Independent directors with expertise should be involved in reviewing and, sometimes, drafting statements. All directors, however, should be fully aware of the company's press releases, public statements, and communications with security holders and sufficiently engaged and active to question and correct inadequate disclosures. In addition to defining the role of independent directors as securities monitors, the article reviews the liability independent directors might face under private causes of action and contrasts it with the SEC's enforcement powers and remedies. The article describes some of the SEC's prior statements that emphasize the role of independent directors as securities monitors and the importance of their providing both guidance and check and balance.
Freezeout Doctrine: Going Private at the Intersection of the Market and the Law
Faith Stevelman, 62(3): 775–912 (May 2007)
Delaware's fiduciary doctrine governing going private transactions by controlling shareholders is presently in disarray. Controllers generally select between single step cash-out mergers and tender offers followed by short-form mergers to do these freezeouts, and they are subject to very different equitable standards depending on the format selected by the controller. Furthermore, the courts' longstanding commitment to applying strict scrutiny in the adjudication of freezeouts is in tension with the popular disfavor towards private class-action litigation. This disarray threatens minorities' interests in freezeouts and capital market values more generally. This Article reviews the foundations of freezeout doctrine and proposes that the Entire Fairness doctrine should apply as the standard of review in all freezeouts unless prior to accepting the controller's offer the target company's independent directors conducted an auction or market check to ascertain if better offers were available.
Meeting Daubert Standards in Calculating Damages for Shareholder Class Action Litigation
Linda Allen, 62(3): 955–970 (May 2007)
Current practice in class action litigation entails a series of arbitrary assumptions about fundamental parameters that may not meet Daubert standards of scientific evidence. This Article surveys the commonly used models used to estimate stock price inflation and the number of damaged shares for the purposes of damage calculations in shareholder class action litigation. This Article proposes tractable methods for improving current practice using: (1) a regression approach to event studies and (2) a new model (denoted the Theoretically-grounded Microstructure Trading Model or TMTM) that incorporates the well-established literature of market microstructure and trade direction into a model that can be estimated utilizing publicly available data. Actual trading data are used to validate the assumptions of the TMTM approach and to refute the assumptions of extant trading models such as the Proportional Trading Model (PTM) and the Two Trader Model (TTM).
Tontine or Takeback: Reversion Provisions in Class Action Settlement Agreements
Ralph C. Ferrara and Riva Khoshaba Parker, 62(3): 971–982 (May 2007)
Class action litigation rages on in securities, antitrust, mass torts and products liability sectors; these actions are more often settled than litigated to verdict. As the classes and claims grow larger, the damages claimed greater, and the potential for entanglements with regulatory and criminal investigations increases, settlement agreements grow increasingly complex as litigants attempt fairly to put to rest claims and allegations from multiple sectors. Inevitably, at the end of the day in most settlements, there is still some money left over in the settlement fund after all the claiming class members have been paid. The dilemma arises as to what to do with this residual amount: one possible, underutilized option is to permit the reversion of any residual funds to the defendants.
Summary of Mendes Hershman Student Writing Contest Prize Essay: Difficult, Duplicative and Wasteful?: The NASD's Prohibition of Class Action Arbitration in the Post- Bazzle Era
Matthew Eisler, 62(3): 1059–1060 (May 2007)
Beyond the Basics: Seventy-five Defenses Securities Litigators Need to Know
Jonathan Eisenberg, 62(4): 1281—1394 (August 2007)
After questioning the value of securities class actions, which are largely unknown outside the United States, the author discusses 75 defenses that courts have used to dismiss securities claims. These defenses are typically raised at the motion to dismiss stage, and are important because securities class actions that survive motions to dismiss are usually settled rather than resolved on the merits. The article provides a template for analyzing the application of each defense to securities class action complaints, and then discusses each defense and references key authorities that practitioners can turn to for further analysis.
An Uninvited Guest: Class Arbitration and the Federal Arbitration Act's Legislative History
David S. Clancy and Matthew M.K. Stein, 63(1): 55–80 (November 2007)
In recent years, there has been an explosion of "class arbitrations"—arbitration proceedings in which the claimant purports to represent a class of absent individuals. In this Article, the authors examine the legislative history of the Federal Arbitration Act ("FAA"), and argue that, in enacting the FAA, Congress intended to open the door to non–judicial dispute resolution proceedings with particular fundamental characteristics, and that class arbitration proceedings do not have those characteristics. The authors argue that class arbitration is therefore a novel type of non–judicial dispute resolution neither reviewed nor approved by Congress, and that, as a result, this "uninvited guest" should be subjected to close legal and public–policy scrutiny. The authors also identify multiple areas of particular concern, including, for example, that courts have been reviewing class arbitration decisions under the traditional standard of review highly deferential to arbitrators, suggesting that we are on a path toward the quiet establishment of a forum that adjudicates disputes involving hundreds, thousands, or even tens of thousands of individuals in decisions that are effectively unreviewable.
Consumer Arbitration: If the FAA "Ain't Broke," Don't Fix It
Alan S. Kaplinsky and Mark J. Levin, 63(3): 907–920 (May 2008)
During 2007, Congress showed significant interest in mandatory pre–dispute consumer arbitration agreements. Some in Congress focused on whether to prohibit them altogether. This Article argues that such legislation is unnecessary because the current system of consumer arbitration works well and needs no fix. The authors review case law and empirical studies showing that the current system of checks and balances in the area of consumer arbitration law is sufficiently protective of consumers' rights. These protections emanate from: (1) the Federal Arbitration Act ("FAA") itself, (2) the careful drafting of arbitration agreements, (3) the use of third–party arbitration administrators, and (4) the rigorous enforcement of the FAA by state and federal courts.
Applying Stoneridge to Restrict Secondary Actor Liability Under Rule 10b-5
Todd G. Cosenza, 64(1): 59-78 (November 2008)
Although the U.S. Supreme Court's decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., was widely viewed as a sweeping rebuke of the application of "scheme" liability to secondary actors, the Court's decision also raised some questions regarding the precise scope of secondary actor liability under section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. There is an obvious tension between the Court's holding that the secondary actors in Stoneridge could not be held liable because their "deceptive acts, which were not disclosed to the investing public, [were] too remote to satisfy the element of reliance" and its pronouncement that "[c]onduct itself can be deceptive" and could therefore satisfy a Rule 10b-5 claim. In particular, the question of what type of conduct satisfies the element of reliance in a claim against a secondary actor who assists in the drafting of a company's public disclosures remains open to interpretation.
This Article first discusses the general standards of section 10(b) liability and the Supreme Court's decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. The next part of the Article compares the judicial standards of secondary actor liability under Rule 10b-5(b)—the bright line, substantial participation, and creator standards—that emerged in the post- Central Bank era. It then discusses Stoneridge and the Court's recent rejection of secondary actor "scheme" liability under Rule 10b-5(a) and (c). Finally, it reviews recent applications of Stoneridge and analyzes the implications of these decisions going forward.
Revisiting Consolidated Edison—A Second Look at the Case that Has Many Questioning Traditional Assumptions Regarding the Availability of Shareholder Damages in Public Company Mergers
Ryan D. Thomas and Russell E. Stair, 64(2): 329-358 (February 2009)
In October 2005, the U.S. Court of Appeals for the Second Circuit in Consolidated Edison, Inc. v. Northeast Utilities ("Con Ed") ruled that electric utility company Northeast Utilities ("NU") and its shareholders were not entitled to recover the $1.2 billion merger premium as damages after NU's suitor, Consolidated Edison, refused to complete an acquisition of NU. This case surprised many M&A practitioners who believed that the shareholder premium (or at least some measure of shareholder damages) would be recoverable in a suit against a buyer that wrongfully terminated or breached a merger agreement. If Con Ed proves to have established a general rule precluding the recovery of shareholder damages for a buyer's breach of a merger agreement, the potential consequences to targets in merger transactions would be substantial—shifting the balance of leverage in any MAC, renegotiation, or settlement discussions decidedly to the buyer and effectively making every deal an "option" deal. This ruling, therefore, has left some target counsel struggling to find a way to ensure that the merger agreement allows for the possibility of shareholder damages while also avoiding the adverse consequences of giving shareholders individual enforcement rights as express third-party beneficiaries of the agreement.
The Con Ed case, however, merits a second look. This Article revisits the Con Ed decision and challenges the conclusion of some observers that the court in Con Ed established a general precedent denying the availability of shareholder damages. This Article also discusses how the holding of Con Ed may very well be confined to the facts and the specific language of the merger agreement at issue in the case. Notwithstanding, the uncertainty surrounding how any particular court may approach the issues raised in Con Ed, this Article proposes model contract language that a target might employ to avoid creating a " Con Ed issue" and to minimize the risk of a result that was not intended by the parties.
Preemption as Micromanagement
Larry Ribstein, 65(3): 789–798 (May 2010)
Reinterpreting Section 141(e) of Delaware's General Corporation Law: Why Interested Directors Should Be "Fully Protected" in Relying on Expert Advice
Thomas A. Uebler, 65(4): 1023–1054 (August 2010)
Directors of Delaware corporations often rely on lawyers, economists, investment bankers, professors, and many other experts in order to exercise their managerial power consistently with their fiduciary duties. Such reliance is encouraged by section 141(e) of the General Corporation Law of the State of Delaware, which states in part that directors "shall . . . be fully protected" in reasonably relying in good faith on expert advice. Section 141(e) should provide all directors of Delaware corporations a defense to liability if, in their capacity as directors, they reasonably relied in good faith on expert advice but nevertheless produced a transaction that is found to be unfair to the corporation or its stockholders, as long as the unfair aspect of the transaction arose from the expert advice. The Delaware Court of Chancery, however, has limited the full protection of section 141(e) by confining it to disinterested directors in duty of care cases. That limitation, which is not expressed in the statute, unfairly punishes interested directors who act with an honesty of purpose and reasonably rely in good faith on expert advice because it requires them to serve as guarantors of potentially flawed expert advice. This Article concludes that Delaware courts should reconsider the application and effect of section 141(e) and allow directors, regardless of their interest in a challenged transaction, to assert section 141(e) as a defense to liability in duty of care and duty of loyalty cases if they reasonably relied in good faith on expert advice.
Putting Stockholders First, Not the First-Filed Complaint
Leo E. Strine, Jr., Lawrence A. Hamermesh, and Matthew C. Jennejohn, 69(1): 1-78 (November 2013)
The prevalence of settlements in class and derivative litigation challenging mergers and acquisitions in which the only payment is to plaintiffs’ attorneys suggests potential systemic dysfunction arising from the increased frequency of parallel litigation in multiple state courts. After examining possible explanations for that dysfunction and the historical development of doctrines limiting parallel state court litigation—the doctrine of forum non conveniens and the “first-filed” doctrine—this article suggests that those doctrines should be revised to better address shareholder class and derivative litigation. Revisions to the doctrine of forum non conveniens should continue the historical trend, deemphasizing fortuitous and increasingly irrelevant geographic considerations, and should place greater emphasis on voluntary choice of law and the development of precedential guidance by the courts of the state responsible for supplying the chosen law. The “first-filed” rule should be replaced in shareholder representative litigation by meaningful consideration of affected parties’ interests and judicial efficiency.
Damages and Reliance Under Section 10(b) of the Exchange Act
Joseph A. Grundfest; 69(2): 307-392 (February 2014)
A textualist interpretation of the implied private right of action under section 10(b) of the Exchange Act concludes that the right to recover money damages in an aftermarket fraud can be no broader than the express right of recovery under section 18(a) of the Exchange Act. The Act’s original legislative history and recent Supreme Court doctrine are consistent with this conclusion, as is the Act’s subsequent legislative history. Section 18(a), however, requires that plaintiffs affirmatively demonstrate actual “eyeball or eardrum” reliance as a precondition to recovery and does not permit a rebuttable presumption of reliance. Accordingly, if the Exchange Act is to be interpreted as a “harmonious whole,” with the scope of recovery under the implied section 10(b) private right being no greater than the recovery available under the most analogous express remedy, section 18(a), then section 10(b) plaintiffs must either demonstrate actual reliance as a precondition to recovery of damages, or the U.S. Supreme Court should revisit Basic, as suggested by four Justices in Amgen, and overturn Basic’s rebuttable presumption of reliance. A textualist approach thus provides a rationale for either distinguishing or reversing Basic that avoids the complex debate over the validity of the efficient market hypothesis, an academic dispute that the Court is not optimally situated to referee.
Standing at the Singularity of the Effective Time: Reconfiguring Delaware’s Law of Standing Following Mergers and Acquisitions
S. Michael Sirkin; 69(2): 429-474 (February 2014)
This article examines the doctrine of standing as applied to mergers and acquisitions of Delaware corporations with pending derivative claims. Finding the existing framework of overlapping rules and exceptions both structurally and doctrinally unsound, this article proposes a novel reconfiguration under which Delaware courts would follow three black-letter rules: (1) stockholders of the target should have standing to sue target directors to challenge a merger directly on the basis that the board failed to achieve adequate value for derivative claims; (2) a merger should eliminate target stockholders’ derivative standing; and (3) stockholders xi of the acquiror as of the time a merger is announced should be deemed contemporaneous owners of claims acquired in the merger for purposes of derivative standing. Following these rules would restore order to the Delaware law of standing in the merger context and would advance the important public policies served by stockholder litigation in the Delaware courts.
SEC Cybersecurity Guidelines: Insights into the Utility Risk Factor Disclosures for Investors
Edward A. Morse, Vasant Raval, and John R. Wingender, Jr., 73(1): 1-34 (Winter 2017/2018)
In October 2011, the SEC issued new guidelines for disclosure of cybersecurity risks. Some firms responded to these guidelines by issuing new risk factor disclosures. This article examines the guidelines and cybersecurity disclosures in the context of existing laws governing securities regulation. It then examines empirical results from firm disclosures following the new guidelines. Evidence shows a relatively small proportion of firms chose to modify their risk factor disclosures, with most firms choosing not to disclose any specific cybersecurity risk. Moreover, disclosing firms generally experienced significant negative stock market price effects on account of making new disclosures. Rather than viewing disclosure as a positive signal of management attentiveness, investors apparently viewed it as a cautionary sign.
How Efficient Is Sufficient: Applying the Concept of Market Efficiency in Litigation Bradford Cornell and John Haut, 74(2) 417-434 (Spring 2019)
The concept of market efficiency has been adopted by courts in a variety of contexts. In reality, markets can never be perfectly efficient or inefficient, but exist somewhere in between depending on the facts and circumstances. Courts, therefore, face a problem in deciding how efficient is sufficient in any particular legal context. Because market prices incorporate the views of numerous market participants, courts have often been willing to presume that a market is efficient so long as the appropriate criteria are satisfied. However, those criteria are different for different types of cases, such as securities class actions, appraisal actions, and cram downs in bankruptcy.
Uncovering the Hidden Conflicts in Securities Class Action Litigation: Lessons from the State Street Case
Benjamin P. Edwards and Anthony Rickey; 75(1): 1551-1570 (Winter 2019-2020)
Courts, Congress, and commentators have long worried that stockholder plaintiffs in securities and M&A litigation, and their counsel, may pursue suits that benefit themselves, rather than absent stockholders or the corporations in which they invest. Following congressional reforms that encouraged the appointment of institutional stockholders as lead plaintiffs in securities actions, significant academic commentary has focused on the problem of “pay to play”—the possibility that class action law firms encourage litigation by making donations to politicians with influence over institutional stockholders, and particularly public sector pension funds.
State Section 11 Litigation in the Post-Cyan Environment (Despite Sciabacucchi)
Michael Klausner, Jason Hegland, Carin LeVine, and Jessica Shin; 75(2): 1769-1790 (Spring 2020)
In Cyan, Inc. v. Beaver County Employees Retirement Fund, the U.S. Supreme Court held that the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) preserved state courts’ jurisdiction to adjudicate cases brought under the Securities Act of 1933, with defendants having no right to remove a case to federal court. The result of this decision has been a dramatic increase in section 11 cases litigated in state court, often with a parallel case brought in federal court against the same defendants based on the same alleged misstatements.
Loss Causation and the Materialization of Risk Doctrine in Securities Fraud Class Actions
Richard A. Booth; 75(2): 1791-1814 (Spring 2020)
In the context of a claim for securities fraud under SEC Rule 10b-5, most federal circuit courts have ruled or recognized that loss causation can be proven by an event that demonstrates an earlier statement by a defendant company to be false. In other words, corrective disclosure need not take the form of speech. Rather, a statement can be shown to be false by the materialization of a risk that was concealed by the company, and investors can be compensated for any losses they suffer as a result. Although this doctrine is well established, its ultimate effect is to overcompensate investors, thus encouraging excessive securities litigation and chilling voluntary disclosure.
The Paradox of Delaware’s “Tools at Hand” Doctrine: An Empirical Investigation
James D. Cox, Kenneth J. Martin, and Randall S. Thomas 75(3): 2123-2172 (Summer 2020)
Much has been written on the subject of abusive shareholder litigation. The last decade has witnessed at first an increase and then a dramatic spike in such suits, primarily suits filed in connection with mergers and acquisitions. Delaware courts are known for not just their deep experience in corporate lawsuits but as being doctrinal innovators. One such innovation occurred in Rales v. Blasband, 634 A.2d 927 (Del. 1993), establishing the “tools at hand” doctrine, whereby, before considering whether to grant a motion to dismiss, the court admonishes the shareholder to resort to inspection rights accorded by the Delaware General Corporation Law so as to gather facts necessary for the complaint to survive the pretrial motion.