Some thoughts on the Ellison settlement

As Christine Hurt notes, the story of Larry Ellison’s $100 million payment to settle his California derivative insider trading suit hasn't gotten the attention it deserves.

The bottom line is that Ellison, having won dismissal of a Delaware derivative suit based on the same alleged insider trading incident, decided to settle in California, obviously to avoid the risk of higher damages there.  Rather than pay the money to the corporation, to the ultimate benefit of shareholders, obviously including Ellison, the money will go to charity.

There are several interesting issues here.  I’m not going to rehash the basic insider trading charge.  And since I haven’t seen the California complaint, I could be getting basic things wrong about the case.  But here goes:

1. The case raises an interesting issue about who is damaged, and how much, by insider trading. What's wrong, if anything, with insider trading, is that it can be a theft of corporate property. It follows that the damage would be to the corporate entity, just as with any corporate opportunity or similar theory.  See my article, Federalism and Insider Trading, 6 Supreme Court Economic Review, 123 (1998). This suggests that a derivative remedy is not only appropriate, but is the only appropriate remedy.  But it's hard to see how damage to the corporation gets close to 100 mil on a non-fanciful theory. So the money may as well go to charity.

2.  What law applies in a case like Ellison's?  I find this especially interesting.  Oracle is a Delaware corporation, so it probably should be Delaware law. The Delaware Supreme Court recently reaffirmed this "internal affairs" choice of law rule, as I have discussed. In that case the court held that Delaware rather than California law applied to a suit involving a Delaware corporation.

3.  But what if California disagrees with me and Delaware and applies its own law?  Then it might, for example, apply a looser test of liability than in Delaware – e.g., not requiring that plaintiff prove that Ellison traded because of the information he had. The Delaware court said California wouldn’t apply California law, which may be wishful thinking, and that it constitutionally couldn’t, which may be wrong, as I discuss in my earlier post.    Ellison apparently didn't want to stick around to find out what would happen.

4.  How does federal insider trading law fit with all this?  There is a federal Oracle case still pending.  The Securities Litigation Uniform Standards Act preempts most shareholder class actions, exempting certain actions against issuers in the so-called “Delaware carve-out.”  But SLUSA doesn’t apply to derivative suits like the ones in the Oracle case. 

5. The innovative settlement here, and the fact that Ellison faces real consequences under state law, raise the issue of whether state law can effectively supplement federal law.  I discuss this issue as applied to the fraud on the market theory in my Fraud on a Noisy Market article noted yesterday.  There I suggest a significant shrinkage of federal liability, but also amending SLUSA to give plaintiffs the option to sue under state business association laws that apply to firms organized under those laws. 

6.  The attraction of a state law approach is that there is a lot of uncertainty about the appropriate rule in many kinds of cases, including insider trading (should we require proof of what motivated the insider trade?) and fraud on the market. This suggests that it might be a good idea to work these ideas out in the "laboratory" of state law. But note that the key to this working is that only one state’s law can apply – no plaintiff shopping for the most litigation-friendly forum. In other words, my suggestion hinges on accepting the internal affairs rule that seems to have been up for graps in the Oracle situation.