Proxy Access Revisited: Viability of Rule 14a-8

Monday, February 23rd, 2015

On July 22, 2011, the U.S. Court of Appeals for the D.C. Circuit vacated Rule 14a-11 in the case of Business Roundtable and Chamber of Commerce v. Securities and Exchange Commission. However, the court’s decision does not end the proxy access debate. On September 6, 2011, the Securities and Exchange Commission (the “SEC”) announced that it would not appeal the D.C. Circuit’s ruling, but instead would reinstate its amendments to rule 14a-8. Effective on September 14, 2011, the SEC adopted an amendment to Rule 14a-8 to prohibit companies from excluding proxy materials shareholder proposals seeking to establish procedures for director nomination or election.

As amended, Rule 14a-8 allows eligible shareholders to establish proxy access standards on a company-by-company basis, rather than the universal, mandatory approach under Rule 14a-11. While companies can still exclude shareholder proposals to remove directors or include specific nominees in the company’s proxy statement, shareholders now can submit for inclusion in a company’s proxy materials a proposal to amend the company’s governance documents to provide for proxy access or that requests the board of directors of the company to implement proxy access. Rule 14a-8 established a channel to enable proxy access, whereby shareholders with 1% of a public company’s shares or $2000 ownership for 1 year are eligible to submit a proposal relating to director elections. Since its amendment, there has been heated debates on the viability of Rule 14a-8 to facilitate private ordering in proxy access.

Would Rule 14a-8 Facilitate Proxy Access?

The major concern is that the SEC staff’s interpretation of Rule 14a-8 in practice would not give shareholders meaningful access to private ordering. One scholar, Gabriella Wertman, has argued that Rule 14a-8 does not facilitate proxy access because the SEC staff application of Rule 14a-8 precedents results in an easy-to-manipulate, systematic advantage for management that effectually strips shareholders of any meaningful opportunity. Drawing on the shareholder proposals in 2012 proxy seasons, Wertman supported her argument that a majority of proposals were challenged by management and then rejected by the SEC no-actions letters. Similarly, another scholar, Robert Jackson, worried that the SEC staff’s adherence to long-standing Rule 14a-8 precedents could give corporate management opportunities to exclude shareholders’ proxy access proposals by providing conflicting proposals.

Recently, the no-action letter issued to Whole Foods Market Inc. seems to have confirmed these concerns. The SEC seems to have allowed corporate management to exclude conflicting proxy access proposals under Rule 14a-8(i)(9) “if the proposal directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting”. It is the first time that the SEC staff decided that corporate management could exclude shareholders’ proxy access proposals under Rule 14a-8(i)(9) due to an alternative proposal by the company. Further, it has been suggested that corporate management could also exclude shareholder’s proxy access proposal when the company has already substantially implemented the proposals under Rule 14a-8(i)(10).

No-Action Letters Issued by the SEC in 2012, 2013 and 2014

To verify Rule 14a-8’s viability to facilitate shareholders’ participation in director nomination, the no-action letters issued by the SEC are the sole sources of data. We obtained data from Division of Corporation Finance 2012, 2013 and 2014 No-Action Letters issued under Rule 14a-8 and searched for [75] companies that received proxy access proposals. A study of the no-action letters relating to proxy access proposals during the proxy seasons of 2013, 2013, and 2014 shows the following:

Table 1. No-Action Letters in 2012, 2013 and 2014

  2012 2013 2014 (till August 31)
Proxy Access Proposals 24 23 28
No-Action Requests 15 8 2
The SEC Staff Decisions 11 rejections

4 withdrawals

4 rejections

4 withdrawals

1 rejection

1 withdrawal

Proposals Voted On 8 15 26
Majority Votes 2 4 7

In the 2012 proxy seasons, 15 out of 24 proxy access proposals submitted by shareholders were deemed excludable by the SEC staff based on drafting errors under Rule 14a-8 precedents. Among 11 rejections, five proposals were vague and indefinite regarding specific eligibility requirements, three proposals were conflicting, two were repetitive and one supplied incorrect information. Shareholders corrected these problems in the proposals submitted for the 2013 proxy seasons, and rejections from the SEC staff were reduced to only four proposals. The proxy access proposals made to the ballot double that of the 2012 proxy season. Among four rejections, three were vague proposals and 1one conflicting proposals. Among four majority votes, two out of four were from management proposals in 2013. In 2014, the trend continues. Only two no-action requests were made against 28 proxy access proposals, among which one was failure to satisfy stipulated ownership requirement. The number of proxy access proposals excluded by no-action requests plummeted in the 2014 proxy season, and the number of proxy access proposals from shareholders with Rule 14a-11 Formula received majority votes also doubled compared with 2013 proxy season. Importantly, three out of seven proxy access proposals were replaced by management proposals.

After 2012, the no-actions letters data supports that Rule 14a-8 no longer imposes technical barrier for shareholders’ proxy access proposals to make it to the ballot. In 2014, 26 out of 28 shareholder proposals were voted on at the ballot. Even though corporate management might have a systematic advantage to exclude shareholders proposals, Rule 14a-8 gives shareholders a chance to submit proxy access proposals and at least force corporate management to provide conflicting proposals at the ballot or substantially implement such proposals if corporate management wants to exclude shareholders’ proposals.



After shareholders adapted in 2012 to the drafting requirements under Rule 14a-8 precedents, Rule 14a-8 seems no longer pose a technical hindrance for proxy access proposals to make to the ballot. Public companies can still submit conflicting proposals or substantially implement similar proposals to reject shareholders’

Business as Usual? A Look at the Supreme Court Bar

Wednesday, February 18th, 2015

The United States Supreme Court evokes a sense of mystique and exclusivity among laymen and lawyers alike. Its front doors are locked, its proceedings are not televised, and its public plaza is not as open to the public as you might believe. A recent Reuters report shows that this exclusivity extends to the court’s functionality: the justices accept only a sliver of the petitions they receive each year. Moreover, Reuters discovered that 66 of the 17,000 lawyers who petitioned the Supreme Court between 2004 and 2012 were at least six times more likely to get their clients’ appeals heard by the court, and that those lawyers are also three times more likely to represent corporate or big business interests. Consequently, criticsargue that public and consumer interests are crowded out as the Supreme Court is reduced to an echo chamber—“a place where an elite group of jurists embraces an elite group of lawyers who reinforce narrow views of how the law should be construed.” Due to the dynamics of the legal market, effective representation of consumer, employee, or other individual interests against big business is unlikely.

Big business interests permeate the Supreme Court Bar. Sixty-six lawyers of the Supreme Court Bar account for less than one percent of lawyers who filed appeals to the Supreme Court, yet they were involved in forty-three percent of the cases that the court chose to hear between 2004 and 2012. This finding led Reuters to conclude that there is a new criterion to whether the court takes an appeal: the qualifications of the lawyer who is bringing it. Whether they were former clerks or personal friends, these litigators share a special relationship with at least one of the justices on the bench. Among these sixty-six lawyers, fifty-one also worked for law firms that primarily represented corporate interests. Criticsargue that because only businesses can pay for the best counsel that money can buy, consumer, employee, and other public interests are not effectively represented at the Supreme Court. In fact, in cases where consumer or employee interests were pitted against those of companies, “a leading attorney was three times more likely to launch an appeal for business than for an individual.”

Big business interests are entrenched in the Supreme Court Bar due to two interrelated reasons. First, the legal market rewards law firms that have a Supreme Court practice that caters to big business interests. Reuters defines big business as “companies that were listed in the S&P 1500 Composite Index, the MSCI All Country World Index, the Forbes list of largest private U.S. companies, and listings of foreign companies with more than $1 billion in annual sales.” Having your petition accepted by the Supreme Court is seen as a significant accomplishment in of itself, and law firms use this to their advantage as they search for new clients. When a law firm successfully represents a company in a Supreme Court case, the accumulation of goodwill generates more business for the law firm from the company in other legal matters. For example, Gibson Dunn earned over fifty million dollars in unrelated legal fees from Wal-Mart after it secured a victory for the corporation in a 2011 employment discrimination case. As Reuters explains, “[s]ecuring profitable, long-term relationships with America’s largest corporations is one reason major law firms began creating Supreme Court practices in the late 1980s and early 1990s.”

Secondly, many firms are barred from representing consumer and employee interests due to potential conflicts of interest. Ashley Parrish, a partner at King & Spalding, explained that, “[a]s a large national firm, we are generally conflicted from representing individuals and advocacy groups in litigation against corporations . . . [because] they are typically suing our clients or prospective clients.” Elite law practices have corporate clients whose activities are so broad and intertwined that lawyers simply refuse to take cases from consumers and employees due to conflicts of interest, whether they can be identified or not. “We do not take cases that could make negative law for our clients,” said Jones Day’s Glen Nager. Although large firms do take cases pro bono cases, those appeals are limited to criminal law or social causes that will not affect American business interests, such as gay marriage. Due to the specter of conflicting interests, elite law practices will generally pass on representing “environmental organizations, labor unions, employees suing employers, or consumers filing class actions.”

These business models encourage elite law firms to represent corporate interests. Consequently, consumers, employees, and other individuals who want to challenge large companies must “seek counsel from a pool of attorneys that’s smaller and, collectively, less successful.” This disparity of quality representation for business and nonbusiness interests will only exacerbate the court’s perceived corporate tilt. The justices point out that top advocates for consumer, employee, and other individual interests do exist. Chief among them are Jeffrey Fisher, who leads Stanford Law School’s Supreme Court clinic, and David Frederick, a former Supreme Court clerk and assistant solicitor general who remains a prolific advocate of consumer interests. However, clinics are a small counterweight, both in size and in influence. Secondly, Frederick is just one lawyer who handles at most a handful of Supreme Court cases a year—some of which as a lawyer for corporate interests.

The Supreme Court docket is dominated by cases brought by firms that commonly represent big business interests. Consequently, consumers who wish to sue corporations must rely on an even smaller pool of lawyers to handle their cases, most of whom are not as successful as those who represent corporate interests. These dynamics in representation only contribute to the court’s image as a business-friendly bench. Moreover, it creates a dampening effect where liberal advocates are “unwilling to bring certain cases to a conservative-leaning high court, fearing an unfavorable decision that would set a nationwide precedent.” Because they fear a Supreme Court reversal of decades-old precedents that favor consumer and employee interests, these advocates pass on the opportunity to represent civil rights and consumer cases. Effective representation of consumer, employee, and other individual interests are therefore rare and unlikely.

The Tax Planning Implications of President Obama’s Proposed Elimination of the “Step-up”

Tuesday, February 10th, 2015

In his State of the Union address on January 20th, President Barack Obama outlined a broad tax reform plan that would eliminate tax loopholes for wealthy individuals and corporations, thereby making more revenue available for state-provided education and childcare. In addition to increasing the total top capital gains and dividend rate to 28 percent and imposing a tax on lifetime gifts of property, the President’s plan would eliminate the “step up” in basis at death. The “step up” provision, which has long existed in the federal tax code, eliminates the capital gains tax on property transferred to a taxpayer’s heirs at his or her death. The provision accomplishes this by automatically raising a taxpayer’s cost basis in an asset (i.e., the price that the taxpayer originally paid to acquire the asset) to the asset’s fair market value at the time of the taxpayer’s death. The step up, while benefitting taxpayers, represents one of the tax system’s largest capital gains loopholes, allowing billions of dollars each year to escape taxation.

Eliminating the stepped-up basis will profoundly impact Americans’ tax liability and estate plan structuring. Part I of the foregoing analysis will illustrate how the stepped-up basis currently achieves tax savings. Part II will explain how eliminating the step up will change the way that trusts and estates attorneys advise clients. Part III will lay out the two methods available to Congress by which to close the loophole. Finally, Part IV will provide policy arguments supporting and opposing elimination of the step-up provision.

I.  The Step-up Provision in Action

To illustrate the mechanics of the “step up” provision, suppose that a grandfather purchased 1000 shares of Apple stock in 1989 at a price of $18 a share for a total cost (or “basis”) of $1800. In 2015, suppose that the stock’s value has increased to $100 a share, for a total value of $100,000. If the grandfather were to sell his shares in 2015, he would pay capital gains tax on the appreciation in the shares’ value, or roughly 20 percent of $98,200 (totaling a tax of $19,640). However, under current law, if the grandfather were to bequeath these shares to his granddaughter, their appreciation in value would be wiped out upon transfer. The granddaughter would effectively acquire the shares as though she had purchased them for $100,000¾the fair market value at the date of the grandfather’s death. If the granddaughter were to sell the stock in 2016 for $101,000, she would only be taxed on $1000¾the difference between the sales price and her stepped-up basis in the stock.

II.  Implications for Tax and Estate Planning

President Obama’s proposal would close the stepped-up basis loophole by treating bequests and gifts other than to charitable organizations as realization events, like other cases where assets change hands.Eliminating the stepped up basis would have far-reaching implications for Americans’ tax and estate planning. In the past, estate planning focused on high-net worth individuals making transfers during their lifetime to avoid the imposition of estate taxes. Today, with increased income tax rates and federal estate-tax exemption amounts, the focus of estate planning will increasingly be on the income tax, particularly the potential income tax savings from the ‘step-up‘ in basis under Section 1014. As such, one of the focal points of estate planning will be the proactive management of the tax basis of assets held by individuals and maximization of the ‘step-up‘ in basis. Experts generally recommend strategizing to hold certain assets until death to maximize the step-up. This move is especially important in high-tax states such as California, where the top combined federal and state capital-gains rate exceeds 35%. If a taxpayer domiciled in California has beneficiaries who live in one of the seven states that have no state income tax, then transferring the assets out of the estate during the taxpayer’s lifetime may be warranted.Consequently, trusts and estates attorneys will now need to ask clients two questions that were not previously significant: Where will you be domiciled at your death, and where are your beneficiaries likely to reside at that time? Estate planners and their clients will also need to consider the client’s life expectancy, the assets’ future return, future inflation, and the client’s expected income tax recognition at the date of death.

III.  Methods by Which to Close the Step-Up Loophole

Although the President’s plan calls for eliminating the step-up loophole by taxing gains at death, Congress could also accomplish the objective by carrying over the grantor’s basis to the grantee (i.e., “carryover basis”). For example, in the aforementioned illustration, the granddaughter’s basis in the inherited Apple stock would equal $18 per share, the same as the grandfather’s basis. The argument for adopting carryover basis is that postponing tax until an actual sale of the property avoids the need to appraise the property and imposes tax at a time when the taxpayer is likely to have cash available to pay the tax. The arguments for taxing gains at death are that it appropriately limits the maximum deferral possibility to a single lifetime; it enforces the principle that income should be taxed to the person who earned it; and it imposes a tax at an ideal time in terms of ability to pay (because the decedent has no use for the amount due as taxes). However, legislators would likely not consider implementing carryover basis, as past Congresses have resoundingly rejected it due to exceeding administrative costs and difficulties. Whichever solution is adopted, both are potentially plagued with proof of basis problems, and would require heirs to present records and receipts that may no longer exist. The question also remains as to whether donors or heirs would pay the tax on gains. Likely, the donors would be taxed, as their income level is generally higher than that of their heirs,’ and taxing them would yield greater revenue to the fisc.

IV.  Policy Arguments Surrounding Eliminating the Step-Up

Defenders of the stepped up basis have justified retaining it on the grounds that it is “paid for” by the estate tax on the asset’s appreciation. They also argue that taxpayers have reasonably relied on the forgiveness of capital gains tax at death in acquiring and retaining appreciated property. To change the rules now would violate reliance by retroactively imposing a tax,although this could be resolved by grandfathering assets owned by current taxpayers or through a gradual annual phase-in.In addition to equity concerns, supporters reason that the step-up encourages savings and investment in industry, which spurs the economy on a macro level. If the step-up were eliminated, for example, taxpayers would have less money to spend and invest.

Opponents of the step-up counter this argument by reasoning that eliminating the provision would in fact level the playing field for the middle class. Most middle class taxpayers spend down their assets during retirement and pay capital gains on any gain accrued, whereas wealthier taxpayers can afford to hold onto assets until death. Although eliminating the step-up would reduce the capital available to taxpayers, it would encourage more charitable contribution as a means of reducing tax. In response to the problem of proof of basis, opponents claim that it is relatively easy to value highly liquid assets such as stock or even real property. Moreover, the President’s plan accounts for the burdens of valuation and reporting by excluding from taxation appreciated tangible personal property other than expensive art and similar collectibles. Yet despite these justifications, opponents’ strongest argument may be that the step-up provision creates a “lock in” effect that decreases economic productivity. By incentivizing taxpayers to hold onto their assets, resources are prevented from moving to their most productive use. Capital often remains tied up for years in stocks, buildings, or land. This lock-in effect persists over time, as wealthy heirs who have no need to sell inherited assets will continue to hold them, thereby exacerbating the national wealth disparity.

Convincing arguments exist on either side, yet whether the President’s proposal gains traction may depend upon the exemption per individual from the capital gains tax. The White House fact sheet stipulates that taxpayers would receive an exemption of $100,000 per individual and $200,000 per couple. Thus, donors would not need to pay anything until the amount bequeathed exceeds those thresholds—however, they would need to track those gifts. While foreclosing the personal property equivalent of the fee tail may be a socially beneficial goal, difficult administration and higher transaction costs (in the form of valuating, reporting, and restructuring existing estate plans) may lead many middle and upper-middle class earners to disfavor the plan.

Should the SEC allow corporations to prevent shareholder access by offering a conflicting proposal that is unlikely to assist shareholders in nominating and electing directors?

Tuesday, February 10th, 2015

Recent events have given the SEC an opportunity to review whether it will allow corporations to rely on the conflicting shareholder proposal provision of Rule 14a-8(i)(9) to exclude shareholder access proposals. Given the important effects of increasing shareholders’ role in nominating and electing directors, the SEC should not allow corporations to exclude a shareholder access proposal by offering a management proposal that, while similar, would apply to so few shareholders that it will not effectively increase shareholder access.



In the 2011 case Business Roundtable v. SEC, the D.C. Circuit vacated SEC Rule 14a-11, which required corporations to include board candidates proposed by shareholders who owned 3% of the corporation’s stock for three years on the corporation’s proxy statement (what is known as a “shareholder access” rule). While the Business Roundtable decision prevented the SEC from implementing a mandatory shareholder access rule, many believed that shareholders could implement similar rules on a company-by-company basis via Rule 14a-8, which allows shareholders to include certain proposals in the corporation’s proxy materials. However, such proposals may be excluded for 13 reasons listed in Rule 14a-8(i), one of which is that the shareholder proposal conflicts with a management-sponsored proposal. As early as 2012, corporate governance scholars predicted that corporations could rely on this ground for exclusion to effectively prevent shareholders from instituting a shareholder access rule via Rule 14a-8.

In 2014, Whole Foods received a 14a-8 proposal that mirrored Rule 14a-11. In response, the Whole Foods board proposed a shareholder access bylaw that only applied to shareholders who owned 9% of the corporation’s shares for 5 years and sought a no action letter from the SEC. The SEC issued a no action letter on December 1, 2014. However, on January 16, 2015 Mary Jo White, Chair of the SEC, announced that the SEC was retracting the no action letter, placing a moratorium on issuing similar no action letters to the 49 corporations who had a pending application, and referring the issue to the SEC Division of Corporation Finance for review. This episode provides the SEC with an opportunity to consider the costs and benefits of shareholder access proposals and recalibrate its approach to granting exemptions based on the conflicting management proposal exclusion.


Shareholder access is an effective way to reduce agency costs and increase corporate value.

Shareholders, who for most large American corporations are geographically dispersed and hold diversified portfolios of investments, suffer from rational apathy and collective action problems. Both of these problems incentivize shareholders to remain passive in the management of the corporation. This is relevant for shareholder voting and especially for the election of corporate directors because without the threat of shareholders voting them out of office, directors have an incentive to engage in activities that are in their best interests rather than those of the corporation (known as “agency costs”). From a normative perspective it is desirable to reduce agency costs, which are inefficient and reduce the societal value of corporations. And one of the best ways to reduce agency costs is to make it easier for shareholders to replace underperforming directors.

In response to these problems, corporate law has created a mechanism that allows shareholders to nominate board candidates and solicit votes for those candidates by sending a proxy statement to fellow shareholders. However, in order to circulate a proxy statement the shareholder must jump through numerous costly procedural hurdles. Thus, the proxy rules place an additional impediment in the way of a shareholder who wishes to elect someone to the board of directors, which only increases rational apathy and collective actions problems. For this reason, a rule that allows certain shareholders to place their own candidates on the corporation’s proxy statement is desirable because it would make it easier to replace directors, which in turn would reduce agency costs and increase the equity value of corporations.

However, there are some problems with shareholder access rules. In addition to the costs of corporate compliance, one prominent concern is that restricting the rule to shareholders who own 3% of the corporation’s shares for three years would shift a dangerous amount of power into the hands of institutional investors — the only investors large enough to be likely to have a 3% stake in a large corporation — who would not necessarily further the best interests of the corporation. This is not as much of a problem as it appears at first glance because in order for candidates to make it onto the board, they have to be elected by the shareholders and current directors would certainly make it clear to shareholders if proposed candidates are unlikely to act in their best interests. Thus, in the aggregate, shareholder access rules are beneficial and the SEC should protect the ability of shareholders to implement them.


How should the SEC treat future attempts to exclude shareholder access proposals?

Given that a shareholder access rule would be “a useful tool for shareowners that would benefit both the markets and corporate boardrooms,” the pertinent question is whether the SEC should allow management to thwart such a proposal by relying on the conflicting shareholder proposal exemption. The purpose of this exemption is to prevent shareholder confusion where a shareholder proposal is substantially similar to a management-supported proposal. However, when corporate management proposes a shareholder access rule like the one proposed by Whole Foods, the Board’s goal does not appear to be to implement a similar proposal, but rather to block the shareholder’s proposal with one that, even if implemented, would be ineffective at allowing shareholders to nominate board candidates via the corporation’s proxy statement. This is because the threshold is so high that it is unlikely that many shareholders could actually take advantage of it and, knowing this, shareholders (or, more realistically, their proxies) are unlikely to vote for it. Thus, to allow corporations to exclude a shareholder access proposal under the conflicting shareholder proposal exemption would “expand[] [the] exclusion way beyond its original intent.” For this reason, such a proposal does not reflect the underlying reason for allowing corporations to exclude a proposal under the conflicting shareholder exemption and the SEC should not allow the board to exclude a shareholder proposal with a lower threshold that is more likely to be met.

If the SEC wants to continue to allow shareholder access rules on a company-by-company basis — rather than, for instance, creating a mandatory opt in rule of shareholder access — it should not allow corporations to exclude shareholder access proposals in cases similar to that presented by Whole Foods where it appears that the Board is trying to “game” the system. While the question of how close the thresholds proposed by the board and by a shareholder must be to qualify for the conflicting shareholder proposal exemption still remains, the SEC should at a minimum not issue a no action letter where the threshold used in the board’s proposal is more than double that proposed by a shareholder. Furthermore, because of the importance of shareholder access, especially as the economy continues to recover from the recent recession, where the SEC is unsure as to whether or not to allow a corporation to exclude a shareholder access proposal, it should defer to the shareholder.

Insider Trading Liability in the Wake of Newman: Limitations on Remote Tippee Liability

Sunday, January 25th, 2015

Trading in public stocks using non-public, material information acquired from a third party brings the risk of insider trading liability. However, liability for traders who receive insider information (“tippees”) but are not associated with the leaking of that information is a currently developing area of law. On December 10, Justice Barrington Parker of the Second Federal Circuit decided the appeal of US v. Newman, a criminal case against two portfolio managers who had traded on tips received through their personal and professional contacts containing non-public information about publicly traded companies. The defendants, Todd Newman and Anthony Chiasson, were found guilty of insider trading at trial in the Federal District Court and appealed their conviction.

Legal Standard and Newman’s Innovation

Interpreting Dirks v. SEC, the Government argued at trial and on appeal that the standard of criminal liability for tippees in insider trading prosecutions was that the tippee must have known that the information they traded on was spread to them by the original tipper after that tipper breached a confidential relationship by sharing the information. Justice Parker did not accept the government’s argument, and instead ruled that “to sustain an insider trading conviction against a tippee, the Government must prove [. . . that] the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit, [and that] the tippee knew of the tipper’s breach.

Here, Justice Parker shifted the focus of the liability analysis from the relationship of trust and confidence between the tipper and their company to the personal benefit received by the tipper as a result of sharing the information. Further, Justice Parker created a requirement that the tippee have known of the personal benefit the tipper received in exchange for the information. In a recent interview, defense attorney Ralph Sicilianostated that he believed this new requirement is significant because it necessitates that the government show that the tippee had actual knowledge of such a personal benefit, which may not be inferred by a court .

Reasoning of the Court

Beginning with the proposition affirmed by Dirks that “nothing in the law requires a symmetry of information in the nation’s securities markets,” Justice Parker wrote that there must be some distinction between non-public information that can be traded on and that which it is illegal to trade on. The Supreme Court has established, in both Dirksand Chiarella v. United States, that “insider trading liability is based on breaches of fiduciary duty, not on informational asymmetries.” Further, when that relationship is breached, liability flows from tipper to tippee; “[t]he test for determining whether the corporate insider has breached his fiduciary duty ‘is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty.’” Following this reasoning, Justice Parker saw a need to establish scienter in criminal tippee defendants, and did so by requiring that defendants have actual knowledge of each element required to prosecute the tipper, including that the tipper breached their relationship of confidence in return for personal gain.

The Court also notes that, although insider trading prosecutions have been vigorous in the past years, the tippees in Newman were more remote from the tipper than in any previous case. The Court criticized the Government for pursuing such remote tippees and observed that the Government’s recommendation of law “gives precious little guidance to all these financial institutions and all these hedge funds out there about a bright­line theory as to what they can and cannot do.” The Court appears to believe that the Newman and Chaisson prosecutions were overzealous.

Open Questions in the Wake of Newman

First, in response to Newman, federal prosecutors have attempted to distinguish its holding from another ongoing insider trading case where the tipper was an attorney for IBM., While introducing the background law of insider trading and its development, Newman discussed the complementary theories of classical and misappropriation insider trading. However, in its analysis, the Court appeals primarily to Dirks, a classical case, and Newman is a classical fact pattern. Prosecutors argue that this is a meaningful distinction, and that the Newman holding does not bind misappropriation cases. The Government made this argument on January 12 in a hearing in the “IBM prosecution” of a group of traders who had traded on information tipped by IBM’s attorney, making the information misappropriated instead of classically leaked by a company insider. Although the District Court has not issued a ruling on the matter, in light of the Circuit Court’s analysis it does not seem likely that the distinction will be found meaningful. To apply this distinction would cause liability for remote tippees to be determined by how the information was released when the tippee had no consistent means of gathering that information which would be inconsistent with the Circuit Court’s goal of limiting liability to more directly-involved tippees.

Second, there is a question of whether there is a “sufficient suspicion” standard. In what appears to be dicta, the Court in Newman describes the information that was received by the defendant tippees, and notes that the type of information that was received was such that it may have been available from a variety of sources, and that “no rational jury would find that the tips were so overwhelmingly suspicious that Newman and Chiasson either knew or consciously avoided knowing that the information came from corporate insiders or that those insiders received any personal benefit in exchange for the disclosure.” Although Justice Parker went no further, this analysis suggests that some level of blatant suspicion would be able to satisfy the requirement that tippee’s know that the information was leaked in exchange for a personal benefit. This language appears to contradict the earlier holding that the Government must show actual knowledge, and it remains to be seen whether courts will expand or restrict this opportunity for prosecutors to avoid establishing actual knowledge.

Finally, there is a question of whether Newman impacts the standard in civil enforcement cases. The SEC brings both civil and criminal cases as part of its insider trading enforcement program. Traditionally, in a civil case, intent or mens rea is not an element, and so the Court’s reasoning regarding scienter is not as compelling. Courts may not interpret Newman to require the same actual knowledge in the tippee for civil cases. Siciliano indicated that there is arguably a higher bar for civil cases now, but it remains to be seen.

Newman is the Second Circuit’s latest effort to clarify the law on insider trading for downstream tippees, and although there are a few remaining outstanding questions, it provides clarity and is especially helpful for defense attorneys.

The Ninth Circuit Reconsiders Last Year’s Controversial Copyright Decision

Sunday, January 25th, 2015

On December 15 of last year, the Ninth Circuit Court of Appeals sat en banc to reconsider Garcia v. Google, one of the most controversial copyright decisions in recent memory. Earlier, in February, a three-judge panel headed by then-Chief Judge Alex Kozinski bucked copyright law traditional wisdom by holding that film actors have a copyright interest in their performances independent of the filmmakers’ interest in the unitary whole. If upheld, the decision could have wide-ranging consequences for the many millions of people involved with or affected by the American film industry, from actors and directors, to movie studios, to third-party content distributors like YouTube, to ordinary consumers of entertainment.


In 2011, Cindy Lee Garcia was hired to play a role in an adventure film set in ancient Arabia tentatively titled Desert Warrior. She filmed her scenes over the course of three-and-a-half days and did not hear anything more about the project until June of 2012 when she saw the footage being used in the now famous video Innocence of Muslims on YouTube. Mark Basseley Youssef, the filmmaker who had hired and directed Garcia had, without her knowledge, edited and partially dubbed her performance into what was now an extremely controversial and offensive anti-Muslim film insulting the Prophet Muhammad. The video incited violent reactions throughout the world, and Garcia herself received several death threats as a result.

Garcia issued several takedown notices to YouTube, which were ignored by its parent company Google. She then sued Google in federal court, claiming that the video’s continued existence was a violation of her copyright interest in her individual performance and seeking both a preliminary and permanent injunction ordering the company to stop hosting the video. The District Court denied Garcia’s petition for a preliminary injunction, holding that she was unlikely to succeed on the merits of her copyright claim. But, in an opinion much criticized by both industry representatives and law professors specializing in intellectual property, the Ninth Circuit reversed and that Garcia’s performance likely constituted an original work of independent creation protected under the Copyright Act. YouTube then removed the video, per the court’s order.

Potential impact on creators, users, and third-party distributors

Garcia’s attorneys stress in their arguments that this is a unique case. In the vast majority of situations, actors either enter into an explicit contract with a written instrument that lays out their rights and obligations with regards to the film or provide the filmmaker(s) with an implied exclusive license to use their copyrighted performance for the purpose of their film. Here, however, Garcia argues that her implied license extended only to the Desert Warrior film she believed she her performance would be used for, and Youssef’s fraud resulted in her never giving up her independent copyright over her performance.

The danger with this argument that the District Court and others have brought up is that the plaintiff provides very little in the way of a limiting principle. In theory, Garcia’s argument and Judge Kozinski’s opinion could stand for the premise that any actor who feels that their performance was misused, or that they were misled by a filmmaker, has a potential cause of action for copyright infringement.

The implications also extend beyond merely film actors.  The Ninth Circuit’s reasoning potentially applies to any of the hundreds of individuals who contribute their work to any large-scale film production, as well as similar contributors in the record industry, and individuals whose “performances” are captured in amateur videos uploaded to YouTube. Filmmakers, movie studios, record studios, distributors, ISPs, and music/video hosting websites will all have to deal with a veritable avalanche of copyright claims and takedown notices from individuals who, previously, were never thought to have had copyright interests in their contributions due to the work-for-hire doctrine or implied licenses. This enlarging of copyright contemplated by the Ninth Circuit panel’s opinion could lead to massive cost increases for the entertainment industry, both on the back end (costs associated with expanding their notice and takedown compliance systems, as well as increased amounts of litigation) and the front end (increased transactions costs associated with having to negotiate licenses with thousands of contributors for whom licenses would previously have never been necessary). And it is very likely that these new costs would eventually be passed onto the consumer, both through higher prices on entertainment and through less entertainment ultimately being produced.

What next?

Thankfully, it appears that Ms. Garcia and Judge Kozinski have taken a minority position on this issue. Only one amicus brief submitted to the Ninth Circuit for its en banc review (the one prepared on behalf of the Screen Actors Guild) sided with Garcia, while ten side with Google and YouTube (including two of the amici submitted by groups of law professors). The en banc panel also appeared largely hostile to Garcia’s position during oral arguments. Thus, it appears likely that the original panel’s opinion, and its dangerous expansion of copyright protections to individual performances, will be overturned.

Possible Legal and Business Consequences of President Obama’s Stringent Net Neutrality Approach

Monday, January 5th, 2015

On November 10th, 2014, President Barack Obama called on the Federal Communications Commission (FCC) to enforce more stringent measures to protect net neutrality on the Internet. Net neutrality entails treating all Internet traffic equally and not giving selective benefits or preferences to one over the other. The President urged the FCC to treat broadband service providers as common utilities providers under Title II of the Telecommunications Act of 1934, which would mean that the Internet service providers cannot “restrict the best access or to pick winners and losers in the online marketplace for services and ideas.” The purpose of these measures, as President Obama suggested, would be to protect a “free and open Internet.”

Background and History of Net Neutrality Laws

 In fact, the FCC had previously enacted net neutrality laws for broadband Internet providers in 2010. Verizon sued the FCC right away and an appeals court struck those laws down on the basis that the FCC cannot enforce them without classifying broadband Internet service providers as common carriers under Title II of the Telecommunications Act. Such reclassification would impose an array of new federal regulations on the broadband providers, and the FCC declined to take such steps in 2002 by categorizing broadband Internet as “information service.” This removed broadband providers from Title II’s coverage. The current Chairman of the FCC, Tom Wheeler, attempted to create a middle-of-the-road approach, but this would have allowed Internet service providers to divide broadband into fast and slow lanes, essentially limiting access for groups of users.       

 Continuing Contentious Debate Over Net Neutrality

The controversial debate over net neutrality has centered on the FCC’s preparation for creating an official guideline, which was originally scheduled for late 2014 but may be postponed to early 2015. As President Obama took a clear side on the contentious issue, some have fiercely backlashed against the proposal of placing broadband under Title II regulation of the Telecommunications Act. The Telecommunications Act already strictly controls phone services, but it may be expanded to cover Internet providers in the future. A Republican FCC member, Cisco Systems Inc. and Intel Corp. stated that President Obama’s strong net neutrality laws would bring lengthy litigation. Ajit Pai, the Republican commissioner, voiced his concerns that the proposed laws would bring “years of regulatory uncertainty” and “serious damage to our nation’s broadband market.” AT&T Chief Executive Officer Randall Stephenson mirrored the prospect of uncertainty, stating that “whether it’s AT&T or not, somebody will litigate that outcome. So we are two, three years down the road before you get any clarity.” Congressional Republicans continue to oppose President Obama’s planned regulation.

President Obama Chooses the “Nuclear Option”

In accordance with the appellate court’s decision, President Obama urged the FCC to reclassify broadband providers as a common carrier utility under Title II of the Telecommunications Act. Without taking this step first, the FCC legally cannot prevent ISPs from controlling access to legal content, throttling different types of Internet traffic, and prioritizing paid content online. This is called the “nuclear option” because “it would set off a legal and legislative fight on a scale that hasn’t been seen in the tech policy world in decades.” The behemoth service providers, such as Comcast and Verizon, will expend [a] tremendous amount of resources to fight the government over the legality of these regulations. President Obama’s statements have already triggered a flood of lobbyist and advocacy e-mails, signaling and foreshadowing the major legal battle that will follow. In response to President Obama’s proposal, Chairman Wheeler essentially stated that the FCC needs more time, quoting it “must take time to get the job done correctly, once and for all, in order to successfully protect consumers and innovators online.”

Social Policy Arguments Surrounding Net Neutrality

The latest events bring us back to the foundational question of the debate: why does net neutrality even matter? Why is it such a controversial matter in our country today? Supporters of net neutrality argue that Title II regulation would create “free and fair flow of traffic” on the Internet, where all users have equal access to content. It would be a superior protection of the consumers who do not have as much power. On the other hand, opponents assert that such a drastic shift would stifle investments in the broadband infrastructure and new services. This would in turn limit broadband providers’ abilities to support high volume traffic and limit innovation in technology.

The debate over net neutrality laws involves important concepts from both business and law. The major broadband providers have already used business and legal ideas to speak out against the proposed Title II movement. Verizon stated that the reclassification would apply for the first time the “1930s-era utility regulation to the internet,” which would “threaten great harm to an open Internet, competition and innovation.” Although it is a shift in law and regulation of broadband providers, numerous companies believe that the potential effect on the business flow of Internet is one of the most problematic issues. AT&T’s executive vice president Jim Cicconi said that such reclassification would do “tremendous harm to the Internet and to U.S. national interests,” while Comcast’s executive vice president David Cohen argued that it would “reverse nearly a decade of precedent, including findings by the Supreme Court.”

At the other end of the spectrum, the senior director of federal policy for consumer advocacy group Consumers Union, Ellen Bloom, lauded the President’s statement by saying that “we do not want industry gatekeepers to pick winners and losers on the Internet.” Bloom’s statement illustrates the difficult tension involved in net neutrality laws. The government wants to protect consumers from being untreated fairly or be limited in their access to online content, but it also has to worry about the chilling effects of the law on the business of broadband providers. We do not want to stifle innovation and development. It is a delicate balance between protection and development.

The decision now lies in Tom Wheeler and the FCC’s hands. The President has made it clear what his position is, and now the FCC must decide if it wants to move forward with the significant change of including Internet service providers under the Telecommunications Act. Perhaps the optimal solution might be to examine what incremental steps we can take towards improving net neutrality. Perhaps this could alleviate the downside risks of the including broadband providers under Title II of the Telecommunications Act, while moving us in the right direction to consumer protection.

Legal Services for Startups: Toward a Web-Based Form System Business

Tuesday, November 25th, 2014

In a 2013 article, Forbes identified 10 Big Legal Mistakes Made By Startups. These include breakdowns in documentation, ignorance of tax consequences, and choice-of-entity issues. Significantly, the article concludes by naming “not having the right legal counsel” as a serious problem for startup companies. Strapped for cash, startups often hire discounted and inexperienced legal counsel from among friends and relatives. Instead, Forbes advises conscientious startups to research and vet potential counsel, retaining attorneys or law firms that have experience in “some, if not many” of the following areas: contract law, employment law, IP law, real estate law, tax law, franchise law, and corporation, commercial and securities law. Perhaps not surprisingly, Forbes does not suggest that startups hire in-house legal counsel.

In his article How Do Startups Obtain Their Legal Services, Darian Ibrahim explores the reasons why many startups choose outside counsel – like the sophisticated full-service firms recommended by Forbes – instead of bringing legal services in-house. Ibrahim’s empirical survey identifies two reasons why startups favor outside counsel: a) early-stage startups cannot justify the expense of an in-house attorney, and b) outside counsel can offer “more coverage” (i.e. more relevant expertise) than in-house. However, Ibrahim’s study also reveals that a minority of startups do choose to hire in-house counsel, for two main reasons: (a) in-house counsel is perceived to have lower information asymmetries about their business, and (b) in-house counsel often demonstrates greater responsiveness and increased monitoring capabilities.

Beyond the Binary of In-house and Outside Counsel 

Ibrahim’s study was one of the first to examine issues of in-house legal representation in the context of startups. However, framing a startup’s legal options as a binary choice between in-house counsel and outside representation ignores several other options for a startup’s legal support. As Ibrahim notes, most companies that use in-house counsel also retain outside counsel, including full-service firms. Furthermore, the choice between hiring in-house and retaining experienced representation may be inapplicable to the youngest and most vulnerable startups; Ibrahim’s study only examines startups that are backed by at least 5 million dollars in venture capital, a sensible limitation that nonetheless excludes alternatively funded companies and nonprofits. These other entitiesmay be financially unable to retain quality counsel, to say nothing of a salaried in-house attorney. (Although Ibrahim explores the possibility of compensating in-house attorneys with stock options, only 6.3 percent of participating startups used this method of compensation, a method that nonprofit startups lack entirely.)

Furthermore, the most socially conscious among for-profit startupsmay be hit hardest by this binary thinking; while not-for-profits are well positioned to obtain grants and pro bono legal services, social enterprises and other for-profits with social or charitable aims may have less access to these resources. For these reasons, the startup community may benefit greatly from the development of cheaper, more direct access to legal services in the early stages of their organizations.

Alternatives for Legal Service: the Form System   

To this end, the startup community should further explore the use of a kind of legal self-help called the form system. In his article The Legal Spark, 78 UMKC L. Rev. 455 (2009), Jeff Thomas references the proprietary form systems used by Silicon valley law firms to counsel young startups and help them develop into sophisticated organizations. While these form systems are currently proprietary to law firms, Thomas proposes that a hypothetical Foundation acquire and develop one such form system and make it available online. The Foundation would also provide “starting point documents,” teach legal and economic strategies, and provide annotations with background and explanatory content to accompany both the documents other counseling content. Thomas emphasizes that this system would be tailored to a specific kind of organization undergoing a particular series of developments, rather than a “collection of random legal information and forms.” Although Thomas’s proposed system focuses on venture capital-backed startups, it is not difficult to imagine form systems developed for other kinds of startups, such as nonprofits, social enterprises, and sole proprietorships. These systems might be housed by the same hypothetical Foundation or perhaps by separate foundations.

A Web-Based Form System Business 

The vehicle that Thomas proposes to make form systems accessible to startups is his Foundation – presumably a charitable foundation functioning as part of the not-for-profit community. However, it may be easier and more efficient to provide startups with a well-maintained form system through the use of a form system business. A business–perhaps charging a monthly access fee or a fee-per-service –  may be particularly well positioned to efficiently compile, manage and distribute form systems. Since, as Thomas imagines, this information could be made available online, a form system business could provide access to legal advice with low overhead, passing its savings on to struggling startups.

Furthermore, as a web-based service provider, a form system business could be national in scope. This is particularly significant in light of concerns about startup attorneys engaging in rent-seeking. In his article Startup Lawyers at the Outskirts, Abraham J.B. Cable describes a growing perception of startup attorneys as engaged in a distinctive practice that combines legal services with civic engagement and support of local economic development. Although he sees the role of specialized startup lawyers as a positive one, Cable expresses concerns about such lawyers developing rent-seeking cottage industries by trying to recreate the conditions that made them successful in early startup communities like Boston and Sillicon Valley. A national, web-based, form system business could ameliorate this concern by shifting focus from communities of specialized lawyers and relocating it to startups, regardless of location. In addition to providing legal services at lower fees, such a company could employ lawyers for legal support and complex issues, but prevent the enterprise from creating a cottage industry for them.

In sum, a web-based form system business could fill a niche in the legal market for low-cost counseling to startups. Furthermore, it could provide this counseling without incentivizing rent-seeking by attorneys or creating a false dichotomy between in-house and outside counsel.

Occupational Licensing: Protecting the Public or Enriching the Entrenched?

Tuesday, November 25th, 2014

Are you at risk from a rogue interior designer? If requirements to be known as a “Certified Interior Designer” are anything to go by, the State of New York believes you might be. To use that title, New York requires applicants to pay a fee of $377, accrue “at least seven years of acceptable education and experience credits,” and pass a three section test known as the National Council for Interior Design Qualification Examination. Fees for this exam can approach $1000, without factoring in any costs for prep materials.

New York’s law was passed in 1990. At the time, supporters warned that without the law, interior designers would continue to suffer from a “lack of credibility” and the public would be vulnerable to “anyone [who] could go hang a shingle and call themselves an interior designer . . .” New York is not alone. 26 states, plus Puerto Rico and Washington, D.C., have interior design laws, with more legislation introduced each year. New York’s law is a “title act,” governing who is permitted to use the phrase “certified interior designer,” but not preventing those without the title from practicing. Other jurisdictions, including Nevada and Washington, D.C., have gone further still by enacting “practice acts” which require anyone wishing to practice interior design to obtain a license first.

It is not just interior designers. The number of professions requiring licenses has exploded from 5% in 1950 to around 30% today.  Discussion of this surge in occupational licensing can often be fodder for light-hearted pieces, with seemingly obligatory references to retail florists (Louisiana requires a $50 fee and passage of a written exam before one can “arrange and sell floral designs, cut flowers and ornamental plants”) or shampoo specialists (Texas requires 100 hours of study on the “theory and practice” of shampooing), and of course a good bit of that 30%  may be desirable licensing of health care workers and the like.

However, as Sophie Quinton points out in National Journal, other occupational licensing requirements make less sense, and can have serious consequences, particularly when they end up “targeting mostly minority women and their businesses.”

Quinton writes about Salamata Sylla, an African hair braider originally from Senegal who now lives in Kent, Washington. State regulators informed Sylla that in Washington, like in many other states, one seeking to operate an African hair braiding business must obtain a cosmetologist’s license. To get this license, Sylla would have to accrue 1600 hours of education at a community college or trade school and pass an exam.

As the Institute for Justice points out, in many instances these mandatory education requirements for hair braiders can devote little or no time at all to actual hair braiding.  For example, Wyoming requires 1000 hours of education to become a licensed hairstylist but dedicates just 1 percent of that educational time to teaching how to braid hair. Missouri requires 1500 hours of education to become a cosmetologist and defines how 1030 of these hours are to be spent. Not one of the 1030 is devoted to braiding hair. This education, unhelpful as it may be to an aspiring hair braider, does not come cheap. The same IJ report found that cosmetology courses meeting state licensing requirements routinely charge between $10,000 and $20,000. Though the Washington Department of Licensing now cites a miscommunication in Sylla’s case and no longer intends to force her to obtain a license, Sylla intends to maintain her lawsuit challenging the restrictions. Plaintiffs have won similar challenges in seven other states.

Regulations like these, which lock some out of the labor market are not harmful to everyone. Indeed, those already in the club can benefit immensely. A study by Morris M. Kleiner and Alan B. Krueger found that occupational licensing can raise wages by around 15%. This is not necessarily reason to cheer. Kleiner warns that this could actually exacerbate inequality, with the well-off having their choice of higher-cost services, while lower income individuals, some of them immigrants like Sylla, are left with fewer options and higher barriers to entry to break into their chosen fields. Krueger, the former head of President Obama’s Council of Economic Advisers, points out that this is only a small part of the overall problems facing the country, but agrees that occupational licensing is “a bit run amuck”, and that there are “too many restrictions for entry.”

The International Interior Design Association asserts that “[i]t’s easy to see why such regulation is necessary both for public safety and the enrichment of the interior design profession.” Perhaps so, and we ought to be more worried about the wellbeing of the residents of the 24 states currently without interior design laws. Perhaps, however, we should focus more on the second half of that statement, and question just who is being enriched by occupational licensing requirements, and at what cost.

In My Mind and In My Car: How the Alliance of Artists and Recording Companies suit against Ford is using old copyright law to solve new industry problems

Sunday, November 16th, 2014

You cannot teach an old dog new tricks – but you might be able to use old laws to solve new problems. The music industry consistently complains about the lack of profits from new technologies, just look at Taylor Swift’s record label, Big Machine Records recent decision to pull their music off of Spotify for the lack of royalties. Set against this background one organization is using a law from 1992 aimed at a niche area of technology to sue car companies who are earning money off of the American public’s love for music. In July, the Alliance of Artists and Recording Companies (AARC) sued Ford and General Motors in a Washington D.C. District Court for the failure to register devices installed in several models of their cars and pay subsequent royalties under the Audio Home Recording Act of 1992 (AHRA). AARC is represents “featured recording artists and sound recording copyright owners […] in the areas of hometaping [sic]/private copy royalties and rental royalties.AARC was formed specifically to collect and distribute AHRA royalties to featured recording artists and owners of the copyright to sound recordings (mostly record companies).

What is AHRA?

AHRA was reached as a compromise to a two-decade long controversy in Congress over home recording that began in the early 1970s. In 1989 the Congressional Office of Technology Assessment (OTA) explained that, “[t]oday’s consumer electronics allow the average citizen to make very good copies of recorded music. […] home copying is becoming much more common.” John H. Gibbons, Director of the OTA explained that, “Copyright owners are concerned, and claim that home copying displaces sales and undermines the economic viability of their industries.” Furthermore, the OTA study found that 4 in 10 Americans over the age of 10 had tape recorded music in 1988 alone and that, “much of this home audiotaping was for the purpose of copying music from records or compact discs to audiocassettes to be played in the car or in portable cassette players.”

In 1992, AHRA was passed as a way to place financial liability directly on the manufacturers of the devices which are used to do this kind of home recording since it would have been too difficult and cumbersome to try and hold individuals liable for their copyright violations. AHRA “does not broadly prohibit digital serial copying of copyright protected audio recordings. Instead, the Act places restrictions only upon a specific type of recording device,” and how the act defines what devices it applies to is the issue at question in the AARC’s lawsuit.

What is the AARC Lawsuit About?

The basic allegation made by AARC in the complaint they submitted to the court is that General Motors and Ford included devices known variously as the Ford “Jukebox” and the GM “Hard Drive Device (HDD)” in over half a million vehicles, and that these devices fit the definition of a Digital Audio Recording Device (“DARD”) and are therefore subject to AHRA.

The applicability of AHRA is based on a series of nested definitions in the first section of the Act that outlines what kinds of devices are covered by it. AHRA requires royalty payments and registration for all Digital Audio Recording Devices. The act defines a DARD as “any machine or device of a type commonly distributed to individuals for use by individuals, whether or not included with or as part of some other machine or device, the digital recording function of which is designed or marketed for the primary purpose of, and that is capable of, making a digital audio copied recording for private use.” Basically, a device is a DARD if it is marketed or designed for the primary purpose of (and is capable of) making a digital audio copied recording, which is a reproduction of a digital music recording, which is a material object with fixed sounds that are not only spoken words, and in which no computer programs are fixed.  The aim of AHRA was to limit serial, ongoing at home copying. If that capability exists, it strengthens the plaintiffs claim for relief, and if not the connection becomes more tenuous.

Why Should I Care?

Technology entrepreneur Mike Masnick in his blog Techdirt claimed that the effort by the AARC to obtain royalties from car companies is simply an effort by the music industry to avoid, “searching for new business models to make money, but rather … default[ing] to new ways to squeeze money out of others through legal changes or lawsuits.” Masnick is not wrong on all accounts—the AARC lawsuit is indeed an effort to squeeze money out of the car industry and these device manufacturers—but what he ignores is the fact that the money may very well belong to the music industry in the first place. The fact remains that devices like the Ford Jukebox and the GM Hard Drive Device are inherently an effort by car companies to capitalize on their customers’ love of music. By installing these devices in their vehicles, they are acknowledging that car buyers are interested in having music at their fingertips as they drive, while still avoiding the need to keep CDs and other media constantly on hand. Ford and GM include these devices in their cars because they believe consumers want them there and they will pay to have them. However, in 1992 Congress decided that companies making money from exactly these kinds of devices could only do so if they shared some of the wealth with the music industry. Ford and GM are profiting from car owners’ love of music, and if they want to do so they have to pay the required royalties to the artists who create that music.

Where Does This Leave Us?

If Americans value the continued production of music it is vital that our laws protect musicians and their representatives. The AARC’s lawsuit, while not a slam dunk—is grounded in sound legal reasoning. AHRA was an obsolete law almost as soon as it was passed. Copyright law has a hard time keeping up with technological change, and it is often artists who lose out the most. If the AARC lawsuit can use an old law—whose target technology no longer exists—to solve a modern problem, they can and they should.