Blog
A New Test on Shareholder Derivative Claims: Delaware Supreme Court opinions in the Zuckerberg
BY: Eugena Liu, RBFL Editor
On September 23, 2021, in the United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, the Delaware Supreme Court adopted a new three-part test as a universal test in determining demand futility. The Zuckerberg test combined the Aronson and Rales, two governing demand futility tests in Delaware law for the past decades.
When Shareholders bring a derivative action on behalf of the corporation, shareholders must either make a demand on the board to request the board consider pursuing litigation or plead with particularized facts that the demand excused as futile. Before the Zuckerberg, Aronson and Rales are used to determine whether demand is excused as futile. The Delaware law has evolved to recognize Aronson as a "special application" or "narrower and circumstance-specific sister test" of Rales. The Aronson test applied when shareholders made a conscious business decision that would decide the litigation demand. The Rales test applied to all other circumstances.
The Zuckerberg’s universal test is a response to the wide adoptions of director exculpation provision under DGCL §102(b)(7). Before the enactment of DGCL §102(b)(7), directors face substantial risk of liability if their decisions are not justified by business judgement rule. But after a company has DGCL §102(b)(7) provision in its charter, its directors face no substantial risk of liability in cases where there was reasonable doubt that the requirements of the business judgment rule would be satisfied. Since the Aronson and Rales test were adopted prior to the enactment of DGCL §102(b)(7), its prongs employed the business judgment rule standard are no longer the appropriate measurement in determining whether directors made impartial business judgment on a litigation demand.
In the Zuckerberg test, courts ask the following three questions on a director-by-director basis when evaluating allegations of demand futility: "(i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand; (ii) whether the director faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; and (iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that would be the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.” “If the answer to any of the questions is “yes” for at least half of the members of the board members, then demand is excused as futile.”
The new three-part test is significant for derivative litigants. Under the new test, a director who is only alleged to have engaged in conduct that is exculpated by §102(b)(7) is qualified from considering a demand. As a practical matter, the adoption of the new test simplifies the analysis of whether a demand was excused as futile. Today, litigants will no longer need to question the application of one test instead of another.
Key Sources:
Aronson v. Lewis, 473 A.2d 805 (Del. 1984).
Ch. Ct. R. §23.1.
Code Ann. tit. 8, § 102(b)(7).
Holger Spamann, Scott Hirst & Gabriel Rauterberg, Corporations in 100 Pages, (3d ed. 2022).
Rales v. Blasband, 634 A.2d 927 (Del. 1993).
United Food and Com. Workers Union v. Zuckerberg, 250 A.3d 862 (Del. Del. Ch. 2020).
United Food and Com. Workers Union v. Zuckerberg, 262 A.3d 1034 (Del. 2021).
Affordable Housing in Un-Affordable Vacation Towns
BY: Nicole Rosker, RBFL Editor
Every winter, almost 1.5 million people visit Aspen to ski its legendary slopes. Every summer, Martha’s Vineyard’s population springs from 17,000 to 200,000. These famous destination towns are so successful at attracting affluent vacationers that they enjoy nicknames like “Billionaire Mountain” and “Hollywood East.”
But stripped of their romantic infamy, these towns tell a different story, one of inequality: where the wealthy play and the lower classes work and struggle to find housing. Luxury real estate, seasonable demand, and limited opportunities for building development make these areas famous and beloved by many—and unlivable for the locals who keep these towns operational. Without sufficient affordable housing for their workforces, places like the Vineyard and Aspen can neither sustain their communities nor keep pace with the tourism industry—leading them straight into an “existential crisis.”
One strategy: impose a transfer fee on the purchases of homes in these areas and use the money to fund affordable housing developments that focus on refurbishing existing properties.
Look to the Coalition to Create the MV Housing Bank, who is proposing a local real estate transfer tax that would impose a 2 percent liability on homebuyers purchasing homes on the island worth more than $1 million. The proceeds would go to a housing bank and be used to generate new affordable housing on the island—75 percent of which must be created by rehabilitating existing developed properties.
Local real estate transfer taxes are difficult to pass, as the state must have a home rule provision—which grants autonomy over local matters to local authorities—and the state must recognize a home transfer tax as one that can fall under local authority. This faces opposition from those who argue that maintaining uniform rent regulations is a statewide concern. There is also criticism that RETTs are unfair and unreliable and discourage mobility for new homeowners.
However, Aspen already maintains a successful local RETT. The town strictly regulates building development to preserve its small town feel and “Aspen brand.” These restrictions create scarcity that drives up home prices, but Pitkin County’s RETT redistributes wealth to affordable housing initiatives that create housing for Aspen’s workforce.
Nevertheless, Aspen routinely struggles every winter to find enough housing for its workforce. A dedicated focus on acquisition-rehabilitation projects may be a way to work around the limited development opportunities.
It may not be efficient or profitable for large projects—and it could be limited by how many existing properties a housing bank can wrangle—but it is a strategy that would preserve the unique attributes of a small community. In fact, part of the success of Aspen’s affordable housing initiative is due to the land use regulations that make real estate so expensive—for they also ensure that affordable housing developments maintain the ski resort’s unique charm. It could also be a defense tactic against cold homes—that sit empty much of the year—and short-term rentals—that drive up rental prices—if a local housing bank can buy back these vacation homes and re-position them as year-round community housing.
The final challenge to an affordable housing initiative is implementing long-term restrictions that ensure the affordability and year-round use of these housing projects. These restrictions are critical to ensure that this housing is used by those who need it and used in a way that strengthens the town as a community, not a seasonal resort.
The success of any affordable housing strategy in a destination town depends on the ability to balance the preservation of the town’s character with the development of workforce housing. These towns may cater to thousands of tourists annually, but to solve their local challenges, they need local answers.
Sources:
Jan G. Laitos & Heidi Ruckriegle, The Problem of Amenity Migrants in North America and
Europe, 45 Urb. Law. 849, 849 (2013).
Act Establishing the Martha’s Vineyard Housing Bank, Coal. to Create The MV Hous. Bank, 4-5, https://static1.squarespace.com/static/6014884e0037306100c34a6f/t/623f0cbf07e95b37e78097f4/1648299200361/An+Act+Establishing+the+Martha%27s+Vineyard+Housing+Bank+%28Draft+3-24-22%29.pdf
Jenny Stuber, Aspen and the American Dream, 19:2 Am. Sociological Ass’n, 34, 35 (2020).
Elizabeth M. Tisher, Historic Housing For All: Historic Preservation as the New Inclusionary
Zoning, Vt. L. Rev. 603, 618 (2017).
Virginia Sargent, Let Cities Decide: End Colorado’s Prohibition on Rent Regulation, 92 U.
Colo. L. Rev. 337, 351 (2021).
Marissa J. Lang, On Martha’s Vineyard, even the doctors can’t afford housing anymore, The
Wash. Post, (Sept. 16, 2022), https://www.washingtonpost.com/dc-md-va/2022/09/16/marthas-vineyard-housing-rentals-crisis/
Heather Hansman, What ski towns tell us about the inequality crisis, Deseret News, (Feb. 8,
The High Standard for Material Adverse Effects: Elon Musk’s On-Again, Off-Again (On Again) Twitter Acquisition
BY: Noah Adams, RBFL Student Editor
In April of 2022, Twitter accepted a $44 billion takeover bid from Elon Musk, which would see the Tesla and SpaceX CEO take the social media company private. Musk, a self-proclaimed free-speech absolutist, declared that his acquisition of Twitter was essential to protect the virtual town square from harmful censorship. However, by May, Musk had announced that the deal was on hold, and was engaged in an online feces-flinging contest with Twitter’s then-CEO Parag Agrawal, replying with a poop emoji to Agrawal’s comments about the deal (on Twitter, of course). In July, Twitter filed suit against Musk in the Delaware Court of Chancery seeking enforcement of the agreement. Ultimately, Musk would decide to go ahead with the purchase for the full $44 billion, but not without some resistance first.
Musk initially sought to get out of the agreement on a longshot material adverse effect (“MAE”) theory. Corporate mergers and acquisitions are typically subject to MAE clauses that allow the buyer to walk away from the deal if something occurs between signing and closing that materially impacts the value of the target company. These clauses generally do not define “material,” so the question of what constitutes a material effect usually falls to the Delaware courts.
Historically, buyers have been largely unsuccessful at arguing MAEs in the Delaware Court of Chancery, where Twitter brought the suit against Musk seeking enforcement of the agreement. In fact, a MAE argument had succeeded just once before, in Akorn, Inc. v. Fresenius Kabi AG, and in that case the target company had suffered a tremendous downturn in performance, resulting in a year-over-year earnings decrease of 51%. However, Twitter suffered no such downturn and Musk’s argument instead hinged on Twitter’s alleged misrepresentation of the number of spambots, or fake user accounts, on the Twitter platform.
Observers at the outset generally agreed that Musk faced a steep uphill battle, but the filing of a whistleblower report by former Twitter executive Peiter Zatko offered Musk new arguments to bolster his case. The whistleblower report alleged that Twitter was not in compliance with a 2011 Federal Trade Commission Consent Order, which could mean remediation costs (in fines and in achieving compliance) of hundreds of millions or billions of dollars for Twitter; Twitter was already fined $150 million in 2019 for violations occurring in the preceding six years. However, the issue of remediation costs’ materiality is decided on a reasonable acquirer standard. Had the case gone to trial, the Delaware Court of Chancery would have been tasked with determining what remediation costs a reasonable acquirer would consider to be material in a case where the acquirer publicly stated that he was buying the target company for “the future of civilization,” and that he did not “care about the economics at all.”
Mercifully, for Chancellor Kathaleen McCormick, the judge presiding over the case, the court managed to escape that responsibility when Musk decided that he would buy Twitter for the full amount after all. McCormick’s no-nonsense approach to the case, limiting discovery and denying Musk’s motions for a longer trial at a later date likely informed Musk’s decision to go ahead with the deal.
The Twitter v. Musk ordeal highlights the difficulty of establishing a MAE and will serve as a case study on the importance of conducting diligence before making an offer. The Delaware Court of Chancery has little interest in creative legal arguments from acquiring parties suffering from buyer’s remorse.
SOURCES:
Jonathan Vanian, Elon Musk Has Been Expressing Buyer’s Remorse Over Twitter for Months, CNBC (July 8, 2002, 8:21 P.M.) https://perma.cc/82KY-NJFF.
Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL, 2018 WL 4719347, (Del. Ch. 2018) aff’d, 198 A.3d 724 (Del. 2018) (unpublished table decision).
Tom Hals, Analysis: Twitter Has Legal Edge in Deal Dispute with Musk, Reuters: Technology (July 11, 2022, 6:29 AM), https://perma.cc/Y32X-UAN7.
Mia Sato, Buying Twitter ‘Is Not a Way to Make Money,’ Says Musk in TED Interview, The Verge (Apr. 14, 2022, 1:32 P.M.), https://perma.cc/66SZ-K3YQ.
Marcy Gordon, Musk Twitter Turnaround Reflects Legal Changes, Associated Press, (Oct. 5 2022), https://perma.cc/BN38-2NP5.
The SEC’s Proposed Climate Related Disclosure Rule
BY: Will Frigerio, RBFL Student Editor
On March 21, 2022, the Securities and Exchange Commission proposed a rule that would require public companies to include climate related disclosures on registration statements and periodic reports. The proposed rule has prompted strong responses, both in support of the rule and arguing against it. Many commentators have questioned the viability of the proposed rule in light of a body of law known as the major questions doctrine, a series of Supreme Court cases that have struck down actions by federal regulatory agencies as unconstitutional.
The major questions doctrine is a relatively recent development. While the Supreme Court has traced the doctrine back to the 19th century, its application has proliferated in recent years. In a string of cases over the last two decades, the Supreme Court has ruled federal agency actions unconstitutional due to the breadth of authority asserted and the economic and political significance of that action. In these cases, the Court focused on whether the agency in question departed from its normal method of regulating, as well as the economic and political significance of the action the agency attempted to take.
West Virginia v. Environmental Protection Agency was the most recent application of the doctrine. There, the Supreme Court overruled an EPA rule promulgated in 2015 called the Clean Power Plan. The Clean Power Plan required existing coal-fired power plants to shift to natural gas or to renewable energy, mostly wind and solar.
In striking down the Clean Power Plan, the Supreme Court emphasized the change in the way the EPA was regulating, transitioning from making specific sources operate more cleanly to a system that would shift polluting activity from cleaner to dirtier sources. The Court also emphasized the economic and political significance of the rule.
In March of 2022, the SEC proposed a rule regarding environmental disclosure requirements for public companies. Naturally, this proposed rule perked many ears and prompted a range of responses, especially in the context of the major questions doctrine.
In one camp, a number of commentators that believe the proposed rule runs afoul of the major questions doctrine. Critics argue that the proposed rule differs from how the SEC has historically regulated and would impose significant costs on public companies.
In the other camp, commenters point out the differences between the Clean Power Plan and the proposed SEC rule: the costs are not as significant, and the proposed rule is in line with what the SEC has been doing for decades: investor oriented disclosures about risks faced by firms. The SEC has to protect investors, and this is just the newest iteration.
Time will tell how courts will grapple with the proposed SEC rule. The SEC rule is more in line with how the SEC has regulated in the past, and the economic impact likely won’t be as grave as the Clean Power Plan. But that is not to say the economic impact will be insignificant, and issues regarding the climate have proved politically trenchant. The rule is currently in notice and comment, and debate is still churning a year after the rule’s proposal.
Back to the Future: Collateralized Fund Obligations Make a Reappearance
BY: Jacob Chaas, RBFL Editor
The laboratory of financial engineering’s latest concoction has received mixed reviews by pundits. Lauded by some as a “Technicolor Dreamcoat” and criticized as a “Frankenstein” by others, the collateralized fund obligation (“CFO”) transaction has seen an explosion in popularity in recent years. Naturally, these novel transactions raise new concerns for regulators and risk managers alike.
Over the past decade, as private equity became an increasingly important part of financial markets, fund managers and other organizations sought increasingly cryptic financing arrangements to raise capital for new funds. Simultaneously, both retail and institutional investors were looking for new ways to invest in private markets and take advantage of the higher returns available to private equity investors. CFO capitalize on these parallel trends and, as such, have been elevated to a new position of relevance.
The CFO is not necessarily new, however. Some of the first rated CFOs came to market in the early 2000s. Reports suggest that there were only about half a dozen CFO transactions before the great financial crisis. During the financial crisis, investors’ interest in complex derivative products – and likely anything with “collateralized” in the name – dried up, and very few CFOs were issued for the early years following the crisis. The ability of CFOs to provide levered returns and generally higher yields than other equity investment instruments have attracted sophisticated yield-hungry investors to the CFO market.
CFOs make use of some of the key structural elements present in other collateralized asset-backed securities. The most infamous of these securities is the collateralized debt obligation, most famous for its role in propagating the sub-prime mortgage crisis of 2007-2009 throughout the broader financial sector. Similarly, CFOs securitize the cash flows from private equity investments and allow investors to invest in these cash flows by purchasing structured notes, arranged in tranches with different positions in the cash flow waterfall and correspondingly different yields. Each tranche gives investors an opportunity to make an investment that most closely aligns to their risk tolerance and preferred rate of return.
CFOs raise three important regulatory and risk management issues. First, since many CFOs are private arrangements among and within private equity funds, issuers are not required to disclose which fund interests comprise that CFO or what investments each fund is making. This makes understanding the risk inherent to each CFO transaction very difficult. Second, CFO issuers generally don’t need to retain any interest in the underlying fund and can entirely liquidate the CFO. This could encourage conflicts of interest between issuers and end buyers. Finally, CFOs allow regulated investors to transform what would otherwise be an equity interest in a debt interest by means of financial engineering, allowing them to get around the more stringent capital requirements associated with holding equities.
Within the next few years, regulators will likely step in to provide more certainty on each of these points. In the meantime, the scope of the burgeoning CFO market will only be restrained by the creativity of the financial laboratory’s engineers.
Bringing in the Big Dogs: Benefits of SEC’s Proposed Climate Risk Disclosure Rule
BY: Jaclyn Rothenberg, RBFL Student Editor
On April 11, 2022, the SEC proposed a new rule: The Enhancement and Standardization of Climate-Related Disclosures for Investors. This rule adds a new subpart to Regulation S-K, which includes three types of emissions disclosures. Scope 1 disclosure requires a company to disclose information about its direct greenhouse gas (GHG) emissions, and Scope 2 disclosure requires indirect emissions from purchased electricity or other forms of energy. Finally, Scope 3 disclosure requires a company to disclose GHG emissions from upstream and downstream activities in its value chain if material or if the company has set a GHG emissions target or goal that includes Scope 3 emissions. A company would be required to disclose all climate-related risks that are “reasonably likely to have material impacts on its business or consolidated financial statements.”
The SEC emphasizes that there are significant benefits to this rule. First, the information about climate-related risks would be more comparable because investors will receive consistent, standardized content from different sized companies, and regardless of industry. Second, investors can better rely on these disclosures because it will be filed with the SEC, which increases potential liability to the firm. If companies fear liability, then companies will carefully consider the content of such disclosures and avoid filing misleading statements (e.g., greenwashing). Thus, investors can be more confident in the accuracy and completeness of the filing.
Third, there are benefits to the market. Because the rule would be mandatory and there is standardized content, investors will be able to better assess these climate risks and the impact on companies’ financial conditions and operations, such as products and services, supply and value chain, adaptation and mitigation activities, investment in research and development, types of operations and location of facilities, acquisitions or divestments, and access to capital. And thus, when investors can make better-informed investment decisions and are better protected, investors will not need to discount the prices of stock. Also, when investors process information more effectively, this improves their estimation of a firm’s future cash flows, leading to more accurate firm valuation. The market will be healthier because of improved liquidity, lower costs of capital, and higher firm valuations. Lastly, the rule reduces agency problems. The concern is that management might act in their own self-interest at the expense of shareholders by disclosing only certain climate-related information at their discretion. With the new rule, shareholders are better able to monitor a company’s climate-related decisions, especially surrounding the potential conflicts between short term and long-term climate risk horizons.
While many lawyers and scholars believed that the SEC would publish the official rule before the end of 2022, as of early January, we have yet to see any rule issued. Is this indicative of significant change between the proposal and the final rule? It’s hard to say. Regardless of the rule adopted, one thing remains clear: transparency, especially around climate-related transition risks, is at the forefront of investor demands. If it’s too early for the big dogs, investors will find other ways.
Key Sources:
Release No. 33-11042, The Enhancement and Standardization of Climate-Related Disclosures for Investors, 87 Fed. Reg. 21334, 21334 (proposed Apr. 11, 2022) (to be codified at 17 C.F.R. pt. 210, 229, 232, 239, and 249).
Section 2(b) of the Securities Act, 15 U.S.C. 77b (b), and Section 3(f) of the Exchange Act, 17 U.S.C. 78c(f), require the Commission, when engaging in rulemaking where it is required to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. Further, Section 23(a)(2) of the Exchange Act, 17 U.S.C. 78w(a)(2), requires the Commission, when making rules under the Exchange Act, to consider the impact that the rules would have on competition, and prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the Exchange Act.
Financial Stability Oversight Council (“FSOC”), Report on Climate-Related Financial Risk 2021 (Oct. 2021) (“2021 FSOC Report”), available at https://home.treasury.gov/system/files/261/FSOC-Climate-Report.pdf (detailing the various ways that climate-related risks pose financial threats both at the firm level and financial system level).
The Future of the Music Industry is NFTs
BY: Kiana Lozzi, RBFL Student Editor
Artists’ incomes have significantly shifted from mechanical to performance royalties and the next shift should be to music NFTs. NFTs, or “non-fungible tokens,” are data units that are stored on a blockchain that transfer ownership of either physical things or digital media. Additionally, NFTs have given artists an opportunity to retain the copyright and reproduction rights for their work and allow musicians to directly license ownership to fans.
NFTs incentivize musicians by offering perpetual royalties, new revenue streams, and the easing of payments. NFTs allow music artists to garner profits that are traditionally inaccessible under copyright law. Under most record label contracts, copyright owners have control over a specific copy up until it is first sold. Therefore, the copyright holder has protection, but receives no royalties from sales after their first copy. In comparison, NFTs allow for continual payments beyond this initial sale. Therefore, royalty payments could increase for music releases and other traditional revenue streams. Merchandise that is sold at shows provides music artist a one-time payment for each article of merchandise. However, if music artists sell NFTs as collectibles, then they have the potential to earn endless stream of revenue from their pieces.
NFTs allocate a percentage of the royalties to someone’s favorite artist and grant other benefits, which has increased the connection between the artist and fan in a novel way. Thus, music NFTs help artists build their community. Additionally, the traditional record label framework for music artists has led to numerous artists getting exploited. However, music NFTs turns fans into shareholders because they own a stake in their favorite music artists and can gain value from it. Thus, altering and promoting consumerism. The role of investor typically and historically has been the record label, which then creates deals that are unfavorable for the artist. Taylor Swift, Frank Ocean, and TLC are a few artists who fell victim to these exploitative record deals and no ownership of their masters.
Music artist, Steve Aoki, launched AOKIVERSE, for his music NFTs in early 2022. Users could join AOKIVERSE by buying an NFT passport that included free tickets to live shows, merchandise, and other members-only events. Moreover, artists no longer need millions of fans spending a dollar on them and supporting a lot of middlemen. Instead, they just need a few hundred fans that really appreciate them enough to invest in their success.
Current legislation does not typically deem NFTs as securities, but they can be securities. The strongest argument for music NFTs not being deemed securities is that the value that music NFTs create is not a standard securitized investment contract, but it is tied to the personal connection that fans have with the artist and their work. Thus, the NFT itself does not produce a high expectation of profit, but it produces the chance for artists and fans to meaningfully connect prior to this technology. Overall, the internet and securitization offered a new revenue model for music artists, and now blockchain technology and NFTs may have forged a new path for artists to disrupt the music industry.
Sources:
Daniel O’Neill, How Music NFTs are Impacting the Creator Economy (Part Two) JingCulture&Crypto (Oct. 31, 2022), https://jingculturecrypto.com/how-music-nfts-are-impacting-the-creator-economy-part-two/
Kaczynski, S., & Kominers, S. D. (2021, November 19). How nfts create value. Harvard Business Review. https://hbr.org/2021/11/how-nfts-create-value
Patel, S. (n.d.). If NFTs Rule the World: A New Wave of Ownership. The International Journal of blockchain law. https://gbbcouncil.org/wp-content/uploads/2022/03/IJBL-Volume-II.pdf
Price, K. (2022, January 5). How nfts are providing music artists with another way to take back control. Fordham Intellectual Property, Media & Entertainment Law Journal. http://www.fordhamiplj.org/2022/01/05/how-nfts-are-providing-music-artists-with-another-way-to-take-back-control/
Talia Smith-Muller,Music NFTs: What You Need to KJnow as a Musician and Fan https://online.berklee.edu/takenote/music-nfts-what-you-need-to-know-as-a-musician-and-fan/
Impact of Celebrity Endorsed Cryptocurrency
BY: Roshni Parikh, RBFL Student Editor
Cryptocurrency (‘crypto’) has permeated through the financial world as a popular investing tool that is relatively easy to use. The problem is that it is inherently risky, if not dangerous, and is not considered a sophisticated investment space due to its fraudulent features, anonymity, and decentralization. The Federal Trade Commission (FTC) and the Securities and Exchange Commission (SEC) have worked extensively to improve regulations, adjusting them to the new crypto environment and scams that arise. However, the current regime is still insufficient to protect consumers from bad actors. Celebrities and influencers, ranging from athletes to actors, endorse crypto opportunities through various platforms, heightening the risk for uneducated and potentially fraudulent investments.
Celebrities receive money from their crypto promotions and are required to follow FTC and SEC guidelines when persuading fans and followers to buy obscure investment products. Federal law requires them to publicly disclose their payments for such promotions, however, the law surrounding disclaimers is not always so clear. Some legal domain lies with the SEC, which imposes restrictions on securities, but celebrities often run afoul the FTC’s rules as well, failing to fully disclose financial ties to the projects they endorse. Notable celebrities, such as Kim Kardashian and Floyd Mayweather, have been subject to high-profile lawsuits for their misleading advertisements, threatening other influencers that they will be held accountable and punished if they do not act with extreme caution.
These endorsements’ pump-and-dump schemes have revealed gaps in the current regulation of crypto. Although the SEC and FTC pleads consumers to research their investment options, celebrities’ names attached to untested and untrustworthy financial technologies still persuade investors into thinking crypto is the path to riches. It is practically undisputed that regulation needs to be stricter on celebrity endorsements of crypto, but with multiple legal actors, it could be difficult to assert who has authority over the financial tool. This poses a question of which government agency should be more robust to prevent future lawsuits, consumer loss, and imploding markets.
One argument may be that cryptocurrencies should be considered securities so that they fall within the SEC’s jurisdiction. Congress has not empowered the SEC to regulate the crypto market, so it remains unclear whether cryptocurrencies are securities. Moreover, to qualify as a security, a transaction must meet the Howey test: (1) an investment of money; (2) in a common enterprise; (3) with a reasonable expectation of profit; (4) that is to be derived “solely” from the efforts of others. Meeting this standard could help clarify who has the rulemaking authority over crypto. Another argument is that the FTC could broaden and strengthen its disclosure requirements for material connections to advertised products to include crypto in 16 C.F.R. § 255. This would help the FTC execute their goals of consumer protection from unfair and deceptive practices because both celebrities and followers would be more aware and cautious.
Sources:
INVESTOR.GOV, Investor Alert: Celebrity Endorsements (Nov. 1, 2017), https://www.investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-alert-celebrity-endorsements.
FED. TRADE COMM’N, NEW ANALYSIS FINDS CONSUMERS REPORTED LOSING MORE THAN $1 BILLION IN CRYPTOCURRENCY TO SCAMS SINCE
2021 (JUNE 3, 2022), https://www.ftc.gov/news-events/news/press-releases/2022/06/new-analysis-finds-consumers-reported-losing-more-1-billion-cryptocurrency-scams-2021.
Roger E. Barton, Christopher J. McNamara, and Michael C. Ward, Are cryptocurrencies securities? The SEC is answering the question, REUTERS (March 21, 2022), https://www.reuters.com/legal/transactional/are-cryptocurrencies-securities-sec-is-answering-question-2022-03-21/.
Timothy M. Barry, #Notfinancial Advice: Empowering the Fed. Trade Comm’n to Regulate Cryptocurrency Soc. Media Influencers, 16 Ohio St. Bus. L.J. 279, 305 (2022).
Jason Goldstein, How New FTC Guidelines on Endorsement and Testimonials Will Affect Traditional and New Media, 28 CARDOZO ART ENT. L.J. 609, 612 (2011).
16 C.F.R. § 255.5 (2009).
Complaint, FTC v. Legacy Learning Sys. Inc. et. al, No. c-004323 (M.D. Tenn. 2011).
Paul Guirguis and Sue Ross, Celebrity Crypto Fines Flag Lessons for Lawyers, BLOOMBERG LAW, (Oct. 13, 2022, 4:01 AM), https://news.bloomberglaw.com/us-law-week/celebrity-crypto-fines-flag-lessons-for-lawyers.
Complaint, FTC v. Teami, Inc., No. 8:20-cv-00518 (M.D. Fla. 2020).
A Brief Overview of the Federal Trade Commission Investigative, Law Enforcement, and Rulemaking Authority, FTC, https://www.ftc.gov/about-ftc/what-we-do/enforcement-authority [https://perma.cc/K3Q7-3FEY] (last updated May 2021) [hereinafter FTC Enforcement Authority].
Timothy B. Lee, SEC warns that celebrity cryptocurrency endorsements may be illegal, ARSTECHNICA (Nov. 2, 2017), https://arstechnica.com/tech-policy/2017/11/sec-warns-that-celebrity-cryptocurrency-endorsements-may-be-illegal/.
The FTC’s Attempts to Limit Merger and Acquisitions Over-broad Non-competes
BY: Conner Ahler, RBFL Editor
The Federal Trade Commission blocked a non-compete agreement between two firms in the process of selling and purchasing gas stations in response to pressure from the Executive Branch to increase competition in the American economy. Employment non-compete agreements are usually the type under such scrutiny, making this action unique. The FTC found a non-compete agreement that fuel companies Arko Corporation, and their subsidiary, GPM Investments LLC (“GPM”), made with fuel company Corrigan Oil (“Corrigan”) violated antitrust standards. The FTC then entered into a Consent Order with both of the firms to resolve the issue.
This FTC action was largely spurred on by pressure from the Executive Branch to crack down on anticompetitive practices across the country. President Biden called upon the FTC and the Attorney General’s office to enforce the initiative. The FTC restricted non-compete agreements twice in 2021 prior to their involvement with GPM and Corrigan by vastly curbing the effects of a non-compete agreement between 7-Eleven, Inc. and Marathon Petroleum Corporation and an employee non-compete agreement made by DaVita, Inc. In the summer of 2022, the FTC entered into a Consent Order with GPM and Corrigan based on GPM’s purchase agreement of 60 gas stations from Corrigan. The FTC found that the non-compete agreement ancillary to this purchase, as well as the resulting lack of competition resulting from the purchase violated antitrust standards.
Generally, non-compete agreements likely satisfy antitrust standards if they protect a legitimate business interest and are reasonable in scope. Freedom from competition is never a legitimate interest. Non-compete agreements must also not “unreasonably restrict the available supply of, or access to, or raise the price of any useful commodity, or tend to create a monopoly.” The FTC evaluated GPM and Corrigan’s agreement under these rules using their own standards. The purchase agreement, selling 60 retail fuel locations in Michigan and Ohio from Corrigan to GPM, was signed on March 8, 2021. The total consideration paid equaled about $94 Million. Corrigan agreed that they would not compete with the 60 locations that GPM purchased and also agreed not to compete with about 190 more GPM fuel locations.
The FTC stated that this agreement violated Section 7 of the Clayton Act, as amended, 15 U.S.C. § 18 and Section 5 of the Federal trade Commission Act as amended, 15 U.S.C. § 45. The restrictions the FTC levied and the reasoning behind them can be found in the content of their Consent Order and other public documents. The FTC first ordered GPM to return five specific fuel locations located in places where loss of a single station would result in an unreasonably non-competitive environment. The FTC then found that the non-compete clauses in the agreement went “well beyond what is reasonably necessary to protect GPM’s investment in the sixty acquired retail Express Stop locations.” The non-compete was amended to only apply to the fifty-five remaining fuel locations, and the limitations were reduced to three years in length and no more than three miles from each location. Finally, the FTC ordered GPM not to enter into any future non-compete agreements related to the sale of fuel locations.
Other firms planning to draft non-compete agreements ancillary to the sale of fuel locations can learn much from this FTC decision. Non-compete agreements must be strictly structured only to protect legitimate business interests, and not unreasonably at the expense of competition. Furthermore, firms should be aware that the FTC will look into the specific location and market surrounding every fuel location, and will prevent sales that unreasonably harm competition. Beyond fuel companies, firms in general should be on notice that the FTC is following the goals that the Executive Branch put forth, and cracking down on non-compete agreements.
Sources
Proclamation No. 14036, 86 Fed. Reg. 36, 987 (Jul. 9, 2021)
FEDERAL TRADE COMMISSION, File No. 211-0087, ANALYSIS OF AGREEMENT CONTAINING CONSENT ORDER TO AID PUBLIC COMMENT, (2022), https://www.ftc.gov/system/files/ftc_gov/pdf/2110087GPMAAPC.pdf [https://perma.cc/82DW-WNU6]
Press Release, Federal Trade Commission, FTC Imposes Strict Limits on DaVita, Inc.’s Future Mergers Following Proposed Acquisition of Utah Dialysis Clinics (Oct. 25, 2021), https://www.ftc.gov/news-events/news/press-releases/2021/10/ftc-imposes-strict-limits-davita-incs-future-mergers-following-proposed-acquisition-utah-dialysis [https://perma.cc/4QBV-NHHR];
FEDERAL TRADE COMMISSION, File No. 211-0013, ANALYSIS OF AGREEMENT CONTAINING CONSENT ORDERS TO AID PUBLIC COMMENT (2021)
Complaint, In re ARKO Corp., GPM Investments, LLC, GPM Southeast, LLC, and GPM Petroleum, LLC, Federal Trade Commission (No. 211-0087), https://www.ftc.gov/system/files/ftc_gov/pdf/2110087GPMComplaint.pdf [https://perma.cc/E992-XQ9N]
C.T. Drechsler, Enforceability of covenant against competition, ancillary to sale or other transfer of business, practice, or property, as affected by territorial extent of restriction, Part 1 of 2, 46 A.L.R.2d 119 (2022)
Robert W. Emerson, Franchising Covenants Against Competition, 80 Iowa L. Rev. 1049, 1053-54 (1995)
Regulation of the Metaverse
BY: Harrison Hayne, RBFL Editor
While speculation about the metaverse has cooled in recent months, it is doubtful that the metaverse will bow out quietly given the billions of dollars invested in its success by major technology players. A multitude of metaverse platforms are still hoping to use the metaverse to transition the human experience into a virtual world.
Regulation is often reactive, so it is unlikely that the metaverse will experience further regulation unless its popularity increases. Regulatory bodies are most likely to regulate the metaverse if potential social and economic issues arise. However, given the massive amount of investment in the metaverse, regulation is likely to be challenged if such regulations will eat into potential profits of investors.
The metaverse is capable of being utilized for a variety of purposes that allow users to mold their personal experience. Current regulations include copyright laws, but the manner of implementation of copyright law in the metaverse remains to be clarified. The Federal Trade Commission (FTC) is the main regulatory body overlooking the metaverse, as the FTC is in charge of enforcing marketing and competition law on the Internet.
So far the primary method of regulating conduct within the metaverse has been through contracts entered into between users the operators of particular metaverse platforms. These terms of service contracts have defined the bounds of acceptable conduct within the particular metaverse platform being used. Problems could arise as these terms of service contracts liable to be minimally enforced to the extent that minimal enforcement drives engagement and use of metaverse platforms.
One of the chief concerns about the metaverse is the use of user data by platform operators. Metaverse operators will be able to use the metaverse to accumulate massive amount of personal data from users, and will look to use this data into revenue. Similar to issues regarding conduct, metaverse platforms have decided to use terms of service contracts between users and operators to define the bounds of permissible uses of user data. The FTC is quite limited in what it can do to enforce mere guidelines regarding user privacy, so it is unlikely that meaningful regulation will take place unless the FTC is delegated greater power from Congress.
Commerce within the metaverse is intertwined with the use of bitcoin and other cryptocurrencies. These blockchain assets could be subject to multiple regulatory bodies, including the SEC and IRS. However, so far the IRS has provided the most clarity into potential regulations. While IRS has opted to treat blockchain assets as property, individual states have been slower to adopt to uniform tax treatment.
There is unlikely to be meaningful change in the way the metaverse is regulated until regulatory bodies see need for change based on regulatory failures. Given the rising unpopularity of the metaverse, it will probably be awhile until metaverse users and operators signal to regulatory bodies that greater regulation is needed.
Sources
See Janna Anderson & Lee Rainie, The Metaverse in 2040, Pew Rsch. Ctr., 84 (June 30, 2022), https://www.pewresearch.org/internet/wp-content/uploads/sites/9/2022/06/PI_2022.06.30_Metaverse-Predictions_FINAL.pdf
See Luc Olinga, Mark Zuckerberg, the Metaverse and Us, THESTREET (Oct. 30, 2022), https://www.thestreet.com/technology/what-does-zuckerberg-know-about-metaverse-that-we-dont
See Tad Simons, Crypto assets and taxes: What you need to know, THOMSON REUTERS (Apr. 6, 2022), https://www.thomsonreuters.com/en-us/posts/tax-and-accounting/crypto-assets-taxation/