The Cybersecurity M&A Rush

2021 saw a jump in cybersecurity deals, and a slowdown in this chunk of tech M&A this year seems highly unlikely. In the first three quarters of the past year, 151 transactions closed compared to 88 and 94 in 2019 and 2020, respectively, with most of them in the identity and cloud security sector. This year could surpass last year’s record figures in M&A deal numbers and value.

There are multiple reasons why paying 11.3 times the average trailing twelve-months-sales to acquire a reliable cybersecurity firm could be a good idea. Nowadays, a hacker attack, data leak, or general severe cybersecurity malfunctioning could spell the death sentence for even a solid and highly profitable corporation. Market players showed to be more than happy to pay hefty premiums to merge with a company that can protect and manage their networks and data. This behavior feels akin to buying insurance against unpredictable and potentially catastrophic events, but with the benefit of making systems more efficient.

The pandemic massively increased the interest in cybersecurity companies and fed market players’ and government paranoia. We learned that nearly everything can be done online, and the need for more investment in network and data protection became painfully obvious. Restrictive border measures during the pandemic accelerated this digital transformation. Besides the driving factor of remote work, e-commerce boomed, and buzzwords like the internet of things, identity management solutions, and even the metaverse are repeated ad nauseam. Moreover, the rising interest in cryptocurrencies and digital assets creates a compelling opportunity for cybercriminals. Cyberattacks and data leaks occasionally made headlines in the last ten years, injecting a substantial dose of fear to companies and governments. From the actions of Edward Snowden to Yahoo’s data leak during Verizon’s merger, or the more recent LinkedIn scandal involving 700 million of its users, some firms were reminded of the importance of cybersecurity management the hard way.

The cybersecurity market is growing at a fast pace. In 2020, the estimated value was $156.26 billion, and it is expected to reach $352.25 billion by 2026, according to a Mordor Intelligence study, meaning a compound annual growth rate of around 14.5%.

The attention players pay to cybersecurity in today’s deal world can be observed not only by looking at the number of companies acquired in the sector, but also by looking at how due diligence is conducted and purchase agreements are drafted. In mid-2020, the ABA Mergers and Acquisition Committee published a study tracking two newly appearing representations and warranties in sale and purchase agreements related to privacy and cybersecurity. Deal lawyers increasingly view cybersecurity due diligence as a crucial element for a successful closing, and cyber risk remains one of the biggest concerns post-acquisition. The complexity of the threats requires firms to spend money and time to discover and protect against cybersecurity threats. This is especially true in the finance, healthcare, retail, and energy sectors.

With a fast-growing market, rising pressure on governments and corporations, and remote work presumably becoming a permanent option for many workers, we will likely experience further growth of cybersecurity deal activity in the following years, which may have interesting effects on the M&A legal practice. From being perceived as a tedious and negligible detail, cybersecurity has become a pivotal component of every deal, and the companies operating in the sector are becoming irresistible targets. Valuations are soaring, and paying attention to cybersecurity action in 2022 will be necessary to keep abreast of the M&A development.

New York State Legislature to Consider the Proposed Fashion Sustainability and Social Accountability Act

New York Assemblywoman Dr. Anna R. Kelles and New York State Senator Alessandra Biaggi introduced the Fashion Sustainability and Social Accountability Act (“the Act”) on January 7th, 2022.

The proposed legislation, which currently remains in committee, would require footwear and apparel manufacturers, who have sales of at least $100 million a year and do business in New York, to map a minimum of 50% of their supply chain. This means companies would be required to gather information about their suppliers and their suppliers’ suppliers from the collection of raw materials to the manufacturing and distribution of products. The Act would require companies that fall within the proposed statute, like H&M and Nike, to identify their most significant social and environmental impacts related to unfair wages, energy consumption, greenhouse gas emission, and water and chemical management. The companies would also be required to disclose the volume of materials—such as leather or cotton—that they sell. Separately, the Act would require each company to draft and implement a proposal to reduce their most socially and environmentally damaging practices. The Act would require their plans to include compliance with the Paris Climate Agreement regarding carbon emissions. The data and reporting these companies are to provide would be made publicly available online.

While the Act is sure to be met with pushback and revision as it advances through the New York state legislative process, its current form offers interesting and innovative strategies for leveraging large corporations into more transparent and environmentally conscious business practices.

The Act targets large corporations who can afford to undertake the substantial costs associated with reporting copious information across their operations. It also allows smaller businesses in the fashion industry to innovate and compete efficiently without these additional operational costs. By imposing costs on big corporations related to their larger infrastructure, the Act may have the added benefit of providing smaller fashion companies with a comparative advantage in New York, a key fashion market for small, potentially disruptive players in the fashion industry.

The Act furthers transparency for inadequate working conditions. It requires large apparel and footwear companies to report and highlight their operations providing deficient pay or unacceptable conditions, potentially leading to improved conditions for workers due to—or in fear of potential—public outrage. In addition, it requires the businesses that fall within the statute to contemplate and effectuate their plans for a more sustainable future.

While concerns about the potential economic impact of this piece of legislation are important to consider, New York City’s primacy in the fashion industry and public support for environmental initiatives will likely disincentivize companies from leaving the state. Large fashion corporations might be tempted to stop doing business in New York. Still, these financial interests are likely outweighed by the prominence of the New York fashion market combined with the current cultural focus on climate change. American consumers are interested in investing in and supportingcompanies committed to sustainability and mitigating their environmental impact. This is demonstrated in the present context by the reluctance of potentially affected brands to speak out against the Act. Whether, in practice, corporations can avoid these disclosures without public backlash remains to be seen.

The Fashion Sustainability and Social Accountability Act is an exciting piece of proposed state legislation that, if successful in its aims, could provide a blueprint for regulation at both the state and federal levels of other industries with large supply chains and lasting environmental impacts.

How Artificial Intelligence Impacts Marginalized Communities

In a world where bias is everywhere, it’s impossible to achieve true neutrality. This is true for even seemingly neutral developments in technology that have no inherent concept of bias. Because we live in a world fraught with systemic inequality and racism, the technologically powered machines humans have created are engrained with the very biases that perpetuate racist and discriminatory notions of thinking. In this article, I seek to discuss the bias that exists in modern Artificial Intelligence (AI) technology, the consequences of such bias, and possible solutions presented by experts in the field.

There is no doubt that AI has its benefits. Many of its creators and adapters saw the “potential to stimulate economic growth [by way of] increased productivity at lower costs, a higher GDP per capita, and job creation.” AI is also regularly used in the education, housing, employment, and credit industries. Furthermore, AI has been used to “revolutionize our approach to medicine, finance, business, media and more.” While all of this is positive news for world advancement, it would be irresponsible to ignore the bias that already exists in these industries, which in turn, creates biases in the AI systems that they implement. Some experts knew that AI would inherent our discriminatory practices which negatively affect people in marginalized communities on a fundamental level. In Olga Akselrod’s article, How Artificial Intelligence can Deepen Racial and Economic Inequities, she shares that “rather than help eliminate discriminatory practices, AI has worsened them — hampering the economic security of marginalized groups that have long dealt with systemic discrimination.” An example of this bias is given by Khari Johnson who wrote an article for Wired, A Move for ‘Algorithmic Reparation’ Calls for Racial Justice in AI. In that article, Khari shares how “algorithms used to screen apartment renters and mortgage applicants disproportionately disadvantaged Black people [due to the] historical patterns of segregation that have poisoned the data on which many algorithms are built.” It feels impossible to create neutral technology when humans have bias seeped into the DNA of our culture. The Federal Trade Commission writes that a further consequence of this bias in healthcare is that “[technological advancements] that [were] meant to benefit all patients may have [also] worsened healthcare disparities for people of color” and as a result, “the economic and racial divide in our country will only deepen.” Every industry that uses AI is affected by this bias and must do the work to make sure that they are not only aware of how it affects communities of color, but also take active steps to curtail its effects. 

Fortunately, experts have suggestions to address this problem. Prior to addressing solutions, I would be remiss to ignore the reality that the vast amount of people in the technology industry is cis-gender white men. Rashida Richardson, one of the few women of color in the tech space, explained that “AI can benefit from adopting principles of transformative justice such as including victims and impacted communities in conversations about how to build and design AI models and make repairing harm part of processes.” Richardson advocates for an inclusion that positively impacts the algorithms. I would further advocate that the makers and users of AI technology begin to actively and purposefully ask marginalized people to share their expertise and experience on all levels– from intentional focus group participants to becoming co-creators and co-implementers of the technology.

Other experts in the field share the following solutions to ending bias in AI technology. Andrew Burt offers a potential solution to ending bias in AI technology and argues that the first step to fixing this problem is to start by “looking at a host of legal and statistical precedents for measuring and ensuring algorithmic fairness.” By this, he means looking at U.S. laws in other areas like civil rights, housing, health care, and employment to understand how these sectors have attempted to tackle discrimination problems and as a model for AI. Burt acknowledges the complexity associated with completely eliminating discrimination but further urges industries and businesses to 1) carefully monitor and document all their attempts to reduce algorithmic unfairness and 2) generate clear, good faith justifications for using the models they eventually deploy. A common concern around these solutions is that it gives businesses that use AI too much of a choice to either implement these solutions or not. Luckily, the Federal Trade Commission (FTC) is working to tackle this by implementing laws like Section 5 of the FTC Act, The Fair Credit Reporting Act, and The Equal Credit Opportunity Act. Each of these laws are attempts to address this issue from a legal standpoint. The FTC effectively puts weight behind Burt’s solutions by making it clear that if AI  implementers fail to hold themselves accountable, they should be prepared for the FTC to do it for them

In the end, the best solution is Richardson’s proposal to invite victims and impacted communities into the conversations around building and designing equitable AI models. As an individual affected by the biases in AI tech, Richardson acknowledges and understands the importance of inclusion. She believes that this involvement is vital if experts aim to devise creative solutions that help avoid as much harm as possible towards marginalized groups.


One of America’s Largest Energy Markets May be on a Path to Its Reckoning

In February 2021, an icy cataclysm struck deep into the heart of Texas.  As citizens struggled to combat severe weather conditions, wholesale prices for electricity spiraling upwards to $9/kWh (for comparison in 2020, wholesale electric supply prices in Texas hovered around 2.2 cents). The chief culprit for the spike was the decline in supply caused by natural gas plants that went offline when they succumbed to the harsh weather conditions that battered the state. In response to this failing, Texas passed SB 2 & 3 which provide for the weatherization of power generation, natural gas facilities, and transmission facilities against extreme conditions.

Additionally, the legislation also provided for governance reforms to the Electric Reliability Council of Texas (“ERCOT”), the overseer of Texas’ peculiar energy market. Many citizens were quick to blame the system operator which has uniquely operated without any direct federal oversight since the foundation of its predecessor in 1941. Since 2000, it has overseen Texas’ deregulated energy market that largely operates according to basic supply-and-demand principles. Post-storm, it has faced major criticism and lawsuits for its handling of the situation that ultimately left millions of Texans without power. In September, Richard Glick, the newly appointed chairman of the Federal Energy Regulatory Commission (“FERC”), took aim at the autonomy of the ERCOT. Glick has called Texas’ arrangement “very short-sighted” and promised to consider recommendations that would bring Texas’ mammoth energy market in line with those around the country.  While Texas’ oil pipelines that supply fuel to generators are generally exempt from FERC oversight, the FERC has alluded to pending investigations of pipeline operators for market manipulation.

These remarks may have been well-heard by the Texas Public Utilities Council (PUC). At a recent meeting, the PUC agreed to explore the possibility of setting a reliability obligation for all load serving entities. Such a reform would create a market for stand-by generation that the grid operator would call upon to perform during periods of high demand on the delivery system. Stand-by generation is typically not compensated by prevailing market prices at dispatch but rather by ‘capacity payments’ set on a roughly annually basis by the grid operator. While critics contend that the imposition of capacity payments, would unduly inflate the consumer cost of electricity and subsidize inefficient assets, supporters say that they would mitigate the widespread blackouts and exorbitant bills that Texans experienced.

As temperatures begin to drop around the country, some fear that Texas is still not prepared for cold winters ahead. The imposition of reliability obligations that clash with the philosophical underpinnings of the Texas market is still speculative and the effects of the recent legislation will not be immediately felt.  The legislature did not mandate that the weatherization requirements of SBs 2 & 3 be implemented until 2023. Because the legislation limited weatherization to only ‘critical’ natural gas wells and pipelines responsible for supplying power plants, regulators must go through the painstaking process of cataloguing such before regulators make asset owners responsible for upgrades.

The irony of America’s energy hub being unable to serve its citizens basic needs may be too much for its citizens to bear once more. In 2011 economists at the Dallas Federal Reserve estimated that it would cost between $85 million and $200 million annually to winterize Texas plants – less than 1% of the annual revenue of the Texas gas industry. On January 2nd, a cold front in West Texas caused gas production to plummet 25% before rebounding. For many Texans, the lingering clouds of energy worries will persist unnecessarily until a more permanent solution is found.

The Metaverse Creates a Multiverse of Legal Concerns

The idea of a virtual world straight out of Ready Player One is rapidly becoming a reality. Whereas the Internet today is largely a 2D platform, the metaverse opens the door to a 3D online experience whereby users could partake in more life-like experiences, potentially turning what was initially a novelty entertainment technology into a major facet of modern life. Metaverse-equipped VR headsets in public could become commonplace. Meta Platforms, Inc., formerly Facebook, rebranded itself in October 2021 to pivot and capitalize on the burgeoning virtual reality (VR) and augmented reality (AR) market. For his part, Apple’s CEO Tim Cook said it will be a critical part of his company’s future as well.

Wall Street has taken notice of this latest development. Since the Meta rebranding was announced, Meta’s share price has gained 6.7% and Apple’s 18%.

Even governments are hopping on the metaverse bandwagon. South Korea’s ministry of science, for example, even formed its own metaverse partnership and could roll out phase one as early as this year. However, there are legal implications and concerns across all corners of the metaverse.

Users’ virtual avatars present new, intersecting issues of intellectual property, fraud, and “meta-personhood.” For example, what sort of ownership rights do creators have over avatars in the metaverse, and where is the line between developing a creative avatar and false representations or illegal impersonations? This likewise raises, and complicates, the question of whether avatars can serve as legal representatives. Metaverse companies have an interest in keeping people in the metaverse for as many hours a day as possible. Avatars being able to be legal representatives for dealmaking, legal proceedings, and processes requiring a unique person could encourage a greater presence and commerce in the metaverse, perhaps creating an entire market of “m-commerce.” However, substantial concerns exist over our ability to verify avatars as legal representatives. Someone could detrimentally rely on the promise of an impersonator of a real-life person using an avatar – and who will enforce metaverse agreements is a whole other puzzle.

Jurisdictional and accompanying bureaucratic matters are also a major concern of the fledgling metaverse landscape. As mentioned above, if an issue arises over a meta contract, whether over potential impersonation of a party or over its substance, it is unclear who has jurisdiction over those issues. Furthermore, taxation could quickly become complicated. If a user obscures their real-world location and makes purchases in the metaverse, local governments may need to fight to collect sales taxes, as many did for Amazon sales.

Additionally, the matter of what behavior is permissible implicates civil and criminal enforcement across the globe. For example, in a video game, destroying virtual environments can be part of the entertainment experience, and would likely continue to be so, in some contexts, within the metaverse. However, outside of entertainment contexts, destroying metaverse property using AR/VR tools could be comparable to destruction of real property. New metaverse crimes are certain to arise, and they may be impossible to predict until they occur. Outside of meta-crime, the metaverse could create problematic consequences for the real world. For example, if another user flashes strobing lights while a user with epilepsy is using a VR headset, that could cause serious medical consequences in the real world.

The creation of the metaverse results in a regulatory vacuum, not unlike the vacuum created by the Internet itself. Governments slowly figured out solutions to some of the legal issues posed by the internet, such as sales taxes. However, the plethora of unresolved questions of online governance indicate that certain regulatory vacuums were never fully addressed. While many characterize the metaverse as a potential way for people to escape from reality, it seems likely that the metaverse may simply trade one set of legal concerns for another.

The Significance of the Nvidia-Arm Merger and the FTC’s Move to Block It

Since Nvidia’s announcement to acquire Arm in late 2020, regulators have lined up to investigate and prevent the deal. Besides the recently-announced US Federal Trade Commission effort to block the merger, the two companies also face formal investigations by the EU, the UK’s Competition and Markets Authority, and agencies in South Korea, Japan, and China. While this effort by one of the biggest semiconductor firms in the world to purchase a significant computer chip designer was always expected to draw scrutiny, the current scenario must be regarded by proponents as close to the worst possible case.

Both Nvidia and Arm are major parts of the global semiconductor industry. Semiconductors and the chips made with them have brought ever smaller, cheaper, more efficient, and more durable computers. Over recent decades, they have become indispensable not only for the usual applications in engineering and telecommunications, but increasingly for many aspects of transportation, manufacturing, medicine, and entertainment. The Covid-19 pandemic, by interrupting global supply chains and causing prolonged chip shortages, has brought a great deal of attention to the crucial role of semiconductors in almost every major sector of the economy. For example, the shortage of chips is one of the main reasons car prices have risen so precipitously over the last year.

Although both companies are crucial in this sensitive global industry, they are critical for distinct and perhaps complementary ways. Nvidia is best known for GPUs—graphics processing units—that were originally associated with computer gaming. Over the last decade, however, they have found a use in almost every powerful computing project, from machine learning to cryptography. Arm, on the other hand, specializes in microprocessors and through the license of its chip designs, supplies approximately 90% of the world’s smartphones with crucial components. Nvidia and Arm have tried to use these distinctions to defend the merger from antitrust criticisms, emphasizing that they are not competitors. While this is essentially true, the deal is still a classic example of vertical integration. Such integration can potentially have social benefits, but its anticompetitive and monopolistic tendencies are also well known.

The potential for the deal to negatively impact market competition hinges on Arm’s unique role in the industry. For much of its thirty-year history, the firm has functioned as the “Switzerland” of microprocessors: Arm designs the chips and licenses them widely to companies like Google, Apple, and Microsoft, usually as part of ongoing support and development relationships that involve the exchange of sensitive or even proprietary information. This means the merger could potentially allow Nvidia to drive down its own costs in sourcing vital technology, but also to strangle its most powerful competitors by gaining valuable non-public information through their previous dealings with Arm.

The FTC’s suit also represents a pivotal moment in American politics that, for all its importance, is ultimately independent of the sensitive particulars of the semiconductor industry. President Biden’s nomination earlier in the year of Lina Khan was a significant moment: Khan is not only (as widely reported) a critic of Big Tech and the youngest FTC chair in history, but even more fundamentally, a scion of the new antitrust movement that has been brewing in neglected corners of the American left for over a decade. This movement sees the post-Watergate Democratic turn against antitrust enforcement (especially in the case of vertical mergers) and policy as the hidden key to modern politics—not to mention many contemporary economic and social problems. They are especially eager to avoid repeating the antitrust mistakes of the Obama administration. Khan’s nomination was thus seen as a somewhat surprising victory for progressives in a particularly substantive area. The FTC’s suit against the merger is Khan’s first major action as chairwoman and has enormous significance for the movement’s efforts to fundamentally transform American antitrust policy.

Nvidia and Arm have already fought back hard against these challenges. Together the two companies argue that the merger will not end Arm’s commercial neutrality, but rather save the stagnant firm from an unforgiving capital market and opportunistic “asset strippers.” More positively, they assert that the deal will drive technological innovation by developing the complementary strengths of the two companies. This could lead to more efficient data centers and even advancements in the new field of edge AI. While it is hard to believe that Nvidia would not, sooner or later, regardless of promises to maintain Arm’s neutrality today, try to use the merger against its competitors, it may well also be true that an IPO would be disastrous for Arm’s current business model or long-term independent survival. And certainly, the potential for complementary development is real. Whatever their outcomes, the deal and the FTC’s suit have enormous significance for the future of this crucial sector.


Challenge and Opportunity in The Global Lithium Rush

The global lithium rush is on. Governments and consumers are concerned about climate change and looking to reduce carbon emissions from public transit systems and vehicles, especially personal vehicles. Whether electrifying these sectors is the best way to address their role in climate change remains a serious policy question, but to a significant extent, governments, markets, and consumers have already decided: people should drive electric cars, ride electric buses, and carry out delivery by electric trucks.

There are currently two major technologies that could power this new infrastructure: lithium-ion batteries and hydrogen fuel cells. Both have significant advantages and disadvantages, but for high frequency, short distance, low volume consumer/retail use, lithium-ion batteries are usually the better option. This is due to the significantly greater energy efficiency of the technology in such applications. Hydrogen cells, by virtue of their greater energy density, are likely superior in longer range and higher volume shipping. But for the most part, further technological and infrastructural development is required before they can seriously challenge the emerging role of lithium-ion batteries in most markets.

Unsurprisingly, these developments are driving a major increase in global lithium demand. Many analysts expect the compound annual growth rate of the global lithium mining industry to run at 5-7% for much of the coming decade. Australia and China have been leaders in the industry for the last several years, but as demand grows, new players are emerging everywhere, seeking to develop new sources of the precious element. Much of this attention is focused on the so-called “Lithium Triangle.” Straddling the borders of Chile, Bolivia, and Argentina, is thought to hold a significant—even perhaps, outright majority—share of the world’s total lithium reserves.

Development of this region faces a number of challenges at the intersection of finance, politics, and environmentalism. Argentina hopes to capitalize on its vast reserves and challenge its neighbor, Chile, which is the leading South American country in the industry. On the other hand, Argentina has faced decade-long economic problems such as continually high inflation, a shifting regulatory apparatus, and relatively high taxes on mining investment. Additionally, there are important issues of public investment, political control, and environmental damage to address.

The strategic-diplomatic significance of lithium and the industries involved in extracting and processing it is also growing. China is the largest electric vehicle market in the world, and Chinese corporations dominate much of the supply and production chain of electric vehicles and their batteries. As the US and China grow more confrontational across the entire spectrum of their complex relationship, this reality adds a level of strategic state competition to what would have been a fierce economic one regardless. Recent supply chain issues, precipitated in large (if not exclusive) part by the COVID-19 pandemic, have also caused more Americans to consider the value of redundancy—and even sovereign control—in the matter of global production and transportation of vital goods and commodities. Such concerns only complement the growing salience of “reshoring” in American political discourse.

Considering the surging market for and growing strategic competition over access to lithium, the recent bidding war between Lithium Americas and Contemporary Amperex Technology Co. Ltd. (CATL) over the Argentine firm Millennial Lithium is especially significant. The Chinese-based CATL, a massive recent growth story, controls approximately a third of the global electric vehicle battery market. Lithium Americas, meanwhile, is a Canada-based company developing mining projects in Nevada and Argentina. Millennial, which had been working on a major lithium claim near Lithium Americas’ own Argentine project, was an attractive expansion opportunity for both companies. Jon Evans, the CEO of Lithium Americas, specifically cited the strategic aspect of the industry as a possible advantage to his company in winning the contest: “This transaction is a lower regulatory risk than CATL or another Chinese company. Like it or not, there’s critical mineral strategies by the US, Canadian, and Australian governments that could have played a part in this.”

The issue has come to the US as well. Lithium Americas also seeks to develop what it claims could become the biggest lithium mine in the world in rural northern Nevada. This development would provide fuel for the US’ own decarbonization goals, position it strongly in a strategic global industry, and do so on American soil with American jobs. It may even be indispensable for some of these important goals. But it would also threaten the local environment, and potentially the interests of ranchers and indigenous people. Indeed, Thacker Pass already looks set to provoke another high-profile legal and political fight in the vein of those over the Keystone and Dakota Access pipelines—only this time, over a flagship green technology. Ultimately, there are no easy answers to the questions posed by the global rush for this “white gold.”

A German Perspective of U.S. Fiduciary Duties

In the United States and Germany, fiduciary duties play a major role on different levels. In the U.S., fiduciary duties’ main justification is in providing protection to shareholders amidst the separation of ownership and control. Therefore, shareholders generally do not owe fiduciary duties to each other. In Germany, a broader rationale applies, i.e., limiting the general powers of influence as well as possibilities of influence of basically everyone within a company. Consequently, every shareholder generally owes fiduciary duties.

In U.S. law, fiduciary duties were early framed as a “punctilio of an honor the most sensitive”. Meinhard v. Salmon, 249 NY 458, 464 (N.Y. 1928). Likewise, in Palmiter, Partnoy, and Pollman’s Business Organizations (3rd ed.), fiduciary duties are characterized as the “’golden rule’ in business firms”. Id. at 23. Overall, fiduciary duties are applied to protect those who delegate power and authority to someone else. They divide into the duty of care and the duty of loyalty. In a partnership, every partner owes fellow partners fiduciary duties. This is different in corporations where shareholders are generally not considered to owe each other fiduciary duties.

In German law, however, fiduciary duties are a compression of general contractual obligations, which may impose duties to act, to promote, to refrain harm from, and to be loyal to the company and the shareholders. Overall, they exist regardless of the type of company. This may result in shareholders having to actively exercise their statutory rights. However, it is controversial what the overall rationale of fiduciary duties is. The predominant view is that these duties are essentially required to limit the general powers of influence and possibilities of influence of someone on the rights and interests of others. Their content and scope depend on the individual circumstances, such as the articles of association, the purpose of the company, or the structure of the association.

Why are U.S. and German law different in that regard? One central reason may be that in the U.S., prevailing atomized shareholder structures do not require any legal obligations among shareholders, which is decisively different from the German background. German corporations have traditionally had strong majority shareholders with fewer free-floating shares. Consequently, the minority had to be protected from the majority.

At the same time, the German approach is somehow similar to the rationale underlying fiduciary duties in the U.S.: although shareholders do not delegate authority and power among each other, both jurisdictions generally regard shareholders as an essential target of protection. Under U.S. law generally, the influence and potential harm is the point of attachment of fiduciary duties. Unsurprisingly, it is the influence on the company which justifies controlling shareholders to owe fiduciary duties. But it has to be considered that even a minority shareholder may use her statutory rights and authority, i.e., influence, over the rights and interests of fellow shareholders. Overall, shareholder influence is materially the same regardless of the controlling nature, which is why even the influence of a minority shareholder may require some limitations.

Fiduciary duties among shareholders, then, may constitute a potential tool to protect shareholders and the company from other shareholders. This can be illustrated by the King v. Mylan deal. Mylan Pharma. intended to buy King Pharma. and Mr. Icahn, a major shareholder of Mylan, opposed because he believed the offered bid for King was too high. To avoid this, Mr. Icahn stopped the deal and a shareholder of King named Perry Corp. bought nearly 10 % of Mylan. This conciliated enough influence on the general meeting. Perry subsequently entered into a swap with a bank that did not bear any economic risk or benefit of the shares. As a consequence, Perry remained formally the shareholder with voting rights, but the position was economically emptied out.

The sole purpose of Perry’s actions was to rule out Mr. Icahn. There was no consideration of whether the deal was beneficial for Mylan or other shareholders. Assuming the deal was overall not beneficial for Mylan, Perry’s actions ultimately harmed not only the company but also Mr. Icahn. Fiduciary duties in this case potentially could have stopped Perry from voting in favor of the deal; it would generally be obliged to promote, to refrain harm from, and to be loyal to the company and its fellow shareholders.

In sum, there is room to think about fiduciary duties among shareholders in a U.S. context. Because all individual circumstances determine the extent and scope of these duties, an appropriate and balanced application is ensured. Likewise, shareholders being bound by fiduciary duties in a non-controlling context may only impose legal obligations in exceptional circumstances, as in the exceptional Mylan v. King deal.

As Pressure on Japanese Corporate Boards Rises, the Legal Uncertainty Around Corporate Defenses Stands Out

Corporate governance in the world’s third-largest economy is at an inflection point. Facing an influx of foreign and domestic activists in their shareholder registers, Japanese boards are pressured to explore what defenses are legal. Unfortunately for them (and their lawyers), the Japanese courts have done a poor job of clarifying what is OK and what is not.

On October 29, 2021, the Tokyo District Court upheld Tokyo Kikai Seisakusho’s exclusion of Asia Development Capital (ADC), a 40% shareholder, from voting at the shareholder meeting. This ruling, which was supported by the Tokyo High Court and Japan’s Supreme Court, is not yet publicly available. But one Tokyo-based corporate lawyer who received the opinion on a confidential basis lambasted the District Court’s reasoning. The opinion read that “it cannot be summarily said that in light of the relevant circumstances, it was unreasonable to leave the judgment whether corporate value or collective shareholder interests would be harmed to the decision of the shareholders affected.” The decision reportedly does not refer to precedent or statute, nor does it spell out what circumstances wouldn’t be enough to exclude a shareholder.

The circumstances in the Tokyo Kikai case were as follows. TSE-listed ADC is a Chinese-controlled entity with an admittedly shady reputation that includes past securities fraud, murky ownership, and unclear business operations. It had rapidly built up a 40% stake over warnings from Tokyo Kikai and failed to offer a management plan to the company’s board. Under Japanese law, with more than 33% ownership, ADC would have veto rights over important board decisions. Sensing danger, Tokyo Kikai convened a special shareholders meeting to vote on implementing a poison pill, and it decided to exclude ADC from that vote. After failing to obtain an injunction in court, ADC conceded to reduce its stake to 32.7%, just below the 33% threshold.

The Japanese courts have been loath come up with a clear rule on corporate defenses. The only Supreme Court case to ever consider poison pill-like defenses, Bull-Dog Sauce (2007), is disappointingly vague, and its value as precedent is questionable. In that case, sauce manufacturer Bull-Dog Sauce’s board attempted to ward off a takeover by U.S. private equity fund Steel Partners by proposing an option dividend that could be exercised by all shareholders except Steel Partners. Unlike a traditional poison pill, Steel Partners would receive cash compensation if the options were exercised, effectively forcing it to cash out as a shareholder. As many as 83.7% of the Bull-Dog Sauce shareholders (virtually every shareholder other than Steel Partners) voted for the proposal, and the U.S. investor went to court for an injunction.

Steel Partners lost. The highest court ruled that the discriminatory dividend did not violate the principle of shareholder equality (Article 109 of Japan’s Companies Act) because it was reasonable. The court reasoned that the interests of shareholders depend on the continuance and development of the company, and when these are threatened by a particular shareholder, discriminatory treatment of that shareholder to protect the other shareholders’ interests is not per se unreasonable. Shareholders must decide whether a particular shareholder is a threat to corporate value, and their decision, if informed and made through proper procedures, must be respected. Since 83.7% of the shareholders had voted in favor of the board’s proposal, they had evidently determined that Steel Partners was a threat, so the defensive measure was legal.

Bull-Dog Sauce involved unusual facts unlikely to recur. In its wake, the poison pills that Japanese companies adopted did not involve cash payments to compensate hostile acquirers. What little the case did suggest is that boards should obtain shareholder ratification of defensive measures, given how much value the Bull-Dog Sauce court assigned to the shareholder vote in that case. Thus, in contrast to Delaware, where boards can independently adopt pills, Japanese boards typically obtain shareholder approval before implementing defensive measures. To illustrate, a Tokyo court recently struck down a poison pill because it was implemented without shareholder ratification.

With Japan, Inc. more threatened than ever before, the need for clarity is at an all-time high. After a record amount of shareholder activism last year, 2021 is shaping up to be an even more eventful year for Japanese boards. Probably the biggest recent highlight was Toshiba’s decision to unwind its conglomerate structure after years of shareholder pressure, adding another chapter to the rollercoaster Toshiba saga of rigged shareholder votes, collusion with government officials, and the CEO being shown the door. Another highlight is SBI’s ongoing hostile takeover attempt for Shinsei Bank, one of the country’s largest banks. The trend of rising activism in Japan is unlikely to reverse course, and one hopes that the country’s courts will address the need to clarify what corporate defenses are legal.

Amidst Industry Volatility, The Fed Fires a Warning Shot Over ‘Meme’ Stocks

Casual observers, traditional retail stock traders, and financing industry professionals alike were off-guard as “meme stocks” surged in value after blocks of retail investors eschewed traditional notions of investing in favor of fun. Meme stocks—securities that experienced rapid volatility stemming from social media—took their place in the cultural zeitgeist after thousands of investors poured support into struggling companies such as Gamestop (GME) and AMC Entertainment Holdings (AMC). Though these stocks were expected to return to their “real” value, “meme-flated” prices have left an impact. A recent November 2021 Federal Reserve report cautions that the rise of meme stocks could pose risks to future financial stability.

Traditionally, stock prices are expected to reflect the value of the company and its future cash flows. This was certainly true for GME and AMC. These publicly traded companies were on thin ice even before the pandemic, amid the decline of brick-and-mortar store and the rise of streaming services. The pandemic caused these companies even sharper losses. Accordingly, bearish hedge funds bet against GME and AMC using options because their share values were low and their core businesses were still struggling. However, these funds recoiled when Gamestop and AMC’s stock prices surged 1,700% and 840%, respectively, late this past January.

AMC and GME shot up due to social media chatter, most notably in the subreddit r/WallStreetBets. The popular Reddit forum provides communication channels for novice stock traders to collectively get behind in certain stocks, regardless of public factors indicating lack of profitability. While many expected meme stocks to be only a fad, that has not been the case. Now, the Fed is paying attention – and warning investors.

The Federal Reserve’s biannual financial stability report published earlier this month directly addressed this trend. The report noted the impact thus far on the markets has been minimal. However, it also highlighted that the GME and AMC short squeezes indicated several trends that could create “broad financial instability.”

First, meme stocks could pose risks to vulnerable investors. While the rise in meme stocks has been driven by young and social media-savvy trading novices, younger investors may wind up bearing the bulk of the negative consequences. The Fed’s report noted that investors with greater debt (including a high percentage of younger investors) are left more vulnerable by large swings. The increased use of “options,” whereby investors can bet on the value of a stock at cost, tend to amplify losses. This leaves younger investors particularly susceptible to sizable swings caused by their peers’ erratic social media chatter.

Second, the Fed likewise warned that elevated risk appetite among retail investors could lead to wider trepidation if the relationship between traditional retail investors and social media continues to become more unpredictable. No one wants to be the next Melvin Capital (a hedge fund that bet against Gamestop during its meme-fueled rise and experienced a 46% loss in the first half of the year). Social media investors’ lack of predictability may incentivize traditional retail investors away from taking risks, driving prudent investors out of the market. Third, the Fed warned that risk management systems lacked calibration for such episodes, noting how this sharp volatility “may require further steps to ensure the resilience of the financial system.”

Despite the Fed’s warnings, the market’s reaction has been to try to ride out the meme-stock wave rather than to try to quell it. Undaunted by the seemingly unpredictable nature of social media stock surges, some have tried to quantify and forecast social media “hype.” In March, Buzz Holdings created an exchange-traded fund called the VanEck Social Sentiment ETF (BUZZ) that tracks the performance of stocks receiving social media hype. The index uses language algorithms monitoring broad social media sources to examine whether comments are positive, negative, or neutral and ranks the stocks based on sentiment and prominence in discussion. BUZZ has not yet proven to be a crystal ball for the next meme stock. Nevertheless, the project demonstrates the industry’s awareness of the potency of meme stocks and its early attempts to predict social media discourse and its effects on share prices.

The Fed’s report confirms that market watchers and financial institutions will likely be on the lookout for market volatility due to social media attention. In turn, the industry’s reaction demonstrates that, despite the Fed’s warnings, it wants to capture the value in that volatility. Predicting the next Gamestop may prove elusive – but doing so could be the name of the game.