The U.S. Supreme Court has agreed to address the circumstances under which defendants in a securities class action can rebut the “fraud on the market” presumption of class-wide reliance necessary for plaintiffs to form a certified class. On December 11, 2020, the Supreme Court granted defendants’ petition to consider whether the Second U.S. Circuit Court of Appeals erred when it certified a plaintiff class in Goldman Sachs Group, Inc., et al., Petitioners v. Arkansas Teacher Retirement System, et al. A decision in the case, the first shareholder class action before the Supreme Court since the appointment of Associate Justice Amy Coney Barrett, could offer insight into how far the current court is willing to deviate from longstanding precedent in this area.
The case itself stems from allegations Goldman Sachs misled investors when marketing a subprime mortgage product in 2007 just as the U.S. housing market was starting to collapse. The investment bank created a collateralized debt obligation (CDO) known as ABACUS 2007- AC1 at the request of hedge fund manager John Paulson so he could bet against the risky underlying subprime mortgages it held. Goldman received $15 million in fees and Paulson pocketed $1 billion by shorting the CDO.
In 2010, Goldman agreed to pay $550 million to settle Securities and Exchange Commission charges for failing to disclose Paulson’s involvement in selecting the CDO’s underlying securities. Goldman Sachs stock fell on news of the enforcement action, the largest-ever SEC penalty against a Wall Street firm. Goldman Sachs shareholders sued the company and three former executives, claiming their false and misleading statements kept its stock price artificially high until the SEC announced its complaint.
In 2012, the district court judge denied defendants’ motion to dismiss and the case proceeded to the class certification stage. Since then, the Second Circuit weighed in twice, the second time in April 2020 when it upheld certification of the plaintiff class, ruling that defendants had failed to rebut the presumption of classwide reliance first established in the Supreme Court’s 1988 Basic Inc. v. Levinson decision. Basic held that “in an open and developed securities market,” a company’s stock price is determined by all material information available to the public. Therefore, under Basic, investors need not show that they individually relied on defendants’ misrepresentations to pursue a claim under Rule 10b-5 of the Securities Exchange Act of 1934. Their reliance is “presumed.”
Basic, however, also held that defendants could rebut this “fraud on the market” presumption by, among other things, showing that the misstatements had no impact on the company’s stock price, a right that was clarified by the Supreme Court in a 2014 decision, Halliburton v. Erica P. John Fund, Inc., known as Halliburton II.
In Goldman, the Second Circuit refused to let defendants rebut the presumption of class-wide reliance by arguing that the bank’s statements about identifying conflicts of interest and acting in clients’ best interests were so “generic” and “aspirational” that they had no impact on the stock price. Accepting that argument, the Second Circuit said in a split decision, would allow defendants to “smuggle materiality” into the class-certification stage. Arguments over materiality— whether a reasonable shareholder would consider the information important to investment decisions—are “merits” issues reserved for trial, which follows class certification.
In its petition, Goldman Sachs asked the Supreme Court to decide whether “a defendant in a securities class action may rebut the presumption of classwide reliance … by pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even though that evidence is also relevant to the substantive element of materiality.” It also sought to clarify whether a defendant rebutting the Basic presumption must persuade a court or simply present evidence on the issue of price impact.
Calling Goldman “the most important securities case to come before the [Supreme] Court” since Halliburton II, the petitioners argued that, left undisturbed, the Second Circuit’s decision would have “devastating practical consequences for public companies” by making it impossible to rebut the Basic presumption. In opposing the petition, lawyers for Arkansas Teacher Retirement System called such “breathless” claims exaggerated, mentioned the lack of a conflict between appeals courts in different circuits, and said neither question posed by the petitioners “presents an issue of recurring importance.” Observers have also pointed out that issues like materiality and price impact, explicitly or not, are usually factors in whether judges grant defendants’ motion to dismiss—something that occurs prior to both the class certification and merits stages.
In its forays into securities class actions in the three decades since Basic, the Supreme Court has nipped and tucked at the rights and obligations of both plaintiffs and defendants without excising shareholders’ fundamental ability to sue as a class under the Exchange Act. Indeed, judicial restraint and respect for prior decisions has been a hallmark of the court led by Chief Justice John Roberts. The addition of Justice Barrett has expanded the court’s conservative majority but is unlikely to cause wholesale overnight abandonment of precedent in this case. It seems far more likely that a pro-petitioner ruling would force plaintiffs to address the issue of price impact earlier in the case than eliminate securities class actions altogether
Pension plans, like the rest of the country, were no doubt happy to wave goodbye to 2020 in the rearview mirror. To say that it was a challenging year would be an understatement. And yet pension trustees and administrators stepped up to fulfill their retirement systems’ mission to deliver pension checks to more than 10 million retirees—including teachers, fire fighters, police officers, other public servants and their beneficiaries—who depend on the timely receipt of their benefit payments. They transitioned their teams to work remotely while processing payments and managing billions of dollars of pension fund assets in a time of tremendous turmoil in the markets. And now they’re ready to welcome 2021!
While we’re hopeful that the rollout of the vaccine will eventually ease the impacts of the COVID 19 crisis on operational and other related issues, here are some issues that the prudent fiduciary may want to watch for in the new year.
- Ethics: We saw an example of the very real impact of the application of state ethics laws in August of last year when issues stemming from the filing of state financial disclosure forms resulted in the departure of a chief investment officer at one of the country’s largest pension plans. Fast forward to January of this year, when a state treasurer and two other trustees filed a complaint with their state ethics commission alleging that the system’s executive director violated ethics laws by providing misleading or false information to the board. Fiduciaries can expect that issues related to disclosure, recusal, and conflict-of-interest law to remain in the forefront.
- SPACs: Special Purchase Acquisition Companies (SPACs) may continue to be another hot topic in 2021 after a tremendous amount of activity in 2020. As of late December, there had been 243 reported SPAC initial public offerings raising total gross proceeds of over $82 billion. The surge in popularity of the use of these “blank check companies” as a way to go public came as the method’s reputation improved, with supporters citing an ability to go public faster with greater certainty regarding the company’s valuation and equity capital raised. But improved governance practices weren’t enough to stave off lawsuits regarding SPACs that started to accumulate in 2020. And in January the Council of Institutional Investors sent comments to the SEC questioning whether a proposed loosening of SPAC listing standards was consistent with the protection of investors and the public interest. Keep an eye out for more on SPACs in 2021.
- Secure Choice: “Secure Choice Pensions” refer to public-private partnerships to provide retirement security for American workers, particularly those who work for small businesses and don’t already have access to a defined benefit or defined contribution plan. In the typical scenario, as described by the National Conference on Public Employee Retirement Systems (NCPERS), a state would enact legislation to establish a Secure Choice plan in which employee participation is voluntary. Contributions would be made by employees and preferably employers as well. For participating employers, administrative and fiduciary duties would largely be removed and placed in the hands of the board of trustees. While each employee would have an individual participant account, all contributions to the plan would be pooled for investment purposes to achieve economies of scale and the ability to negotiate lower fees. To date, almost a dozen states have passed legislation to create secure choice plans and an additional two dozen have pending legislation to do so.
- ESG: Environmental, Social and Governance (ESG) issues will no doubt remain a hot topic for pension plans in 2021. As the CFA Institutes notes, ESG analysis has become an increasingly important part of the investment process and is “now entering a true mainstreaming phase” as investors incorporate ESG data to gain a fuller understanding of the entities in which they invest and the risks they face. Expect an increased focus on reporting standards and metrics in 2021.
- Regulatory Changes: A new administration in Washington will bring changes to federal agencies such as the DOL and the SEC that will affect pension plans. For example, the DOL’s guidance on ERISA rules on ESG investing, while not directly applicable to public pension plans, is influential in creating standards that are looked to even for non-ERISA plans. The SEC’s new rules on proxy voting and other issues will be closely watched for potential reversal in areas such as the rules governing proxy advisory firms, which underwent sweeping changes under Trump-appointed Chairman Jay Clayton. Also note that with control of both the House and Senate, Democrats may use the Congressional Review Act to reverse federal regulations made in the last 60 days of the administration.
- DE&I: Diversity, Equity and Inclusion, or DE&I as it is commonly called, is one aspect of the “S” in ESG investing. Look for increasing calls for corporate board diversity building on efforts by Nasdaq and others such as the U.S. Chamber of Commerce and the Real Estate Roundtable. Moreover, DE&I is also something that is increasingly being addressed by pension systems in their own internal policies and procedures. Several major pension funds stepped up their DE&I efforts in 2020 and more will likely do so in 2021.
Finally, here’s a jaw-dropping fiduciary story to carry you into the new year. We know that pension plans are long-term (or indeed perpetual) investors, but this really brings it home: in 2020, the last Civil War pensioner died. The 90-year-old woman had cognitive impairments, qualifying her for a lifetime pension as an adult child of a veteran. Her father, who served as a private in the Confederate Army before defecting to the Union, was on his second marriage when she was born just weeks before his 84th birthday.
With an evenly split Senate, a bitterly divided electorate and a pandemic battering the nation’s physical and economic health, the Biden-Harris administration faces seemingly overwhelming choices about where to expend its energies and political capital over its first 100 days.
President Joe Biden has made clear that getting Congress to pass his $1.9 trillion COVID-19 relief plan is the administration’s top priority. As for the rest, as Vice President Kamala Harris told NPR less than a week before inauguration day: “We have to multitask, which means, as with anyone, we have a lot of priorities and we mean to see them through.”
One of those many priorities will be strengthening investor protections after four years during which the Republican-led Securities and Exchange Commission largely prioritized capital formation often to the detriment of investor protection.
Democratic Senate wins in Georgia that give the vice president the tiebreaking vote should make it easier to win Senate approval for the administration’s pick, former Commodity Futures Trading Commission Chair Gary Gensler. Gensler, a former Goldman Sachs executive who is deeply familiar with Wall Street, revitalized the moribund CFTC and enacted tough rules governing the derivative products at the heart of the last financial crisis. He is widely seen as a strong pro-investor choice for the job.
For Cohen Milstein Partner Laura H. Posner, mapping the road ahead starts with a look back at opportunities missed and problems exacerbated under the Trump administration. Ms. Posner offers a regulator’s perspective on the question. As former Chief of the New Jersey Bureau of Securities, she was that state’s top securities regulator. She also served as Chair of Enforcement for the North American Administrator Association, where she helped set regulatory enforcement priorities for securities regulators. Ms. Posner outlined some of her priorities for the SEC as part of a “Symposium on Financial and Corporate Regulation in the Biden Administration” hosted by Business Scholarship podcaster Andrew K. Jennings. Below are excerpts from Ms. Posner’s comments, edited for style and brevity.
Restoring Confidence in the Markets
The Biden administration, Congress, and whoever becomes Chair of the SEC, will be highly focused on recovering the economy after the pandemic. A critical part of that recovery will require taking meaningful steps to renew confidence in the public markets and in the ability of investors, particularly retail investors, to grow their retirement assets. To effectively do that, this administration is going to have to deal with the deregulation and focus on capital formation that the SEC under the Trump administration focused on, and instead turn to investor protection and putting back up some of the guardrails and protections necessary to give investors confidence in the markets.
You’re going to see [a shift] in terms of the regulatory priorities of the agency: the types of rules that they propose and what they’re focused on. But it will also impact how they handle enforcement. We’ll see more focus on public companies. Rather than the smaller private exemption type of fraud or Ponzi schemes, we’ll hopefully see a renewed focus again on accounting fraud. This has been I guess a real pet peeve of mine—and this is not unique to this administration—but we have seen very little oversight of the accounting industry post Sarbanes-Oxley. While certainly the number of restatements has come down, the amount of accounting fraud has not. So I anticipate we’ll see a focus on enforcement. And enforcement of public companies and of accounting fraud gives real confidence to folks investing in the markets that there is a regulator on the beat—that someone is overseeing these companies and ensuring that they act appropriately.
Regulation Best Interest
Ed: The SEC’s 2019 Regulation Best Interest (Reg BI) established a standard of conduct for broker-dealers and investment advisers to act “in the best interest” of their clients but fell short of imposing stricter fiduciary standards of duty, loyalty and care like those required of pension trustees and professionals. Ms. Posner says this is especially important, given the number of investment professionals who wear “dual hats” in their roles as stockbrokers and investment advisors.
It was an absolute mistake not to put in place a fiduciary duty rule. Protecting investors, particularly retail investors, is critical to a well-functioning market and it is particularly important right now, given that retirement savings fall far short of what is necessary.
Not having some form of a uniform fiduciary duty rule across brokers, investment advisors and folks dealing with retirement accounts makes it very confusing both for the financial professional to keep track of their various and often conflicting requirements and for the investor. It raises further issues of compliance oversight by the institutions that employ these financial professionals as well.
While it may not be feasible to entirely change Reg BI and transform it into a fiduciary duty rule—although I do hope that is considered—there are changes that can be made to give Reg BI some real teeth. First, from an enforcement perspective, actually bringing cases to enforce the law. From an examination perspective, ensuring that these regs are being followed. And from a regulatory guidance perspective, the SEC can define what “best interest” means, because the rule certainly doesn’t do that now. And it could be defined in a way that makes it much more in accordance with a fiduciary duty obligation. I think that’s something this administration will be focused on. It was part of the Democratic platform this year and I would expect to see something along those lines
Environmental, Social, and Governance (ESG)
With regard to ESG and climate risk factors, I think there is uniform desire by the institutional investor community for these types of factors to be set forth in public disclosures. You saw the SEC’s Investor Advisory Committee recommending that public companies issue more thorough disclosures explaining their ESG commitments and citing that asset managers consider ESG policies important to their investment strategies.
The Biden administration has put climate and racial justice as two of its top four priorities. This seems like a very opportune place for them to establish some sort of new disclosure requirements, hopefully uniform ones, that will make a real difference in the governance of companies and the ability of companies to withstand these systemic, market-changing issues.
Forced Arbitration Clauses
We’ve seen the proliferation of forced arbitration in basically every aspect of our lives—from our telephone contracts to the TVs we buy to our employment agreements—and there has been a renewed effort, largely driven by Professor Emeritus Hal Scott at Harvard, to include forced arbitration agreements in the bylaws or certificates of incorporation of public companies. I think that is a huge mistake for many, many reasons, not the least of which is that you largely lose the deterrent effect of private litigation when securities fraud class actions no longer exist. Further, arbitration is conducted largely out of public sight. There is no development of the law or best practices for companies to follow when there is no public law.
Perhaps most importantly from an investor perspective is that you lose the ability to provide real and meaningful recoveries to investors in many circumstances. The private securities bar is infinitely more effective at returning money to investors than the SEC, and the SEC and state regulators have regularly said that private litigation is a necessary component to oversight of the financial markets. Regulators simply do not have the resources or personnel necessary to pursue all these cases and to recover the kind of money that private litigation does for investors.
Recent Changes to Proxy Rules
The SEC has made it significantly more difficult for investors, particularly retail investors, to propose new rules and changes or to renew proposals over time. This impedes the voice of shareholders bringing to a company’s attention things that they need to pay attention to. And research has shown time and time again that shareholder proposals can generate positive long-term returns for companies and that limiting the ability of shareholders to submit proposals is quite harmful to companies.
In addition, we’re seeing over time that shareholder proposals are gaining significantly more support. The percentage of shareholder voting in support of proxy proposals has increased dramatically and putting in these proxy proposal rule changes will likely serve to stifle campaigns that have been building momentum over years.
The proxy rule changes were a solution looking for a problem. The number of shareholder proposals is very modest. It accounts for less than 2% of voting items at U.S. shareholder meetings and, on average, only 13% of Russell 3000 companies even receive a shareholder proposal in a given year. And these proposals have played a valuable role in making changes in corporate governance policies, in corporate reporting, in practices on environmental and social matters. They include rules on board and committee independence, board diversity, independent board leadership, shareholder rights (including a majority-vote standard in elections for directors), accounting for stock options—a whole host of things that have been not only good for shareholder value but good for good corporate governance and good corporate citizenship.
Securities fraud claims against EQT Corporation, one of the largest producers of natural gas in the United States, are proceeding to the discovery and class certification phases after a federal judge denied defendants’ motion to dismiss the case.
Cohen Milstein is co-lead counsel for the proposed classes of investors, representing co-lead plaintiffs Northeast Carpenters Annuity Fund and the Northeast Carpenters Pension Fund. Defendants include EQT, certain of its former officers and former and current directors, and the former CEO and a former director of Rice Energy, Inc.
EQT drills and completes natural gas wells through hydraulic fracturing, operating mainly in the Appalachian Basin. In June 2017, defendants announced that EQT was planning to acquire its competitor, Rice, in a deal valued at $6.7 billion. Defendants promised shareholders that EQT’s and Rice’s combined gas drilling acreage would enable the new EQT to drill 1,200 additional well locations with an average lateral length of 12,000 feet, generating synergies worth at least $2.5 billion and saving $100 million in the first year alone.
To win shareholder approval, defendants had to beat back claims by an investor, JANA Partners, who publicly argued that EQT’s claim of achievable synergies was inflated by more than $1 billion. EQT adamantly denied JANA’s criticisms, and in November 2017, the acquisition closed. Through most of 2018, EQT assured investors that the company had “hit the ground running” and was “well on track” to achieve “several hundred million dollars” more in synergies than it had projected.
Lead plaintiffs allege that defendants misled investors because their claimed numbers of achievable drilling locations and well length were in fact impossible to drill on the companies’ combined acreage. Lead plaintiffs also argue that defendants misrepresented their drilling abilities and their intent to incorporate Rice’s best practices. After the acquisition, EQT racked up operational problems and hundreds of millions of dollars in extra costs, which it concealed from investors for months. As the truth was revealed, EQT’s stock price fell, damaging investors.
On December 2, 2020, Judge Robert J. Colville of the U.S. District Court for the Western District of Pennsylvania upheld all nine claims brought by lead plaintiffs pursuant to the Securities Exchange Act of 1934 and the Securities Act of 1933. In doing so, Judge Colville found that the achievability of defendants’ purported synergies presented “a genuine issue of material, present fact,” as did EQT’s leaders’ post-acquisition statements touting the newly forged company’s successes. Judge Colville also rejected defendants’ argument that JANA’s assertions should have put investors on notice of the potential unreliability of their statements; to the contrary, Judge Colville held, defendants’ “consistent and strong” denials supported a finding that defendants at least spoke recklessly.
Lead plaintiffs’ claims are bolstered by revelations from some of Rice’s former owners, including Toby and Derek Rice, who launched a proxy fight for control of EQT in 2019. According to those former owners, EQT “consistently misled shareholders” regarding the acquisition, “did not seek and ha[d] not achieved the synergies and cost savings that were the purported rationale” for the acquisition and used “misleading math” in its accounting. The former Rice leaders gained control of EQT in June 2019, and Toby Rice became its CEO.
The case is In re EQT Securities Litigation, No. 2:19-cv-00754-RJC (W.D. Pa.).
Shareholders suing global Big Four auditing firm Deloitte & Touche, LLP cleared an important hurdle on November 17, 2020, when the U.S. District Court for the District of South Carolina denied Deloitte’s motion to dismiss the Class’ complaint in its entirety. This ruling is a significant victory for investors. Plaintiffs face a very high bar for finding auditors liable for securities fraud, making it particularly rare for auditor cases to withstand motions to dismiss.
The lawsuit accuses Deloitte of violating the Securities Exchange Act of 1934 by allowing SCANA Corporation, the former public utility company in South Carolina, to mislead investors about the true status of a massive nuclear energy expansion project at the Virgin C. Summer Nuclear Station in South Carolina. In the largest civil fraud in South Carolina history, SCANA repeatedly concealed delays in the $9 billion project. The eventual public abandonment and revelation of the true status of the failed project resulted in hundreds of millions of dollars in losses for SCANA’s investors.
For years, despite obvious and voluminous evidence to the contrary, Deloitte provided unqualified and“clean” audit opinions declaring that SCANA’s financial statements and internal controls over financial reporting were free from any material misstatements. Deloitte’s blessing of SCANA’s financial statements was a profound auditing failure, which facilitated SCANA’s concealment of evidence showing that the Nuclear Project was hopelessly behind schedule, was doomed to fail and would not be eligible for billions of tax credits.
SCANA’s eventual abandonment of the nuclear project in 2017 has been described as “one of the worst economic calamities in South Carolina,” leading to SCANA’s acquisition by Dominion Energy in the face of almost-certain bankruptcy. Following a $192.5 million settlement with SCANA’s shareholders, federal authorities brought both civil claims against the Company and criminal fraud charges against two of SCANA’s executives, who would later both plead guilty. Notably, neither the earlier private class action nor the federal authorities brought claims against Deloitte for its role in the fraud.
In her bench ruling following oral argument on defendants’ motion to dismiss, Judge Margaret B. Seymour ruled that “even under the heightened standards applicable” in auditor cases, the shareholders plausibly alleged that Deloitte “helped conceal the fraud from investors by blessing” SCANA’s financial statements which misrepresented the true status of the project and “continued to reassure investors that the project would be completed in time, even though they knew this information was false.” Judge Seymour further held that shareholders sufficiently alleged that Deloitte did so despite its obligations to review and understand significant internal and external reports that conflicted with SCANA’s representations to investors regarding the project, a failure which amounted “to basically no audit at all.”
Coming on the heels of the successful motion to dismiss and class certification decisions obtained by Cohen Milstein in a separate case pending against Big Four auditing firm KPMG, Judge Seymour’s ruling is a significant victory demonstrating that even under the high standards applicable to such cases, auditors can be held to account if they fail to adhere to their obligations to objectively and independently evaluate the accuracy of a public company’s financial statements.
Daniel H. Silverman, a Partner in Cohen Milstein’s Antitrust practice, will speak on the panel “Opportunity or Risk? A Discussion Among Experts on Bringing Private Monopolization Cases” at the American Antitrust Institute’s 14th Annual Private Antitrust Enforcement Conference on November 11, 2020. The panel will examine prospects for strengthening private anti-monopoly enforcement, challenges presented by key cases, and litigation issues related to bringing private cases.
The 14th Annual Private Antitrust Enforcement Conference will take place November 10-12, 2020. The conference will include a series of panels featuring antitrust thought leaders from academia, advocacy, and enforcement.
Rizo v. Yovino,[1] has finally reached a conclusion after an unusual history, in which an en banc decision was vacated by the U.S. Supreme Court due to having been issued several days after its author, U.S. Circuit Judge Stephen Reinhardt of the U.S. Court of Appeals for the Ninth Circuit, passed away.
Upon the case’s return to the Ninth Circuit, another judge was randomly selected to join the en banc panel, and a new decision was issued, which, like the earlier en banc ruling, overturned the Ninth Circuit’s 1982 decision in Kouba v. Allstate Insurance Co.,[2] and held that prior pay was not a factor other than sex that could be used as a defense in an Equal Pay Act claim. The defendant once again sought review by the Supreme Court, which recently denied certiorari.[3]
The Ninth Circuit’s analysis began by holding that the list of three specific affirmative defenses in the EPA — seniority, merit and productivity systems — provide context for the fourth: any other factor other than sex. Thus, a factor other than sex must be one that, like the first three enumerated, is job-related and based on legitimate business reasons.
This standard is consistent with the great weight of circuit court decisions.[4] Only the U.S. Court of Appeals for the Seventh Circuit has held there is no limitation on other factors.[5] The U.S. Court of Appeals for the Eighth Circuit occupies a middle ground in which proposed factors are evaluated on a case-by-case basis to preserve business freedoms.[6]
Applying the job relatedness test to prior pay, the Ninth Circuit easily concluded that prior pay is not related to the new job.
While prior pay could be viewed as a proxy for factors such as education, skills or experience related to the prior job, that does not serve to make prior pay itself related to the new job; indeed, the employer is expected to point not to a mere difference in education or experience, but to how that education is relevant to the new job. This is consistent with the employer bearing the burden of proving that “sex provide[d] no part of the basis for the wage differential.”[7]
The Ninth Circuit’s conclusion that prior pay cannot satisfy standards applicable to the factor-other-than-sex defense is consistent with several other circuits, though more definitive. The U.S. Courts of Appeals for the Sixth, Tenth and Eleventh Circuits have all held that prior pay cannot be the sole reason for a pay differential, but have not barred it from being considered in all circumstances, in addition to prior experience.[8]
The U.S. Court of Appeals for the Second Circuit has not squarely addressed consideration of prior pay, but in adopting a high bar for what can constitute a factor other than sex in Aldrich v. Randolph Central School District in 1992, the court cited “When Prior Pay Isn’t Equal Pay: A Proposed Standard for the Identification of ‘Factors Other Than Sex’ Under the Equal Pay Act”[9] by Jeanne Hamburg, which suggests openness to Rizo’s rule.[10]
The Eighth Circuit has permitted use of prior salary as a defense to incumbent pay disparities only after ensuring in Drum v. Leeson Electric Corp. in 2009 “that an employer does not rely on the prohibited ‘market force theory’ to justify lower wages” for women based solely on gender.[11] Courts have held that reliance on prior pay alone is simply another form of the market force theory long rejected by the Supreme Court.[12]
Consistent with its outlier anything goes standard, the Seventh Circuit has explicitly accepted reliance on prior pay alone as a factor other than sex, without qualification.[13]
While the U.S. Court of Appeals for the Fourth Circuit recently ruled in Spencer v. Virginia State University that reliance on prior pay with the same employer was a factor other than sex,[14] the court did not discuss its rationale, and it seems to be in tension with its 2018 decision in U.S. Equal Employment Opportunity Commission v. Maryland Insurance Administration,[15] which held that a defendant must show job-related distinctions actually caused the pay difference.
Given the broad consensus that prior pay alone does not qualify as a factor other than sex, the long-standing rejection of market force theory by the Supreme Court, and agreement that factors must be job-related, Rizo appears to be leading a trend toward rejecting prior pay as a factor other than sex. This trend is also consistent with efforts at the state level to bar employers from asking candidates about their salary history — such laws are now in effect in 16 states or territories.[16]
Four of those states also bar consideration of prior pay if that information is obtained without asking the applicant to provide it.[17] Plainly, employers — whether in a state already subject to a statutory bar or not — need to be prepared to establish pay rates without basing them on prior pay going forward.
Employees have greater opportunities to challenge existing pay disparities too. Since employers tend to defend prior pay as a proxy for the value of past education or experience, we would expect to see employers relying directly on past experience or education rather than prior pay when challenged over pay disparities.
That shift will make it harder for employers to justify distinctions when men and women have equivalent past experience, but did not come to the employer with equivalent prior salaries — a far-too-common experience.
“The most important single thing is to focus obsessively on the customer. Our goal is to be earth’s most customer-centric company.”— Jeff Bezos, CEO of Amazon.com, Inc.
On August 13, 2020 in Bolger v. Amazon.com, LLC1 , California’s Fourth Appellate District held that Amazon.com, LLC can be held liable for a third-party sellers’ defective products. This article discusses that decision, its background, and its potential aftermath.
Amazon.com, LLC is a subsidiary of the parent company Amazon. com, Inc. Amazon.com, LLC is the entity that runs Amazon.com. Amazon.com LLC (hereinafter “Amazon”) is a Delaware company with its principal address in Seattle, Washington. In the U.S., approximately half of all online shopping dollars are spent on Amazon.com.
Amazon establishes the pricing for approximately 40 percent of products it selects, buys, and sells to customers online. Those products were not at issue on appeal. The remaining 60 percent are products sold by third parties through Amazon’s website. These third-party sellers select their own products, source them from manufacturers or distributors, set the product’s price, and reach customers through Amazon.com.
In 2017, the Bolger Plaintiff sued several companies, including Amazon.com LLC, and at least one California corporation, alleging that they were accountable for negligence, breach of warranty, and strict liability in selling a Hewlett Packard laptop computer that exploded in her lap causing severe burns to her body. The Amazon listing for the battery identified the seller as “E-life,” a fictitious name used by Lenoge Technology (HK) Ltd. Lenoge was served but did not appear, so the trial court entered a default.
On September 25, 2020, Cohen Milstein announced an historic agreement with Alphabet, Google’s parent company, to settle shareholder derivative litigation over allegations that the company’s leadership enabled and concealed egregious sexual misconduct by top executives. The most significant and sweeping resolution of a #MeToo derivative lawsuit to date, the settlement shows that shareholders can protect their long-term investment in a company by seeking meaningful corporate governance reform through litigation.
The case was filed after an October 25, 2018 article in The New York Times revealed that Google had protected, praised, and rewarded Android platform founder Andy Rubin despite an internal investigation finding that he had been credibly accused of sexual harassment. The article prompted a global walkout of 20,000 Alphabet employees dissatisfied with the company’s handling of sexual harassment; unsurprisingly, the walkout generated immense public scrutiny. Over the next year, new reports revealed that more Alphabet executives had engaged in sexual misconduct and that, rather than taking any corrective action, the company had offered them large severance packages or permitted them to modify their 10b5-1 stock trading plans so they could leave the company with tens of millions of dollars and unblemished records.
Like many tech companies, Google believes its workforce is its most important asset. The company invests tremendous resources to recruit, pay, and develop top talent. But the double standard that had taken hold at Google, where top male executives deemed too important to be disciplined were allowed to engage in sexual misconduct, harmed not only the individual victims but also Google’s broader ability to recruit and retain the best people. By allowing this harmful workplace culture to fester, Google’s actions threatened the investment Alphabet’s shareholders had made in the company.
Seeking to end and remedy these harms to the company, Alphabet shareholders Northern California Pipe Trades Pension Plan and Teamsters Local 272 Labor Management Pension Fund filed a derivative lawsuit in California state court in January 2019, represented by Cohen Milstein. Our clients were appointed to act as co-lead plaintiffs on behalf of all Alphabet stockholders, along with an individual investor. A working group of four attorneys, including Julie Goldsmith Reiser of Cohen Milstein, led the settlement negotiations.
After a vigorous back and forth, the parties reached a comprehensive settlement that addressed every aspect of the employment experience and required significant governance reforms. Alphabet agreed to devote $310 million to diversity, equity, and inclusion (“DEI”) initiatives—the largest public commitment to such efforts by any tech company. The company also agreed to sweeping reforms to employment policies, including ending mandatory arbitration in harassment, discrimination, and retaliation-related disputes between any Alphabet company and an employee or extended workforce member; limiting Google’s use of non-disclosure agreements, so that employees can discuss the underlying facts and circumstances of an incident and the reporting process; and calibrating corrective action recommendations across business units to ensure that employees receive consistent consequences for the same misconduct. In addition, Alphabet agreed to establish a DEI Advisory Council, guided by outside experts, including retired federal judge Nancy Gertner, and internal leaders, including CEO Sundar Pichai.
Alphabet also agreed to institute governance measures to ensure that its Board of Directors is informed of and accountable for overseeing risks arising from sexual harassment by executives and, more broadly, fostering a diverse, equitable, and inclusive culture. Key features of the settlement with respect to governance include expanding the Audit Committee’s charter to Audit and Compliance, with quarterly reports to the full board on legal and regulatory compliance, and preventing employees with 10b5-1 stock purchase plans from amending their trading plans while subject to investigations or a lawsuit for sexual misconduct. Additionally, the settlement creates greater transparency for shareholders by requiring an accounting of DEI expenditures in the annual Diversity Report.
The settlement and Cohen Milstein’s leadership in the case have received significant attention, including coverage by major media outlets such as The New York Times, The Wall Street Journal, Pensions & Investments, and CNBC.
This settlement sets a new standard for the tech industry. It strengthens Alphabet’s ability and obligation to respond effectively and lawfully to sexual harassment, retaliation, and discrimination. And importantly, the settlement is well-positioned to succeed. Many of the individuals involved in the alleged wrongdoing have since left or reduced their roles in the company. In addition, by sitting on the DEI Advisory Council for its first year, new CEO Sundar Pichar is demonstrating the importance of robust cultural change to the company. As Pichai advised the employees after the settlement was announced, he “hope[s] these commitments will serve as a strong signal to all of you that we are not going back in time.”
The Alphabet derivative litigation demonstrates shareholders’ ability to effect significant change to protect the public companies in which they invest. When a company’s best asset is its workforce, investors and employees have a shared interest in ensuring that corporate boards enact fair, lawful, and equitable policies that allow employees to thrive. We look forward to continued representation of investors in significant and transformative derivative litigation.
Two years after passing legislation requiring California-based companies to include women on their boards of directors, the state has enacted a bill to expand that mandate to members of a broad range of underrepresented communities. At the signing ceremony on September 30, 2020, the bill’s co-author urged other states to follow California’s lead. That same day, a lawsuit was brought seeking to overturn the new legislation as unconstitutional. How should pension trustees incorporate this information into their own deliberations about diversity issues? The answer, as always, starts with adherence to fundamental fiduciary principles.
Background on Diversity Requirement
Under the law, California companies must appoint at least one board member from underrepresented communities by 2021 and, depending on the size of the board, two or three such directors by 2022. The law defines a member of an underrepresented community as someone who self-identifies as “Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native” or as gay, lesbian, bisexual, or transgender.
The law permits the California Secretary of State to impose fines for violations of the law. Lawmakers cited data from a 2018 study from Deloitte and the Alliance for Board Diversity that found 84% of Fortune 500 company board seats were held by individuals who identified as white, a number that they noted is significantly higher than that group’s share of the general population.
This legislation follows another first-in-the-nation California law enacted in 2018 that mandated that the boards of publicly traded companies headquartered in the state include female directors. That law required corporations to include at least one female director by 2019 and, depending on the size of the board, two or three female directors by the end of 2021. When that law was passed, 29% of California-headquartered companies had all-male boards and, by 2019, the percentage had dropped to 4% according to a study by the KPMG Board Leadership Center.
The new law has already been challenged in state court by the same groups that sued to contest the 2018 law. The same day the new law was signed, three California taxpayers, backed by a conservative national nonprofit, filed a complaint in California Superior Court alleging that the new law violates the state constitution.
Other constitutional law experts do not share that view. For example, Dean Erwin Chemerinsky of the UC Berkeley School of Law has said he believes there is a strong argument that the laws are constitutional, since there is a compelling need to enhance diversity on corporate boards.
It will remain for the courts to decide whether these laws are sufficiently narrowly tailored to meet the compelling need. Institutional investors increasingly have focused on board diversity and have been evaluating companies that lack sufficient board diversity. Just a week before the California law was enacted, Connecticut State Treasurer Shawn T. Wooden announced that his office was partnering with the Ford Foundation to assemble a coalition of CEOs to confront longstanding racial economic disparities and their impact on the nation’s economy, including increasing diversity on their boards.
Contrast with Recent DOL Proposals
The California Law stands in sharp contrast to recent action of the U.S. Department of Labor (DOL) in proposing regulations under the Employee Retirement Income Security Act (ERISA) in two areas: consideration of environment, social, and governance (ESG) factors when making investment decisions, and shareholder rights including proxy voting.
In June 2020, in proposing regulations in the area of ESG the DOL stated that “ESG investing raises heightened concerns under ERISA.” According to the DOL, the growing emphasis on ESG investing may be prompting fiduciaries to make investment decisions for purposes other than the only permissible reasons—to provide benefits to participants and beneficiaries and defray reasonable expenses of administering the plan.
The proposed regulations are intended to confirm that ERISA requires plan fiduciaries to select investments based solely on financial considerations that are relevant to the risk-adjusted economic value of a particular investment. They also make clear that fiduciaries may not invest in ESG vehicles when they understand an underlying investment strategy of the vehicle is to subordinate return or increase risk for the purpose of what DOL refers to as non-pecuniary objectives.
While the DOL acknowledges that ESG factors may qualify as economic considerations, they caution that this is true “only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.”
In August, the DOL released a proposal to amend its regulations to address the application of ERISA’s fiduciary duties of prudence and loyalty to the exercise of shareholder rights in the area of proxy voting. The DOL reiterated that fiduciaries may not subordinate the interests of plan participants and beneficiaries in their retirement income to any non-pecuniary objective. Stating that there appears to be a view among some that plan fiduciaries are required to vote all proxies, the proposed rule would instead provide that proxies may be voted only when the fiduciary prudently determines that the matter being voted upon would have an economic impact on the plan. The proposal contains a new provision under which plan fiduciaries must require that investment managers and proxy voting or advisory firms sufficiently document the rationale for proxy voting decisions or recommendations in order to demonstrate that the rationale was based upon the expected economic benefit to the plan.
DOL’s proposals have significance even for public pension plans because although ERISA is not binding on public pension plans, it does establish principles that set standards of conduct that inform the nature of fiduciary duty even for public plans.
Key Takeaways
It is clear that consideration of diversity is a topic of importance today to institutional investors including public pension plans and will likely remain so in the future. In light of increasing attention and assessment of advantages from corporate board diversity and engaged corporate governance on such social issues through proxy voting, fiduciaries will undoubtedly remain cognizant of these issues. What, then, is the role of a prudent fiduciary when addressing such issues? Fiduciaries may consider such issues provided they do so in a manner that reflects proper attention to their fiduciary duties.
Focus should be on the fundamental aspects of fiduciary duty. First, the underlying fiduciary principles—i.e., the exclusive benefit rule and the duties of loyalty, prudence, and care—must remain paramount. In addition, it is important to note that fiduciaries are judged by the process undertaken to reach decisions so that establishment of a reasonable decision-making process and adherence to that process help to demonstrate prudence. Finally, documentation of the process is key to demonstrating prudence. Fiduciaries would be well served by documenting the important effect of diversity from the perspective of material economic considerations, whether they are looking at corporate board performance or at investment risk, return and performance. The prudent fiduciary will be well served by a focus on these fundamentals.