Investors suing GreenSky, Inc. and its underwriters for failing to disclose important changes to the company’s business in documents accompanying its 2018 initial public offering (“IPO”) cleared an important procedural hurdle recently when a federal judge denied defendants’ motion to dismiss the case.

Judge Alvin K. Hellerstein of the U.S. District Court for the Southern District of New York announced his ruling from the bench November 25, 2019 after presiding over a spirited oral argument, handled largely on the plaintiffs’ side by Cohen Milstein Managing Partner Steven J. Toll with participation by Partner S. Douglas Bunch. Judge Hellerstein issued his order denying the motion to dismiss the next day.

Cohen Milstein is co-lead counsel in the case, representing co-lead plaintiffs Northeast Carpenters Annuity Fund and El Paso Firemen & Policemen’s Pension Fund. Judge Hellerstein upheld all claims alleged by those two funds, dismissing only one overlapping claim brought by a third co-lead plaintiff, the Employees’ Retirement System of the City of Baton Rouge and Parish of East Baton Rouge.

GreenSky is a technology company that operates an online platform that allows creditors to process loan applications at the point of sale. More than 10,000 businesses use GreenSky’s platform.

Plaintiffs argued that GreenSky was required under the Securities Act of 1933 to tell IPO investors about its decision to sharply reduce business from solar energy merchants who earned the company high transaction fees in favor of other less-profitable merchants.

In 2016, two years before its IPO, GreenSky had derived approximately 20 percent of its transaction-fee revenues from solar panel merchants; that share had dropped to 12 percent by 2017 and to 8 percent in the first quarter of 2018, just before the IPO. By the second quarter of 2018, it had fallen to 5 percent. While it was aggressively reducing its presence in the solar panel business, where the average transaction fee was 14 percent, the company was increasing its involvement in the elective healthcare industry, where the average transaction fee was 6.5 percent. When the truth about GreenSky’s reduced transaction fees and consequential impact on transaction fee revenue emerged, the company’s stock price fell, damaging investors.

At issue was whether, taken at face value, plaintiffs’ allegations appeared plausible and were pleaded with enough particularity and detail.

At the November hearing, defense counsel argued that the company was not required to disclose the shift in merchant mix in its offering documents and that some of the decline in business from solar panel merchants was unexpected. Defense counsel also contended that the risk disclosures contained in the prospectus for the IPO constituted sufficient disclosure.

Judge Hellerstein, however, noted that the shift from the higher-profit solar panel sector to lower-profit elective healthcare merchants seemed “counterintuitive” and was never explained in the prospectus. “There’s something missing here. It doesn’t make sense,” he said. Toll argued that the prospectus and other offering documents made virtually no mention of the solar panel merchants, let alone their importance to the company’s bottom line. Despite all the pages in the prospectus devoted to risk disclosures, “you do not find the words ‘solar panel merchant’ in any risk factor in the entire prospectus,” he said.

In addition, Toll said, investors couldn’t know how a shift to healthcare would hurt the company without knowing more about its reliance on solar panel merchants. “This was their most profitable business,” he said. “It’s not like it’s 1 percent. It’s 20 percent in ’16. The investors aren’t told that. They don’t have a clue. So when [GreenSky] make[s] this disclosure they are going to actively reduce transaction volume with solar merchants, no investor knows what that means.”

The judge agreed. “The prospectus cries out for an explanation,” he said. “It doesn’t make sense without more of an explanation. At this point, I have too many questions to grant the motion [to dismiss] in this aspect.”

The case, In re GreenSky Securities Litigation, No. 18 Civ. 11071 (S.D.N.Y.), is proceeding to discovery.

A Checklist for 2020

Ask public pension plan trustees or counsel what keeps them up at night, and you’re likely to hear about ethics, compliance and fiduciary issues. Resolve to address these issues in 2020. Here’s a checklist to help you achieve your New Year’s resolution.

Tone at the Top: “Tone at the top” is not just a cliché—it has a significant effect on an organization and its people, and shapes the culture of ethics, compliance and risk management. Several organizational studies have shown that, when presented with a hypothetical ethical quandary, only a small percentage of individuals in an organization are likely to always do the right thing or the wrong thing. For the vast majority—90 percent, according to these studies—their choice of actions will depend upon the organization’s culture and the individuals’ access to guidance.

These studies confirm that when faced with a moral choice, most people act based upon environmental circumstances. For that reason, it is essential to set the correct tone and focus on core values. Communicate the message throughout the organization, speaking frequently on it, and integrating the message throughout. Articulate the mission and the values of the organization. Don’t just pay them lip service. When an organization’s ethical culture is weak you can wind up with headlines like those we’ve seen over the years—pay to play scandals, improper disability awards, pension spiking, nepotism, lack of oversight, and misrepresentation—which have led to ethics investigations, criminal convictions, regulatory enforcement actions, and reputational damage. Don’t let that happen to your organization.

A Resource for Guidance: The organizational studies cited above also found that access to information and guidance were key factors in determining ethics and compliance issues. Make sure your organization has a resource where people can comfortably go get the answers to ethical questions. The person tasked with responding to questions from trustees and staff must be knowledgeable, approachable and able to address sensitive questions. Importantly, that person must be given enough resources to respond quickly.

A Reporting Mechanism: Ethical cultures create an atmosphere in which individuals are comfortable coming forward to report wrongdoing. Be sure you have an appropriate resource where people can report allegations without fear of retaliation and with a belief that the issue will be taken seriously, together with a mechanism for investigating such allegations.

Codes of Ethics: An important element of the vigorous and robust ethics program needed to create an ethical culture or maintain an existing ethical culture is a code of ethics that sets forth permissible and impermissible conduct. Such codes must be workable and clearly written, preferably with examples of actual conflicts of interest or situations that create the appearance of a conflict. Many public pension plans have separate codes for trustees and employees, although sometimes both appear in the same document. At a minimum, codes must be consistent with the state or local ethics laws, but public pension systems often wish to adopt customized codes that are directly applicable to the work and mission of pension plans.

Training Program: Clearly communicating rules is essential to compliance. Put in place a comprehensive training program to educate trustees and staff. Remember the 90 percent of the population cited in the studies above—the overwhelming majority of trustees and employees are trying to do the right thing and need access to resources to help them do so. Among the elements of an effective training program are annual fiduciary training for trustees and appropriate staff, and regular ethics and compliance training for trustees and all staff. Attendees say they often prefer shorter, more frequent training sessions on tightly focused topics. Use a variety of speakers to keep the material fresh. For example, while a staff member is likely in the best position to train on the organization’s code of ethics, you may wish to invite a trainer from your jurisdiction’s commission on open meetings/open records to speak on those requirements for a subsequent session.

Governance: It is hard to overstate the importance of good governance in public pension plan management and success. Among the most critical questions in this area is whether the board has delegated appropriately and, having delegated, is careful to exercise appropriate oversight without micromanaging day-to-day operations. While trustees should not be substituting their judgment for that of staff who have been delegated authority, trustees are responsible for carefully monitoring and overseeing those operations and for regularly reviewing the performance of direct reports (the Executive Director and sometimes the Chief Investment Officer).

Policies and Procedures: Policies and procedures are at the heart of the public pension plan and can provide a strong system of internal controls. Many plans organize their policies in a Board Governance Manual that sets forth committee charters and contains such policies as a Communication Policy, Gifts Policy, Travel Policy, Placement Agent and Political Contribution Policy, Whistleblower Policy, and Discrimination, Harassment and Retaliation Policy, among others. In addition to having the right internal controls in place, policies and procedures must be regularly revisited and revised so that they remain relevant and robust.

Chief among policies is the Investment Policy Statement (IPS), which is at the core of good governance. The IPS should clearly set forth investment objectives; roles and responsibilities among trustees, staff, consultants and advisers; long-term strategic asset allocation; operational guidelines for carrying out the asset allocation; and rules for monitoring and reviewing the investment strategy.

Process: Remember that fiduciaries are judged by the process by which they reach their decisions. Establishing a reasonable decision-making process and adhering to that process helps to demonstrate prudence. Documenting the process is an important part of demonstrating prudence. Be sure that your review process has been sufficiently memorialized in order to demonstrate such prudence.

Happy New Year!

In a 150-page complaint filed on December 31, 2019, styled Advanced Gynecology and Laparoscopy of North Jersey.et. al. v. Cigna Health and Life Insurance, Cigna is accused of violations of the Employee Retirement Income Security Act of 1974 (ERISA), of acting in violation of the Racketeer Influenced and Corrupt Organizations Act (RICO), and of committing a variety of state law violations. The Complaint accuses Cigna of engaging in several “brazen embezzlement and conversion schemes, through which it maximizes profits by defrauding patients, healthcare providers, and health plans of insurance out of tens of millions of dollars every year.”[1] Complaint ¶ 1. The plaintiffs, a number of different out-of-network health care providers, allege that Cigna cheats out-of-network healthcare providers by massively underpaying them for medically necessary services already rendered to beneficiaries of health plans administered by Cigna. Id. Cigna then allegedly retains those amounts withheld, which rightfully belong to the health plans, for its own use. Id. The complaint alleges that as a result, Cigna shifts the “financial responsibility for covered expenses onto the backs of patients, their employers, and [p]laintiffs, while Cigna gets rich.” Id.

The plaintiffs claim they protested Cigna’s unlawful processes and procedures in numerous communications to Cigna management. However, Cigna management allegedly informed them that Cigna has no compliance department capable of addressing these issues and encouraged the providers to file a lawsuit to “prompt Cigna to act.” Complaint ¶ 2. This lawsuit was filed on the heels of two similar class-action lawsuits against Cigna and its third-party administrator (TPA), American Specialty Health (ASH). Cigna settled these lawsuits for $20M total (one for $11.75M and one for $8.25M) in September of 2019. Both lawsuits were filed by out-of-network chiropractors, and alleged that Cigna and ASH colluded to overcharge members of Cigna’s employer-sponsored health plans. Specifically, the cases alleged that ASH charged employer-sponsored health plans hidden fees, by [including false charges for therapy services that were never provided /calling certain charges medical expenses for therapy services.] The plaintiffs accused Cigna and ASH of breaching their ERISA duties by concealing information about the true nature of the charges and alleged that Cigna falsified the Explanation of Benefits (EOB) forms to hide ASH’s administrative fees. The settlement was approved by the Pennsylvania district court judge, and neither Cigna nor ASH admitted any wrongdoing, although the judge’s approval order acknowledge that both organizations agreed to take certain actions to reform some aspects of their business.

• Cross-plan offsetting occurs after a plan’s carrier or TPA determines that an out-of-network provider received an overpayment; the overpayment is “reimbursed” by offsetting the amount owed with another payment owed to the same provider under a different health plan. 
• Many times, the alleged overpayments are made from an employer’s fully insured plan and the offset is taken from an employer’s self-funded plan. This can result in self-funded plan participants facing large “balance bills” or “surprise bills” if the provider seeks to recover the remainder of its charges that were offset by the TPA.
• This practice raises many fiduciary concerns under ERISA, including the duties to monitor, to act prudently and to refrain from using plan assets for any purpose other than providing benefits to plan participants and beneficiaries and defraying reasonable administrative expenses.
• The DOL believes cross-plan offsetting violates ERISA. Although dicta, the court in Peterson v. United Health Group also believes the practice likely violates ERISA. 
• You can also be liable, as a plan fiduciary. You should ask your TPA if they engage in cross-plan offsetting and if allowable, best practices is to opt out of that practice. 

By: Julie Goldsmith Reiser

Note: This opinion piece originally appeared in the January 1, 2020 edition of the Financial Times.

 

Toxic corporate culture drags down morale and can be a bombshell waiting to explode

When banks harm customers and preventable wildfires rage, corporate boards are remade and top executives are fired. Since 2016, when US regulators revealed that Wells Fargo had opened millions of unauthorised accounts, nine of 14 members of the bank’s board of directors have stepped down, and the chief executive has changed twice. Pacific Gas & Electric, blamed for sparking wildfires in California, has brought in a new CEO and 10 new directors, or 77 per cent of its board.

One might expect companies reeling from sexual harassment scandals, brought to light by the #MeToo movement, to hold their corporate directors similarly accountable. As a lawyer who represents investors in lawsuits against corporate boards, I can tell you that the reality is very different when it comes to cases that involved allegations of pervasive sexual harassment, such as the ongoing litigation against Alphabet. Directors of companies embroiled in #MeToo-related crises have largely avoided accountability. 

Take, for example, what used to be known as 21st Century Fox. In the first year following reports of rampant sexual harassment by news chief Roger Ailes and anchor Bill O’Reilly, not a single member of the company’s board of directors stepped down. Even today, Fox has just one woman on its board. 

There has also been no turnover on the board of directors at National Beverage Corp, even though billionaire CEO Nick Caporella has faced lawsuits alleging sexual misconduct (which he denies). Likewise, the Martin Agency’s creative director, Joe Alexander, left his firm suddenly in 2017 after multiple allegations of improper behaviour (which he denies). Although its parent company, Interpublic Group Cos Inc, installed female leadership at the Martin Agency, IPG’s board remained the same. 

Boards may feel comfortable giving themselves a pass because the top court in Delaware, where most US companies are incorporated, ruled in the 2000 case of White v Panic that an all-male corporate board’s decision to settle eight sexual harassment lawsuits with company funds, and to take no disciplinary action against the CEO, were “routine business decisions in the interest of the corporation”. 

Companies have successfully invoked this ruling for years. As far as I know, the recent ruling that the board of directors of Wynn Resorts may face liability for failing to adequately investigate or act on allegations of sexual harassment by company founder Steve Wynn, is the sole recent exception. (Full disclosure: I represent shareholders who recently settled with Wynn Resorts. He denies misconduct.) 

The Delaware courts are more willing to hold boards of directors to account when public health and safety are jeopardised. Recently, judges there allowed a lawsuit to go ahead that alleges Clovis Oncology’s board “ignored” red flags about safety in clinical trials. They also revived a lawsuit against ice-cream maker Blue Bell’s corporate board over a listeria scandal. 

It is time to force boards to respond to sexual harassment scandals that trigger public safety concerns within their own workforce. White v Panic should be overturned, so it cannot be used to shield boards that enable sexual predators. This is not just the right thing to do. It makes financial sense. A toxic corporate culture drags down workforce morale and can be a bombshell waiting to explode. A company hit by scandal suffers damage to both its reputation and stock price, and may struggle with a leadership transition. 

Boards should stop hiding behind an outdated legal decision to dodge responsibility for preventing sexual harassment and discrimination. Enabling harassers is a breach of directors’ fiduciary duties. Shareholders ought to insist on the removal of those who are complicit. 

* * *

A PDF of this opinion piece can be accessed here.

Since 2006, plaintiffs seeking to demonstrate class-wide damages in consumer fraud actions have often used conjoint analysis.[1] But recently some conjoint-based damage models have faced judicial rejection.

According to these decisions, while conjoint surveys can provide a reliable average as to the impact on demand from a corrected disclosure, they cannot alone provide the fair market value of a good or service. While conjoint surveys can support damage models, proponents should take additional steps or include alternative models with class certification.

The Value of Conjoint Surveys

Conjoint analysis involves a multifactorial survey that displays to participants a series of choice sets — matrices with changing attributes. After the participant makes their selections, the survey expert converts the choices to part-worths.[2] If price is an attribute, the conjoint analysis can be used to value the differing attributes and allow the surveyor to quantify a feature’s demand. This can help answer a key causation question: How much less would consumers have paid if the seller had accurately represented or disclosed the truth about an attribute?

A conjoint survey identifying a reduced consumer demand can accomplish three things. First, it can support Article III standing by demonstrating that the misrepresentation impacted price harming all purchasers.[3] Second, if the degree of impact on price would matter to the reasonable consumer, it can support materiality.[4] Third, the survey can serve as part of a damage model that measures the refund owed to consumers related to the misrepresentation’s price impact.[5]

Conjoint Analysis and Damage Models

The limits of a conjoint-based damage model are often explored in the motion to exclude under Federal Rule of Evidence 702 and Daubert v. Merrell Dow Pharmaceuticals Inc.,[6] and the motion for class certification under Federal Rule of Civil Procedure 23 and Comcast Corp. v. Behrend.[7]

Daubert requires that the expert be qualified, the method reliable and the opinion aid the trier of fact. Comcast requires that if a model is being used to support class-wide damages, that it fit with plaintiff’s liability theory. For consumer class actions, that may be a subset of the benefit-of-the-bargain theory — that the consumer paid a price premium due to a misrepresented feature or an undisclosed defect.[8]

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.

By Laura H. Posner

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.

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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.”