Business Law Prof Blog

Business Law Professors Square Off Over Sarbanes-Oxley

Joseph Nocera's column in today NYT (Business Section),  "For All Its Cost, Sarbanes Law is Working," was a typical Nocera effort to declare.  He takes a controversial topic, breezes over the claims for and against and declares.  He has done, for example, a column on Donaldson as head of the SEC, declaring that he did a good job.  In his column he quotes two law professors, William J. Carney and Steven Bainbridge, on the law "unintended consequences and quotes Harvey J. Goldschmid:  "There is no question it has been a great piece of legislation, and anybody who says otherwise is talking like a darn fool."  Ouch, Goldschmid was on the SEC when the SOX was put into place and had an important hand in the implementing rules. Well, lots of folks are talking like fools.

There are two parts of the argument that are hard to deny.  First, Congress intended the legislation to clean up the corporation scandals of 2002.  A primary part of its purpose was to fix auditing; auditors had misbehaved.  The primary effect of the legislation has been to enrich auditors.  Auditors have more important positions inside companies and must do more;  audit fees have skyrocketed.  So a profession misbehaves, Congress writes legislation to discipline them and the profession profits big time -- what a great country.  We should we suspicious of any legislation that has this effect.    Second,  of course the legislation has benefits, the question is the cost of the benefits.  Nocera quotes CEOs saying that they learned some things about their companies from Section 404 internal controls audits.  Nocera uses these CEO revelations, in the final analysis, to say the legislation works.  Pretty shallow stuff.  An argument like this could justify any number of very silly disclosure rules.  [Make all companies run environmental bore hole tests on every acres of land every year or so;  some CEOs will learn something.]  All companies must do Section 404 audits and some will learn a bit that they would otherwise not know --but many (most?)companies, making a business decision on information, would not do them if not forced to -- the total information gains from the 404 audits do not exceed the total costs of the rules.   The continuing exemption for small companies (and the discussion of the exemption) is where the rule's true problems are revealed for all to see.

Icahn Bids for Fairmont

Carl Icahn has announced a hostile bid for legal control of Fairmont.  He has offered to pay $40 a share for enough shares to obtain voting control,   total offer of $1.2 billion. article  The shares have jumped to over $40 a share, indicating that the market believes that a higher offer will be made.  Icahn has taken the position that the company should sell itself to a large hotel chain.  Fairmont is looking for other buyers. who will buy the entire company -- ironically what Icahn would do if he closed his tender offer.  My guess?  The company will sell (100 percent) to a chain and Icahn will be happy, cashing in on his toehold stock position, with the company having done what he wanted it to do in the first place.

Harvard Business Law Professors in the News

Both major papers, the WSJ and the NYT, featured Professor Robert Clark's conflict situation in the Icahn proxy contest with Time Warner.  Clark is the Time Warner's board and also on the board of Icahn adviser, Larzard.  If Icahn decides to sue the Time Warner board for breach of duty as a part of the proxy contest strategy, Clark would be an important witness (and perhaps even a defendant).  Clark joined the board in 2003, after most of the mistakes Icahn alleges were made.  But the current board, which includes Clark, is responding to the Icahn demands and that response could generate litigation. 

Also of interest has been the failure of Professor Guhan Subramanian, as a plaintiff's expert, to convince Vice Chancellor Strine of much of anything in two recent cases, In re Cox Communications and In re Toys R Us.  Vice Chancellor Strine is an adjunct professor himself at Harvard and often participates in Harvard programs.  Given the difficult es Vice Chancellor Strine gave some Stanford professors for a lack of independence of a collegial relationship in the Oracle litigation (a professor on the SLC was held to be not independent of another professor who was a defendant) one wonders whether the appearance of Harvard law school professors in Strine's court, either as defendants or experts, could raise related questions. 

Clark's colleague Lucian Bebchuk has defended Clark's integrity in the WSJ but, according to the Oracle opinion, Bebchuk also is not independent.       

Hedge Fund Settlement Deal Announced

According to the SEC, Millennium Partners LP agreed to pay $180 million in fines and restitution to settle charges brought against it by the New York Attorney General’s office and the SEC for its fraudulent trading activity.  Millennium made over $100 million in ill-gotten revenues by “flying under the radar.”  The limited partnership set up a series of shell companies, accounts, and P.O. boxes in an effort to throw off the SEC monitoring of its market-timing transactions. 

"Millennium developed multiple schemes that cost mutual fund investors tens of millions of dollars," Spitzer said. "As a result of our investigation, those frauds have been halted, and restitution will be made to investors who were harmed."

For more, click here.

Going Private Because of Sarbanes-Oxley

Posted by Bill Sjostrom

There has been talk recently that SOX is causing public companies to go private.  SOX was mentioned by the CEO of Georgia-Pacific as a reason why it agreed to be acquired by Koch.  I suspect the true reason is that Koch offered Georgia-Pacific a 39% premium (see here and here).  No longer being subject to SOX and other regulations is the gravy, and giving it as a reason for selling out makes for a good sound bite.

I think S&P’s chief economist has it right.  According to this Business Week article, in his view: 

SOX is a factor in the recent wave of privatizations, but a relatively minor one. He does, however, think the legislation makes it even harder to be a public company, which creates another incentive for outfits to stay or go private. "Most of the issue is, I think, transitional. Once companies learn to operate in the new environment, it should stabilize."

Increased regulation has always been a disadvantage of going public, but for the companies that decide to go public they conclude it and other disadvantages are outweighed by the advantages of going public.  SOX changes the calculus by magnifying the regulation disadvantage, so on the margins it may lead to some companies (likely small companies) deciding to stay private or go private, but I don't see a bunch of Georgia-Pacific sized companies doing the same.

New SEC Proposal on Public Filings

Yesterday the SEC proposed new rules for public filings.  Companies may file annual reports and proxy solicitation materials on line as long as non computer users can still ask for mailed copies.  The new rules will make proxy contests somewhat less expensive as challengers can also use the on line proxy solicitation process.  The comment period is 60 days at which date the agency votes to finalize the rules.  If finalized the rules will be in place for the 2007 proxy season.

The proposal is modest, indeed it is underwhelming.  The Internet has been in full flower for over ten years and the agency just now decides to allow for on line disclosure.  Moreover, the rules do not address the ticklish shareholder voting questions that have been debated for several years--questions such as broker's default voting and shareholder access to the management's proxy card.  In other words the SEC's pace has been glacial and lacking imagination.  Finally, the most important issue faced by the SEC over the use of the Internet is the use of the Internet for securities offerings -- something the SEC has dragged its heels on for years.  The Internet could drastically reduce the cost of raising money in securities offerings, particularly for small companies, if the SEC could design procedures that would work.  The old 33 Act procedures for offerings make no sense in the Internet age.   

Pozen Editorial in the WSJ

Robert Pozen ("Democracy by Proxy")writes an editorial to encourage the SEC to "allow" shareholders of public companies to modify traditional shareholder voting systems with some sensible suggestions.  The problem with his analysis is that the SEC's permission is not required.  Companies can write bylaws without the SEC's sanction do to what he suggests: allow shareholders to nominate a "short list" of candidates, for example.  Firms can voluntarily do most of what he wants.  Companies chose not to.  Shareholders have pressured firms to adopt new voting bylaws.  Some firms have; most resist, using very technical legal arguments that are a front for their unwillingness.  For an example of the arguments see Phyllis Plitch, Critics Fault Changes to Board Votes (WSJ, 11/29 at B8)(we will be sued). 

Anti-Wal-Mart Legislation

The Maryland legislature passed a statute, vetoed by the Governor, that would have forced Wal-Mart to use at least 8% of its payroll on employee health care.  article  I was surprised the backers did not go French and ask for a 35 hour work week and a minimum hourly wage of $12 an hour as well.

Delaware Law on M & A: Reasoning Into Corners

Delaware now has different six legal tests for M & A cases and are soon to fashion a seventh.  Add two old tests and you are up to nine.  The new ones, since 1985: Business Judgment Rule with a threshold test of adequate information (Van Gorkam):  Enhanced Scrutiny, reasonableness/proportionality (Unocal);  Enhanced Scrutiny, best price in control changes (Revlon);  entire fairness (Weinberger); compelling justification (Blasius); and coercion (Salamon).  The old ones:  waste; entrenchment of position (Cheff).  The Van Gorkam test can be modified by charter amendment, substituting a new test and Unocal test has subdivided sub parts:  the reasonable threat test has three sub-parts (opp. loss, structural, and substantive coercion) the proportional response test has three sub-parts (draconian which divides into preclusive and coercive and, if not draconian, range of reasonableness (Unitrin).  And we are facing the development another major new test good faith (Disney) that will necessarily apply to acquisition decisions.  Honorable mention goes to the difference between best practice, standards of conduct and standards of judicial review and between the business judgment doctrine and the business judgment rule.

The test that applies may determine the result.  We get very odd dichotomies:  The courts respect a shareholder's decision to vote but not her decision to sell shares.  Stock consideration in big mergers gets a better legal test than cash consideration.  A squeeze-out with a tender-offer merger combination gets a better legal test than a squeeze-out with a straight merger....

Other states are, one by one, refusing to buy into the doctrine.  Some states bail out by statute (Indiana, Ohio & Virginia) and some by case law (New York and North Carolina).  Some other state courts just misunderstand and misapply the doctrines.  Heck, even the trial court judges in Delaware are surprised by the twists and turns (note the many Cede remands).

How did the Delaware court create such a unnecessarily complex legal structure for evaluating conduct in acquisitions?  Much of it appears to be a political response to public reaction in a very charged era, the 80s.  For example, the court was stunned with the negative business community reaction to Revlon, cut back on the case in Time, receiving more negative comment, and then reversed course again in QVC, all the while attempting to reconcile the cases and not overrule anything.  Other stories are similar:  VanGorkam led to Brehm (with the state legislative also intervening with a waiver statute) which will now give us a new Disney doctrine on good faith. 

The Delaware courts are solid and reliable; they need to temper this case to case judicial lurching of doctrine.

   

Some People Deserve to Lose Money

I just watched Mad Money with Jim Kramer.  He recommended a Korean stock, call letters FORM.  At close the stock was down $1.00.  After his recommendation, the ticker at the bottom of the screen started to register after hours trades in the stock. Trade after trade pushed the stock from down $1.00 to up over $1.50 by the time the ticker stopped registering the after hours trades.  The name of the show is correct; this is madness.   

UK to Scrap "Social Issue" Disclosures

Chancellor Brown of the UK has announced that the government will scrap announced plans to include more robust disclosure of soft information for UK companies. Article  The UK had undertaken to add a layer of public disclosure to the EU directive on the subject, the new layer to include soft information on future strategies and on various social questions, such as a company's environmental impact.  The Chancellor stated that the disclosure plans added to much to the expense of a normal public filing.  The move will be a major disappointment for those who want company's to make public declarations on various social questions affected by the company's operations.  Company's can always make such statements voluntarily of course; proponents want a legal requirement that they be forced to do so.

Darn.  I thought UK would slam its companies and we would finally recover some of ground we lost after hurting our companies with the Sarbanes Oxley, Section 404 debacle. Shucks.

Street Names

Most individuals (80 percent) hold stock through brokerage houses.  The stock is titled in the street name of the brokerage houses and the individual investor is an equitable (beneficial) owner of the stock so held.  Communications from a corporation to the individual investors must go through the brokerage house (whose name is on the corporation's share transfer record),  The brokerage house has a legal obligation (under federal securities laws) to pass the material from corporations through to the beneficial owners.   The beneficial owners, for example, get the proxy solicitation materials.

Corporations want to have the names of the beneficial owners to communicate with them directly;  they want an SEC rule that would give them the names of all beneficial owners.  The corporations should not have a legal right to them.  The relationship between brokers and individual investors is a matter of contract and the two parties to the contract ought to be able to do as they please.  The contract should give individuals the option to disclose, as it does now.  In this regard the contract should also give individuals the choice the whether or not to let brokers vote their shares (and how) if the individuals chose not to do so.  This the brokerage contracts often do not do.

Hedge Fund Regulation

The early results of the soon to be effective hedge fund regulation show how far the funds will to avoid regulation.  Some hedge funds are avoiding the new rules by imposing two year lock-ins of investors (to the investor's detriment who can no longer discipline fund mangers by threatening withdrawals); others are narrowing their investor base to under 15 very large individual investors;  and finally some are considering a move from Conn.to the Bahamas.

What do to with SROs?

The move of non-profit stock exchanges to for profit corporations has led to a searching analysis of what to do with the regulatory arms of the old exchanges.  No one is comfortable with for profit exchanges running self regulatory systems under the oversight of the government.  The SEC has published a concept release on the issue, asking for opinions on what a new system should look like.  The current SROs of the NASD and NYSE,which have been or will be spun off into non-profit organizations, are in merger talks. 

I have always believed that the SROs have underperformed over the years and would take the opportunity to abolish them completely.  The SEC should regulate the exchanges directly.  The for profit exchanges, however, should continue to be free to discipline their membership consistent with general anti-trust principles on refusals to deal and restraint of trade.  The exchanges, even when run for profit, with have a reputational interest in the quality of their membership; they should be free to restrict member and discipline members on factors such as integrity, trading acumen, and capital worth.   Similarly exchanges should continue to have the freedom to impose listing requirements on traded companies.  The exchanges can compete with each other on the quality of their members and their listed companies; traditional market solutions will work here.

Delaware Legislature Needs to Step Up to Clean Up Court Holdings In M&A

    Delaware court doctrine in corporations is in disarray.  Vice Chancellor Strine is in open disagreement with five major Delaware Supreme Court opinions,  Cede II, Unitrin, Lynch, Time & Omnicare.  And he is right.  His disagreements test his lower court role however as he snipes at the opinions in his subsequent opinions and in law review articles and cites too frequently the dissent and overruled lower court opinions in the cases.  Another Vice Chancellor admits in footnotes that important doctrines are confused (does the business judgment apply when a SC negotiates a related-party transaction that does not involve a conflicted controlling shareholder).   The Supreme Court is too proud of its traditional as a stable court to overrule bad precedent and thus constantly attempts to reconcile cases with each new holding; it creates a proliferation of complex, interwoven doctrine that surprises even their lower court judges. The QVC/Time change of control distinction, for exampel, distinguishs directors duties in cash deals from stock swap deals without good reason.  The only solution is legislative.  The Delaware legislature, taking a cue from the ABA Model Act, must legislate to put more doctrine on directors duties in the corporate code.  It will give them, and the lawyers that advise them, an opportunity to sort out the doctrines and clean it up.