Business Law Prof Blog

Obama on Profits

The press has well covered President Obama's remarks on "shameful" Wall Street bonuses paid last week.  As it should. One phrase in his remarks is odd, however.  He added:

"There would be time for them to rake in profits and bonuses later in the economic cycle," he said. "But now is not that time."

Why are "profits" bad?  Bonuses without profits is looting by executives. But do we not want our companies, such as Ford and GM, to return to profitability? "Raking" in profits at American companies would be great, anytime.

Government's Knee-Jerk Responses in an Economic SlowDown

Reading the country's economic history one cannot help but be struck by the pattern in government responses to any economic slowdown.  In order the government will: 1) Attack market players (short sellers,speculators, and those who use leverage), 2) Attack the markets themselves (bank holidays, stock market closings, wage and price controls, industry cartels, foreclosure moratorium, import restrictions, buy American clauses), 3) Set interest charges below market rates (attacking the valve of its currency), 4) Provide government funds (first in loan then in grant), in order, to banks, companies, states, and unemployed workers, 5) Start large government works projects, and 6) Nationalize private industry (very similar to 5)).  4)5) and 6) are done with deficit spending (borrowed money).  One could also argue that step 7) is Engage in a major war.  I hope not.  The answer to critics of FDR's New Deal (which did not pull us out of the depression) is that the government did not spend enough; perhaps the answer to critics of Bush is that the war in the Middle East was not big enough.  An alternative 7) which we have not tried but dictators in many countries have is 7) Inflate (devalue) your currency once the government debt builds up to intolerable levels.

Roche's "Hostile" Bid for Genentech

Roche has announced a "hostile" bid for Genentech at $86.50 a share.  Sounds simple enough. It's not.  Roche already owns 54 percent of the stock.  It is making a hostile bid for the remaining shares in a company it already controls.  A special negotiating committee of the Genentech board had rejected the Roche offer of $89 a share.  The bid comes in a falling market, with financing very difficult to secure, on the eve of a drug approval, and for a company that has most of its value in employee knowhow.  Very risky stuff.  Roche will hope to close a negotiated offer with the new pressure and then defend in court the value paid. Keep in mind that much of this is to convince a judge that the price paid for a minority shares is "intrinsically fair."

Stimulus Bill

The press and commentators are picking apart the House and the Senate Stimulus Bill, noting many (most) of the items are not directly related to quick job creation because they are, among other things, 1) time delayed, 2) promoting social goals, or 3) promoting regional goals (pork).  We should not be surprised.  Members of Congress are elected by regional voters and supported (with campaign contributions) by groups promoting social goals (environmentalists, unions, trial lawyers, health care advocates).  Give the members of Congress $800 to $900 billion to spend and they have an overwhelming incentive to favor local causes and social causes that provide party funding support.  Congressmen Barney Frank's recent comment is choice.  When Geithner put in place rules to log all calls on spending the TARP money and will, apparently, put the logs on the Internet (I will believe this when I see it), reported tracked down Frank, who was front page news in the Wall Street Journal for pressuring Treasury to put TARP money in a Boston bank that did not deserve it (TARP bails out only healthy banks; this one should be wound up).  Frank's response, and I paraphrase:  "Glad to see the log made public. My constituents will know I am going to bat for them."  This Bill will be a very crude approximation of a true Stimulus Bill.  And there are huge costs for not getting the Bill right; the government borrowing to support the bill will deplete funds for private investment and deplete funds for borrowing by other suffering countries.  If the gains from the Bill do not outweigh the costs (the so-called multiplier is less than one), the Bill will be a domestic and international dead weight loss. We will have to beat the recession despite the Bill's increased burden. 

Geithner the Pragmatist

Geithner is know as a "pragmatist."  This is why he only paid two years of back taxes when he owed four; the statute of limitations had run on the two years.  He passes strict new anti-lobbying rules and then hires for his Chief of Staff and very, very well connected lobbyist with Goldman Sachs.  A pragmatist, indeed.  Odds are he will run Goldman when he leaves the Secretary's office.

Hedge Fund Whipsaw

In the UK, Parliament had three of the leaders of its largest hedge funds on the hot seat.  The members wanted to know whether they were making too much money off the bank difficulties in the country. Some of the funds had shorted bank stocks.  To defend themselves the fund managers showed their market losses. This apparently made the members feel better.  So hedge funds, had they collapsed like the domestic banks, would have been pilloried for taking on too much risk, were not pilloried for making money.  Their defense was that they also lost some money.  In the United States we will regulate hedge funds for taking on too much risk even though they are not the cause of our troubles and we are begging, begging them to put their money in the market.  Hedge fund managers had better have a very good sense of humor or humour.

Thain Craps Out

The news that Thain "resigned" from Bank of America is remarkable for its underlying text.  First, why did Thain, a very smart fellow, give silly ammunition to those who want to attack his decisions.  By buying a 35,000 dollar toilet on the company's ticket he gives an open option to those who want he out to embarrass him publicly.  He could buy the toilet for his home and no one would have bothered him.  Second, and more important, where are the lawyers who drafted the acquisition agreement?  Apparently, Merrill traders accumulated losses after the deal was signed and before it was closed. Moreover, Thain pain bonuses to workers after the deal was signed and days before it was closed.  Any decent acquisition agreement would have given Bank of America veto rights over major Merrill decisions from signing to closing.  Why did BofA not monitor Merrill trading or Merrill compensation practice during this period and exercise its contract rights?  Finally, we will wait to hear about Thain's buyout agreement and wonder about the TARP payment conditions that limit severance payments. Correction:  I have been instucted in the comments that a commode is not a toilet; it is used to hold a camber pot.

Delaware Cases: A New Line of LLC Cases

The last several years of Delaware business cases had many cases on predictable issues -- merger approvals, compensation, fiduciary duty, executive defense expense indemnification, and inspection procedure.  The surprise was the heavy number of cases on contract theory and its application to LLCs.  It is clear that Delaware is now seeking to establish a leading position in the country with a strong pro-contractual view on LLC operating agreements, buttressed significantly by a strong view on the limits of judges in rewriting and modifying contract obligations and language. 

Is the UK Bankrupt? Lessons

Just as the problems in the UK foreshadowed ours in the late 20s, do the problems in the UK now foreshadow ours?  There is a serious debate about whether the UK, as a country, is bankrupt.  It has poured money into the Royal Bank of Scotland.  The bank is still unsound, full of bad assets that have yet to be accurately priced, and the country owns 70 percent of the stock of the bank.  We have poured money into financial institutions that are still unsound and seem willing to put more in.  One of the authors of the bailouts, Geithner is the new Secretary of the Treasury, who admits to some past mistakes (not his apparently) and, promises to do it better in future bailout packages (and in his future tax returns).  We now learn that Barney Frank, and others (Ohio, NC, and Ala.), have directed bailout money to banks in their constituency base  -- no based on their health but based on their location.  Of course politicians will do this -- their incentives to do this are overwhelming.  At issue ought to be whether bailouts are futile and inherently misdirected given political incentives.

Tracing Bailout Money in the Banks: the Journalists are Asking the Wrong Question

It is good sport to call someone at the large banks that have received government bailout money and ask:  "Were did the money go?"  The right answer to a physical tracing question is "I do not know."  It is the wrong question.  Cash is fungible and not sensibly traceable physically.  Cash used for one purpose frees up cash for another.  The right question has to be "What did the bank do once it received the grants that it would not have done had it not received the grants?"  Once asked this way the questioner would get a reasonable answer.  Banks worried about capital reserves would be folly to lend more money in high- risk consumer or business markets, increasing capital reserve calculation problems; they sensible would buttress capital reserve ratios by holding the cash (or securities that count as cash) or using cash to pay off liabilities that count against the capital reserve.  Why pillory banks for doing what is prudent in a down economy?  They have be critizied for making excessive risky loans to "people who could not pay" and are now lending very, conservatively.  If the the government wants more risky loan made, the government will have to do it (nationalizing a private bank to use as a conduit or using the Treasure dollars or the Fed's reserves).

Geithner Takes a Cue From Obama: "We Will Have a Plan"

Geithner's testimony at his confirmation hearings was priceless.  He announced a "bold" plan (ie. "not incremental") on a "dramatic scale" that "hopefully" would come in the "next few weeks."  The plan, when it appears, will fix a multitude of problems, tight credit, foreclosures, bank insolvency, international confidence in our markets. Asked for policy principles or details he demurred, agreeing amiably with any Congressperson that had a thought.  "Yes, we are considering that...(fill in the blank)."   No-one asked the obvious: "How can you describe a plan as "bold" and "dramatic" that has not yet to be formed and that is "hopefully" soon to appear?  Sounds like trouble brewing. 

Chrysler "Alliance" with Fiat: Giveaway Funded by the US?

Chrysler is selling 35 percent of itself and a warrant for another 20 percent to Fiat.  The price? No Fiat cash.  Fiat puts in technology and new products.  The warrant strike price is set at a measly $25 million.  The government must put in another $3 billion to make the deal work.  So, in essence, the government is paying Fiat $3 billion to take 55 percent of the company and see is they can make a go of it with their new products.  Do we believe Fiat will save Chrysler's American jobs?

New York Times Finds a Sugar Daddy

Carlos Slim loaned $250 million to the New York Times to keep it going, for now.  It was not much of a deal.  The note pays 14 percent (three percent is optional pay-in-kind junk) and comes with warrants, convertible into common (I assume they are out of the money but I do not know).  Slim already owns 6.4 percent of Times common (the limited voting stuff), for which he paid $128 million -- it is now worth $58 million.  The messages??  1) The private market would not take 14 percent notes?  Whew. The New York Times is in deep trouble. 2) Foreign investors are suckers.  When foreign investors appear to buy American name brand assets --  the  Empire State Building, Pebble Beach Gold Course, the NY Times - they, like 60 year old rich folks buying old muscle cars from the 60s at Barrett Jackson auctions, lose their bearings and pay too much -- for the hobby of it all.   We will wait in vain for the financial columnists of the NY Times to comment. Gretchen, got a view?

BofA's Deal for Merrill Awash with Questions

Bank of American closed its purchase of Merrill Lynch on January 1 of this year.  BofA shareholders voted to ratify the deal on Dec. 5 of last year.  We now know facts that we did not know at the closing and that the shareholders of BofA did not know when they voted to ratify the deal.  At some time in early December, the CEO of Bank of America knew that Merrill's debts were worse than he had anticipated when he priced the deal.  Paulson and Bernanke urged him to close anyway and, apparently, offered government support.  Traders and shareholders knew none of this until mid-January.  This is lawsuit heaven.  The government will not get sued, of course, but Bank of America will -- for federal securities act violations and for breach of fiduciary duty.  But the government's role will be an odd one; with government supporting confidentiality and the SEC floating around the lawsuits of lack of disclosure we will see some very fancy high stepping.  This will take years to play out but it is well worth the watch.  Once again Paulson comes up short in the crunch. 

Geithner and Bailouts

Geithner's tax troubles are well known but less discussed is his role in the bank bailouts.  The position of Chairman of the New York Federal Reserve Bank has, since the days of Strong in the 20s, been itself a very powerful position. The NY Fed is the best capitalized of the 12 Federal Reserve Banks and does much of the Fed's bidding.  What was his role in the bailout bill, TARP?  Did he recommend money to Citigroup and Bank of America?  On what grounds?  The press coverage out of New York on the appointment is very favorable and this itself should be a warning. The New York financial community is happy with his appointment. Why? Because he is soft on the New York financial community.  Congress is barking up the wrong tree on his confirmation. So what else is new?

Citigroup and GE Need to Bust-up

Citigroup and GE and old fashioned conglomerates that grew too broadly, too fast and need to be busted-up, focusing on a core business and selling or spinning off all others.  Too bad hostile takeovers are dead; a bust-up buyout would be appropriate for both companies.

Geithner's Troubles

Obama's choice for the Secretary of the Treasury, Geithner, has, as the press refers to it, a "hiccup" in his confirmation.  He did not declare personal income on which to pay taxes for several years, corrected late, and, as Secretary of the Treasury will run the Internal Revenue Service.  He also employed a house-keeper that, for a few months, had expired immigration papers. This is peanuts and will get some attention. But the item that is not peanuts, Geithner's significant supportive role in the crazy patchwork of government bailouts under Paulson, will go undiscussed and, apparently, does not matter.  He will be confirmed.  He ought not be confirmed, on the merits of his job performance as President of the NY Fed.    

Independent Directors and Satyam Computer

Sat yam Computer, a Indian company, has been exposed as a giant financial fraud.  The government of India is attempting to reduce the damage and, effectively, has taken over the company.  On the board were two Harvard academics.  One, Krishina G. Palepu, is a Harvard business school profession with an expertise in, you guessed it, corporate governance.  The other, Mangalan Srinivasan, is an adviser to and distinguished fellow of the Kennedy School, Harvard. Both had approved the company's efforts to purchase two subsidiaries owed by the sons of the founder (the crook).  Whether this says something about Harvard, academics, independent directors, or experts in managementor "corporate goverance," I leave to you.

President Hoover and the Great Depression

A quick education on the great depression has convinced me that President Hoover has "gotten a bad rap" or, more accurately, is blamed for the wrong thing -- doing nothing-- and should be blamed for the right thing -- starting the New Deal.  The effect of blaming Hoover for laissez-faire and extolling the virtues of President FDR for the New Deal is to mount a case for the New Deal.  But Hoover was not laissez-faire, as he himself laments later, he established the precedent and foundations of the New Deal -- he just did not put a name on it.  Read Hoover's 1931 speech to Congress with his nine point plan -- it is very, very interventionist and statest.  Hoover's administration acted to hold up wages (Davis-Bacon act, among other efforts), to lower Fed discount rates, to lower mortgage rates with  the Home Loan Bank system, to attack short sellers and stock prices, to reform bankrutcy to facilitate debt forgiveness, to loan money through the RRC to states and local governments, to loan money to banks and railroads, to start multiple public works projects (remember the Hoover Dam?), to restrict immigration, to enact tariffs, to regulate capital requirements in banks (Glass-Steagall Act), and to cartels commodities to fix prices (wheat and cotton).  If one wants to compare a laissez-faire government approach to a depression to an activities approach to a depression one should compare the 1921-22 depression with the 1929 to 1940 depression.

Litigation Over a Triggered Poison Pill: Selectica

When a poison pill threatens potential acquirers, the acquiring company usually files suit to have the pill declared invalid -- before the the acquisition.  In an unusual case, a group of purchasers triggered a poison pill intentionally, the target company, Selectica, refused to withdraw it and the target company began litigation in the Delaware Chancery Court to have the pill declared valid.  The pill, a shareholder rights plan that dilutes the acquirer by exchanging one right for one share of target stock not held by the acquiring group, had two unusual features, first it had a 4.99 percent trigger -- very low-- and second it gave the Selectica board ten days after the triggering purchase to withdraw or act on the pill's dilution. The case will provide the Delaware courts yet another opportunity to consider limits on the use of poison pill plans.  I hope they will take it and declare the 4.99 percent trigger too low to be justifiable as a takeover protection.