April 29, 2006
CFIUS and Dubai in the News Again
President Bush approved a CFIUS recommendation to approve a takeover of a British company by a Dubai stated owned company. Sound familiar? The Dubai company is Dubai International Capital and the British company is Doncasters Group, which owns nine United States facilities. Several of the United States factories supply critical parts for military vehicles and aircraft; high-tech turbine fan blades for engines, for example. CFIUS did the full 45 day review and the President, per the formal review, informed Congress of his decision. Congress did not balk. Those in Congress, who criticized the Dubai Ports World acquisition of a British company that operates several United States port facilities, approved this deal and took pains to justify their lack of opposition. Sen. Charles Schumer, for example, noted the difference in procedure and that this was " a product" not a "service." "The opportunity to Infiltrate and sabotage is both more difficult and more detectable," he noted. Both distinctions do not make much sense. Procedure did not matter in the Ports World acquisition -- a offer to do a 45 day review was met with derision and a House resolution to block the deal regardless. The supply of turbine fan blades could be constricted and the technology stolen. I suspect that members of Congress recognize that they cannot seriously upset a valuable global trading partners such as Dubai; a little grandstanding for the folks at home will be tolerated by Dubai as long as Congress does not make a habit of it.
Congratulations Class of 2006
I wish to take a moment to congratulate the 3rd year graduating class at Moritz College of Law. It contains a delightful group of talented new business lawyers, forty or more have taken at least three of my business law classes (eighty or so have taken two). They gave me the ultimate tribute --second in the vote for graduation speaker -- I do not have to prepare a speech this year as last; they also roasted me in the Hearsay with a very funny "news" story and an award for working the most "non-law" into law school class. I greatly enjoyed the privilege of getting to know many of you folks both in and out and class and wish you well. Bess you folks.
The story today in the NYT on stock options for Nelson J. Marchioli, the CEO of Denny's, is yet another illustration of a market problem in executive compensation. Denny's was paying its CEO in "in the money" stock options (options with an exercise price below the market price at the time of the grant, a discount). Most compensation options are awarded "at the money" (exercise price is at market price at the time of the grant). Some are "out of the money" (exercise price is above market price at the time of the grant). The "in the money" stock options have immediate value equal to the discount. The value is cash value if the options can be exercised and the underlying stock sold immediately or if the options can be sold immediately. Yet the value was hidden in the public filings of Denny's. Only a tipped off, thoughtful NYTs reporter, Eric Dash, could find it. Corporate officials say market forces determine executive pay and then work very hard to hide the pay from the shareholders, those who are paying the salaries. Disclosure rules are stretched to the limit with the sole aim of avoiding a full disclosure to shareholders on the full amount of pay packages granted CEOs and other senior executives. Boards who pay such salaries as agents of the shareholders are fearful of telling their principals, the shareholders, how much they are paying seniors executives. There is no market working when one-side in a bargain cannot figure out the facts. It is a national disgrace. And I am disgusted that I am moved to write something that sounds like it came out of the mouth of Jimmy Carter.
April 28, 2006
NYSE Luncheon Club to Close
Those in the midst of culture or economic change who get caught up in the detail and overlook the magnitude of the shift can be jolted into recognition by insignificant events. The closing of the Stock Exchange Luncheon Club is such an event. The Luncheon Club has served Wall Street brokers and bankers since 1898 in an oak paneled room on the seventh floor of the New York Stock Exchange building in downtown Manhattan. There is a sitting room with heavy leather chairs and elk heads overhead. Andrew Carnegie ate there; the club was once a hub of gossip and conspiracy. The club is closing. Enhanced security, electronic trading, the NYSE now a for profit, publicly traded company, the troubles of the last NYSE major- domo, Richard Grasso, have killed the club's business.
California's Effort to Regulate California Resident Corporations
The State of Delaware has, since the 20s, enjoyed the privilege of being the place of incorporation of over one-half of the country’s largest, publicly-traded corporations. There has been a tremor in the legal rules that underlie the foundation of this structure. Does the tremor forebode a larger quake?
Corporations that have no business dealings in Delaware often elect to incorporate in Delaware, choosing to be governed by Delaware’s corporate code and by Delaware case law for its preeminent business court, the Delaware Court of Chancery.
Over thirty years ago the California legislature, chagrined over California businesses escaping California law, passed Section 2115. The Section applies selected sections of the California Corporations Code to business in which (1) more than one-half of the outstanding voting securities are held of record by California persons and (2) more than one-half of the business, determined by a formula dependent on property, sales and payroll, is conducted in California.
The California legislation wanted selected shareholder protections contained in California law to apply to such corporations. Among the selected provisions are rules on the election and removal of directors by shareholders, directors’ duties, and on shareholder ratification of major company acquisitions. The Delaware courts have always viewed the California Section as void.
The matter came to a head in when Examen Corporation, incorporated in Delaware but with headquarters in California, entered into a merger agreement with Reed Elsevier. Examen had two classes of stock, preferred and common. Under Delaware law the two classes of stock vote as a single class; under California law each class votes separately and both must ratify the deal. Examen sought to apply the Delaware rule and the owner of over 80 percent of the preferred stock, VantagePoint Venture Partners, complained.
Both sides ran to court. Examen sought a declaratory judgment in the Delaware Court of Chancery and VantagePoint filed suit in California Superior Court. The Delaware court stayed the California proceeding and then the Delaware courts, not surprisingly, found that the Delaware rule governed the Examen vote. On appeal the Delaware Supreme Court affirmed. The “internal affairs” doctrine, which Delaware court held has constitutional dimensions, requires the law of the place of incorporation apply to all matters pertaining to the relationships “among or between the corporation and its officers, directors, and shareholders.” The merger closed and the Delaware Chancery Court released the stay on the California proceedings with a statement that it expected the California courts to defer to the Delaware court’s decision.
A second conflict soon emerged. A California shareholder, Friese, of a Delaware corporation, Peregrine Systems, doing business primarily in California, sought to apply a California section, 25502.5, that permits derivative actions based on claims of insider trading against directors and officers. Delaware does not have such a provision. A California court of appeal allowed the action The California court held that the internal affairs doctrine does not apply to state securities laws.
If California courts stick to their guns, Delaware’s supremacy as a place of incorporation is in serious jeopardy. The advantages of incorporating in Delaware would be eroded considerably if a state could apply its own laws on corporate structure to local businesses regardless of the place of incorporation. Delaware courts assume that the Supreme Court of the United States would have to step in and resolve the conflict in favor of Delaware’s supremacy using the Commerce Clause in the federal constitution.
The constitutional issue is not free from doubt, however. The constitutional doctrine has yet to be fully thought through. Discussed by the Supreme Court in CTS Corporation v Dynamics Corporation of America, a 1987 decision on state anti-takeover statutes, The Court based its theory of the Commerce Clause prohibition is on the difficulty of applying inconsistent state statutes to a single corporation. The doctrine “avoid[s] …fragmentation … facilitates planning and enhances predictability,” and prevents “inequalities, intolerable confusion and uncertainty.”
But the doctrine has problems in application that have not been worked through. For example, the internal affairs doctrine historically does not apply to state securities laws, which can be inconsistent. Are corporate governance rules fashioned as securities laws outside the doctrine? There are numerous other examples – state insurance and banking laws, for example. Moreover, there are intermediate positions on the doctrine that could both limit confusion and yet still respect a state’s sovereignty over business operations within its own borders. The Supreme Court could sanction the application of whichever state corporate code provision law is the most restrictive if both could laws could otherwise be satisfied, for example. The higher voting requirements of California for the Examen merger ratification would also satisfy the Delaware voting requirements so California rules could apply.
In any event, there is more to be said on the matter. For Delaware the risk is small of losing its position of pre-eminence but the size of the potential calamity of an adverse decision is huge. Delaware would have to enact an income tax rather than fund thirty percent or so of its government expenses on corporate franchise fees.
April 27, 2006
Da Vinci Code Opinion
A London judge, Justice Peter Smith, deciding the recent "Da Vinci Code" copyright infringement case for the defendant (Dan Brown), embedded a code into his opinion. His 71 page ruling contains italicized letters in the text. On page 51 he notes that one must read the two books in issue, "holy Blood and the Holy Grail" and the "Da Vinci Code," to solve the puzzle. The quirky opinion is a classic and will join other top ten quirky opinions in Ango-American jurisprudence (Justice Blackman's baseball hall of fame in the baseball antitrust exemption case; Chancellor Strines' opinion in Tyson Foods (I am "torn about the correct outcome"but -- will bring the hammer down) and Judge Owen's opinion in Alaska Hardware (I note on the Internet that the defendant sells crack cocaine...). Any other favorites?
April 26, 2006
Who Brought Down Enron?
Kenneth Lay is echoing Jeffery Skilling on the cause of the end of Enron: a few lower level executives misbehaved and the newspapers and speculators (short-sellers) blew the misdeeds out of proportion and created a panic ( a "run on the bank") among other investors, clients, counter-parties, and suppliers. The company had a healthy core business and was brought down by exaggerated rumors. An interesting question for both is how the company could have corrected the rumors and survived. Would immediate self-investigation, followed by a full public accounting of the problems and by suitable corrections, have saved the company?
Cox Testimony Before Congress
The Chairman of the Securities and Exchange Commission, Christopher Cox, appeared before the Senate Banking Committee for the first time yesterday. He outlined SEC priorities and addressed the concerns of the Senators. There were no surprises but no disappointments either. The SEC will rethink its proposed rules on the structure of mutual fund boards of directors (which were ill advised). SEC new initiatives will include a review of the registration of credit-rating agencies (which is welcome). There is not enough competition in the credit-rating agency market, only five are approved, and the participants are too cozy with clients and with each other. Members of Congress asked Cox to speak to the health of the nation's capital markets (our markets have lost market share in the new listings markets) and to the ramifications of upcoming securities exchange mergers (including oversees mergers).
April 25, 2006
GAO Report on LLCs
The GAO today issued a report on what it calls "shell" companies. Shell companies are primarily LLCs that take full advantage of the anonymity allowed by state codes. Several states allow "front" nominees in their official filings. Moreover, since state officials never check on the names submitted in registration of any individuals named as officers (or directors, if a corporation), some firms simply submit fake names. The GAO is concerned that shell companies are used for tax cheating and money laundering. The three states named as homes for LLCs that engage in questionable conduct are Delaware, Oregon, and Nevada.