### In the 

# United States Court of Appeals For the Seventh Circuit

____________________ No. 14

- 1647
C ORRE O PPORTUNITIES F UND , LP, et al. , Plaintiffs

- Appellants ,

v.
E MMIS C OMMUNICATIONS C ORPORATION , Defendant

- Appellee

.

____________________ Appeal from the United States District Court for the Southern District of Indiana , Indianapolis Division. No. 1:12

- cv

- 491

- SEB

- TAB

— Sarah Evans Barker , Judge

.

____________________
A RGUED D ECEMBER 5, 2014

— D ECIDED J ULY 2, 2015

____________________

Before F LAUM , E ASTERBROOK , and K ANNE , Circuit Judges

. E ASTERBROOK , Circuit Judge

. Plaintiffs, who own preferred stock in Emmis Communications Corp., contend that Emmis violated Indiana law by voting some shares . The suit is in federal court because, at its outset, it in cluded a non

frivolous claim under federal securities law. The district court analyzed the federal claim at length before ruling against the Owners (as we call the plaintiffs) . 892 F. Supp. 2d2 No. 14

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1076 (S.D. Ind. 2012). The Owners now rely entirely on Ind iana corporate law. To keep this opinion manageable , we pare away all but the most vital facts; the rest are in the district court’s exhaustive opinion s

. (The district court’s 2014 opinion on the state

- law issues is not published but is available from the court .) In 1999 Emmis issued 2.875 million shares of preferred stock for $50 a share, raising about $144 million. The shares promised cumulative dividends of $3.125 a year. A dividend is “cumulative” when any unpaid portion carrie s over to the next year. If any dividends on the preferred stock remain unpaid , Emmis cannot repurchase any of its common stock, or pay dividends on it , and the preferred stockholders can elect two members of its board of directors . To change any of the preferred stock’s rights, Emmis needs the consent of two

thirds of the outstanding preferred shares. In October 2008 Emmis stopped paying dividends on the preferred stock. It blames the financial crunch, but the re ason is irrelevant. It has not paid anything on the preferr ed shares since then, so the cumulative dividends piled up and prevented the firm from paying dividends on common stock or issuing any senior securities , which has made it hard for Emmis to raise new capital. In 2010 Emmis asked the owners of the preferred stock to accept a going

- private transaction in which their stock would be exchanged for subordinated debt rather than cash; this pro posal failed to get a 2/3 vote, which was required because going private entails retiring the common stock, a step inconsis tent with the pre ferred shar eholders’ rights unless they were first paid $50 a share plus all cumulative dividends.No. 14

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By 2011 the preferred shares were trading in the market at about 25¢ on the dollar, and owners were disaffected. Some asked Emmis to repurch ase the preferred stock, but that was not attractive because even one outstanding share would leave Emmis saddled with all of the preferred stock’s burdens . Of course, if the number of outstanding shares

were small enough, Emmis could afford to buy this re sidue at par plus all accumulated dividends; but if owners thought that Emmis would do that, then they would not sell to E mmis at a deep discount (everyone would want to be the ow ner whose shares were purchased on the back end, at max imum price ) , and all t he shares would remain outstanding. Emmis’s management began to search for ways to change the terms of the preferred stock. That, too, required a 2/3 vote, but many owners were willing to sell at a discount, and
to prom ise favorable votes as part of the tr ansaction, as long

as Emmis could ensure that holdouts would not get better
terms. It ultimately chose two ways to get enough votes. First, Emmis signed holders of approximately 60% of the preferred shares to what the parties call “total return swaps.” Emm is promised to purchase each preferred share for about $15 ; Emmis paid, and the owners delivered their shares to an escrow. Closing was deferred for five years (though it could be accelerated at Emmis’s option, or if the shares were delisted and stopped tr ading) . The selling ow ners agreed to vote their share s as Emmis instructed during the interim. Emmis adopted this device because, once it pu rchased any given share out right, it would ha ve been retired and lost voting rights . Ind. Code §23

- 1

- 25

- 3(a). A s lon g as a share is “outstanding ,” however , it has a vote. Ind. Code §23

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- 2(a). And in Indiana, apparently alone among the states,4 No. 14

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a corporation can vote its own shares. Ind. Code §23

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- 2(6). That’s why Emmis set out to acquire voting rights while leavi ng the shares “outstand ing.” Second, Emmis repurchased some of the preferred stock in a tender offer and reissued it to a trust for the benefit of employees . The trust was established to pay bonuses to workers who stuck with the firm through the financial downturn. The trustee had instructions to vote this stock at management’s direction . Senior managers and members of the firm’s board were excluded, which left them free to pr opose and vote on the deal without a conflict of interest.
The two devices together allowed Emmis to control more than 2/3 of the votes

. (Plaintiffs own most of the remaining preferred shares.) Emmis then called on owners of both common and preferred stock to vote on whether the terms of th e preferred stock should be changed. Both groups a pproved by the required margin. The cumulative feature of the preferred stock’s d ividends was eliminated; the other rights we mentioned earlier also were abrogated . This would not have been possible if the documents creating the pr eferred stock had made a change in its terms a compensable event; then all a 2/3 vote could have done would have been to replace the favorable terms with a cash payment (equal, say, to $50 a share plus accrued dividends). But that saf eguard was not there, which is what made this transaction economically attractive to Emmis (which is to say, investors other than the preferred shareholders). Once the vote had been completed, the escrow agent closed the swap transa ction, and Emmis reti red the preferred shares it received

. As this litigation has proceeded, most of the Owners’ a rguments have fallen away. We’ve mentioned the securities

-No. 14

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law arguments. The Owners also contended, for example, that Emmis violated its fiduciary duty by reducing the rights of one set of investors in order to increase the wealth of a nother set. But the district court rejected all of the Owners’
state

- law arguments. On appeal the Owners pursue only two arguments. They maintain that the shares in the swap transactio ns were no longer “outstanding” for the purpose of §23

- 1

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- 2(a) and so lost their votes. And they contend that the trust should be ignored because the shares were not held in a fiduciary c apacity . We start with the latter argument. Indiana allows corpor at ions to vote their own shares “e xcept as otherwise prohibited by this article.” Ind. Code §23

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- 2(6). One statutory exception is §23

- 1

- 30

- 2(b), which provides that a corporation is not entitled to vote its shares if they are owned by a second corporatio n, and the issuing corporation owns a majority of the stock of that second co rporation. This limits holding

- company structures and might be thought to rule out some trust structures too , including ESOPs (employee stock ownership plans). Subsection 2(c) the n provides an exception to the exception: “ Subsection (b) does not limit the power of a corporation to vote any shares, including its own shares, held by it in or for an employee benefit plan or in any other fiduciary capacity. ” That’s the rule on which Em mis relied to vote the shares in the trust, and the district judge concluded that this was proper. Plaintiffs do not deny that the structure satisfied the r equirements of trust law and that the beneficiaries of the trust were employees. Instead they conten d that the trust should be disregarded because the design was to vote the preferred stock in a way that decreased its value, and then exchange6 No. 14

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preferred for common stock. The Owners depict this as a value

- reducing transaction. But what has that to do with the question whether the shares were held by “an employee benefit plan”? It might have been a ground for complaint by the employees under Indiana’s law of trusts, but the Owners are not among the trust’s beneficiaries and do not invoke trust law. Once we c onclude, as we have done, that this was an “employee benefit plan , ” the corporate

- law question has been answered: Emmis (through the trustee) was entitled to vote the shares. The Owners’ objection to the votes cast by holders of the shares subject to the s waps is that even though Indiana a llows corporations to vote their own shares, they may vote only “outstanding” shares (Ind. Code §23

- 1

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- 2(a)), and these shares, the Owners insist, were not “outstanding.” Yet they were owned by persons other than Emmis

. Having put up a lot of money, Emmis understandably wanted the vote, which would affect the value of the shares. (Every state’s law permits an owner to transfer a vote in connection with an economic interest in the shares, such as a pledge to secure a loan.) If shares ceased to be “outs tanding” as soon as their

owners delivered them to an escrow , however, they would have retained that retired status even if the exchange was never completed . Nothing we could find in Indiana law co ntemplates the possibility of shares drifting in and out of “outstanding” status as the probability or timing of a co mpleted sale fluctuates.
The Ow ners observe that Emmis structured this transa ction so that it would bear the economic risk of the shares, while the original owners no longer faced variability in the shares’ market price. That’s true. So if this transaction hadNo. 14

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been conducted in any state but Indiana, a court probably would have said that Emmis could not vote these shares, b ecause it was their beneficial owner even if not their legal owner. But Indiana allows corporations to deal in and vote their own shares

. Indiana gives voting rights to record ow ners , see Ind. Code §23

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- 24, and the parties involved in the swaps were the record owners, who under Indi ana law could agree to vote as Emmis dir ected. Ind. Code §23

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- 2. All that’s necessary is that the shares be outstanding

— as these shares were until the transaction closed and Emmis r eceived the shares

. Indiana law is dis tinc tive , but it is not our job to reduce inter

- state variance in corpora te law. The reader will note that we have not cited a single dec ision by an Indi ana court. That’s because none interpret s the statutes we have discussed. The parties have cited a few opinions by Indiana’s judiciary, but they do not address these statutes a nd seem to us to have little bearing on the transactions Emmis designed

. Left to our own devices, we would have thought that these novel state

- law questions b elong in state court. (The parties are not of completely diverse citizenship.) But the Owners file d their suit in federal court under the federal

- question jurisdiction and did not ask the district judge to send the state issues to state court

. The state

law issues were vigorously litigated , and because neither side asked the district judge to relinquis h supplemental j urisdiction, 28 U.S.C. §1367(c)(1), (3), we conclude that she did not abuse her dis cretion in resolving all as pects of the pa rties’ dispute

. The undercurrent of the Owners’ briefs is that the judic iary should not let the common stockholders (who elect the board) get away with improving their own position at the8 No. 14

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expense of the preferred stockholders. As we’ve mentioned, the agreements establishing the preferred stock might have required compensation if the terms changed , but they did not do so. And perhaps there were reasons to omit such clauses. Throughout the history of corporate law, several kinds of doctrines have made it hard for firms to issue new stock, or pay dividends on common stock, while previously issued sto ck (preferred or common) was in arrears. Those requirements slowly disappeared from state law because they made it hard for firms to recapitalize without going through bankruptcy. See Bayless Manning & James J. Hanks, Jr., Legal Capital 36

– 47, 67

– 95 (2013) . For Emmis, which wan ted to recapitalize by going private, the alternative to chan ging the preferred stock’s terms might have been reorganiz ation under Chapter 11, which would have allowed the value of that stock to be written down. Maybe that’s why owner s of more than 2/3 of the preferred stock freely sold to (or agreed to swaps with) Emmis; they voted with their wallets that the terms they were getting were better than the likely outcome of standing pat on the shares’ origin al contractual rights.
But if this is wrong, still it would not be a good reason to undermine Indiana’s decision, codified in Ind. Code §23

- 1

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- 2(6), that corporations may deal in and vote their own shares. If as the Owners maintain this was a deliberately value

- reducing use of that s tatutory power, then the right d efendants would have been the members of Emmis’s board, and the right theory would have been that the directors vi olated their duty of loyalty by using their positions to transfer wealth from one class of investors to anothe r. Yet the Owners did not sue the directors; their only fiduciary

- duty claim was against the corporation itself, and the district court held thatNo. 14

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in Indiana corporations (unlike directors) do not have fid uciary duties to investors . All that remains are arg uments about the extent of statutory power rather than about the propriety of its use, and w e’ve explained why Emmis had the authority to act as it did.
An amicus brief filed by the Council of Institutional Inve stors asks us to reverse because, in the Coun cil’s view, Emmis did not employ “corporate governance best practices.” The Council apparently scorns state law and would prefer a sy nthetic federal corporate common law, or perhaps a requir ement that every state use the same principles as Delaware. If jud ges (and state legislators) could be sufficiently sure what the best practices are, that would be an attractive idea. But it is hard to know the full effects of corporate codes, which lead to contractual adjustments and changes in prices. Fe deralism permit s states to adopt different codes, after which people can choose which states’ firms to invest in, and at what price. See Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ow nership Structure , 3 J. Fin

. Econ . 305 (1976); Ralph K. Winter, State Law, Shareholder Protection, and the Theory of the Corpor ation , 6 J. Legal Stud. 251 (1977); Eugene F. Fama, Agency Pro blems and the Theory of the Firm , 88 J. Pol

. Econ. 288 (1980). Confident assertions along the lines of “state X’s rule Y is bad for investors, so Y should be stamped out” have run through corporate law and commentary since Governor Woodrow Wilson persuaded New Jersey’s legislature to r eplace investors’ contractual arrangements with mandatory prescription s, and businesses responded not by using New Jersey’s rules but by reincorporating in the more permissive Delaware. Doubtless m any corporate rules are bad for inve s-10 No. 14

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tors, but the way to find them is by competition and price adjustments, not judicial attempt s to suppress fe deralism

. The process of competition has yielded su bstantial benefits

. See Roberta Romano, The Genius of American Corporate Law (1993). Indiana’s willingness to allow corporations to vote their own shares may be good, or it may be bad, but the abi lity to negotiate for better terms, or invest elsewhere, rather than judicially imposed “best practic es, ” is how corporate law protects investors.
A FFIRMED