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October 2019 Month in Review

WLF Legal Pulse - Tue, 11/05/2019 - 8:15am

To read more about the items below, click the link above for a PDF of the newsletter.

NEW FILINGS

  • The Alien Tort Statute does not permit human-rights activists to file federal-court claims based on a defendant’s conduct in foreign countries. (Nestle USA, Inc. v. Doe I)
  • The Federal Trade Commission improperly held that drug companies’ settlement of patent-infringement litigation violated antitrust laws, without evidence that the settlement harmed competition. (Impax Laboratories, Inc. v. FTC)
  • Regulations proposed by the Department of Housing and Urban Development appropriately limit the scope of disparate-impact liability under the Fair Housing Act. (In re FHA Disparate-Impact Liability)
  • Proposed Food and Drug Administration regulations violate the First Amendment by compelling cigarette manufacturers to place controversial statements on product labeling. (In re Required Warnings for Cigarette Packaging and Advertisements)
  • Property owners are entitled to compensation under the Takings Clause when a government arbitrarily delays their building permit. (Bottini v. City of San Diego)
  • Antitrust law is designed to protect competition, not competitors; it does not concern itself with evidence that a defendant may have desired to harm a competitor. (Swisher Int’l v. Trendsettah USA)

DECISIONS

  • The Ninth Circuit declines to reconsider its certification of a class of Facebook users despite no evidence that they suffered any injury. (In re Facebook Biometric Information Privacy Litig.)
  • U.S. Supreme Court declines to review a Ninth Circuit decision barring removal to federal court (under the Class Action Fairness Act) of a “mass action” in which a single state-court judge is coordinating thousands of identical claims. (Pfizer, Inc. v. Adamyan)
  • The U.S. Supreme Court declines to review a Ninth Circuit decision holding that the Americans with Disabilities Act extends to cyberspace and requires companies to revamp their web sites to accommodate the needs of the visually impaired. (Domino’s Pizza, LLC v. Robles)
  • The U.S. Supreme Court declines to review a California court decision that, in conflict with the Federal Arbitration Act, refuses to enforce an arbitration agreement. (Winston & Strawn LLP v. Ramos)
  • The U.S. Court of Appeals for the District of Columbia Circuit upholds a decision by the Federal Communications Commission to rescind its 2015 “net neutrality” rules, which imposed burdensome regulations on Internet providers. (Mozilla Corp. v. FCC)

The post October 2019 Month in Review appeared first on Washington Legal Foundation.

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WLF Asks U.S. Supreme Court to Clarify When Government May Compel Speech

WLF Legal Pulse - Fri, 11/01/2019 - 8:00am

“The decision below, if left to stand, would allow government regulators to transform a First Amendment test created to correct false or misleading speech into a justification for foisting false or misleading speech onto the public.”
—Cory Andrews, Vice President of Litigation

Click here for WLFs brief.

(Washington, D.C.)—Washington Legal Foundation (WLF) today filed an amicus curiae brief urging the U.S. Supreme Court to review—and ultimately to strike down—a Berkeley, California ordinance that requires all cell-phone retailers to warn their customers about the supposed dangers of ordinary cell-phone use.

The petition marks CTIA’s second time asking the high court to review the Berkeley ordinance. The Court granted an earlier petition without opinion in 2018, vacating a decision of the U.S. Court of Appeals for the Ninth Circuit that upheld the ordinance and remanding the case for reconsideration in light of National Institute of Family and Life Advocates v. Becerra (2018). Even so, the Ninth Circuit once again sustained the ordinance against a First Amendment challenge, holding that the city’s mandated warning qualifies as a purely factual and noncontroversial disclosure under Zauderer v. Office of Disciplinary Counsel of Supreme Court of Ohio (1985). 

Berkeley’s mandated warning informs cell-phone users how to avoid the purported dangers of being overexposed to radiofrequency (RF) from their cell phones. But the Federal Communications Commission (FCC), in concert with other federal agencies responsible for ensuring health and safety, already ensures that U.S. cell phones have RF-exposure limits 50 times below the level of any adverse biological effect. As a result, the FCC has determined that any cell phone legally sold in the United States is a “safe phone.”

In its brief, WLF explains that by divorcing the government’s authority to compel speech from any need to remedy pre-existing commercial speech, the decision below grants Berkeley a roving commission to compel speech entirely on its own terms. The city’s mandated warning is thus not a traditional commercial-speech disclosure under Zauderer, but a freestanding speech compulsion subject to strict scrutiny. And even if Zauderer applies, WLF’s brief argues, Berkeley’s mandated warning misleads readers into believing that ordinary cell-phone use may be dangerous. Not only is that message intentionally misleading, it is highly controversial and thus cannot pass constitutional muster under Zauderer.

Celebrating its 42nd year, WLF is America’s premier public-interest law firm and policy center advocating for free-market principles, limited government, individual liberty, and the rule of law.

The post WLF Asks U.S. Supreme Court to Clarify When Government May Compel Speech appeared first on Washington Legal Foundation.

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Playing Nice in a No-Action Sandbox: The SEC’s Careful Approach to a Blockchain System for Clearing and Settling Equity Trades

WLF Legal Pulse - Thu, 10/31/2019 - 12:53pm

Daniel S. Alter is a Shareholder in the New York, NY office of Murphy & McGonigle P.C. and is the WLF Legal Pulse’s Featured Expert Contributor, Legal & Regulatory Challenges for Digital Assets.

Three cheers for the Securities and Exchange Commission!  On October 28, 2019, the SEC’s Division of Trading and Markets issued a no-action letter to Paxos Trust Company, LLC, a New York State chartered trust company (Paxos), essentially permitting Paxos to operate a blockchain-based settlement system without first registering as a clearing agency under Section 17 of the Securities Exchange Act of 1934 (“No-Action Letter”).  This may be a baby step for the agency, but it’s nevertheless a very big one.

The No-Action Letter is a baby step because it gives Paxos a license to test its blockchain prototype for only two years and under very limited conditions.  Described by the SEC, these conditions are “reasonably designed to ensure that activity remains de minimis through operating parameters designed to limit the scope of operations and manage financial and settlement risk, using, among other things, participation requirements and limits, securities eligibility criteria, margin collection, volume limits, ongoing monitoring, and regular reporting to [SEC] Staff.”  In other words, the agency will be keeping a tight rein on the project.

But that’s great!  It’s exactly what the SEC should be doing—and much more of it.  As with anything else, blockchain applications will improve through trial and error.  Given how high the stakes are for the proper clearing and settlement of trades in the securities market, however, it’s critical to work out the kinks of any new technology before handing over the keys.  Although entrepreneurs may find excitement in the concept of disruption, the idea of it is pure dread for regulators.

Viewed from that perspective, the SEC’s decision finally to go down this path at all is a very big baby step.  And for others looking to make similar headway with the agency, there are at least two important lessons to be learned here:

First, packaging matters.  In its request for no action relief, Paxos sought permission from the SEC to conduct a short-term “Feasibility Study.”  This was an invitation for the SEC to become proactively involved in determining whether the Paxos system can work to the agency’s satisfaction.  It was not a declaration of theoretical superiority with an implicit charge of Luddism.  A little humility can go a long way.

The second point is simultaneously both subtle and glaring.  So far, commentators have not focused on the fact that the No-Action Letter hinges on a Paxos account at the Depository Trust Company or DTC.  The DTC is a “central securities depository”—a common utility that holds securities in certificated or uncertificated form so that they can be transferred between buyers and sellers more quickly via book entries rather than through physical delivery.  It is one of the cornerstones of our present market infrastructure.

Paxos proposes to use its own DTC account to hold its clients’ securities in subaccounts.  Once a client deposits its securities into the Paxos subaccount, Paxos will create “a digitized security entitlement, which is a digital representation” of the clients’ assets.  Paxos will then use those digital representations to clear and settle securities trades on a blockchain, thereby allowing the instantaneous swap of assets for cash in those client subaccounts.  The Paxos system purports to reduce clearing and settlement time to 0—an accomplishment that would vastly reduce financial risk in the market and release significant amounts of capital held in reserve pending trade completion.

Ironically, to the blockchain evangelist preaching the good news of disintermediation, this solution is the devil’s design.  Instead of removing the inefficiencies and risks associated with trusted financial middleman (like DTC)—which is the fundamental peer-to-peer promise of blockchain technology—Paxos intends to add itself as another layer to the clearing and settlement process.  Heresy.

Or is it faithful pragmatism?  This model may be a necessary step in the infrastructure evolution.  Surely, the SEC found comfort in the idea that client securities will remain at the DTC, a familiar and reliable custodian.  And perhaps that backstop convinced the agency to take a big baby step.

Consider, also, there may be other existing market structures onto which blockchain technology might be grafted—at least at first—to accomplish a great benefit.  The No-Action Letter reaffirms something obvious yet important; perhaps innovators not so much, but Commissioners need to walk before they can run.

The post Playing Nice in a No-Action Sandbox: The SEC’s Careful Approach to a Blockchain System for Clearing and Settling Equity Trades appeared first on Washington Legal Foundation.

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If it Takes History Seriously, the Supreme Court Will Strike Down the CFPB

WLF Legal Pulse - Thu, 10/31/2019 - 10:13am

Everyone knows where to find the most powerful person in Washington. He lives and works in an old neoclassical mansion known as the White House. Every day, swarms of tourists, cranks, and clowns gather at the fence beyond his front door, tacitly acknowledging his preeminence.

Where can one find Washington’s second most powerful person? Is he at the main executive building? Is she in an office next to the Capitol? Perhaps he’s at the Supreme Court? Plausible suggestions all. But no one in these places can get much done without the support of other—sometimes many other—equally mighty and ambitious people.

There’s a case to be made that the second most powerful person in the federal government sits a block from the West Wing, in a drab concrete structure the sightseers invariably pass without a glance. The building houses the Consumer Financial Protection Bureau, the director of which implements more than a dozen major statutes—and answers to no one. Not to voters. Not to other bureaucrats. Not even to the chief executive. Although a CFPB director can be fired for misconduct, she cannot be removed due to her policies. The protocols she imposes, the priorities she sets, and the tactics she uses are in her hands to make. Her choices are her own. The president is stuck with them.

What are we to make of this? What do the traditions of our nation and our law have to say about this regulatory lord and her fiefdom?

*

“Will no one rid me of this turbulent priest?” Four knights immortalized this howl of protest, indignantly emitted by Henry II while his blood was up, by taking it seriously. They took their leave, rode to the Norman coast, and crossed the Channel. They found the Archbishop of Canterbury, Thomas Becket, in his cathedral, and they hacked him to pieces.

Becket had once been the king’s friend and counsellor. When Henry had him appointed archbishop in 1162, however, he promptly went native. The Church of that day was a power apart—a body with its own lands and privileges, its own laws and courts—and Becket became its champion. He denied the Crown’s authority, undermined royal policy at every turn, and excommunicated clerics loyal to the king. Henry could do little about any of it except shout and sputter. When at last, in 1170, the knights mistook one of Henry’s many impotent tirades as a command and removed Becket by cutting him down, the scandal shook the kingdom to the core. Becket was hailed a martyr and a saint. Henry spent years atoning for the sacrilege he had set on foot.

Just as the King of England could not always remove a man, neither could he always retain one. Edward II’s favorite, Piers Gaveston, gave the high and mighty of the realm nicknames such as “burst belly” and “the cuckold’s bird.” The barons took him to the woods and executed him in 1312.

Parliament impeached Charles I’s first minister, the Earl of Strafford, in 1640. When Strafford proceeded to defend himself a little too ably at his trial, the Puritans dropped the impeachment, attainted him, forced the king to sign a death warrant, and had him beheaded before 100,000 spectators. Charles never forgave himself. When he in his turn stepped onto a scaffold in 1649, he declared that God was punishing him for the “unjust sentence” that he had “suffered to take effect.”

But these dramatic episodes are aberrations. They are exceptional. For centuries England’s high officials—its chancellors, its judges, and, once Henry VIII had his way, even its bishops—served at the king’s pleasure. A minister’s powers were the king’s powers. They were, as Maitland explained, “royal prerogatives” that “the king might lawfully exercise himself were he capable of discharging personally the vast business of government.” An untrammeled power of appointment and removal was itself such a prerogative.

Some of these prerogatives were stripped away just as the American colonies were becoming a going concern. After the Revolution of 1688, the Crown lost finally and for all time the power to suspend a law. No sovereign has vetoed a bill from the throne since Queen Anne did so in 1708. When Anne died in 1714, the monarchy’s power to remove a judge “during good behavior” died with her. Royal authority withered further under George I and George II, Hanoverians who cared little about England or its affairs. Although George III took some interest in governing, by his day the king no longer attended cabinet meetings.

Yet the king remained formidable, at least in theory. He retained his say in foreign affairs. And his power to appoint and remove officers was untouched. The king, Blackstone wrote in 1765, was still “the fountain of honour, of office, and of privilege.” It was for him alone, therefore, to decide “in what capacities, with what privileges, and under what distinctions his people [we]re best qualified to serve and to act under him.” He could even create new offices, albeit only with what money parliament might supply.

The Declaration of Independence accuses George III of committing “every act which may define a Tyrant.” At times the document seems to rail against a despot whose writ ran no farther than Thomas Jefferson’s imagination. Accurate or no, however, Jefferson’s view of the king played on the minds of the men who assembled for the Constitutional Convention in 1787. The charter they crafted prises many royal prerogatives from the grasp of our chief executive. In line with the British practice by that time, he may not remove judges. But he also may not declare war or create offices; those powers belong to Congress. And he may not make treaties or appoint senior officers by himself; he needs the Senate’s approval.

But the British monarchy was not the Framers’ only point of reference. The Articles of Confederation had created a meagre executive power and assigned it to Congress. Forget George III; the absence of a separate executive was, Jefferson exclaimed, “the source of more evil than we have ever experienced from any other cause.” “Nothing is so embarrassing nor so mischievous in a great assembly as the details of execution,” he cried. Hamilton agreed. The lack of a “proper executive” led, he wrote, to a “want of method and energy.” “Responsibility” was too “diffused.” The Framers wanted to fix this problem.

So it is important to note how the Framers went about trimming the executive bough. First, they invested a chief executive with his panoply: they roundly vested “the executive Power” in a single “President.” Then, when they wanted to revoke some prerogative or other, they did so openly and in plain words. The president may not “provide and maintain a Navy”; he may not grant anyone a “Title of Nobility”; and so on. The Framers wanted to reduce the president’s authority to a point, and no further. “All the powers properly belonging to the executive department of the government are given,” as Fisher Ames put it to the First Congress, “and such only taken away as are expressly excepted.”

The Constitution requires the president to rely on Congress to erect and fund offices, and on the Senate to approve principal officers. Meanwhile, however, it commands the president, and the president alone, to “take Care that the Laws be faithfully executed.” And although it says that judges “shall hold their offices during good behavior,” it extends no like protection to executive officials. A balance has plainly been struck. The president answers to Congress, but the government answers to the president. An officer must, in Washington’s words, “assist the supreme Magistrate in discharging the duties of his trust.”

When Jefferson became president, he circulated among his heads of departments a letter setting Washington’s administration as his standard. Washington had required his officers to keep him “always in accurate possession of all facts and proceedings.” He had “formed a central point for the different [executive] branches, preserved a unity of object and action among them,” and “met himself the due responsibility for whatever was done.” Jefferson contrasted this approach with “Mr. Adams’s administration,” in which the president, during “his long and habitual absences,” let the government be “parceled out” among “four independent heads, drawing sometimes in opposite directions.” “That the former is preferable to the latter course,” declared Jefferson, “cannot be doubted.” Washington—and Jefferson—clearly believed that the president may guide, command, and, when necessary, remove government officials. Indeed, although no law granted the president a removal power, Washington, Adams, and Jefferson each dismissed many officers. Jefferson fired 124 of them.

The early presidents’ conduct was not challenged. To the contrary, the First Congress endorsed the notion that the president enjoys an unfettered removal power. When Madison moved to establish a Department of Foreign Affairs, “the head of which” was to be an officer “removable by the President,” a debate erupted about the nature of the removal power. A few representatives argued that removal required an impeachment trial in the Senate. Others argued that the Senate’s approval, at least, was necessary. Still others believed that, although the president should be allowed to remove people at will, his power to do so came not from the Constitution but from Congress. Madison, for his part, contended that “the lowest officers, the middle grade, and the highest” all “depend, as they ought, on the president.” And because he in turn depends on the “community,” the “chain of dependence” terminates in “the people.” An unqualified removal power ensures, in other words, that voters may hold the president to account for his officers’ actions.

In what is now known as the Decision of 1789, Congress passed several bills that contained no removal clause, but that discussed who would manage the papers of a removed officer. The traditional view holds that Congress thereby affirmed that the Constitution empowers the president to remove officers at will. Legislators on both sides of the debate placed that gloss on the affair in their private letters. The votes turned, one senator wrote, on “whether the President had a constitutional right to remove; not on the expediency of it.” Madison told Jefferson that his colleagues had taken the position “most consonant” to “the text of the Constitution” and “the requisite responsibility and harmony in the Executive Department.”

It was not until the twentieth century that the Supreme Court turned its gaze squarely on removal. When at last it did so, it threw its weight behind what was by then the custom and understanding of more than 130 years. Although the president holds all “executive power,” the court said in Myers v. United States (1926), he “alone and unaided could not execute the laws.” He must “execute them by the assistance of subordinates,” and, to do so effectively, he must be able to remove “those for whom he cannot continue to be responsible.”

*

This has been a story about the American government as it was designed and built. The government described in grade-school textbooks. The government in which one branch makes the law, another administers it, and a third applies it to cases and controversies. The plan never worked perfectly. That was never a possibility. The lines between the powers are at times too obscure, the humans tasked with finding them often too fallible and corrupt. But the model endured. Its imprint was real.

That model is gone. Not long after Myers, the Supreme Court declared, in Humphrey’s Executor v. United States (1935), that some officers can be subject only to for-cause removal. The court permitted the creation of a new, fourth branch of government. The fourth branch exercises not only executive powers, but also “quasi-judicial” and “quasi-legislative” ones. This is the branch of the commissions and boards—the branch of the Federal Trade Commission, the Securities and Exchange Commission, and the National Labor Relations Board, to name but a few. These independent agencies have their own rules, their own judges, and their own domains. They are, like Becket’s Church, a power apart.

The court has approved, in particular, of agencies governed by panels. Spreading control among a number of board members or commissioners, we are told, makes the novel bodies’ autonomy and clout more tolerable. We are to rest easy because, in a committee of five, only a confederacy of at least three may ignore, foil, and defy the president and the public.

In recent years, however, in what seems almost like a deliberate effort to wreak constitutional havoc, Congress has taken to creating departments governed by individual directors. The most powerful of these is the head of the Consumer Financial Protection Bureau. She is tasked with administering a raft of consumer-protection laws. She decides what rules her agency will issue, against whom they will be enforced, and what the penalties for breaking them will be. She draws her budget—more than $600 million—from another independent body, which shields her appropriations from the threat of presidential veto. She serves a five-year term, which means she often will proceed under a president who did not even choose her. And still, she can be removed only for “inefficiency, neglect of duty, or malfeasance in office.”

Earlier this month the Supreme Court agreed to decide, in Seila Law LLC v. Consumer Financial Protection Bureau, whether the CFPB’s structure is constitutional. The case will be contentious. Many issues will be hotly debated. The question of when and how the court may overturn its own rulings will likely attract much attention. The supposed virtues of politically insulated experts, and the palpable vices of the current chief executive, will surely worm their way into the discussion. There can be no doubt, however, about what the constitutional text and history teach us. The president, they say, can remove officers at will.

Also published by Forbes.com on WLF’s contributor page.

The post If it Takes History Seriously, the Supreme Court Will Strike Down the CFPB appeared first on Washington Legal Foundation.

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Delaware Chancery Court Clarifies Review Standard for Challenges to Conflicted-Controller Transactions

WLF Legal Pulse - Wed, 10/30/2019 - 3:11pm

Stephen M. Bainbridge is William D. Warren Distinguished Professor of Law, UCLA School of Law and serves as the WLF Legal Pulse’s Featured Expert Contributor, Corporate Governance/Securities Law.

In an important recent decision, Tornetta v. Musk,1 the Delaware Chancery Court provided new guidance on how to structure conflict-of-interest transactions to which a corporation’s controlling shareholder is a party. The case involves a shareholder lawsuit challenging an incentive compensation plan granted to Tesla, Inc.’s CEO, Elon Musk. The plan laid out twelve tranches of stock options to be awarded over a ten-year period. In order for Musk to receive each tranche, Tesla had to achieve specified milestones in market capitalization and operating results. According to the Plaintiff, the fair present value of the award was either $2.6 or $3.7 billion, which allegedly dwarfed CEO compensation at Tesla’s peer companies by orders of magnitude.

Tesla’s board of directors and its disinterested shareholders approved the compensation plan. Seventy-three percent of the disinterested shares were represented in person or by proxy at the stockholder meeting during which the plan was approved voted. They represented 47% of the total number of outstanding disinterested shares.

In his opinion, Vice Chancellor Joseph Slights acknowledged that Delaware courts normally approach boards’ executive compensation decisions with a high degree of deference. Critically, however, Musk is not just Tesla’s CEO but also its controlling shareholder.2 A controlling shareholder has been analogized to the proverbial 800-pound gorilla,3 which gives rise to “an obvious fear that even putatively independent directors may owe or feel a more-than-wholesome allegiance to the interests of the controller, rather than to the corporation and its public stockholders.”4

In response to that risk, Delaware law imposes a more intrusive standard of review on conflicted-controller transactions than on ordinary business decisions. In the latter, the standard of review is the business judgment rule; in the former, however, the burden of proof shifts to the conflicted controller to show that the transaction was fair to the corporation and its minority shareholders. In Kahn v. Lynch Communications Systems, Inc.,5 for example, the Delaware Supreme Court reaffirmed that the “exclusive standard of judicial review in examining the propriety of an interested cash-out merger transaction by a controlling or dominating shareholder is entire fairness.” Having said that, however, the Kahn court further held that “approval of the transaction by an independent committee of directors or an informed majority of minority shareholders shifts the burden of proof on the issue of fairness from the controlling or dominating shareholder to the challenging shareholder-plaintiff.”

The Kahn court’s description of fairness as the “exclusive” standard of review seemed to preclude invoking the business judgment rule in conflicted-controller transactions. In its 2014 decision in Kahn v. M & F Worldwide Corp. (“MFW”),6 however, the Delaware Supreme Court held that “when a controlling stockholder merger has, from the time of the controller’s first overture, been subject to (i) negotiation and approval by a special committee of independent directors fully empowered to say no, and (ii) approval by an uncoerced, fully informed vote of a majority of the minority investors” the standard of review becomes the business judgment rule.7

In Tornetta, the Tesla defendants argued that MFW was irrelevant to the facts of this case:

They rely heavily on a ‘statutory rubric’ argument, claiming MFW’s dual protections, devised in the context of a squeeze-out merger, mimic the approvals required by 8 Del C. § 251 but have no practical application to transactions where our law does not mandate approval at both the board and stockholder levels. … I do agree with Defendants that nothing in MFW or its progeny would suggest the Supreme Court intended to extend the holding to other transactions involving controlling stockholders.8

Vice Chancellor Slights, however, observed that the risk of coercion is just as present when a conflicted controller enters into a compensation arrangement as when it proposes a freezeout merger:

Indeed, in the CEO compensation context, the minority knows full well the CEO is staying with the company whether vel non his compensation plan is approved. As our Supreme Court observed in Tremont II:

‘[I]n a transaction such as the one considered … the controlling shareholder will continue to dominate the company regardless of the outcome of the transaction. The risk is thus created that those who pass upon the propriety of the transaction might perceive that disapproval may result in retaliation by the controlling shareholder.’

These words apply with equal force to the compensation setting.9

Accordingly, in order for a conflicted-controller transaction to be reviewed under the business judgment rule rather than entire fairness, the transaction must receive both of MFW’s dual protections.

On the facts before it, the Vice Chancellor—for purposes of defendants’ motion to dismiss—concluded that:

I have determined on the pleadings that Defendants have satisfied the ‘majority of the minority’ condition but have not satisfied the ‘fully functioning, independent special committee’ condition. The burden of persuasion shifts to Plaintiff, therefore, to demonstrate the Award is not entirely fair. At this stage, the bar set for Plaintiff is to demonstrate from well-pled facts that it is reasonably conceivable the Award is unfair to Tesla. [H]e has cleared the bar, albeit just barely.10

The Vice Chancellor’s conclusion that the “majority of the minority” vote requirement was satisfied required him to distinguish then Chancellor (and now Chief Justice) Leo Strine’s decision in In re PNB Holding Co. Shareholders Litigation11 In that case, plaintiff shareholders had challenged a freezeout merger with a controlling shareholder. In that context, Strine held that approval of a conflicted interest transaction by a “majority of the minority” means approval by a majority of the outstanding disinterested shares not just a majority of those present and voting:

The cleansing effect of ratification depends on the intuition that when most of the affected minority affirmatively approves the transaction, their self-interested decision to approve is sufficient proof of fairness to obviate a judicial examination of that question. I do not believe that the same confidence flows when the transaction simply garners more votes in favor than votes against, or abstentions from, the merger from the minority who actually vote. That position requires an untenable assumption that those who did not return a proxy were members of a ‘silent affirmative majority of the minority.’ That is especially so in the merger context when a refusal to return a proxy (if informedly made) is more likely a passive dissent. Why? Because under 8 Del. C. § 251, a vote of a ‘majority of the outstanding stock of the corporation entitled to vote’ is required for merger approval, and a failure to cast a ballot is a de facto no vote. Therefore, giving ratification effect only if a majority of the disinterested shares outstanding were cast in favor of the transaction also coheres with § 251. [FN74]

FN74. I need not, and do not, hold that a qualifying ratification vote always needs to track the percentage approval required for the underlying transaction. One can posit a situation when a particular type of transaction requires, by charter, a 66.67% supermajority vote, and a conflicted stockholder holds 40% of the total vote, with the rest of the votes held by disinterested stockholders. To promote fair treatment, the board makes approval subject to a majority of the minority vote condition. Nothing in this opinion suggests that ratification effect would not be given if an informed majority of the minority of the remaining 60% of the electorate voted in favor of the transaction.12

As Vice Chancellor Slights observed, however, DGCL § 251 required that the freezeout merger at issue in PNB—like all mergers—be approved by a majority of the outstanding shares. In contrast, under DGCL § 216(2) ordinary matters only require the affirmative vote of a majority of the shareholders present at the meeting. Accordingly, the court limited PNB’s definition of the majority of the minority to cases in which the statute requires approval by a majority of the outstanding shares.

This aspect of the Vice Chancellor’s decision is less well supported than the remainder of his analysis. First, neither § 216 nor § 251 expressly applies to conflicted-controller transactions. Those statutes speak to the basic vote required to authorize corporate action, not to the vote required to insulate a conflict-of-interest transaction from judicial review for fairness. Second, a close reading of Strine’s decision shows that he saw § 251 as strengthening the underlying argument for requiring approval by a majority of the disinterested shares rather than just a majority of the disinterested shares present at the meeting.

Overall, however, Vice Chancellor Slight’s opinion is a well-reasoned and persuasive extension of the trend in Delaware law towards judicial deference to corporate actions that benefited from procedural safeguards designed to ensure that the pertinent decision makers are free from coercion by a conflicted controller. It strengthens the argument that MFW is not limited to freezeout mergers, but rather now provides a roadmap by which all conflicted-controller transactions can receive the protections of the business judgment rule.

Notes:

  1. 2019 WL 4566943 (Del. Ch. Sept. 20, 2019).
  2. In an earlier decision involving Tesla, Vice Chancellor Slights had determined that Musk was Tesla’s controlling shareholder despite owning only 22% of Tesla’s voting stock. See In re Tesla Motors, Inc. Stockholder Litig., 2018 WL 1560293 (Del. Ch. Mar. 28, 2018), appeal refused sub nom. Musk v. Arkansas Teacher Ret. System, 184 A.3d 1292 (Del. 2018).
  3. In re Pure Resources, Inc. Shareholders Litig., 808 A.2d 421, 436 (Del. Ch. 2002).
  4. Leo E. Strine, Jr., The Delaware Way: How We Do Corporate Law and Some of the New Challenges We (and Europe) Face, 30 Del. J. Corp. L. 673, 678 (2005).
  5. 638 A.2d 1110, 1117 (Del. 1994).
  6. 88 A.3d 635 (Del. 2014).
  7. As the Supreme Court summarized its holding:

[T]he business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.

Id. at 645.

  1. Tornetta, 2019 WL 4566943 at *13. The defendants’ argument is supported by some commentators, as Ann Lipton has pointed out:

Itai Fiegenbaum argued that entire fairness should be the rule – even with MFW procedures in place – for less than transformative transactions.  See Fiegenbaum, The Controlling Shareholder Enforcement Gap, Am. Bus. L.J. (forthcoming).  Fiegenbaum claims that in a squeeze out kind of transaction, all eyes are on the controller, there’s a real likelihood of litigation, and that scrutiny coupled with MFW procedures may protect minority stockholders.  But in more ordinary transactions, that frequently will need to be brought derivatively and thus satisfy the demand requirement, controllers know that the chance of litigation is slight.

Vice Chancellor Slights did not address that concern.

  1. Id. at *11-12.
  2. Id. at *14.
  3. 2006 WL 2403999 (Del. Ch. 2006).
  4. Id. at *15.

The post Delaware Chancery Court Clarifies Review Standard for Challenges to Conflicted-Controller Transactions appeared first on Washington Legal Foundation.

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Force of Nature: The Power of Small Businesses in America’s Recreational Infrastructure

House Small Business Committee News - Wed, 10/30/2019 - 11:30am

The Committee on Small Business will meet for a hearing titled, “Force of Nature: The Power of Small Businesses in America’s Recreational Infrastructure.” The hearing is scheduled to begin at 11:30 A.M. on Wednesday, October 30, 2019 in Room 2360 of the Rayburn House Office Building.

The economic prosperity of the nation is impacted by the growing recreational and tourism sector, which is served by many small businesses. As Congress contemplates an infrastructure package, it is important to consider the outdoor recreational infrastructure, which produced $427.2 billion in gross economic output and supported over 5.1 million jobs nationwide in 2017. The hearing will examine the economic impact of the outdoor recreational infrastructure, how small businesses contribute to this industry, and how the federal government can ensure the industry continues to positively impact the economy through a comprehensive infrastructure package.

To view a livestream of the hearing, please click here. 


Hearing Notice 

Hearing Memo 

Witness List 

Witnesses 

Mr. Ray Rasker, Ph.D.
Executive Director
Headwaters Economics
Bozeman, MT
Testimony 

Mr. Frank-Paul Anthony King
President and CEO
Temple Fork Outfitters (“TFO”)
Dallas, TX
Testimony 

Ms. Lindsey Davis
Co-Founder and CEO
WYLDER
Salt Lake City, UT
Testimony 

Mr. John Wooden
Owner
River Valley Power & Sport
Rochester, MN
*Testifying on behalf of the National Marine Manufacturers Association
Testimony 

 

*Witness testimony will be posted within 24 hours after the hearing’s occurrence

 
 
 

Creating the Clean Energy Workforce

House Small Business Committee News - Tue, 10/29/2019 - 10:00am

The Committee on Small Business Subcommittee on Innovation and Workforce Development will hold a hearing titled, “Creating the Clean Energy Workforce.” The hearing is scheduled to begin at 10:00 A.M. on Tuesday, October 29, 2019 in Room 2360 of the Rayburn House Office Building.

The clean energy workforce has skyrocketed to over 4 million jobs due to dropping technology costs, more demand for clean and efficient energy technology, and supportive policies and investment at the local and state levels. With solar and wind increasing by 24.5% and 16 percent respectively from 2016 to 2017, solar and wind jobs are now outnumbering coal and gas jobs in 30 states and the District of Columbia. Further, energy efficiency jobs make up most of the clean energy workforce, supporting at least 2.2 million jobs across the country. As the country continues to develop and utilize this workforce, it is critical the voices of small businesses are heard as they employ many of these workers and need a steady pipeline of skilled workers. The hearing will delve into the various facets of the renewable energy workforce and the needs of small employers.

To view a livestream of the hearing, please click here. 


Hearing Notice 

Hearing Memo 

Witness List 

Witnesses 

Mr. Mark Farrar Jackson
Vice President
Community Housing Partners dba CHP Energy Solutions
Christiansburg, VA
Testimony 

Mr. Jason L. Wardrip
Business Manager
Colorado Building and Construction Trades Council
Denver, CO
Testimony 

Mr. Ed Gilliland, CEcD, AICP, PMP
Senior Director
The Solar Foundation
Washington, DC
Testimony 

 

*Witness testimony will be posted within 24 hours after the hearing’s occurrence

 
 

Idaho Court Refuses to Peel Away Liability Protections from Brand-Name Drug Makers

WLF Legal Pulse - Tue, 10/29/2019 - 8:10am

Recently, an Idaho state court declined to adopt the novel, plaintiff-friendly theory of “innovator liability.” This theory, where adopted, imposes tort liability on brand-name drug manufacturers for injuries caused by generic versions of their drug. In Stirling v. Novartis Pharmaceuticals Corp., et al., No. CV01-18-4880 (Idaho Dist. Ct. Sept. 25, 2019), the court ruled that the plaintiffs could not sue Novartis for injuries caused by a generic drug. Faced with an issue of first impression in Idaho, Judge Greenwood declined to follow outlier decisions from state courts in California and Massachusetts. If upheld on appeal, Stirling will remove Idaho from plaintiffs’ lawyers’ litigation-tourism itinerary, at least for the purpose of some pharmaceutical litigation.

The Food, Drug, and Cosmetic Act, 21 U.S.C. § 301 et seq., prohibits the marketing of a new drug unless the manufacturer has submitted a New Drug Application (NDA) and the Food and Drug Administration (FDA) has approved the drug as safe and effective for its intended use. Under the Hatch-Waxman Amendments, enacted in 1984, “generic drugs” “can gain FDA approval simply by showing equivalence to a drug that has already been approved by the FDA.” PLIVA, Inc. v. Mensing, 564 U.S. 604, 612-13 (2011) (citing 21 U.S.C. § 255(j)(2)(A)). And under the current regulatory scheme, only brand-name manufacturers can make changes to a drug’s approved labeling (FDA can also require labeling changes to update warnings, describe adverse reactions, etc.). Generic manufacturers are only responsible for ensuring its label is identical to the brand-name drug’s label.

In Stirling, plaintiff Michelle Stirling alleged that a drug she took to suppress premature labor in women caused her and her child harm. Stirling and her husband brought six causes of action against Novartis including negligent failure to warn and negligence per se. Novartis moved to dismiss for lack of personal jurisdiction and for failure to state a claim.

Novartis owned the NDA for the brand-name drug Brethine. As the owner of this NDA, Novartis developed, manufactured, packaged, labeled, marketed, and distributed Brethine until around December 2001 when it sold the NDA rights. The plaintiffs alleged that the generic equivalent to Brethine, terbutaline sulfate, caused the injury, though the complaint does not mention who manufactured that specific product.

The court first addressed the concept of innovator liability. The plaintiffs’ memorandum defined innovator liability as “a theory under which a brand-name drug manufacturer may be held liable for injuries caused by an individual’s ingestion of the generic version of its drug” because the generic manufacturer has no control over the contents of the label. Stirling, No. CV01-18-4880, slip op. at 6. The court analyzed each count in the complaint to determine whether Idaho would recognize innovator liability. But even before beginning its legal analysis, the court made clear that one “crucial fact” prevailed throughout the complaint: “Novartis did not manufacture the drug that caused the injuries.” Id. at 7.

In dismissing the negligent failure-to-warn claim, the court discussed general negligence principles as well as the theory of innovator liability. The court noted that Novartis essentially challenged whether a manufacturer has a legal duty to warn the consumer of a similar product on the market. The court found that Idaho law generally holds that a company is not liable for injuries caused by other companies. Id.at 8 (citing Garrett v. Nobles, 102 Idaho 369, 372 (1981)).

It then turned to the Iowa Supreme Court for guidance in the generic-drug context. In Huck v. Wyeth, Inc., 850 N.W.2d 353, 380-81 (Iowa 2014), the Iowa court bluntly called out this theory of liability for what it is—“deep-pocket jurisprudence [which] is law without principle.” Plaintiffs in such cases conflate the “foreseeability” of an injury with the existence of a legal duty in the first place. Id. But in order for foreseeability to play a role, a legal duty of care must first exist. Anything can conceivably be foreseeable, but without a legal duty, there is no tort liability. The Stirling court found Iowa’s reasoning persuasive and held that it would not expand tort liability to cover brand manufacturers for injuries caused by generic equivalents.

Similarly, the court dismissed the negligence per se claim by following the “traditional notion that the manufacturer of a product cannot be held liable where its product did not cause the alleged harm.” Stirling, No. CV01-18-4880, slip op. at 9. The other causes of action failed for the same reason.

Stirling echoes recent decisions in West Virginia and the U.S. Court of Appeals for the Seventh Circuit that rejected innovator liability. In McNair v. Johnson & Johnson, 241 W. Va. 26 (2018), the West Virginia Supreme Court held that a plaintiff may not recover damages in a strict-liability action unless it can show “that the defendant either manufactured or sold the product that allegedly injured the plaintiff.” Id. at 34. In reaching this holding, the court stated that the defendant is only liable if it breaks its duty of care to the plaintiff, and foreseeability of risk, while important, does not go so far as to create such a duty. Id. at 35-37. WLF filed an amicus curiae brief in McNair, criticizing plaintiffs’ lawyers’ attempts to conflate foreseeability with a duty of care and arguing that adopting innovator liability would mark a sharp and unwarranted break from longstanding principles of tort law.

In another case involving the theory of innovator liability, the Seventh Circuit held that federal law preempted state-law claims demanding that GSK add a different warning to its label. Dolin v. GlaxoSmithKline, LLC, 901 F.3d 803 (7th Cir. 2018). WLF also filed an amicus curiae brief in Dolin.

While those courts have properly limited the scope of tort liability to a company that actually owes a legal duty, other courts have usurped the federal government’s authority to regulate drug labeling. The California Supreme Court decided that brand-name drug manufacturers have a duty “to warn of the risks about which it knew or reasonably should have known, regardless of whether the consumer is prescribed the brand-name drug or its generic ‘bioequivalent.’” T.H. v. Novartis Pharm. Corp., 4 Cal. 5th 145, 165 (2017). In reaching its decision, the court focused primarily on the foreseeability of harm, and held that duty stems from foreseeability. Id. at 166-68. Then, looking at public-policy concerns, it held that the brand-name manufacturer was in the best position to bear the costs. Id. at 168-74. This decision is a clear example of the type of “deep-pocket jurisprudence” that Stirling, McNair, and Dolin avoided.

Massachusetts also adopted a form of innovator liability, but to a lesser extent than California. See Rafferty v. Merck & Co., Inc., 479 Mass. 141 (2018). There, the court held that manufacturers could be found “reckless” but not “negligent” in failing to update labels resulting in “an unreasonable risk of death or grave bodily injury.” Id. at 157.  

In order for a brand-name manufacturer to be liable for a plaintiff’s harms, the manufacturer must owe a duty of care to that plaintiff. Foreseeability of harm determines the scope of a duty; it does not determine whether one actually exists. The majority of courts around the country recognize this, and the Idaho trial court should be lauded for doing so in Stirling. As the plaintiffs’ bar works its way across America testing out this legal theory, courts will be asked to embrace the radical notion that manufacturers should be liable for products they did not make.

Decisions such as Stirling remind those courts to stay in their lane, and leave the expansion of drug-labeling requirements to federal legislators and, where appropriate, federal regulators. They should also bear in mind that any departure from longstanding principles of tort law will be the proverbial inch that plaintiffs’ lawyers will take and use to expand the law a mile or more.

Also published by Forbes.com on WLF’s contributor page.

The post Idaho Court Refuses to Peel Away Liability Protections from Brand-Name Drug Makers appeared first on Washington Legal Foundation.

Categories: Latest News

WLF Urges Supreme Court to Bar Claims Under Alien Tort Statute Based on Overseas Activities

WLF Legal Pulse - Mon, 10/28/2019 - 3:59pm

“Congress adopted the Alien Tort Statute in 1789 to grant federal courts jurisdiction over cases involving piracy and assaults on ambassadors.  Activist attorneys and judges have transformed the law into a tool for second-guessing U.S. foreign policy and for attacking the overseas conduct of corporations.”
—Richard Samp, WLF Chief Counsel

Click here for WLF’s brief.

WASHINGTON, DC—Washington Legal Foundation (WLF) today urged the U.S. Supreme Court to review (and ultimately overturn) an appeals court decision that permits activists to go forward with a suit charging cocoa processors and chocolate manufacturers with aiding and abetting human rights violations by farmers in the Ivory Coast. In an amicus curiae brief filed in support of two related certiorari petitions, WLF argued that the appeals court decision directly conflicts with other decisions that limit such human-rights lawsuits to claims: (1) arising within the United States and (2) filed against individuals, not against corporations. WLF’s brief was joined by the Allied Educational Foundation.

The plaintiffs are citizens of Mali who, as children, worked on Ivory Coast cocoa farms. They allege that cocoa farmers mistreated them. The U.S. Court of Appeals for the Ninth Circuit held that their lawsuit should be permitted to go forward under the Alien Tort Statute (ATS), which authorizes tort claims based on violations of “the law of nations.” The appeals court held that the defendants could be brought to trial for aiding and abetting slavery based on evidence that they took advantage of the lower prices available for cocoa produced under slave conditions.

WLF argued that immediate Supreme Court review is particularly warranted because the Ninth Circuit permitted the suit to go forward even though it has been pending for 14 years and even though the appeals court found that the complaint has yet to adequately state an actionable ATS claim. WLF charged that the apparent purpose of the lawsuit is to assist with a human-rights campaign being waged in the press and before legislatures, not to seriously pursue claims against those who purchase products from farmers who engage in abusive labor practices.

Washington Legal Foundation preserves and defends America’s free-enterprise system by litigating, educating, and advocating for free-market principles, a limited and accountable government, individual and business civil liberties, and the rule of law.

The post WLF Urges Supreme Court to Bar Claims Under Alien Tort Statute Based on Overseas Activities appeared first on Washington Legal Foundation.

Categories: Latest News

Expert Evidence Standards Under Review: Committee Considers Possible Amendments to Rule FRE 702

WLF Legal Pulse - Fri, 10/25/2019 - 8:00am

By Alex Dahl, general counsel of Lawyers for Civil Justice and Founder & CEO of Strategic Policy Counsel, PLLC.

The Advisory Committee on Evidence Rules is considering whether to amend Federal Rule of Evidence 702 to address “overstatement” by expert witnesses, which occurs when an expert expresses a degree of confidence that cannot be supported by the expert’s principles and methods.

Expert testimony is required when cases involve “scientific, technical or specialized knowledge” that falls outside the common experience of the trier of fact.  Rule 702 establishes standards for admission of expert testimony in order to ensure the reliability of such information.  Rule 702 was last amended in 2000 in response to the U.S. Supreme Court’s decisions in Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993), and its progeny, including Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999). 

Currently, Rule 702 allows opinion testimony by a witness who is qualified as an expert by knowledge, skill, experience, training, or education if:

(a) the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue;

(b) the testimony is based on sufficient facts or data;

(c) the testimony is the product of reliable principles and methods; and

(d) the expert has reliably applied the principles and methods to the facts of the case.

The Committee is considering a possible amendment that would add the following requirement to the list of Rule 702’s admissibility factors: “(e) the expert does not claim a degree of confidence that is unsupported by a reliable application of the principles and methods.”

The Committee’s interest in amending Rule 702 stems from a September 2016 report by the President’s Council of Advisors on Science and Technology (PCAST) titled “Forensic Science in Criminal Courts: Ensuring Scientific Validity of Feature-Comparison Methods.”  The Committee held a symposium about the PCAST report in 2017, and much of the discussion concerned the problem of forensic experts overstating their conclusions. 

After considering many options, the Committee determined that writing a rule expressly for forensic science would be ill-advised and decided to focus instead on the possibility of addressing overstatement by amending Rule 702, which governs expert testimony in both criminal and civil cases. 

At the same time, the Committee has also been considering an amendment to Rule 702 that would clarify that the questions of sufficiency of basis (subdivision (b)) and reliability of application (subdivision (d)) are issues of admissibility, not weight, and are governed by the preponderance of evidence standard under Rule 104(a).  Courts frequently confuse this standard.  It now appears unlikely that the Committee will amend the text of the rule for that purpose, but it may address the problem in the Committee Note if it proceeds with an amendment addressing overstatement.  The decision whether to proceed with an amendment is likely to be made at the Committee’s Spring 2020 meeting.

In the meantime, the Committee is studying how courts decide on the admissibility of expert testimony in practice.  At its upcoming October 25 meeting, the Committee will host a “miniconference” about “best practices” in handling Daubert issues and conducting Daubert hearings.  Participants in the miniconference will include: Judge Vince Chhabria (N.D. Cal.); Judge Keith P. Ellison (S.D. Tex.); Judge John Z. Lee (N.D. Ill.); Judge William H. Orrick III (N.D. Cal.); Judge Edmund A. Sargus, Jr. (S.D. Ohio); Judge Sarah S. Vance (E.D. La.); and Professor Ed Cheng of Vanderbilt Law School.  The transcript will be sent to all federal judges and published in the Fordham Law Review.

The post Expert Evidence Standards Under Review: Committee Considers Possible Amendments to Rule FRE 702 appeared first on Washington Legal Foundation.

Categories: Latest News

Federal Securities Law Should Supersede Conflicting Procedural Rules in Securities Class Actions

WLF Legal Pulse - Fri, 10/25/2019 - 8:00am

By Doug Greene, Jessie M. Gabriel, Douglas Shively, and Genevieve York-Erwin; Doug Greene leads BakerHostetler’s firmwide Securities and Governance Litigation Team. Jessie M. Gabriel and Douglas Shively are Partners, and Genevieve York-Erwin is an Associate, with the Firm.*

The pleading stage is critically important in securities fraud class actions. A plaintiff’s survival of a motion to dismiss opens the door to burdensome discovery at a company’s highest levels, and even meritless claims that advance beyond the pleading stage raise the specter of protracted, expensive litigation and the non-zero risk of substantial liability. Not surprisingly, most cases that are not dismissed ultimately settle. While this dynamic is not unique to securities litigation, it is markedly amplified in this context.

Congress enacted the Private Securities Litigation Reform Act of 1995 “[a]s a check against abusive litigation.”1 To prevent meritless securities class actions, the Reform Act, which amends the Securities Act of 1933 (‘33 Act) and the Securities Exchange Act of 1934 (‘34 Act), imposes heightened requirements for pleading that a challenged statement was false or misleading, and that it was made with intent to defraud (scienter). Congress specified that the district court “shall dismiss the complaint” on a motion to dismiss if it does not meet the Reform Act’s heightened pleading standard.

Consistent with this intent, two important Supreme Court cases have construed the relevant federal securities statutes as requiring courts to consider the full factual context when evaluating allegations of falsity and scienter. In Tellabs, the Court considered what it means for a plaintiff to plead a “strong inference” of scienter, and concluded that “this inquiry is inherently comparative” and requires courts to consider not only the complaint but also documents incorporated by reference and matters of which courts may take judicial notice. A few years later, in Omnicare Inc. v. Laborers District Council Construction Industry Pension Fund,2 the Court reached a similar conclusion with respect to the falsity element, holding that this element also requires courts to consider the full context in which challenged statements were made, including other statements made by the company, industry context, and other publicly available information. Together, these decisions, and the federal securities statutes on which they’re based, compel courts to consider the full range of publicly available, judicially noticeable, and incorporated documents and information for context when evaluating the sufficiency of securities claims.

And yet the general rules of procedure and evidence in federal court would seem to limit this mode of evaluation. The federal pleading rules severely restrict the information that courts may consider on motions to dismiss beyond the complaint itself. The federal rules also say that in evaluating a motion to dismiss, courts are to take all factual allegations in the complaint as true and draw all inferences in plaintiffs’ favor. In short, the general rules forbid consideration of most outside materials and facts and the weighing of competing inferences, even as the securities statutes require this contextual, comparative analysis.

How then should the federal securities statutes’ substantive pleading requirements be harmonized with the federal procedural rules that generally govern courts’ consideration of motions to dismiss? Ultimately, the Rules Enabling Act dictates that federal substantive law must control these issues. But this result is rarely (if ever) truly achieved in practice.

Below we discuss two recent appellate decisions that provide noteworthy examples of courts getting it wrong, confounding the statutory standards by favoring procedural rules over substantive law. These decisions are just the tip of the iceberg: virtually every decision on securities class action motions to dismiss improperly elevates procedure over substance to some degree. This approach is incorrect and risks frustrating Congress’ purpose in enacting the Reform Act—screening meritless securities fraud claims at the pleading stage.

In order to effectuate Congressional intent, courts must recognize that the federal securities statutes, including the Reform Act’s heightened pleading requirements, trump federal rules of procedure and require courts to consider a fuller range of materials and facts in securities class actions than on a typical motion to dismiss. The defense bar, in turn, can help courts get this right by framing our arguments on this subject in terms of Omnicare’s and Tellabs’s substantive requirements and animating principles, rather than just the general procedural rules of judicial notice and incorporation by reference. 

Recent Decisions Restrict Judicial Notice and Incorporation by Reference

Last year, the Ninth Circuit addressed judicial notice and incorporation by reference in Khoja v. Orexigen Therapeutics,3 a securities class action under the Exchange Act. At its core, the opinion concerned a district court’s ability to consider the full array of facts before the court to determine whether a plaintiff properly pleaded all elements of a securities fraud claim.

The plaintiffs alleged that Orexigen’s concealment of material facts and misstatements on the benefits of its drugs artificially inflated its stock’s value. Once the truth was revealed, according to plaintiffs, Orexigen’s common stock price plunged 25 percent in three days. In their motion to dismiss, the defendants requested that the district court consider various documents referenced in the complaint and other documents subject to judicial notice, and the court did.

The Ninth Circuit found that the district court abused its discretion by considering the documents, citing the general rule that “a court may take judicial notice of matters of public record without converting the motion to dismiss into a summary judgment motion, but a court cannot take judicial notice of disputed facts contained in such public records.”4 The panel found, for example, the district court erred when it failed to specify which facts it judicially noticed from a transcript, but merely indicated that it would not “take notice of the truth of the facts cited within the exhibit.”5 Regarding incorporation by reference, the panel held “it is improper to assume the truth of an incorporated document if such assumptions only serve to dispute facts stated in a well-pleaded complaint,” and “if a document merely creates a defense to the well-pled allegations in the complaint, then that document did not necessarily form the basis of the complaint”6

The panel’s holdings reflect its concern that if defendants can “present their own version of the facts at the pleading stage—and district courts accept those facts as uncontroverted and true—it becomes near impossible for even the most aggrieved plaintiff to demonstrate a sufficiently ‘plausible’ claim for relief.”7 In this regard, the panel noted that it perceived a “concerning pattern in securities cases … exploiting these procedures [i.e., judicial noticing and incorporation by reference] improperly to defeat what would otherwise constitute adequately stated claims at the pleading stage.”8

The Ninth Circuit is not alone in struggling with this issue. The Fourth Circuit issued a similar opinion in Zak v. Chelsea Therapeutics International Ltd.9 There, the plaintiffs also alleged that the defendants made material misstatements and omissions about the company’s new drug, and the district court granted the defendants’ motion to dismiss.

The appellants argued that the district court erred in taking judicial notice of certain documents filed with the U.S. Securities and Exchange Commission, principally Form 4s concerning the defendants’ individual transactions in the company’s stock. The appellants contended the documents were not integral to the complaint because the appellants did not rely on the defendants’ stock transactions to plead scienter. The appellees argued that courts regularly review SEC filings at the pleading stage and that these filings were important in order to properly weigh the competing inferences regarding scienter.

The Fourth Circuit held that a court may look to outside evidence, such as the Form 4s, only when it is “integral to and explicitly relied on in the complaint and when the plaintiffs do not challenge the document’s authenticity.”10 Moreover, even when looking to outside documents is proper, courts must still construe them in the light most favorable to plaintiffs.11 Because the complaint did not rely on the Form 4s, the panel held those filings were not integral to the complaint and that the district court improperly considered them.12 The court also held that the district court improperly construed the documents against the plaintiffs: While the court used them to make findings of fact, the documents themselves failed to establish such facts. The panel found this to be reversible error.

Supreme Court’s Construction of Reform Act Requires Courts to Consider Full Context

The Supreme Court’s decisions in Omnicare and Tellabs call into question decisions like Orexigen and Chelsea Therapeutics. While these circuit court decisions restrict the record a court may consider at the pleading stage, the Supreme Court’s decisions require courts to consider the full context properly before the court in evaluating allegations of falsity and scienter.

In Omnicare, the Supreme Court emphasized that showing a statement to be misleading is “no small task” for plaintiffs.13 In determining whether plaintiffs meet this burden, courts must consider not only the full statement being challenged and the context in which it was made, but also other statements made by the company and other publicly available information, including the customs and practices of the relevant industry.

Omnicare followed Tellabs, the Supreme Court’s seminal scienter decision. In Tellabs, the Court construed the Reform Act’s requirement that plaintiffs must plead a “strong inference” of scienter. The Tellabs Court rejected the Seventh Circuit’s holding that a plaintiff need only allege ‘“facts from which … a reasonable person could infer that the defendant acted with the required intent.’”14 While that standard comports generally with federal pleading rules, Tellabs held that it falls short of the Reform Act’s requirements: “Congress did not merely require plaintiffs to ‘provide a factual basis for [their] scienter allegations’ …. Instead, Congress required plaintiffs to plead with particularity facts that give rise to a ‘strong’—i.e., a powerful or cogent—inference.”15

From these principles, the Tellabs Court concluded:

The strength of an inference cannot be decided in a vacuum. The inquiry is inherently comparative: How likely is it that one conclusion, as compared to others, follows from the underlying facts? To determine whether the plaintiff has alleged facts that give rise to the requisite “strong inference” of scienter, a court must consider plausible nonculpable explanations for the defendant’s conduct, as well as inferences favoring the plaintiff.16

In conducting this comparative inquiry, “courts must consider the complaint in its entirety, as well as other sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss, in particular, documents incorporated into the complaint by reference, and matters of which a court may take judicial notice.”17

Tellabs’s holding that the Reform Act requires courts to weigh “plausible nonculpable explanations … as well as inferences favoring the plaintiff” at the pleading stage marks a significant departure from general motion-to-dismiss procedures, where all reasonable inferences must be drawn in the plaintiff’s favor. The significance of this innovation is diminished, however, to the extent courts are precluded from considering facts properly before them through judicial notice or incorporation by reference, or construing them solely in plaintiffs’ favor under 12(b)(6) standards. Indeed, even the rarely-challenged general rule that courts may not consider judicially noticed facts as true conflicts with the substantive securities laws to the extent that it prevents courts from considering facts that are necessary to a full contextual analysis and proper weighing of competing inferences.  

In deciding Tellabs, the Supreme Court signaled that the Reform Act’s pleading requirements contemplate a judicial “gatekeeping” function that goes beyond the scope of normal motion-to-dismiss procedures. In an illuminating footnote, the Court observed that “in numerous contexts, gatekeeping judicial determinations prevent submission of claims to a jury’s judgment without violating the Seventh Amendment,” citing as examples “judgment as a matter of law,” “summary judgment,” and that “expert testimony can be excluded based on judicial determination of reliability.”18 On this point, Tellabs also referenced a 1902 Supreme Court decision upholding a procedure requiring defendants to submit affidavits supporting their defenses in certain contract actions, and authorizing courts to enter judgment for plaintiffs when it found an affidavit to be unsatisfactory.19 The Tellabs Court noted that “[j]ust as the purpose of § 21D(b) [i.e., the Reform Act’s heightened scienter requirement] is to screen out frivolous complaints, the purpose of the prescription at issue in Fidelity & Deposit Co. was to ‘preserve the court from frivolous defenses.’”20 The Court thus strongly suggested a far more significant departure from normal procedures than Orexigen and Chelsea Therapeutics reflect.  Indeed, the procedural limitations imposed by these appellate decisions would seem to undermine the intended substantive effects of the Reform Act.

The Conflict Must Be Resolved in Favor of Federal Statutes

This conflict between decisions like Orexigen and Chelsea Therapeutics and the contextual, comparative analysis of falsity and scienter required by the Supreme Court’s construction of federal securities law must be resolved in favor of the federal statutes. Courts generally recognize that the Reform Act and other substantive federal statutes supersede procedural rules to the extent they conflict. The Sixth Circuit, for example, has held that “[i]n light of [the Reform Act’s heightened pleading] requirements, we think it is correct to interpret [the Reform Act] as … limiting the scope of Rule 15(a),” otherwise “the purpose of [the Reform Act] would be frustrated.”21 While other federal circuit courts have disagreed that Rule 15 conflicts with the Reform Act, they have not disputed the premise that the Reform Act would prevail in a conflict.22

Moreover, the Rules Enabling Act provides that procedural rules may not abridge a party’s substantive rights.23 The Supreme Court has explained that a procedural rule infringes substantive rights “if it alters the rules of decision by which the court will adjudicate those rights,” as opposed to “governing only the manner and the means by which the litigants’ rights are enforced.”24 For this reason too, procedural rules that conflict with the federal securities statutes’ substantive requirements must give way.

Conclusion

Decisions like Orexigen and Chelsea Therapeutics conflict with the Supreme Court’s direction to courts to consider all relevant facts—whether or not specifically pled—to gain a more complete picture at the motion-to-dismiss stage, and to prevent plaintiffs from cherry-picking allegations to survive a motion to dismiss. But defense counsel can help combat this doctrinal confusion through better briefing. When seeking consideration of materials or facts outside the complaint at the pleading stage, the defense bar should ground its arguments in the substantive requirements of the ’33 Act, ’34 Act, and Reform Act, as construed by Omnicare and Tellabs, not just the procedural rules of judicial notice and incorporation by reference.

____________________________

*The authors thank Mr. Greene’s former Wilson Sonsini partner Bruce Vanyo, now Chair of Katten’s Securities Litigation Group, for his helpful feedback on this article. Mr. Vanyo led the Silicon Valley’s advocacy for the Private Securities Litigation Reform Act of 1995, and devised legal arguments that shaped key early Reform Act decisions in defendants’ favor, including Silicon Graphics. The authors hope this Legal Backgrounder yields improvements in the law in the way that those decisions did.

Notes:

The post Federal Securities Law Should Supersede Conflicting Procedural Rules in Securities Class Actions appeared first on Washington Legal Foundation.

Categories: Latest News

Snobbery Underlies Clamor Against Innovation, WLF Attorney Writes in Truth on the Market

WLF Legal Pulse - Wed, 10/23/2019 - 1:12pm

Smartphones, AI algorithms, and social media have joined multi-passenger carriages, lanterns, and the waltz as targets of pseudo-intellectual snobbery, writes Washington Legal Foundation’s Senior Litigation Counsel today in the highly regarded blog Truth on the Market.

The same type of people that today question whether Facebook might “break democracy” and deride YouTube’s auto-play feature, Corbin Barthold writes, were sounding alarms over the new technology of their times in the past. This “smart set” refuses to take a “wider view of history” because “it’s not in their nature.” Corbin continues:

“As Schumpeter understood, the ‘intellectual group’ cannot help attacking ‘the foundations of capitalist society.’ ‘It lives on criticism and its whole position depends on criticism that stings.'”

The “old fashioned and priggish” naysayers, Corbin explains, simply don’t trust the average American to make his or her own choices about activities like online shopping and watching videos:

We now hit the crux of the intellectuals’ (and Josh Hawley’s) complaint. It’s not a gripe about Big Tech so much as a gripe about you. You, the average person, are too dim, weak, and base. You lack the wits to use an iPhone on your own terms. You lack the self-control to post, ‘like’, and share in moderation (or the discipline to make your children follow suit). You lack the virtue to abstain from the pleasures of Prime-membership consumerism.

Read the post in its entirety here.

The post Snobbery Underlies Clamor Against Innovation, WLF Attorney Writes in <em>Truth on the Market</em> appeared first on Washington Legal Foundation.

Categories: Latest News

Prison to Proprietorship: Entrepreneurship Opportunities for the Formerly Incarcerated

House Small Business Committee News - Wed, 10/23/2019 - 11:30am

The Committee on Small Business will meet for a hearing titled, “Prison to Proprietorship: Entrepreneurship Opportunities for the Formerly Incarcerated.” The hearing is scheduled to begin at 11:30 A.M. on Wednesday, October 23, 2019 in Room 2360 of the Rayburn House Office Building.

Many formerly incarcerated individuals face barriers to reentering the workforce. Some employers hesitate to hire the formerly incarcerated, which drastically reduces employment possibilities and earnings potential. Entrepreneurship can help to overcome these barriers to employment and reduce recidivism. The hearing will discuss entrepreneurship training options for incarcerated and formerly incarcerated individuals.

To view a livestream of the hearing, please click here. 

Hearing Notice 

Hearing Memo 

Witness List 

Witnesses 

Mr. Shon Hopwood
Associate Professor of Law 
Georgetown University Law Center
Washington, DC 
Testimony 

Mr. Gary Wozniak
President and CEO
RecoveryPark
Detroit, MI 
Testimony 

Ms. Corinne Ann Hodges
CEO
Association of Women's Business Centers
Washington, DC
Testimony 

 

*Witness testimony will be posted within 24 hours after the hearing’s occurrence

 

Native 8(a) Contracting: Emerging Issues

House Small Business Committee News - Tue, 10/22/2019 - 10:00am

The Committee on Small Business Subcommittee on Investigations, Oversight, and Regulations will hold a hearing titled, “Native 8(a) Contracting: Emerging Issues.” The hearing is scheduled to begin at 10:00 A.M. on Tuesday, October 22, 2019 in Room 2360 of the Rayburn House Office Building.

Recognizing the positive impact that the SBA’s 8(a) program could have on tribal communities living in devastating poverty with little to no economic opportunity, Congress created the exceptions in the law for enterprises owned communally by tribes, Alaska Native Corporations and Native Hawaiian Organizations – community-based organizations required to provide social, economic and cultural benefits to their Native owners in perpetuity. The hearing will assess the past, present, and future issues surrounding the program in order to ensure it is operating in accordance with Congressional intent.

To view a livestream of the hearing, please click here. 

Hearing Notice 

Hearing Memo 

Witness List 

Witnesses 

Mr. Edwin A. (Skip) Vincent
Chairman and Founder
The Hawaii Pacific Foundation
Honolulu, HI
Testimony

Mr. Gabriel Kompkoff
CEO
Chugach Alaska Corporation
Anchorage, AK
Testimony 

Mr. Joe Valandra
Executive Director
Native American Contractors Association
Washington, DC
Testimony 

Christine V. Williams
Managing Partner
Outlook Law LLC
Anchorage, AK
Testimony 


 

*Witness testimony will be posted within 24 hours after the hearing’s occurrence

WLF Urges HUD to Limit Disparate-Impact Liability under Fair Housing Act

WLF Legal Pulse - Mon, 10/21/2019 - 3:44pm

“The Fair Housing Act prohibits denial of housing because of race or other prohibited factors. The Supreme Court held that the FHA provides only limited authorization for ‘disparate-impact’ claims challenging facially neutral housing policies. HUD is properly revising its regulations to conform with the Court’s mandate.”
—Richard Samp, WLF Chief Counsel

Click here for WLF’s comments.

WASHINGTON, DC—Washington Legal Foundation (WLF) on October 18 called on the U.S. Department of Housing and Urban Development (HUD) to impose strict limits on lawsuits seeking to impose liability under the Fair Housing Act (FHA) when no evidence exists the defendant intended to discriminate against members of a protected group. In formal comments filed at HUD’s invitation, WLF applauds HUD’s proposal to limit potential liability when a plaintiff alleges simply that a defendant’s policy or practice has greater impact on a protected group than on the population as a whole (known as “disparate impact” liability).

The FHA proscribes “mak[ing] unavailable or deny[ing] a dwelling to any person because of race, religion, sex, familial status, or national origin.” Although Congress adopted the FHA in 1968, it was not until 2015 that the Supreme Court considered whether the statute authorizes disparate-impact claims. The Court’s 2015 Inclusive Communities decision held that disparate-impact liability is sometimes appropriate, but only under limited circumstances. The Court explained that strict limitations are required “to protect defendants against abusive” claims and to enable regulated entities “to make the practical business choices and profit-related decisions that sustain a vibrant business and dynamic free-enterprise system.”

WLF’s comments argue that existing HUD regulations, adopted before the 2015 decision, authorize imposition of disparate-impact liability that is far broader than the Court contemplated. WLF particularly applauds HUD’s proposal to impose on the plaintiff an initial burden of demonstrating that a challenged policy or practice is “arbitrary, artificial, and unnecessary to achieve a valid interest or legitimate objective.”

WLF also urges HUD to modify its proposed rule governing application of the FHA to insurance companies. WLF notes that Congress has long recognized the primacy of state law over federal law in the regulation of insurance. In light of that primacy, WLF suggest that HUD specify that when state law expressly authorizes a challenged practice, the practice should not be subject to challenge under the FHA—even if the plaintiffs allege that the practice has a disparate impact on protected minority groups.

Washington Legal Foundation preserves and defends America’s free-enterprise system by litigating, educating, and advocating for free-market principles, a limited and accountable government, individual and business civil liberties, and the rule of law.

The post WLF Urges HUD to Limit Disparate-Impact Liability under Fair Housing Act appeared first on Washington Legal Foundation.

Categories: Latest News

Harvesting the Digital Age: Connecting our Communities for a Better Future

House Small Business Committee News - Mon, 10/21/2019 - 1:00pm

The Committee on Small Business Subcommittee on Rural Development, Agriculture, Trade, and Entrepreneurship will meet for a field hearing titled, “Harvesting the Digital Age: Connecting our Communities for a Better Future.” The hearing is scheduled to begin at 1:00 P.M. on Monday, October 21, 2019 at Adams County Agricultural and Natural Resources Center, 670 Old Harrisburg Road, Gettysburg, Pennsylvania 17325-3404.

Without the ability to disseminate the high costs of deployment or leverage economies of scale, small communities often rely on assistance from the Federal Communications Commission and the Department of Agriculture to mitigate these high costs. Recent improvements to these programs have helped, but more can be done, especially as Congress debates an infrastructure bill. Over the last couple of years, Congress has enacted several bipartisan efforts to quickly increase the amount of resources available to these communities, but a lack of clarity leaves many of these programs underutilized.


Hearing Notice 

Hearing Memo 

Witness List 

Witnesses 

Mr. Brandon W. Carson
Director, Planning & Community Development Division
Southern Alleghenies Planning & Development Commission
Altoona, PA
Testimony 
 

*Witness testimony will be posted within 24 hours after the hearing’s occurrence



 

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