Tuesday, October 17, 2017

Guest Post: Zohar Goshen and Richard Squire’s “Principal Costs: A New Theory for Corporate Law and Governance”

The following is a guest post from Bernard S. Sharfman*:

The foundation of my understanding of corporate governance rests on a small but growing number of essays, articles, and books.  These writings include Henry Manne’s Mergers and the Market for Corporate Control, Michael Dooley’s Two Models of Corporate Governance, Stephen Bainbridge’s Director Primacy: The Means and Ends of Corporate Governance and The Business Judgment Rule as Abstention Doctrine, Kenneth J. Arrow, The Limits of Organization, Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Law, Zohar Goshen & Gideon Parchomovsky’s The Essential Role of Securities Regulation, and Alon Brav, Wei Jiang, Frank Partnoy & Randall Thomas’ Hedge Fund Activism, Corporate Governance, and Firm Performance.  Recently, I have added to this esteemed list Zohar Goshen and Richard Squire’s Principal Costs: A New Theory for Corporate Law and Governance.

Goshen and Squire put forth a new theory, the “principal-cost theory,” which posits that a firm’s optimal corporate governance arrangements result from a calculus that seeks to minimize total control costs, not just agency costs (“the economic losses resulting from managers’ natural incentive to advance their personal interests even when those interests conflict with the goal of maximizing their firm’s value”):

The theory states that each firm’s optimal governance structure minimizes total control costs, which are the sum of principal costs and agent costs. Principal costs occur when investors exercise control, and agent costs occur when managers exercise control. Both types of cost can be subdivided into competence costs, which arise from honest mistakes attributable to a lack of expertise, information, or talent, and conflict costs, which arise from the skewed incentives produced by the separation of ownership and control.  When investors exercise control, they make mistakes due to a lack of expertise, information, or talent, thereby generating principal competence costs. To avoid such costs, they delegate control to managers whom they expect will run the firm more competently. But delegation separates ownership from control, leading to agent conflict costs, and also to principal conflict costs to the extent that principals retain the power to hold managers accountable. Finally, managers themselves can make honest mistakes, generating agent competence costs. 

Moreover, it is important to understand that the theory is firm specific:

Principal costs and agent costs are substitutes for each other: Any reallocation of control rights between investors and managers decreases one type of cost but increases the other. The rate of substitution is firm specific, based on factors such as the firm’s business strategy, its industry, and the personal characteristics of its investors and managers. Therefore, each firm has a distinct division of control rights that minimizes total control costs. Because the cost-minimizing division varies by firm, the optimal governance structure does as well. The implication is that law’s proper role is to allow firms to select from a wide range of governance structures, rather than to mandate some structures and ban others. 

The bottom line is that “A firm that seeks to maximize total returns will weigh principal costs against agent costs when deciding how to divide control between managers and investors.”

A minimization of total control costs approach to the identification of optimal governance arrangements allows for the fundamental value of authority in large organizations to be respected and acknowledged, something which is missing in many academic works that only focus on agency costs.  According to Michael Dooley, “Where the residual claimants are not expected to run the firm and especially when they are many in number (thus increasing disparities in information and interests), their function becomes specialized to risk-bearing, thereby creating both the opportunity and necessity for managerial specialists.” According to Rose and Sharfman, “Especially where there are a large number of shareholders, it is much more efficient, in terms of maximizing shareholder value, for the Board and executive management—the corporate actors that possess overwhelming advantages in terms of information, including nonpublic information, and whose skills in the management of the company are honed by specialization in the management of this one company—to make corporate decisions rather than shareholders.”

The calculus of the principal-cost theory also allows for the potential for Bainbridge’s director primacy as a positive theory to be proven correct for any particular firm:  “As a positive theory of corporate governance, the director primacy model strongly emphasizes the role of fiat - i.e., the centralized decisionmaking authority possessed by the board of directors.” In the context of Goshen and Squire’s calculus, Bainbridge is arguing that principal costs will greatly outweigh agency costs when total control costs are minimized.  

Finally, Goshen and Squire’s theory allows for an understanding of why dual-class share structures continue to persist and why they have been successfully implemented at companies such as Alphabet (Google) and Facebook.  Their theory is critical to the argument I make in my most recent paper, A Private Ordering Defense of a Company's Right to Use Dual Class Share Structures in IPOs.  In sum, Goshen and Squire’s theory allows for a more robust understanding of what is meant by optimal corporate governance arrangements, something that an exclusive focus on agency costs does not allow.     

*This post comes to us from Bernard S. Sharfman, who is an associate fellow at the R Street Institute, a member of the Journal of Corporation Law’s editorial advisory board, a visiting professor at the University of Maryland School of Law (Spring 2018), and a former visiting assistant professor at Case Western Reserve University School of Law (Spring 2013 and 2014).

October 17, 2017 in Corporate Governance, Corporations, Joshua P. Fershee | Permalink | Comments (0)

SEALSB 2017 - Conference Deadlines This Friday

The information below the line is from an e-mail I received about the SEALSB Conference. The SEALSB conference is the southeastern regional conference for law professors in business schools, but we have had practicing lawyers (especially those hoping to break into academia) and law school professors participate in the past.

The conference rotates locations in the southeast, and this year the conference will be held in Atlanta, GA from November 9-11. 

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SEALSB Conference 2017
 
The deadline to upload papers for inclusion in the conference materials has been extended to this Friday, October 20th. You may upload your paper by clicking on the following link: Paper Upload. Otherwise, please bring 25 copies to the meeting.
 
Friday, October 20th is also the conference registration deadline, so if you are planning to attend the conference but have not yet registered please make sure you do so sometime this week!
 
Additional information is available on the Conference Website. We look forward to seeing you at the Georgian Terrace!

October 17, 2017 in Business Associations, Business School, Conferences, Haskell Murray, Research/Scholarhip | Permalink | Comments (0)

Monday, October 16, 2017

Blockchain-Based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets. Oh, My!

My UT Law colleague Jonathan Rohr has coauthored (with Aaron Wright) an important piece of scholarship on an of-the-moment topic--financial instrument offerings using distributed ledger technology.  Even more fun?  He and his co-author are interested in aspects of this topic at its intersection with the regulation of securities offerings.  Totally cool.

Here is the extended abstract.  I cannot wait to dig into this one.  Can you?  As of the time I authored this post, the article already had almost 700 downloads . . . .  Join the crowd!

+++++

Blockchain-Based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets

Jonathan Rohr & Aaron Wright

Best known for their role in the creation of cryptocurrencies like bitcoin, blockchains are revolutionizing the way tech entrepreneurs are financing their business enterprises. In 2017 alone, over $2.2 billion has been raised through the sale of blockchain-based digital tokens in what some are calling initial coin offerings or “ICOs,” with some sales lasting mere seconds. In a token sale, organizers of a project sell digital tokens to members of the public to finance the development of future technology. An active secondary market for tokens has emerged, with tokens being bought and sold on cryptocurrency exchanges scattered across the globe, with often wild price fluctuations.

The recent explosion of token sales could mark the beginning of a broader shift in public capital markets—one similar to the shift in media distribution that started several decades ago. Blockchains drastically reduce the cost of exchanging value and enable anyone to transmit digitized assets around the globe in a highly trusted manner, stoking dreams of truly global capital markets that leverage the power of a blockchain and the Internet to facilitate capital formation.

The spectacular growth of tokens sales has caused some to argue that these sales simply serve as new tools for hucksters and unscrupulous charlatans to fleece consumers, raising the attention of regulators across the globe. A more careful analysis, however, reveals that blockchain-based tokens represent a wide variety of assets that take a variety of forms. Some are obvious investment vehicles and entitle their holders to economic rights like a share of any profits generated by the project. Others carry with them the right to use and govern the technology that is being developed with funds generated by the token sale and may represent the beginning of a new way to build and fund powerful technological platforms.

Lacking homogeneity, the status of tokens under U.S. securities laws is anything but clear. The test under which security status is assessed—the Howey test—has uncertain application to blockchain-based tokens, particularly those that entitle the holder to use a particular technological service, because they also present the possibility of making a profit by selling the token on a secondary market. Although the SEC recently issued a Report of Investigation in which it found that one type of token qualified as a security, confusion surrounds the boundaries between the types of tokens that will be deemed securities and those that will not.

Blockchain-based tokens exhibit disparate features and have characteristics that make current registration exemptions a poor fit for token sales. In addition to including requirements that do not fit squarely with blockchain-based systems, the transfer restrictions that apply to the most popular exemptions would have the perverse effect of restricting the ability of U.S. consumers to access a new generation of digital technology. The result is an uncertain regulatory environment in which token sellers do not have a sensible path to compliance.

In this Article, we argue that the SEC and Congress should provide token sellers and the exchanges that facilitate token sales with additional certainty. Specifically, we propose that the SEC provide guidance on how it will apply the Howey test to digital tokens, particularly those that mix aspects of consumption and use with the potential for a profit. We also propose that lawmakers adopt both a compliance-driven safe harbor for online exchanges that list tokens with a reasonable belief that the public sale of such tokens is not a violation of Section 5 as well as an exemption to the Section 5 registration requirement that has been tailored to digital tokens.

October 16, 2017 in Corporate Finance, Current Affairs, Entrepreneurship, Joan Heminway, Research/Scholarhip, Securities Regulation, Web/Tech | Permalink | Comments (0)

Sunday, October 15, 2017

ICYMI: #corpgov Weekend Roundup (October 15, 2017)

October 15, 2017 in Stefan J. Padfield | Permalink | Comments (0)

Saturday, October 14, 2017

Unicorn Governance and Power

We’ve talked about Uber and its tribulations a few times here at BLPB, including what I feel is one of the remarkable aspects of the saga – the fact that a private company is being treated as public in the general imagination.

In keeping with that theme, Renee Jones just posted The Unicorn Governance Trap to SSRN, with the basic thesis that Uber and companies like it (Theranos, Zenefits, etc) are experiencing governance pathologies precisely because they inhabit a hybrid space between public and private.  (George Georgiev made an abbreviated version of the same argument in a column for The Hill several months ago.)  Jones contends that these unicorn companies feature the separation of ownership and control typical of a public company, but they are not subject to the same disciplining mechanisms from investors of voice (due to dual-class shares), exit (due to the limits on liquidity inherent in private status), and litigation (due to lack of public reporting obligations, and potential securities fraud claims – though on that last point, but see Theranos and Uber litigation).  She distinguishes private companies that grew large in an earlier era, where ownership and control are unified (typically, family-owned businesses).  She also points out – though she is not the first – that efforts to increase the number of IPOs by limiting regulatory burdens as the Trump Administration would like to do are misguided; IPOs have likely declined because companies do not need them if they can raise capital privately.

To be sure, there are limits to how far the argument can be taken (Exs. A , B, and C.)  And the problems at unicorns may have less to do with securities regulation than with the current fashion for treating founders like auteurs.  Still, it does seem like the relatively new ability for companies to raise massive amounts of capital without the discipline of the broader markets encourages a degree of corporate governance laxity. 

If that's right, then it represents a real-time demonstration of the importance of corporate governance for the broader society.   Typically, corporate governance is treated as “private law,” a function of private contracting among investors and managers.  Corporate governance principles are designed to protect investors from exploitation, but do not usually take protection of other stakeholders as part of their central mandate.  This is, after all, the ideological basis of the internal affairs doctrine.  Scott Hirst recently argued that investors should choose the extent to which companies are subject to federal securities regulation, explicitly adopting the position that only corporate governance externalities – and not other kinds of social welfare externalities – are part of the calculus.

But now we can see that, whether by design or happy accident, obligations placed on firms ostensibly for the protection of investors have very tangible effects on employees, customers, competitors, and general compliance with the rule of law.  It is not clear that external regulation alone can carry this responsibility, because the whole point is that certain managers/controllers may be undeterrable, or only deterrable at significant cost.  They can be contained only via constraints on their power to act in the first place, and that’s where corporate governance comes in.

In sum, as I tell my students on day one, corporate law is about the regulation of power. 

October 14, 2017 in Ann Lipton | Permalink | Comments (0)

Friday, October 13, 2017

Nonprofit v. Benefit Corporation v. Traditional For-Profit Hospitals

Earlier this week, my two-year old daughter was in the pediatric ICU with a virus that attacked her lungs. We spent two nights at The Monroe Carell Jr. Children's Hospital at Vanderbilt (“Vanderbilt Children’s). Thankfully, she was released Wednesday afternoon and is doing well. Unfortunately, many of the children on her floor had been in the hospital for weeks or months and were not afforded such a quick recovery. There cannot be many places more sad than the pediatric ICU.

Since returning home, I confirmed that Vanderbilt Children’s is a nonprofit organization, as I suspected. I do wonder whether the hospital would be operated the same if it were a benefit corporation or as a traditional corporation.

Some of the decisions made at the hospital seems like they would have been indefensible from a shareholder perspective, if the hospital had been for-profit. Vanderbilt Children’s has a captive market, with no serious competitors that I know of in the immediate area. Yet, the hospital doesn’t charge for parking. If they did, I don’t think it would impact anyone’s decision to choose them because, again, there aren’t really other options, and the care is the important part anyway. The food court was pretty reasonably priced, and they probably could have charged double without seriously impacting demand; the people at the hospital valued time with their children more than a few dollars. The hospital was beautifully decorated with art aimed at children – for example, with a big duck on the elevator ceiling, which my daughter absolutely loved. There were stars on the ceiling of the hospital rooms, cartoons on TVs in every room, etc. All of this presumably cost more than a drab room, and perhaps it was all donated, but assuming it actually cost more, I am not sure those things would result in any financial return on investment.

As we have discussed many times on this blog, even in the traditional for-profit setting, the business judgment rule likely protects the decisions of the board of directors, even if the promised ROI seems poor. But at what point – especially when the board knows there will be no return on the investment at all - is it waste? (Note: Question sparked by a discussion that Stefan Padfied, Josh Fershee, and I had in Knoxville after a session at the UTK business law conference this year). And, in any event, the Dodge and eBay cases may lead to some doubt in the way a case may play out. And even if the law is highly unlikely to enforce shareholder wealth maximization, the norm in traditional for-profit corporations may lead to directorial decisions that we find problematic as a society, especially in a hospital setting.

Now, maybe the Hippocratic Oath, community expectations, and various regulations make it so nonprofit and forprofit hospitals operate similarly. As a father of a patient, however, even as a free market inclined professor, I would prefer hospitals to be nonprofit and clearly focused on care first. Also, some forprofit hospitals are supposedly considering going the benefit corporation route, which may be a step in the right direction – at least they have an obligation to consider various stakeholders (even if, currently, the statutory enforcement mechanisms are extremely weak) and at least there are some reporting requirements (even if , currently, reporting compliance is miserable low in the states I have examined and the statutory language is painfully vague).

I am not sure I have ever been in a situation where I would have paid everything I had, and had no other good options for the immediate need, and yet I still did not feel taken advantage of by the organization. There is much more that could be said on these issues, but I do wonder whether organizational form was important here. And, if so, what is the solution? Require hospitals to be nonprofits (or at least benefit corporations, if those statutes were amended to add more teeth)?

October 13, 2017 in Business Associations, Corporate Governance, Corporations, CSR, Delaware, Ethics, Family, Haskell Murray, Social Enterprise | Permalink | Comments (7)

Thursday, October 12, 2017

ICYMI: #corpgov Midweek Roundup (Oct. 12, 2017)

October 12, 2017 in Stefan J. Padfield | Permalink | Comments (0)

Wednesday, October 11, 2017

Call for Proposals: Organizing, Deploying & Regulating Capital in the U.S.

From our friend and BLPB colleague, Anne Tucker, following is nice workshop opportunity for your consideration: 

Dear Colleagues,

We (Rob Weber & Anne Tucker) are submitting a funding proposal to host a works-in-progress workshop for 4-8 scholars at Georgia State University College of Law, in Atlanta, Georgia in spring 2018 [between April 16th and May 8th].  Workshop participants will submit a 10-15 page treatment and read all participant papers prior to attending the workshop.  If our proposal is accepted, we will have funding to sponsor travel and provide meals for participants. Interested parties should email amtucker@gsu.edu on or before November 15th with a short abstract (no more than 500 words) of your proposed contribution that is responsive to the description below. Please include your name, school, and whether you will require airfare, miles reimbursement and/or hotel. We will notify interested parties in late December regarding the funding of the workshop and acceptance of proposals.  Please direct all inquiries to Rob Weber (mailto:rweber@gsu.edu) or Anne Tucker (amtucker@gsu.edu).

Call for Proposals: Organizing, Deploying & Regulating Capital in the U.S.

Our topic description is intentionally broad reflecting our different areas of focus, and hoping to draw a diverse group of participants.  Possible topics include, but are not limited to:

  • The idea of financial intermediation: regulation of market failures, the continued relevance of the idea of financial intermediation as a framework for thinking about the financial system, and the legitimating role that the intermediation theme-frame plays in the political economy of financial regulation.
  • Examining institutional investors as a vehicle for individual investments, block shareholders in the economy, a source of efficiency or inefficiency, an evolving industry with the rise of index funds and ETFs, and targets of SEC liquidity regulations.
  • The role and regulation of private equity and hedge funds in U.S. capital markets looking at regulatory efforts, shadow banking concerns, influences in M&A trends, and other sector trends.

This workshop targets works-in-progress and is intended to jump-start your thinking and writing for the 2018 summer.  Our goal is to provide comments, direction, and connections early in the writing and research phase rather than polishing completed or nearly completed pieces.  Bring your early ideas and your next phase projects.  We ask for a 10-15 page treatment of your thesis (three weeks before the workshop) and initial ideas to facilitate feedback, collaboration, and direction from participating in the workshop. Interested parties should email amtucker@gsu.edu on or before November 15th with a short abstract (no more than 500 words) of your proposed contribution that is responsive to the description below. Please include your name, school, and whether you will require airfare, miles reimbursement and/or hotel. We will notify interested parties in late December regarding the funding of the workshop and acceptance of proposals.  Please direct all inquiries to Rob Weber (rweber@gsu.edu) or Anne Tucker (amtucker@gsu.edu).

Thank you!

Anne & Rob

October 11, 2017 in Anne Tucker, Call for Papers, Corporate Finance, Financial Markets, Joshua P. Fershee, Law School, M&A, Research/Scholarhip, Securities Regulation, Writing | Permalink | Comments (0)

University of New Mexico: Faculty Position in Business Law and/or Intellectual Property

UNIVERSITY OF NEW MEXICO SCHOOL OF LAW

BUSINESS LAW AND/OR INTELLECTUAL PROPERTY

OPEN RANK FACULTY POSITION

The University of New Mexico ("UNM") School of Law invites applications for a faculty position in Business Law and/or Intellectual Property. The faculty position is a full-time tenured or tenure-track position starting in Fall 2018. Entry-level and experienced teachers are encouraged to apply. Courses taught by this faculty member could include general business courses, intellectual property courses, and commercial law courses. Candidates must possess a J.D. or equivalent legal degree. Preferred qualifications include a record of demonstrated excellence or the promise of excellence in teaching and academic scholarship and who demonstrate a commitment to diversity, equity, inclusion, and student success, as well as working with broadly diverse communities. Academic rank and salary will be based on experience and qualifications. For best consideration, applicants should apply by October 22, 2017. The position will remain open until filled. For complete information, visit the UNMJobs website: https://unmjobs.unm.edu/. The position is listed as Open Rank – Business Law Requisition Number 2761.

The University of New Mexico is an Affirmative Action/Equal Opportunity Employer.

Direct Link to Job: https://unm.csod.com/ats/careersite/jobdetails.aspx?site=1&c=unm&id=2761&m=-1&u=16023

October 11, 2017 in Jobs, Joshua P. Fershee, Law School, Research/Scholarhip, Service, Teaching | Permalink | Comments (0)

Do We Need Universal Proxies?

Earlier this week, I had the pleasure of hearing a talk about universal proxies from Scott Hirst, Research Director of Harvard’s Program on Institutional Investors.

By way of background, last Fall under the Obama Administration, the SEC proposed a requirement for universal proxies noting:

Today’s proposal recognizes that few shareholders can dedicate the time and resources necessary to attend a company’s meeting in person and that, in the modern marketplace, most voting is done by proxy.  This proposal requires a modest change to address this reality.  As proposed, each party in a contest still would bear the costs associated with filing its own proxy statement, and with conducting its own independent solicitation.  The main difference would be in the form of the proxy card attached to the proxy statement.  Subject to certain notice, filing, form, and content requirements, today’s proposal would require each side in a contest for the first time to provide a universal proxy card listing all the candidates up for election.

The Council of Institutional Investors favors their use explaining, “"Universal" proxy cards would let shareowners vote for the nominees they wish to represent them on corporate boards. This is vitally important in proxy contests, when board seats (and in some cases, board control) are at stake. Universal proxy cards would make for a fairer, less cumbersome voting process.” 

The U.S. Chamber of Commerce has historically spoken out against them, arguing:

Mandating a universal ballot, also known as a universal proxy card, at all public companies would inevitably increase the frequency and ease of proxy fights. Such a development has no clear benefit to public companies, their shareholders, or other stakeholders. The SEC has historically sought to remain neutral with respect to interactions between public companies and their investors, and has always taken great care not to implement any rule that would favor one side over the other. We do not understand why the SEC would now pursue a policy that would increase the regularity of contested elections or cause greater turnover in the boardroom.

I can't speak for the Chamber, but I imagine one big concern would be whether universal proxies would provide proxy advisors such as ISS and Glass Lewis even more power than they already have with institutional investors. When I asked Hirst about this, he did not believe that the level of influence would rise significantly.

Hirst’s paper provides an empirical study that supports his contention that reform would help mitigate some of the distortions from the current system. It’s worth a read, although he acknowledges that in the current political climate, his proposal will not likely gain much traction. The abstract is below:

Contested director elections are a central feature of the corporate landscape, and underlie shareholder activism. Shareholders vote by unilateral proxies, which prevent them from “mixing and matching” among nominees from either side. The solution is universal proxies. The Securities and Exchange Commission has proposed a universal proxy rule, which has been the subject of heated debate and conflicting claims. This paper provides the first empirical analysis of universal proxies, allowing evaluation of these claims.

The paper’s analysis shows that unilateral proxies can lead to distorted proxy contest outcomes, which disenfranchise shareholders. By removing these distortions, universal proxies would improve corporate suffrage. Empirical analysis shows that distorted proxy contests are a significant problem: 11% of proxy contests at large U.S. corporations between 2001 and 2016 can be expected to have had distorted outcomes. Contrary to the claims of most commentators, removing distortions can most often be expected to favor management nominees, by a significant margin (two-thirds of distorted contests, versus one-third for dissident nominees). A universal proxy rule is therefore unlikely to lead to more proxy contests, or to greater success by special interest groups.

Given that the arguments made against a universal proxy rule are not valid, the SEC should implement proxy regulation. A rule permitting corporations to opt-out of universal proxies would be superior to the SEC’s proposed mandatory rule. If the SEC chooses not to implement a universal proxy regulation, investors could implement universal proxies through private ordering to adopt “nominee consent policies.

October 11, 2017 in Corporate Governance, Corporate Personality, Corporations, Financial Markets, Marcia Narine Weldon, Securities Regulation, Shareholders | Permalink | Comments (0)

Monday, October 9, 2017

Call for Papers: 2018 National Business Law Scholars Conference

National Business Law Scholars Conference
Thursday & Friday, June 21-22, 2018

Call for Papers

The National Business Law Scholars Conference (NBLSC) will be held on Thursday and Friday, June 21-22, 2018, at the University of Georgia School of Law in Athens, Georgia.  A vibrant college town, Athens is readily accessible from the Atlanta airport by vans that depart hourly. Information about transportation, hotels, and other conference-related matters can be found on the conference website.

This is the ninth meeting of the NBLSC, an annual conference that draws legal scholars from across the United States and around the world.  We welcome all scholarly submissions relating to business law. Junior scholars and those considering entering the legal academy are especially encouraged to participate. If you are thinking about entering the academy and would like to receive informal mentoring and learn more about job market dynamics, please let us know when you make your submission.

To submit a presentation, email Professor Eric C. Chaffee at eric.chaffee@utoledo.edu with an abstract or paper by February 16, 2018.  Please title the email “NBLSC Submission – {Your Name}.”  If you would like to attend, but not present, email Professor Chaffee with an email entitled “NBLSC Attendance.”  Please specify in your email whether you are willing to serve as a panel moderator.  We will respond to submissions with notifications of acceptance shortly after the submission deadline. We anticipate circulating the conference schedule in May.

Keynote Speakers:

Paul G. Mahoney
David and Mary Harrison Distinguished Professor of Law
University of Virginia School of Law

Cindy A. Schipani
Merwin H. Waterman Collegiate Professor of Business Administration
Professor of Business Law
University of Michigan Ross School of Business

Featured Panels:

The Criminal Side of Business in 2018

Miriam Baer, Professor of Law, Brooklyn Law School
José A. Cabranes, U.S. Circuit Judge, U.S. Court of Appeals for the Second Circuit
Peter J. Henning, Professor of Law, Wayne State University School of Law
Kate Stith, Lafayette S. Foster Professor of Law, Yale Law School
Larry D. Thompson, John A. Sibley Professor in Corporate and Business Law, University of Georgia School of Law

A Wild Decade in Finance: 2008-18

William W. Bratton, Nicholas F. Gallicchio Professor of Law, University of Pennsylvania Law School
Giles T. Cohen, Attorney, Securities & Exchange Commission
Lisa M. Fairfax, Leroy Sorenson Merrifield Research Professor of Law, George Washington University Law School
James Park, Professor of Law, UCLA School of Law
Roberta Romano, Sterling Professor of Law, Yale Law School
Veronica Root, Associate Professor of Law, Notre Dame Law School

Conference Organizers:

Anthony J. Casey (The University of Chicago Law School)
Eric C. Chaffee (The University of Toledo College of Law)
Steven Davidoff Solomon (University of California, Berkeley School of Law)
Joan MacLeod Heminway (The University of Tennessee College of Law)
Kristin N. Johnson (Seton Hall University School of Law)
Elizabeth Pollman (Loyola Law School, Los Angeles)
Margaret V. Sachs (University of Georgia School of Law)
Jeff Schwartz (University of Utah S.J. Quinney College of Law)

October 9, 2017 in Call for Papers, Conferences, Joan Heminway | Permalink | Comments (0)

Sunday, October 8, 2017

ICYMI: #corpgov Weekend Roundup (October 8, 2017)

October 8, 2017 in Stefan J. Padfield | Permalink | Comments (0)

Saturday, October 7, 2017

Omissions Liability: Tempest in a Teapot or Gathering Storm?

Readers of this blog know about the case of Leidos, Inc. v. Indiana Public Retirement System, currently pending before the Supreme Court, which will decide whether an omission of required information can give rise to private liability under Rule 10b-5.  In Leidos, the corporate defendant engaged in a scheme of overbilling on a New York City contract, which ultimately resulted in a deferred prosecution agreement and significant monetary penalties.  The plaintiffs alleged that the company violated Rule 10b-5 by failing to disclose the conduct and associated potential penalties as a “known trend”  in its SEC filings, as required by Item 303.  The Second Circuit allowed the claim to proceed; Leidos now argues before the Supreme Court that its failure to disclose required information cannot satisfy the element of falsity in a private claim brought under Rule 10b-5.  In other words, the question is whether – assuming all the other elements of a fraud claim are established (materiality, scienter, loss causation, etc) – can the omission of required information count as a false statement?

Joan Heminway co-authored an amicus brief arguing that Rule 10b-5 does provide for omissions liability, and this is an issue I’ve blogged about a few times, so forgive me if this post treads some familiar ground.

The case has generated a fair amount of commentary from the bar, including various warnings of unlimited liability should the Supreme Court rule for the plaintiffs.  Professor Joseph Grundfest has now jumped into the fray, contending that – while he agrees with various textual arguments as to why no liability should attach – in the end, he doesn’t think it matters very much.   The crux of his argument is that the securities laws require so much disclosure as a matter of course that there will almost never be a case where a pure omission cannot be transmogrified into a misleading half-truth.  In Leidos itself, he notes that the court also upheld the plaintiffs’ allegation that the corporate financial statements violated accounting rules for failure to allege a loss contingency – resulting from fines and recoupment of the overbilling – and speculates that the plaintiffs could have brought claims based on the company’s representations that it did not expect any losses resulting from pending litigation, as well as such “half-truths” as its warnings of potential risks from “[m]isconduct of our employees.”  He also argues that – though the matter is uncertain – required CEO and CFO certifications under Sarbanes Oxley can also constitute affirmative misstatements when information has been omitted from a securities filing, which would once again make omissions liability unnecessary.

I agree that pure omissions cases are relatively rare, and that due to the extensive disclosure requirements of the federal securities laws, most undisclosed misconduct/misfortune can be pinned to an arguably false affirmative statement (a point that I’ve discussed in my articles Slouching Towards Monell and Reviving Reliance).  But I don’t think the matter is quite as trivial as Prof. Grundfest sees it.

First, when it comes to certifications, those are attributed solely to the CEO and CFO.  Not all securities claims depend on the liability of the CEO and CFO; at the very least, at the pleading stage, the plaintiffs may not be able to demonstrate the scienter of the CEO and CFO.  In Leidos itself, for example, for reasons I don’t fully understand, somehow all of the individual defendants were dropped from the case, leaving only the corporate defendant.  Thus, leaving aside other issues of whether such certifications are actionable in the first place, they’re an unreliable predicate for liability.

More broadly, however, what Prof. Grundfest overlooks is that many courts - rightly or wrongly -  treat Rule 10b-5 claims with varying degrees of skepticism, and plaintiffs reasonably want to belt-and-suspender it.   Now, to be sure, if a judge is determined to dismiss a claim, the judge will find a way to do so (naturally, the opposite is true for a judge who is determined to sustain a claim).  But between those extremes there is a great deal of variation, and broadening the grounds for liability will make it harder for even the skeptical judge to dismiss a claim out of hand.

When it comes to omitted information, for sure, public companies are already subject to so many disclosure requirements that there will always be some affirmative statement that is arguably rendered misleading whenever there is a significant undisclosed problem, which should theoretically make pure omissions liability unnecessary.  But courts are often hostile to these kinds of claims – I think of them as icebergs – where major trouble is pinned to a banal bit of boilerplate.  (You know, like an iceberg, where the tiny above-water misstatement is the ostensible hook to bring a claim based on dramatic concealed problems.)   Courts typically recognize – correctly – that in such cases, the plaintiff is not so much complaining about the statement so much as the conduct, and since it is only statements (not conduct) that are regulated by the federal securities laws, they find other grounds on which to base a dismissal.  One favorite is puffery, which is precisely what happened in Leidos – the plaintiffs claimed that the defendants’ representations about ethics and integrity were rendered false by the scheme, and those claims were thrown out on materiality grounds.  Omissions liability, by contrast, is immune from a puffery defense, and thus represents another weapon in the plaintiffs’ arsenal.

Similarly, in many cases the alleged “half-truth” will come in the form of a potentially forward-looking statement, which may then be protected by the PSLRA safe harbor.  If so, pinning liability to that statement (or even to the risk disclosures) may be impossible for the plaintiffs.  Once again, then, pure omissions liability will save the plaintiffs' complaint.

To be sure, as Prof. Grundfest points out, in Leidos, the Second Circuit agreed that the failure to account for potential losses due to the fraud rendered the corporate financial statements false.  But that was highly unusual, and likely due to the fact that the misconduct was already the subject of a criminal investigation.  Courts have often refused to treat financial statements as false simply because the income was generated in an illicit manner, see Steiner v. MedQuist, Inc., 2006 WL 2827740 (D.N.J. Sept. 29, 2006), and that’s particularly likely to be true when there is no governmental investigation underway.

The same goes for Leidos’s statements about potential liability from pending claims/litigation.  Prof. Grundfest might be correct that these were also false statements, but only after 2010, when the first criminal complaint was filed.  Though the plaintiffs altered their claims along the way, the original class period began in 2007 – before there was any pending litigation.

It is also worth observing that omissions cases might be easier to litigate procedurally.  When plaintiffs allege the existence of affirmative misstatements, defendants often argue that the misstatement failed to result in a detectable impact on stock prices, and that therefore fraud on the market liability is unavailable (an argument I’ve repeatedly discussed).  That’s not an issue for omissions liability. 

Point being, I don’t think my disagreements with Prof. Grundfest are too dramatic – I’ll concede that we’re not talking about a massive number of cases – but I think there are enough to make a difference. 

That said, I disagree with the “sky is falling” pronouncements of practitioners who fear that they will have to bury investors in an “avalanche of trivial information,” Basic, Inc. v. Levinson, 485 U.S. 224 (1988), if the Supreme Court permits the claims in Leidos to proceed.  As I argue in Reviving Reliance, I actually think that if liability is expanded to cover omissions, courts will push back by narrowing their interpretation of the scope of required disclosures in the first place – which will have real repercussions for SEC enforcement.

October 7, 2017 in Ann Lipton | Permalink | Comments (3)

Friday, October 6, 2017

Stonyfield's Struggles and Successes as a Social Business

Yesterday, I listened to How I Built This' podcast on Gary Hirshberg of Stonyfield Yogurt.

I assume most readers are familiar with Stonyfield Yogurt, and perhaps a bit of its story, but I think the podcast goes far beyond what is generally known. 

The main thing that stuck out in the podcast was how many struggles Stonyfield faced. Most of the companies featured on How I Built This struggle for a few months or even a few years, but Stonyfield seemed to face more than its share of challenges for well over a decade. The yogurt seemed pretty popular early on, but production, distribution, and cash flow problems haunted them. Stonyfield also had a tough time sticking with their organic commitment, abandoning organic for a few years when they outsourced production and couldn't convince the farmers to follow their practices. With friends and family members' patient investing (including Gary's mother and mother-in-law), Stonyfield finally found financial success after raising money for its own production facility, readopting organic, and finding broader distribution.

After about 20 years, Stonyfield sold the vast majority of the company to large multinational Group Danone. Gary explained that some investors were looking for liquidity and that he felt it was time to pay them back for their commitment. Gary was able to negotiate some control rights for himself (unspecified in the podcast) and stayed on as chairman. While this sale was a big payday for investors, it is unclear how much of the original commitment to the environment and community remained. Also, the podcast did not mention that Danone announced, a few months ago, that it would sell Stonyfield

Personally, I am a fan of Stonyfield's yogurt and it will be interesting to follow their story under new ownership. I also think students and faculty members could benefit from listening to stories like this to remind us that success is rarely easy and quick. 

October 6, 2017 in Business Associations, Corporate Governance, Corporations, CSR, Current Affairs, Entrepreneurship, Haskell Murray, Shareholders, Social Enterprise | Permalink | Comments (1)

Thursday, October 5, 2017

ICYMI: #corpgov Midweek Roundup (Oct. 5, 2017)

October 5, 2017 in Stefan J. Padfield | Permalink | Comments (0)

Should Employees Have Their Day in Court? The Supreme Court and Mandatory Arbitration

On Monday, the Supreme Court heard argument on three cases[1] that could have a significant impact on an estimated 55% of employers and 25 million employees. The Court will opine on the controversial use of class action waivers and mandatory arbitration in the employment context. Specifically, the Court will decide whether mandatory arbitration violates the National Labor Relations Act or is permissible under the Federal Arbitration Act. Notably, the NLRA applies in the non-union context as well.

Monday’s argument was noteworthy for another reason—the Trump Administration reversed its position and thus supported the employers instead of the employees as the Obama Administration had done when the cases were first filed. The current administration also argued against its own NLRB’s position that these agreements are invalid.

In a decision handed down by the NLRB before the Trump Administration switched sides on the issue, the agency ruled that Dish Network’s mandatory arbitration provision violates §8(a)(1) of the NLRA because it “specifies in broad terms that it applies to ‘any claim, controversy and/or dispute between them, arising out of and/or in any way related to Employee’s application for employment, employment and/or termination of employment, whenever and wherever brought.’” The Board believed that employees would “reasonably construe” that they could not file charges with the NLRB, and this interfered with their §7 rights.

The potential impact of the Supreme Court case goes far beyond employment law, however. As the NLRB explained on Monday:

The Board's rule here is correct for three reasons. First, it relies on long-standing precedent, barring enforcement of contracts that interfere with the right of employees to act together concertedly to improve their lot as employees. Second, finding individual arbitration agreements unenforceable under the Federal Arbitrations Act savings clause because are legal under the National Labor Relations Act gives full effect to both statutes. And, third, the employer's position would require this Court, for the first time, to enforce an arbitration agreement that violates an express prohibition in another coequal federal statute. (emphasis added).

This view contradicted the employers' opening statement that:

Respondents claim that arbitration agreements providing for individual arbitration that would otherwise be enforceable under the FAA are nonetheless invalid by operation of another federal statute. This Court's cases provide a well-trod path for resolving such claims. Because of the clarity with which the FAA speaks to enforcing arbitration agreements as written, the FAA will only yield in the face of a contrary congressional command and the tie goes to arbitration. Applying those principles to Section 7 of the NLRA, the result is clear that the FAA should not yield.

My co-bloggers have written about mandatory arbitration in other contexts (e.g., Josh Fershee on derivative suits here, Ann Lipton on IPOs here, on corporate governance here, and on shareholder disputes here, and Joan Heminway promoting Steve Bradford’s work here). Although Monday’s case addresses the employment arena, many have concerns with the potential unequal playing field in arbitral settings, and I anticipate more litigation or calls for legislation.  

I wrote about arbitration in 2015, after a New York Times series let the world in on corporate America’s secret. Before that expose, most people had no idea that they couldn’t sue their mobile phone provider or a host of other companies because they had consented to arbitration. Most Americans subject to arbitration never pay attention to the provisions in their employee handbook or in the pile of paperwork they sign upon hire. They don’t realize until they want to sue that they have given up their right to litigate over wage and hour disputes or join a class action.

As a defense lawyer, I drafted and rolled out class action waivers and arbitration provisions for businesses that wanted to reduce the likelihood of potentially crippling legal fees and settlements. In most cases, the employees needed to sign as a condition of continued employment. Thus, I’m conflicted about the Court’s deliberations. I see the business rationale for mandatory arbitration of disputes especially for small businesses, but as a consumer or potential plaintiff, I know I would personally feel robbed of my day in court.

The Court waited until Justice Gorsuch was on board to avoid a 4-4 split, but he did not ask any questions during oral argument. Given the questions that were asked and the makeup of the Court, most observers predict a 5-4 decision upholding mandatory arbitrations. The transcript of the argument is here. If that happens, I know that many more employers who were on the fence will implement these provisions. If they’re smart, they will also beef up their compliance programs and internal complaint mechanisms so that employees don’t need to resort to outsiders to enforce their rights.

My colleague Teresa Verges, who runs the Investor Rights Clinic at the University of Miami, has written a thought-provoking article that assumes that arbitration is here to stay. She proposes a more fair arbitral forum for those she labels “forced participants.” The abstract is below:

Decades of Supreme Court decisions elevating the Federal Arbitration Act (FAA) have led to an explosion of mandatory arbitration in the United States. A form of dispute resolution once used primarily between merchants and businesses to resolve their disputes, arbitration has expanded to myriad sectors, such as consumer and service disputes, investor disputes, employment and civil rights disputes. This article explores this expansion to such non-traditional contexts and argues that this shift requires the arbitral forum to evolve to increase protections for forced participants and millions of potential claims that involve matters of public policy. By way of example, decades of forced arbitration of securities disputes has led to increased due process and procedural reforms, even as concerns remain about investor access, the lack of transparency and investors’ perception of fairness.

I’ll report back on the Court’s eventual ruling, but in the meantime, perhaps some policymakers should consider some of Professor Verges’ proposals. Practically speaking though, once the NLRB has its full complement of commissioners, we can expect more employer-friendly decisions in general under the Trump Administration.

 

[1] Murphy Oil USA v. N.L.R.B., 808 F.3d 1013 (5th Cir. 2015), cert. granted, 137 S. Ct. 809, 196 L. Ed. 2d 595 (2017); Lewis v. Epic Sys. Corp., 823 F.3d 1147 (7th Cir. 2016), cert. granted, 137 S. Ct. 809, 196 l. Ed. 2d. 595 (2017); Morris v. Ernst & Young, LLP, 834 F.3d 975 (9th Cir. 2016), cert. granted, 137 S. Ct. 809, 196 L. Ed. 2d 595 (2017)

October 5, 2017 in Compliance, Corporate Governance, Corporations, Current Affairs, Employment Law, Legislation, Litigation, Marcia Narine Weldon | Permalink | Comments (0)

Wednesday, October 4, 2017

Revising How to Handle Derivative Claims (or Not)

Yesterday, Professor Bainbridge posted "Is there a case for abolishing derivative litigation? He makes the case as follows: 

A radical solution would be elimination of derivative litigation. For lawyers, the idea of a wrong without a legal remedy is so counter-intuitive that it scarcely can be contemplated. Yet, derivative litigation appears to have little if any beneficial accountability effects. On the other side of the equation, derivative litigation is a high cost constraint and infringement upon the board’s authority. If making corporate law consists mainly of balancing the competing claims of accountability and authority, the balance arguably tips against derivative litigation. Note, moreover, that eliminating derivative litigation does not eliminate director accountability. Directors would remain subject to various forms of market discipline, including the important markets for corporate control and employment, proxy contests, and shareholder litigation where the challenged misconduct gives rise to a direct cause of action.

If eliminating derivative litigation seems too extreme, why not allow firms to opt out of the derivative suit process by charter amendment? Virtually all states now allow corporations to adopt charter provisions limiting director and officer liability. If corporate law consists of a set of default rules the parties generally should be free to amend, as we claim, there seems little reason not to expand the liability limitation statutes to allow corporations to opt out of derivative litigation.

I think he makes a good point.  And included in the market discipline and other measures that Bainbridge notes would remain in place to maintain director accountability, there would be the shareholder response to the market.  That is, if shareholders value derivative litigation as an option ex ante, the entity can choose to include derivative litigation at the outset or to add it later if the directors determine the lack of a derivative suit option is impacting the entity's value.  

Professor Bainbridge's post also reminded me of another option: arbitrating derivative suits.  A friend of mine made just such a proposal several years ago while we were in law school: 

There are a number of factors that make the arbitration of derivative suits desirable. First, the costs of an arbitration proceeding are usually lower than that of a judicial proceeding, due to the reduced discovery costs. By alleviating some of the concern that any D & O insurance coverage will be eaten-up by litigation costs, a corporation should have incentive to defend “frivolous” or “marginal” derivative claims more aggressively. Second, and directly related to litigation costs, attorneys' fees should be cut significantly via the use of arbitration, thus preserving a larger part of any pecuniary award that the corporation is awarded. Third, the reduced incentive of corporations to settle should discourage the initiation of “frivolous” or “marginal” derivative suits.

Andrew J. Sockol, A Natural Evolution: Compulsory Arbitration of Shareholder Derivative Suits in Publicly Traded Corporations, 77 Tul. L. Rev. 1095, 1114 (2003) (footnote omitted). 

Given the usually modest benefit of derivative suits, early settlement of meritorious suits, and the ever-present risk of strike suits, these alternatives are well worth considering.  

October 4, 2017 in ADR, Corporate Finance, Corporate Governance, Corporations, Delaware, Financial Markets, Joshua P. Fershee, Litigation, Securities Regulation | Permalink | Comments (3)

Monday, October 2, 2017

Fitbit and Publicness

As some of our BLPB readers know, I am a habitual 12,000-step-a-day walker.  I monitor my progress on steps, stairs, and sometimes sleep using a Fitbit "One" that I have had since Christmas Day 2012.  Fitbit recently announced that it is discontinuing the One.  So, if my existing One dies off, I will have to switch trackers.  And, sadly, I am likely to have to switch suppliers.  While Fitbit has been good to me, the rest of its trackers are not at all interesting or suitable for my desired uses.  They are almost all wrist models, and the one clip-on tracker Fitbit sells is relatively bulky and antiquated.

I am not the only one who is unhappy about the discontinuation of the One tracker.  Fitbit has discussion boards for members of its "community."  The discussion board titled "Is Fitbit One being discontinued?" (which was started over the summer) has lit up over the past week.  As of the time of this post, there were 519 posts in the Fitbit forum.  

I have been impressed by the passion of the folks who have posted comments and responses.  Many posted reviews of other Fitbit products and competitor products that might be adequate substitutes for the One for some users.  But I have been fascinated by the nature of several posts, including a number that focus on corporate governance and finance matters.  Community members were motivated to check into and comment on Fitbit's published financial statements, litigation profile, and trends in the mix of product sales.  Some encouraged calling either Fitbit's customer service line or mutual funds that hold Fitbit shares (and they named the funds) to express concerns.  One member of the community posted that he is worried about Fitbit's employees, customers, and shareholders in the event Fitbit's business goes South.  

The comments made on the Fitbit community discussion board reminded me of Hillary Sale's work on publicness, including her article entitled Public Governance.  In that article, she observes:

Publicness is both a process and an outcome. When corporate actors lose sight of the fact that the companies they run and decisions they make impact society more generally, and not just shareholders, they are subjected to publicness. Outside actors like the media, bloggers, and Congress demand reform and become involved in the debate. Decisions about governance move from Wall Street to Main Street.

Hillary A. Sale, Public Governance, 81 Geo. Wash. L. Rev. 1012, 1013 (2013).  She later echoes that thought in a slightly different way:
 
Key to an understanding of publicness . . . is that the group demanding governance is larger than the stated partners (i.e., shareholders, directors, and officers) and includes outside actors. Employing a crabbed definition of this group is actually part of the problem. Those “outsiders” scrutinize decisionmaking and incentives. They monitor failures of internal governance, press for more external governance, and then publicness grows.
 
Id. at 1034.  The users of Fitbit's discussion board are digesting and reporting on Fitbit's operations and seeking governance changes in a public forum.  They are seeking ways to be heard by management.  Moderators occasionally post commentary and promise to pass on comments to Fitbit's management.  This is publicness--feedback loops that enhance public scrutiny and sway over the firm.
 
I doubt any of this will save the Fitbit One.  It seems that the firm is moving on with new products, notwithstanding significant customer demand.  So, once my rechargeable battery dies, I will be in the market for a new tracker.   I am accepting recommendations . . . .

October 2, 2017 in Corporate Governance, Joan Heminway, Marketing, Technology | Permalink | Comments (1)

Sunday, October 1, 2017

ICYMI: #corpgov Weekend Roundup (October 1, 2017)

October 1, 2017 in Stefan J. Padfield | Permalink | Comments (0)

Saturday, September 30, 2017

Asset Manager, Heal Thyself

Earlier this week, the Wall Street Journal reported that many institutional investors – including large mutual fund complexes like BlackRock and State Street – have become concerned about “overboarding,” namely, the phenomenon where corporate directors sit on multiple boards.

There are good reasons to be concerned.  Researchers have found that in many, though perhaps not all, cases when corporate directors are “overboarded” – and thus presumably unable to devote their full attention to governance at particular companies – companies are less profitable and have a lower market to book ratio.  (Similarly effects are found for distracted directors.)

That said, there’s a particular irony in seeing mutual fund companies, of all investors, leading the charge.  Most mutual fund companies employ a single board – or a few clusters of boards – to oversee all of the funds in the complex.  This can result in directors serving on over 100 boards in extreme cases.  State Street’s Equity 500 Index Fund, for example, reports trustees who serve on 72 or 78 boards within the complex.  BlackRock’s Target Allocation Funds have trustees who serve on either 28 and 98 different boards (depending on how you count).

I’ll admit this is something of a cheap shot: presumably each fund is much more similar to the other funds than are the various companies at which overboarding concerns are raised.  Still, when you get to over 20 funds per director, that’s a lot, no?  Or 50 funds?  Especially since the funds have varying interests – they might stand on opposite sides of a merger, or invest at different levels within a single firm’s capital structure, or compete for limited opportunities like IPO allocations and pre-IPO shares.  Different funds might even be differently invested  in firms within an industry, and thus have divergent interests regarding competition between the firms.  (Cf. Jose Azar et al., Anti-Competitive Effects of Common Ownership).  Not to mention the fact that the independent directors of a mutual fund are supposed to be the fund’s “watchdogs” against exploitation by the sponsor, but service on multiple boards - with associated salaries - may cause the relationship to become suspiciously cozy.

Point being, the overboarding concern is a real one.  But… I’m not quite sure BlackRock is the right face for the resistance.

September 30, 2017 in Ann Lipton | Permalink | Comments (1)