The title of the section of the Journal is Products Liability. Each month, various types of defective products and corresponding litigation are described in hopes of educating you and warning you about what’s literally in your backyard. But, regardless of your legal acumen or experience level, it’s often good to take a step back and rethink the basics.
Black’s Law Dictionary (11th ed. 2019) defines products liability as, “1. A manufacturer’s or seller’s tort liability for any damages or injuries suffered by a buyer, user, or bystander as a result of a defective product. 1. Products liability can be based on a theory of negligence, strict liability, or breach of warranty. 2. The legal theory by which liability is imposed on the manufacturer or seller of a defective product. 3. The field of law dealing with this theory. — Also termed product liability; (specif.) manufacturer’s liability. See LIABILITY; 402A ACTION. — products-liability, adj.”
Seems simple enough. A company makes and sells a product. Your client uses it. Your client gets hurt. There must be a defect. Well, maybe – let’s look a little closer.
Products don’t just magically appear on store shelves or in Amazon’s inventory; they start in someone‘s imagination. Often that someone is working in a marketing department and looking for something new to sell to make more profit for themselves or their company. Regardless of where a product starts, at every step in the process, from imagination, design, testing, and manufacture, through sale, there is a duty to act with reasonable care toward the end user.
Nearly a quarter of Americans say they never plan to retire, and it is not because they all love their jobs. Nearly half of Americans will reach retirement age with too little savings to fund it. Yet amidst this retirement crisis, when Americans turn to a financial professional for help, they may be putting their trust in someone whose interests are contrary to their own—a conflict that, when it leads to bad advice, imposes costs on investors that they simply cannot afford.
Given an opportunity to end this conflict and provide essential clarity to investors, the Securities and Exchange Commission (“SEC”) instead enshrined it. In June, the SEC finalized “Regulation Best Interest” (“Reg BI”), which essentially authorized brokers to put other interests before those of their investor clients as long as those conflicts are disclosed in some manner.1 Now investors’ best hope for protection from the dangers of such conflicted advice lies with state officials and others who are challenging Reg BI in court or imposing stricter standards for their own states.
The SEC’s approval of Reg BI flies in the face of regulators’ mission to protect investors of all sizes by issuing (and enforcing) rules and regulations designed to ensure that Wall Street puts investors first. As SEC Commissioner Robert J. Jackson explained in his public dissent of Reg BI: “[r]ather than requiring Wall Street to put investors first, [Reg. BI] retains a muddled standard that exposes millions of Americans to the costs of conflicted advice. Even worse, contrary to what Americans have heard for a generation, the [SEC] today concludes that investment advisers are not true fiduciaries. Today’s actions fail to arm Americans with the tools they need to survive the Nation’s retirement crisis.”2
Commissioner Jackson was not alone in his criticism: nearly every consumer and investor advocacy group, from the AARP to the Consumer Federation of America, sharply criticized Reg BI, along with op-ed writers in newspapers and financial magazines across America. Even investment adviser associations opposed it. The lone supporters of the SEC’s Rule were those who were set to personally gain from its weakness—broker-dealers.
As a result of the SEC’s failure to put investors first, Reg BI faces challenges on several fronts. In the wake of the SEC’s Final Rules on Reg BI, eight attorneys general—including those of California, Connecticut, Delaware, Maine, New Mexico, New York, Oregon and the District of Columbia—filed a federal lawsuit, State of New York et al v. United States Securities and Exchange Commission and Walter “Jay” Clayton III, in the Southern District of New York, arguing that Reg BI fails to meet basic investor protections that were laid out in the 2010 Dodd-Frank Act.3 “With this rule, the SEC is choosing Wall Street over Main Street,” New York Attorney General Letitia James said in a statement announcing the lawsuit. “Instead of adopting the investor protections of Dodd-Frank, this watered-down rule puts brokers first. The SEC is now promulgating a rule that fails to address the confusion felt by consumers and fails to remedy the conflicting advice that motivated Congress to act in the first place.” The lawsuit seeks to vacate the final Reg BI rule, which was issued in June after a 3-1 vote by the SEC, and permanently prevent its scheduled implementation on June 30, 2020.
The Attorneys General claim that Reg BI “undermines critical consumer protections for retail investors” and increases investor confusion around the standards of conduct that apply when they get an investment recommendation from a broker versus a recommendation from a registered investment adviser. Specifically, the Attorneys General argue in the lawsuit that the SEC exceeded its statutory authority in violation of the Administrative Procedure Act by issuing the final rule, and that Reg BI fails to meaningfully elevate broker-dealer standards beyond their existing suitability requirements and, instead, allows them to consider their own interests when making recommendations. They also argue that Reg BI is likely to produce continued investor and industry confusion because it relies on a vague “best interest” standard and leaves key terms undefined, exacerbating investors’ existing confusion over the duties of broker-dealers. The lawsuit states that the “Commission’s disregard for Congress’s directives in the Dodd-Frank Act
will harm Plaintiffs and their residents. Among the harms they will suffer, Plaintiffs will lose revenue from the taxable portions of distributions from their residents’ investment and retirement accounts that are worth less because of expensive conflicts of interest in investment advice; Plaintiffs will bear a greater financial burden to assist retirees and others whose savings are insufficient to meet their needs due to conflicted investment advice; and the regulation will harm Plaintiffs’ strong quasi-sovereign interest in protecting the economic well-being of their residents.”
Immediately following the filing of the Attorneys General lawsuit, an organization of over 1,000 registered investment advisers, XY Planning Network, and one of its members filed a second lawsuit that seeks to set aside or delay implementation of Reg BI. Like the Attorneys General, the investment adviser plaintiffs argue the SEC exceeded its authority under Dodd-Frank, in violation of the APA, by adopting a rule that neither establishes a universal conduct standard, nor a standard that requires broker-dealers to make recommendations without regard to their own financial interests.
Meanwhile, states including Nevada, New Jersey, New York and Massachusetts have either approved, proposed or are considering actual fiduciary rules for broker dealers operating within their state borders. For example, Nevada enacted a new law, effective July 1, that imposes a fiduciary duty on broker-dealers and investment advisers. Similarly, the New Jersey Bureau of Securities is in the final stages of implementing a regulation which requires advisors and brokers offering retail advice in the state to adhere to a uniform fiduciary standard. And William F. Galvin, Secretary of the Commonwealth of Massachusetts, released a proposed broker-dealer conduct rule that will “apply a fiduciary duty of care and loyalty to both investment advisers and broker-dealers who handle money belonging to anyone in Massachusetts.”4
In addition, a rule that partially took effect in New York last month requires intermediaries selling annuities and life insurance to act in customers’ best interests, and the Certified Financial Planner Board of Standards Inc. is similarly expanding its fiduciary standard for financial advisers and brokers who hold the group’s CFP mark.
Meanwhile, the U.S. House of Representatives, led by the Chair of the House Financial Services Committee, Representative Maxine Waters (D-CA), approved legislation in June that would block Reg BI from taking effect. That provision was approved as part of the annual Financial Services and General Government Appropriations Act (H.R. 3351) to fund the SEC and a broad range of government agencies for the 2020 fiscal year. A companion provision is unlikely to be approved by the current Senate but may come up later this year as a bargaining chip during congressional budget negotiations.
While the fate of Reg BI is pending, we urge all investors to take matters into their own hands—seek out and demand true fiduciary advice from financial professionals willing to put your interests first—and continue to press for meaningful protections in both the states and with your government representatives, so that all investors can have the opportunity for a safe and secure retirement.
1. Reg BI followed in the wake of a rule issued in 2016 by the Obama Administration’s Department of Labor that would have imposed a fiduciary duty on brokers making investment recommendations to savers in retirement accounts such as 401(k)s and IRAs. The rule was ultimately abandoned by the Trump Administration and then killed by the 5th Circuit Court of Appeals last year after surviving a lawsuit in Dallas federal court.
2. Currently, brokers are only required to have a reasonable basis to believe a recommended transaction or investment strategy is “suitable” for a customer in light of the customer’s investment profile, not that the recommended transaction or strategy be the best or even good for the investor. Reg BI builds on the obligation to provide suitable recommendations by requiring that broker-dealers also consider potential risks and relative costs associated with recommendations, disclose certain information about the broker-client relationship, and disclose or eliminate certain conflicts of interest. Importantly, while the standard of conduct established in Reg BI draws in certain respects from key fiduciary principles, it does not establish a fiduciary standard for broker-dealers or require that investor interests are put first.
3. Section 913 of the Dodd-Frank Act called for a commission to conduct a study regarding gaps or deficiencies in the regulation of broker-dealers and investment advisers and authorized the SEC to promulgate rules requiring that the standards of conduct for providing personalized investment advice “be the same and that the standard shall be to act in the best interest of the investor” but “without regard to” the personal interests of the financial professional providing the advice.
4. Following the release of Reg BI, several other states and state securities regulators, including those in Connecticut, Illinois, Maryland, and Mississippi, also signaled a willingness to implement their own broker-dealer conduct rules that will be more rigorous than the standard set out in Reg BI.
When Chief Justice Leo Strine of the Delaware Supreme Court retires this fall after more than 20 years on the bench, he will leave a legacy of decisions that have changed or clarified significant matters often raised in corporate and stockholder litigation. As Chief Justice of the state’s only appeals court since 2014 and before that on the Court of Chancery, Chief Justice Strine displayed creativity, acerbic wit and an unparalleled clarity in complex matters of Delaware corporate law, which frequently serves as a model for business jurisprudence in other states.
Although he has authored hundreds of opinions over the years, some of which were more shareholder-friendly than others, two decisions from his tenure as Chief Justice illustrate Strine’s influence over principles of Delaware law and corporate governance matters.
Firstly, in June of this year, in Marchand v. Blue Bell Creameries, 212 A. 2d. 805 (Del. 2019) (“Blue Bell Creameries”) the Delaware Supreme Court reinforced a corporate board’s duty to oversee company management, reversing a Chancery Court ruling that had dismissed a derivative action asserting so-called Caremark claims. The Blue Bell Creameries plaintiffs had alleged claims based on the directors’ failure to oversee the proper management of the company’s safety risks as related to a fatal food poisoning outbreak and product recall. Writing for the court, Chief Justice Strine reinforced the guiding principles relevant to the board’s duty of oversight in the context of stockholder derivative litigation as originally articulated in the landmark decision In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 106 (Del. Ch. 1996).
In Blue Bell Creameries, plaintiffs had alleged that defendants breached their duties of care and loyalty by “knowingly disregarding contamination risks and failing to oversee the safety of Blue Bell’s food-marketing operations.” In addition to finding that one director’s very close and personal ties to the Company’s CEO rendered him conflicted and not able to objectively consider a demand on the Board to investigate the alleged claims, the Supreme Court found that “Blue Bell[’s] board failed to implement any system to monitor Blue Bell’s food safety performance or compliance.” Citing Caremark, Chief Justice Strine wrote that “[a] board’s ‘utter failure to attempt to assure a reasonable information and reporting system exists’ is an act of bad faith in breach of the duty of loyalty.”
Reinforcing the board’s duties, the Court held that under Caremark, a board is required to “make a good faith effort to put in place a reasonable system of monitoring and reporting about the corporation’s central compliance risks.” With this holding, Chief Justice Strine provided additional clarity to potential Caremark claims emphasizing that “[i]f Caremark means anything, it is that a corporate board must make a good faith effort to exercise its duty of care. A failure to make that effort constitutes a breach of duty of loyalty.” Based on Chief Justice Strine’s analysis of Caremark, the Supreme Court reversed the Chancery Court’s decision and sustained the derivative plaintiffs’ claims. There is little doubt that Blue Bell Creameries will be relied upon by shareholder litigants for years to come.
The second opinion, which Chief Justice Strine authored in 2015, caused a sea-change in the types of merger litigation filed in Delaware Chancery Court. In Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015), Chief Justice Strine took the opportunity to clarify and reconcile application of the business judgment rule for directors in a post-closing damages action involving an arms-length merger where there was a fully informed non-coercive shareholder vote. Writing for a unanimous court, Chief Justice Strine confronted, among other things, the proper application of the business judgment rule in the context of an ostensibly arms-length merger transaction. After concluding that the transaction did not involve a controlling stockholder which would have implicated the duty of loyalty and negated application of the business judgment rule, Chief Justice Strine concluded that where “the [vote] of a disinterested stockholder majority [ ] determines that a transaction with a party other than a controlling stockholder is in their best interests,” Delaware will apply the business judgment rule. The decision ultimately eliminated what was perceived as wasteful pre-merger litigation in the Delaware courts, while still permitting stockholders to challenge coercive, self-dealing, misleading or otherwise unfair corporate transactions.
These two cases are prime examples of Chief Justice Strine’s lasting influence over Delaware corporate law. While the specifics of his next move are unknown, he recently issued a research paper published by the University of Pennsylvania Law School’s Institute for Law and Economics indicating that the scale of his ambition is no less than legal and regulatory reform to change the behavior of U.S. corporations and institutional investors. Entitled “Toward Fair and Sustainable Capitalism,” his proposal aims to “reform the American corporate governance system by aligning the incentives of those who control large U.S. corporations with the interests of working Americans who must put their hard-earned savings in mutual funds in their 401(k) and 529 plans.” To achieve this goal, Strine says, he will push for laws and regulations that require corporations and institutional investors to “give appropriate consideration to and make fair disclosure of their policies regarding” what Strine calls “EESG”—in which he adds “Employees” to the now-familiar trio of Environmental, Social and Governance policy. The comprehensive list of proposals includes everything from changes in tax law (closing the carried-interest loophole, establishing a financial transaction tax, and lengthening from one to five years the holding period for long-term capital gains), corporate behavior (requiring some corporate boards to create “workforce committees” to address employee concerns and expanding corporate disclosure requirements to include their impact on society, the environment, workers and consumers) and institutional investing (requiring heightened EESG disclosures).
Although retiring from the bench, clearly Chief Justice Strine will remain active and engaged in pursuing policies reflecting his view of the appropriate balance between corporations and their stockholders as reflected in this most recent paper. Whether as an academic or in some other context, his future contributions will undoubtedly generate significant debate among all interested constituents.
Even casual observers of securities litigation trends know that in recent years case filings have increased. Using new data, a pair of recent empirical studies addressed questions of interest to institutional investors: is the number of opt-out cases going up and how involved are mutual funds in shareholder lawsuits?
The first study titled Opt-Out Cases in Securities Class Action Settlements: 2014-2018 Update from Cornerstone Research concluded that opt-out cases remain a “significant (although still relatively small) part of the securities class action landscape.” Cornerstone researchers found that at least one opt-out case filed in 82 of the 1,775 class actions settled in the 23 years between the beginning of 1996, when the Private Securities Litigation Reform Act (“PSLRA”) took effect, and the end of 2018. The 4.6% opt-out rate increased to 8.9% for cases settled from 2014 through 2018, during which opt-outs were filed in 34 of the 382 settled class actions. The opt-out rate rose significantly for large cases, especially in the most recent time period. Overall in the post-PSLRA era, 28% of cases that settled for more than $20 million drew opt-outs, while two-thirds of “mega-settlements” over $500 million had opt-outs associated with them. All four cases that settled for over $500 million in 2014-2018 attracted opt-out plaintiffs.
The Cornerstone study theorized that the apparent increase in opt-out cases since 2014 may be due to a succession of court decisions that found that investors could not rely on the existence of a class action to extend, or “toll,” the three-year statute of repose contained in the Securities Act of 1933; the only way to guarantee that a court won’t dismiss their claims as untimely is to file their own lawsuit less than three years after the allegedly unlawful behavior at issue took place. The same logic applies to the five-year statute of repose found in the Securities Exchange Act of 1934 (“Exchange Act”).
One area where the Cornerstone researchers were unable to shed new light was on whether more recent opt-out plaintiffs were able to continue to achieve higher settlements than their class-action counterparts. Settlement data for the 26% of opt-outs filed in the post-PSLRA era, showed opt-out plaintiffs getting a 13% premium over other class members. But most of it corresponded to cases settled prior to 2014.
Finally, the Cornerstone study looked at the type of plaintiffs filing direct actions and noted the “significant role” played by mutual funds, hedge funds, and other investment firms, which participated in 15 of the 34 opt-outs in 2014-2018. Individuals, trusts, and other companies were involved in 30 of the 34 opt-outs.
The involvement of mutual funds in securities litigation—or, more accurately, the lack thereof—is precisely the subject of the second study, a University of Chicago Law Review working paper entitled “Toward a Mission Statement for Mutual Funds in Shareholder Litigation.” The empirical study by Sean Griffith, a professor at Fordham University School of Law, and Dorothy Lund, an assistant professor at USC’s Gould School of Law, shows that the ten largest mutual fund companies “very rarely” participate in securities litigation despite their highly vocal claims that they are actively engaged to improve corporate governance.
“Traditionally, there are three levers of power in corporate governance: voting, selling, and suing,” the authors wrote in an article posted on Columbia Law School’s Blue Sky Blog. “Selling is not an option for many mutual funds—especially index funds, EFTs, and other passive funds that are effectively long-only—leaving them with only two remaining levers of power: voting and suing. Yet mutual funds use only one: They vote, but do not sue.”
Griffith and Lund looked at ten years of data on the major types of securities litigation and found that the ten largest U.S. mutual fund companies were involved in just ten traditional shareholder lawsuits involving five instances of managerial misconduct—all of them opt-outs. Over the same ten years, the major mutual fund companies filed just one appraisal-rights action and no derivative cases. None of the funds had served as lead plaintiff. In contrast, for example, Griffith and Lund found that large hedge funds sued more frequently than their mutual fund counterparts, most often bringing derivative or other fiduciary cases that lined up with their activist positions.
The authors urge mutual fund companies to more closely monitor “agency costs and conflicts of interest” that discourage them from undertaking litigation. Such conflicts include the desire not to sue corporate clients that are the source of 401(k) and other advisory business and an unwillingness to serve as lead plaintiff because it benefits all investment companies, including competitors.
Whatever the causes, the impact of large mutual fund companies’ decision to sit on the sidelines in most types of securities litigation is enormous because of the vast size of their public equity holdings, the authors argue, and greater involvement would benefit mutual fund investors by increasing overall returns, providing effective deterrence to corporate wrongdoing, implementing meaningful corporate governance reform, and intervening in non-meritorious cases.
The working paper concludes that mutual fund companies’ decision to sit on the sidelines in most types of securities litigation has a negative impact on investors and may not be in the companies’ best interests. “Our empirical study of the largest mutual funds’ conduct in shareholder litigation leaves little doubt that mutual funds are not using litigation as a tool to create value for investors. Mutual funds’ abysmal litigation record sheds light on the broader debate over mutual funds’ stewardship incentives,” they write. “To the extent that mutual funds take governance seriously, as some, including the funds themselves, claim they do, they must reform their approach to shareholder litigation.”
On September 19, Cohen Milstein, representing the Northeast Carpenters Annuity Fund and the Northeast Carpenters Pension fund (“Northeast Carpenters”), was appointed co-lead counsel in a securities class action against EQT Corporation (“EQT” or “Company”). The case, In re EQT Corporation Securities Litigation, No. 2:19-cv-00754, is currently pending in the U.S. District Court for the Western District of Pennsylvania before U.S. Magistrate Judge Maureen P. Kelly.
In the case, Northeast Carpenters and its co-lead plaintiff the Government of Guam Retirement Fund (“Guam”) allege that EQT misrepresented the “substantial synergies” that were expected to arise from a planned merger with rival natural gas producer Rice Energy due to “the contiguous and complementary nature of Rice’s asset base with EQT’s.”
This case is somewhat unique in that, repeatedly throughout the proposed class period, activist investor JANA Partners LLC challenged the accuracy of EQT’s statements to investors about the purported benefits of the merger, calling the Company’s calculation of $2.5 billion in synergies “highly questionable.” In multiple letters to the Company, JANA argued that abutting acreage acquired in the Rice transaction would only marginally increase lateral well length—touted as the primary benefit of the merger—and even where parcels of newly acquired land were adjacent to land EQT already owned, many of those parcels had already been drilled out. Actual synergies, according to JANA, would be approximately $1.3 billion less than EQT was advertising. JANA also noted that EQT executives were improperly incentivized to complete the merger, regardless of whether it was in the best interests of shareholders because of their compensation structure.
On October 25, 2018, EQT reported its financial results for the third quarter of 2018, revealing the truth: the merger had not only failed to achieve the represented benefits, it had created inefficiencies. In particular, the Company had not been able to achieve the lateral well length it told investors was possible. EQT shares fell 13% on the news, dropping from a close of $40.46 per share on October 24, 2018 to $35.34 on October 25, 2018—a single-day erasure of nearly $700 million in shareholder value. Over the next several days, EQT shares fell to as low as $31.00 per share—less than half what the Company was worth when the acquisition closed in November 2017.
The precise contours of the case may shift as Cohen Milstein and its co-lead counsel vigorously seek new information to bolster and expand the amended complaint, which will likely be filed later this year. As of now, however, Northeast Carpenters and Guam are pursuing the action under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 on behalf of all investors who purchased EQT common stock between June 19, 2017 and October 24, 2018. The co-lead plaintiffs are also bringing claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 on behalf of all persons who purchased or otherwise acquired EQT common stock in exchange for their shares of Rice common stock as of September 25, 2017, the record date for shareholders to vote on the merger with Rice.
A one-page statement of corporate principles signed by the heads of more than 180 U.S. companies has created quite a furor in the ordinarily sedate and staid field of fiduciary law. The Statement on the Purpose of a Corporation issued by the Business Roundtable in August provides that while each of the individual companies serves its own corporate purpose, they “share a fundamental commitment to all of [their] stakeholders” (emphasis in original). In the Statement, the CEOs commit to deliver value to their customers, invest in their employees, deal fairly and ethically with suppliers, support the communities in which they work, and generate long-term value for shareholders as providers of capital. The Statement concludes by emphasizing that:
Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities, and our country.
So why all the fuss? The Business Roundtable has periodically issued principles of corporate governance since 1978, and each version since 1997 has endorsed principles of shareholder primacy. By broadening its vision to give equal attention to other stakeholders, the latest Statement suggests a new and different standard for corporate responsibility.
The Statement immediately prompted commentary from academics, business leaders, lawyers, and corporate governance experts across the ideological spectrum. Some, such as The New York Times’ Andrew Ross Sorkin, called it a significant and welcome shift to rethink the responsibility of corporations to society. Others argued that it was the role of government rather than corporations to address societal concerns.
Still others noted that the Statement characterized shareholders only as providers of capital and not as owners of the corporations, warning that in trying to serve all stakeholders equally, boards of directors would be sidetracked from serving the long term interests of the owners of companies, including pensions funds.
The Council of Institutional Investors (“CII”), whose members hold a collective $4 trillion in assets, warned that “accountability to everyone means accountability to no one” and articulated its position that boards and managers need to sustain a focus on long-term shareholder value. In order to achieve that long-term shareholder value, according to CII, “it is critical to respect stakeholders but also have a clear accountability to company owners.”
CII’s Chair and the Executive Director and Chief Investment Officer of the Florida State Board of Administration, Ashbel Williams, applauded the Roundtable for its intent, but said they “did not get the words quite right.” In a thoughtful commentary, Williams noted that it would have been preferable for the Roundtable to “say more clearly that the fair treatment for customers, employees, suppliers and communities is necessary to create sustainable, long-term shareholder value.”
Public pension plan trustees will recognize a parallel to their fiduciary duty of loyalty, established in state and common law, to act solely in the best interest of the members and beneficiaries of the plans, and the ongoing debate regarding the appropriate role of consideration of environmental, social and governance (“ESG”) factors in investment decision-making in light of that fiduciary duty. A public pension plan trustee must always act for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. This does not mean that ESG factors may never be taken into consideration; when ESG factors affect the economic merits of an investment analysis, for example, they may be integrated into investment decision-making in the same manner as more traditional financial measures of risk and return.
A corporate director likewise has a fiduciary duty to act in the best interests of the shareholders, not to further the interests of other constituencies. But as noted in an analysis by Morton Pierce published on the Harvard Law School Forum on Corporate Governance, “if directors feel that taking into account the views of employees, customers or suppliers on a given issue would further the interests of shareholders, they are currently empowered to do so.” Pierce notes that there is no need to change the basis for corporate decisions in order to consider other stakeholders in such a situation.
There will no doubt continue to be lively discussion regarding whether the Statement is merely symbolic or reflects a more significant cultural shift in the norms applicable to public corporations. Still, it is possible to read the Statement in a manner that can be reconciled with the principles of existing law on fiduciary duty, and the initial uproar may turn out to be overblown.
The article “Child Safety” originally appeared in the Florida Justice Association Journal (Summer 2019). Please contact any of the authors if you’d like to learn more about Cohen Milstein’s experience in product liability claims related to products specifically designed for babies and young children.
The field of child safety is always evolving. With changing federal standards, advances in technology, and frequent safety recalls, it is hard for parents to stay informed. Recently, the U.S. Consumer Product Safety Commission recalled more than 5 million infant inclined sleepers. This article details the companies that sold the defective products, the breadth of the recalls, the underlying safety defects that led to the recalls, and a few practice tips on how to successfully handle a product defect infant death claim.
Kids II Rocking Sleeper
On April 26, 2019, the Consumer Product Safety Commission (“CPSC”) ordered Kids II, Inc., to recall approximately 694,000 of its Rocking Sleepers. As of 2012, five infants died while using the product, some as a result of rolling from a back-lying position to a stomach-lying position while unrestrained.1 The product, which retailed in the $40 to $80 range, was sold from March 2012, through April, 2019, online and at major retailers nationwide, including Walmart, Target, and Toys “R” Us.
Kids II, Inc., is a private domestic for-profit corporation headquartered in Atlanta, Georgia. It has approximately 500 employees worldwide in 15 offices. Its annual revenue hovers around $300 million.
Fisher-Price Rock ’n Play Sleeper
On April 12, 2019, the CPSC ordered Fisher-Price, Inc., to recall approximately 4.7 million infant sleepers. As of 2009, more than 30 infant fatalities have occurred in its Rock ’n Play Sleepers.4 As with the Kids II Rocking Sleeper, some of these deaths occurred after the infants rolled over, from back to front, while unrestrained.5 The product was sold at major retailers for approximately $40 to $149. Fisher-Price knew how consumers used its sleeper — Instagram has thousands of images of babies, unrestrained, free of harness, and surrounded by blankets and stuffed animals while in a sleeper.6 Fisher-Price’s marketing materials made claims that its inclined sleeper allowed babies to sleep comfy all night long.7 It emphasized the product’s soft padding and angled positions, which safety experts say are dangerous characteristics.
Fisher-Price, Inc., is a domestic for-profit corporation headquartered in East Aurora, New York. It is a subsidiary of Mattel, sells products worldwide, and has an annual revenue average of about $1.1 billion.
Cohen Milstein’s Complex Tort Litigation practice group publishes the bi-weekly Complex Tort Eblast addressing a number of consumer safety and product liability issues.
The Tesla Model 3 may not be as safe as Tesla claims it to be.
As reported in the Observer and CNBC last week, the U.S. National Highway Traffic Safety Administration (NHTSA) sent Tesla a cease-and-desist letter regarding “misleading statements” it made about the safety rating of Tesla’s Model 3.
The October 17, 2018 letter, obtained by Plainsite through a Freedom of Information Act request, revealed that NHTSA ordered “Tesla to stop advertising the Model 3 as the safest car tested by the agency.”
NHTSA specifically took issue with a blog post published by Tesla in October 2018 in which the company claimed that “not only has Model 3 achieved a perfect five-star safety rating in every category and sub-category” of the NHTSA Government 5-Star Safety Rating program, but NHTSA’s “tests also show that it has the lowest probability of injury of all cars the safety agency has ever tested.”
NHTSA said that Tesla’s use of terms such as “safest” and “perfect” are “misleading, because there are multiple cars rated five stars but the agency doesn’t rank vehicles under the same ratings,” according to the Observer.
Although NHTSA referred the matter to the Federal Trade Commission’s Bureau of Consumer Protection for deceptive marketing, Tesla stands firm on its safety claims and has so far declined to remove the blog post, according to Automotive News.
Tesla has been linked to using misleading marketing characterizations of Tesla vehicles in past. In fact, according to Consumer Reports, consumer groups and safety advocates have taken issue with Tesla “for overhyping the capabilities of technologies, such as the Autopilot driver-assistance system and the company’s ‘Full Self Driving’ feature.”
According to the Observer, the NHTSA correspondence obtained by Plainsite also “included subpoena orders that the NHTSA sent to Tesla following several recent crash incidents, including a fatal crash in March of this year (2019) involving a Model 3 car operating on Autopilot.”
View the NHTSA letter and supporting documents.
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Cohen Milstein’s Unsafe & Defective Products, Catastrophic Injury & Wrongful Death, and Consumer Protection teams have successfully represented clients in numerous automotive-related cases against leading car and automotive parts manufacturers, including Takata, Ford, Toyota, Caterpillar, PACCAR, General Motors, Chrysler.
Learn more about Cohen Milstein’s Complex Tort Litigation and Consumer Protection practices or please call us at 561.515.1400.
We Co-Counsel Nationwide.
Securities laws and regulations exist, in part, to make sure securities trade on a level playing field where all investors have access to the same company information at the same time. But while it is unlawful for corporate insiders to trade securities based on nonpublic information, there is plenty of evidence that company executives and officers continue to profit on their inside knowledge despite existing restrictions.
The current Congress is considering several measures to close such loopholes. One of these laws, which would tighten the rules governing prearranged trading plans, is awaiting Senate action after overwhelming approval in the House. Another would end what its sponsor called “decades of ambiguity” by expressly making it a federal crime to trade on wrongfully obtained non-public information.
Here is a brief update of where these bills stand in the legislative process, beginning with the one that is furthest along.
The Promoting Transparent Standards for Corporate Insiders Act
This bill, which passed the House of Representatives with near-unanimous support, would direct the Securities and Exchange Commission to study changes to prevent manipulation of Rule 10b5-1 trading plans, which give corporate insiders an “affirmative defense” against allegations of unlawful insider trading.
Rule 10b5-1, enacted by the SEC in 2000 pursuant to its rule-making authority under the Securities Exchange Act of 1934, defines insider trading as the buying or selling of a security while in possession of “material nonpublic information” about that security or its issuer.
But SEC Rule 10b5-1 also shields insiders who become aware of nonpublic information after they decide to trade but before the trade is executed—who, in other words, don’t base their decision on inside information. By setting up Rule 10b5-1 trading plans that instruct investment professionals to buy or sell stock in certain quantities at prearranged times, executives and board members can often avoid insider trading liability even if they profit from a trade’s timing.
When the Department of Justice, the SEC, or private plaintiffs point to suspicious trading patterns by corporate insiders as evidence that they knew about a fraudulent scheme of which the public was unaware, these executives and officers often successfully present their use of trading plans as evidence to negate their liability—the affirmative defense ensconced in Rule 10b5-1.
Yet almost from the day Rule 10b5-1 trading plans were established, they have been criticized as susceptible to manipulation by corporate insiders. A 2016 study in the Columbia Business Law Review, for example, concluded that insiders often set up, modified, and discontinued plans to capitalize on nonpublic information. Its examination of more than 1.5 million insider transactions registered with the SEC from 2003 through 2013 found that insiders with plans in place profited as much as insiders without restrictions. “Our evidence clearly shows that these safe harbor plans are being abused to hide profitable trades made while in possession of material non-public information,” its authors wrote.i
Looking to close such loopholes, the proposed bill would order the SEC to do a one-year study to determine whether the rule should be amended to allow plans to be established only during issuer-adopted trading windows, limit the ability of issuers and insiders to adopt multiple plans, and restrict how often plans can be modified or canceled. The SEC would be required to consider imposing mandatory delays between a plan’s establishment or modification and the first prearranged trade.
In a rare display of high-level bipartisanship, the bill was co-sponsored by House Financial Services Committee Chairwoman Maxine Waters (D-Calif.) and Ranking Member Patrick McHenry (R-N.C.), and approved by a 413-to-3 vote on January 28, 2019. The Senate version of the bill was referred to the Committee on Banking, Housing and Urban Affairs.
The Insider Trading Prohibition Act
Because there is no express definition of insider trading in the federal securities laws, it has become an example of “judge-made” law, with judges in each successive case relying on previous rulings to discern whether a defendant’s behavior runs afoul of Section 10(b) of the Exchange Act. The Insider Trading Prohibition Act introduced by Rep. Jim Himes (D-Conn.) seeks to codify the law of insider trading.
In Himes’ words, the Act “would make it a federal crime to trade a security based on material, nonpublic information that was wrongly obtained, ending decades of ambiguity for a crime that has never been clearly defined by the law.”
The Insider Trading Prohibition Act goes beyond the individual who trades on insider knowledge. It would make it unlawful to communicate an inside “tip” to someone who may be reasonably expected to trade on it. It defines as wrongful any information obtained through “theft, bribery, misrepresentation or espionage,” in violation of computer data privacy laws, intellectual property laws, or breaches of fiduciary duty or confidentiality.
Importantly, the bill would also remove a requirement in some jurisdictions that the “tippee” know that the “tipper” received a personal benefit from sharing the information, as long as the tippee knew or recklessly disregarded that the information was wrongfully obtained. In Congressional testimony in support of the bill, Columbia Law School Professor John C. Coffee, Jr. called the requirement of showing a benefit to the tipper “a significant barrier to insider trading enforcement” because it is easy to hide and because Wall Street essentially runs on favors. (Coffee serves on a task force formed in October 2018 by former U.S. Attorney Preet Bharara to explore changes in insider trading laws. The task force includes former regulators, prosecutors, judges, academics, and defense lawyers. It has not yet released its report.)
Finally, the bill would authorize the SEC to use its discretion to exempt any individual or transaction from liability under it.
The House Financial Services Committee unanimously approved the measure, with vocal support from Reps. Waters and McHenry. It is awaiting consideration by the full House.
The 8-K Trading Gap Act of 2019
Another loophole exploited by corporate insiders involves the four-day delay between the time a company learns of potentially market-moving information and the time it is required to report that information to the SEC (and thus the public) by filing a Form 8-K.
The so-called “8-K trading gap” was a term coined by current SEC Commissioner Robert J. Jackson, Jr. in a 2015 research paper he published while at Columbia Law School. Jackson and his co-authors concluded that “public-company insiders trade during the 8-K gap—and earn economically and statistically meaningful profits while doing so.”ii His findings echoed a 2012 investigation by The Wall Street Journal, which similarly found “that many executives reaped robust gains when they traded ahead of major announcements.”iii
The bill proposed by Rep. Carolyn Maloney (D-N.Y.) would amend the Exchange Act to require the SEC to eliminate the four-day gap with exceptions for certain transactions entitled to safe harbor protections, such as trades made under Rule 10b5-1 trading plans. The bill was discussed at an April 3 hearing of the House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets, which Maloney chairs.
Stock Buybacks
Research by SEC Commissioner Jackson may also prompt Congressional action on another common practice—heavy sales of company stock by executives following buyback announcements—that while not strictly insider trading, can allow them to profit handsomely.
In December 2018, Sen. Chris Van Hollen asked Jackson to clarify his research after SEC Chairman Jay Clayton commented to the Senate Banking Committee that Jackson’s findings of larger-than-usual insider selling after buyback announcements could be coincidental. Maybe executives sell stock after buybacks, the thinking goes, because they are newly freed of company-imposed insider trading restrictions in place before the announcement, when the executives had possessed nonpublic information.
Share prices typically go up once a company announces that it plans to repurchase its own stock: a buyback announcement is essentially a declaration that the company thinks the stock is trading cheaply; the buyback itself also takes shares off the open market, reducing supply. Swimming in extra cash following the 2017 tax cuts, corporations repurchased a record $806 billion of their own shares last year, according to figures compiled by S&P Dow Jones Indices. SEC rules currently provide a “safe harbor” that reduces liability when companies repurchase their own common stock on open markets.
In a March 2019 letter responding to Van Hollen, Jackson said additional research had shown higher-than-usual insider trading after buybacks regardless of company’s pre-announcement trading restrictions. In his letter, Jackson also noted another “troubling trend.” When insiders sell after a buyback announcement, the company’s “long-term performance is worse,” he said. “This raises the concern that insiders’ stock-based pay gives them incentives to pursue buybacks that maximize their pay—but do not make sense for long-term investors.”
Van Hollen said Jackson’s findings showed “that corporate executives can use buybacks to cash out at high prices to the detriment of their company and investors.” Van Hollen now plans to introduce a bill that would require the SEC to review its current buyback rules.
i See Taylan Mavruk and H. Nejat Seyhun, “Do SEC’s 10B5-1 Safe Harbor Rules Need To Be Rewritten?,” Columbia Business Law Review, Vol 2016, pp. 182-183, and H. Nejat Seyhun and Taylan Mavruk, “SEC Needs to Rewrite its 10b5-1 Safe Harbor Rules,” The CLS Blue Sky Blog, June 2, 2016.
ii See Columbia Law and Economics Working Paper No. 524, “The 8-K Trading Gap,” Alma Cohen, Robert J. Jackson, Jr., and Joshua Mitts, September 7, 2015.
iii See The Wall Street Journal, “Executives’ Good Luck in Trading Own Stock,” by Susan Pulliam and Rob Barry, Nov. 27, 2012.
The last few months have offered several examples of why attention to fiduciary duty remains a critical and evolving component of a pension plan trustee’s responsibility. Debates about the precise nature of fiduciary duty, its appropriate application, and its scope have popped up in the retail, the regulatory, and the pension fund spaces. These debates underscore the need for pension fund trustees to remain focused on and current about their fiduciary responsibility.
In April, President Trump signed an executive order promoting energy infrastructure and economic growth that requires the Secretary of Labor to review existing guidance regarding the fiduciary duty for proxy voting. Because they take seriously DOL guidance on ERISA (the law governing private pensions), public pension fund trustees may well be affected by this executive order when making ESG-related assessments in this area.
In June, the SEC adopted Regulation Best Interest (Regulation BI) to impose new rules for brokers when offering investment advice. The precise nature of the fiduciary responsibility required by brokers under Regulation BI was subject to interpretation and not resolved by its over 700 pages. Industry advocates lauded Regulation BI for its protective features while consumer advocates were less sure that fiduciary obligations as promised were as clear as touted. At about the same time, the House of Representatives passed the SECURE Act, which may have muddled the precise nature of the fiduciary obligations of employers who offer annuities in their retirement plans.
Also, a commissioner of the Commodities Futures Trading Commission is creating a panel of experts to explore the impact of climate change on financial markets while state financial regulators and legislators are considering the impacts of some of the recent changes affecting fiduciary duty in the areas described above.
These recent actions that can impact the fiduciary duty of brokers, employers, trustees and others reflect the continued essential nature of the responsibility of those entrusted with managing public pension funds.
Public pension trustees must act in the best interests of their members and beneficiaries. The fact that others may have different views of how to exercise that responsibility does not diminish the trustees’ ongoing duty in putting the beneficiaries’ interests first. Should changes in the legal standards for how public pension trustees must act be adopted, the trustees must remain aware to ensure compliance with that new standard. These may not be easy rules for trustees to follow but they are essential to the proper functioning of the public pension system.