Business Law Prof Blog

Dent on Shareholder Rights

George W. Dent Jr. has posted The Essential Unity of Shareholders and the Myth of Investor Short-Termism on SSRN with the following abstract:

The separation of ownership and control publicized by Berle and Means in 1932 persists today. Domination of public companies by self-serving and ineffective executives costs America billions of dollars every year and contributed to the current economic meltdown. Repeated efforts to solve this problem – including the Sarbanes-Oxley Act, expanded disclosure duties, and more stringent requirements for director independence – have had little benefit and have sometimes made matters worse. The flaws in our corporate governance system are a growing problem for America's economy as disillusioned investors increasingly place their capital in other countries. Nonetheless, proposals for greater shareholder power have encountered criticisms: various shareholders have conflicting goals; shareholders favor a short-term perspective at the expense of the long-term health of companies; and shareholders lack the knowledge needed to play a positive leading role in corporate governance. This article refutes these charges. It shows that the objections to shareholder power are greatly exaggerated, often contradict elementary economic principles, and have no empirical basis; they are myths. The article delves into the latest research in financial economics to demonstrate that greater shareholder power is associated with better corporate performance in all respects, including those respects in which critics charge that shareholder influence would be detrimental.

ECC

Johnson on Securities Regulation

Jennifer J. Johnson has posted Private Placements: A Regulatory Black Hole on SSRN with the following abstract:

Many investors, including vulnerable senior citizens, are victimized each year in dubious securities offerings yet governmental regulators can do little to intervene. Utilizing the Rule 506 private placement exemption, promoters today can escape regulatory review by both federal and state securities officials. While states at one time served as "local cops on the beat" to protect their citizens, Congress in 1996 preempted state authority, thus creating a situation in which suspect investment schemes can proliferate below any governmental radar screen. This article questions the continued wisdom of this regulatory vacuum, especially in light of recent financial events.

This article reviews the legislative history of this preemptive statute, the National Securities Markets Improvements Act of 1996 (NSMIA), and concludes that the preemption of private placements either resulted from congressional misconceptions, back room politics arising from the
conservative deregulatory agenda of the decade, or both. After analyzing the regulations and the private placement market as it existed in 1996, and as it operates today, the article concludes that NSMIA's cogent preemptive force primarily impacts state authority over the smaller, most risky private placements. Combined with the lack of federal oversight, this statutory preemption creates a regulatory abyss that permits many questionable offerings to take place. In its zeal to deregulate, Congress left many investors with little, if any, governmental protection. This article proposes a
return to state supervision of designated private placements. This modest proposal would foster capital formation, protect investors, and provide for a more rational and efficient legislative framework to regulate private securities transactions.

ECC

Harris on Private Equity

Lee Harris has posted A Critical Theory of Private Equity on SSRN with the following abstract:

In the private equity world, partnership agreements have received praise from many corners for reducing the agency costs arising between the interests of fund managers and investors. This article sets out to assess contract design in private equity partnerships. The argument here is that the importance of many of these heralded contract design features has been overstated. Part II describes the legal rights of investors in private equity funds. By default, investors in private limited partnerships have limited rights to participate in day-to-day operations or challenge decisions of fund managers. As a result of this set of default legal rules, investors in these funds face a familiar agency problem. That is, fund managers may be emboldened to pursue their own self-interest at the expense of investor interests. Some have boasted that contract design resolves many of these major agency problems. Parts III and IV describe a few of the best private contractual arrangements that investors have used to overcome these legal and economic constraints. As will be shown, however, many of these contract design features have severe shortcomings. Contract design appears to be an uncertain solution to the problem of agency costs in private equity limited partnerships.

ECC

Nees on Oversight Liability

Anne Tucker Nees has posted Who's the Boss: Unmasking Oversight Liability within the Corporate Power Puzzle on SSRN with the following abstract:

This article explores the competing interests between director authority and accountability within the doctrinal developments underpinning the arguments for and against director oversight liability. The historic losses suffered by companies entangled in the web of subprime mortgages, collateralized debt holdings, and the ensuing credit crisis have brought the role of corporate directors as risk managers under renewed public scrutiny. Directors' authority and their accountability to shareholders are two critical pieces to striking the appropriate balance among the roles, rights, and responsibilities of directors, officers, shareholders, and other corporate constituencies who operate within the corporate power puzzle. Numerous shareholder derivative suits brought in the wake of such losses allege, among other claims, that directors breached their fiduciary duties by failing to provide adequate oversight of their companies' high-risk investments. Despite being a frequently pled claim, director oversight liability is somewhat of a legal myth because previous court language hinging liability on the presence of ignored "red flags" remains largely unexamined, undefined, and inapplicable to such cases. This article proposes an alternative judicial approach to analyzing director oversight liability by articulating a five-pronged, process-oriented test to define "red flags" and, thus, director oversight liability. By articulating a test for oversight liability that avoids the substantive review and second-guessing of board decisions disfavored in corporate law, this article advocates that an appropriate balance between director authority and accountability be struck.

ECC

Socrates knew that he did not know, but Todd Henderson knows that Roger Cohen is a moron.

Over at Truth on the Market, Prof. Todd Henderson of Chicago takes on Roger Cohen of the New York Times.  In what Larry Ribstein describes as a "great post", Henderson uses the following terms and phrases to describe Cohen and his idea: "moron"; "drivel"; "faux-intellectual babble"; "absurd"; "sophistry"; "simplistic and downright silly".  The focus of Prof. Henderson's ire?  The statement by Cohen that: "When it comes to health it makes sense to involve government, which is accountable to the people, rather than corporations, which are accountable to shareholders."  Henderson asserts that: "Shareholders are people. Who exactly does Mr. Cohen think owns our corporations? We do. The 'people' who allegedly can hold our government to account are exactly the same people who can hold our corporations to account."  So, does that mean we can go ahead and amend the Constitution to replace "We the People" with "We Shareholders"?

SJP

Nelson on the Financial Crisis

Grant Nelson has posted Confronting the Mortgage Meltdown: A Brief for the Federalization of State Mortgage Foreclosure Law on SSRN with the following abstract:

This Article argues for federal preemption of state procedures governing the foreclosure of mortgages and security interests in rents. While it also suggests that federal action limiting or prohibiting state anti-deficiency legislation may be appropriate, it leaves this issue to future consideration. Thus, its major focus is to advocate the congressional adoption of both Uniform Nonjudicial Foreclosure Act (UNFA) and Uniform Assignment of Rents Act (UARA) to make them available to all lenders nationwide. However, the federal government has a special stake in greater uniformity for its own account. This is especially the case as to mortgages on real estate. The fallout of the economic crisis of the past year and a half has made it the owner or guarantor of millions of mortgages. It will be confronted with an overwhelming number of foreclosures that will survive all attempts at modification. Given the fact that Fannie Mae and Freddie Mac are now wards of the federal government, the federal stake in efficient and fair foreclosure procedures has become compelling. Forcing the federal government to foreclose possibly hundreds of thousands of mortgages judicially in many states seems almost surreal. Given the enormous cost of this crisis to the federal taxpayers, the government should not be held hostage to arcane and outmoded foreclosure procedures. Even in nonjudicial foreclosure states, the federalization of Fannie Mae and Freddie Mac probably necessitates changes in some statutes to comply with constitutional due process mandates. At the very minimum, the federal Single Family and Multifamily Acts with minor modifications should be made available to all federal agencies.

ECC

Mitchell on Law and Economics

Lawrence E. Mitchell has posted Toward a New Law and Economics: The Case of the Stock Market on SSRN with the following abstract:

Do the public equity markets play the macroeconomic role we believe them to play? What is the relationship between the U.S. public equity markets and American economic growth? What do these conclusions teach us about the approaches we take and should take in evaluating and designing the laws of corporate governance and securities regulation?

The law and economics paradigm of the last forty years may be mistaken in assuming that economic efficiency on an individual (or institutional) level is sufficient to ensure economic welfare on a macroeconomic level. While legal scholars have carefully and usefully examined the effects of a wide range of regulations on individual and institutional behavior, they have largely done so without considering the broader economic roles individuals and institutions play in building a growing and sustainable economy that creates wealth and jobs. Asking these broader questions may lead to reexamination of the ways in which we encourage the creation of economic institutions and incentives for economic behavior.

This paper exemplifies this new approach through an examination of the role of the U.S. public equity markets, concluding that their contribution to economic growth is highly limited. Public equity markets do not generally finance the formation of productive capital except in the limited, but important, role they play in providing exit opportunities for entrepreneurs and venture capitalists. But I do not accept this conclusion uncritically, noting that even claims for the importance of public equity markets for business creation may well be overstated, and that there is considerable research yet to be done. Moreover, even if the conclusion holds, an overall appraisal of this contribution in the broader context of the public equity markets raise important questions for corporate governance, financial regulation, and the structure of market institutions.

ECC

Sticking with the Veil-Piercing Theme

Yesterday the United States Court of Appeals for the Eighth Circuit, in an ERISA action, issued an opinion that mirrors my response to at least a few exam questions on veil-piecing each year:  finish your analysis.
 
The court made clear that, contrary to the lower court’s analysis, piercing the veil is, in fact, still a two-part test.  To pierce the corporate veil in this context, a court must determine: “(1) whether a corporation was controlled by another to the extent it had independence in form only, and (2) whether the corporation was used as a subterfuge to defeat public convenience, justify wrong, or perpetrate a fraud.”
 
The defendants in the case, among other things, commingled funds (almost always a no-no) and generally disregarded corporate formalities in a way that justified the determination that the corporation lacked independence.  However, the court reversed and remanded for a trial on the second issue:  “whether the corporation was used as a subterfuge to defeat public convenience, justify wrong, or perpetrate a fraud.” 
 
The Eighth Circuit noted that the district court, as well as the plaintiffs, provided little explanation about why the same facts that established the first prong of the veil-piercing test also satisfied the second prong.  Given a lack of evidence and “the lack of explanation on the second prong of the test,” the court found “trialworthy issues” warranting remand.
 
The lesson: Even when it seems obvious, you need to finish the job. And it’s better sooner rather than later. 
 
--Josh Fershee

Online Poker as "Tax Fairness"

Personally, I don't care what you call it ... just legalize it.  (We are reportedly talking about an extra $40-50 billion in tax revenue over the next 10 years.)

SJP

Are Republicans more likely than Democrats to support "fat bank profits, generous bonuses and stingy lending policies" during an economic recovery?

Apparently, some Wall Street lobbyists think so.

SJP

Symposium Announcement - The Fall of the Economy: How New York Can Rise to the Challenge

On March 5, 2010, The Journal of Civil Rights and Economic Development at St. John's University School of Law will host a symposium entitled: The Fall of the Economy: How New York Can Rise to the Challenge.  The web page for the event describes the event as follows:

This Symposium will foster a discussion about business social responsibility, government bailouts of big business and the mortgage foreclosure crisis. As a backdrop, the panels will also explore the economic inequities in the United States, and in New York City, that predated the recent economic crisis and have been exacerbated by the  biggest economic collapse since the Great Depression. The goal of this Symposium is to learn lessons from what caused the market collapse and to determine how to repair the breaches in our economic system.

Notably, my friend and co-blogger, Scott Colesanti, will be presenting at the symposium.  Based on his presence alone, I'm sure it will be great event.  Of course, the rest of the panels look good also.

ECC

A Veil Piercing Epidemic in the High Plains?

From 1999 until 2007, the North Dakota Supreme Court did not hear single case seeking to “pierce the veil” of a limited liability entity.  This is especially significant because there is not an intermediate court of appeals in the state; litigants in the state appeal directly to the state's Supreme Court. Thus, it’s not as though the Court simply declined to hear any cases on the issue. 
 
Since 2007, however, there has been a (relative) rash of veil piercing cases.  The North Dakota Supreme Court has issued four decisions on the issue, piercing the veil in all four cases.  Coughlin Const. Co., Inc. v. Nu-Tec Industries, Inc., 755 N.W.2d 867 (N.D. 2008) (piercing the veil of a corporation); Red River Wings, Inc. v. Hoot, Inc., 751 N.W.2d 206  N.D. 2008) (piercing the veil of a limited liability partnership); Intercept Corp. v. Calima Financial, LLC, 741 N.W.2d 209 (N.D. 2007) (piercing the veil of a limited liability company); Axtmann v. Chillemi, 740 N.W.2d 838 (N.D. 2007) (piercing the veil of a corporation).
 
I have to wonder if this simply a fluke or is there a discernable trend in these kinds of cases (both in their existence and outcomes)?   One might expect a surge in veil piercing cases when the economy is poor, but the state of North Dakota has managed to escape most of the ill effects of the nation’s financial crisis.  In fact, only North Dakota and Wyoming posted budget surpluses last year.   Then again, I arrived in North Dakota and began teaching Business Associations in 2007, so perhaps I was the catalyst. But that can’t be it, either, as the Axtmann and Intercept Corp. cases (at a minimum) would already have been well underway. 
 

Regardless, this could be interesting.  I plan to take a look at other states to see if this is a trend around the country or simply a blip on the North Dakota radar. In the meantime, I welcome any thoughts or comments.

--Josh Fershee

Long live the painful mosaic...

Securities Regulation is undoubtedly a difficult patchwork of federal and state, civil and criminal, private and public authorities and actions.  So it was conceived in 1933/34, and so it remains today.

As we were all reminded by the written decision of Honorable Judge Rakoff that yesterday approved the settlement between the SEC and Bank of America.  In "reluctantly" granting approval, the court nonetheless reiterated enough concerns about the events attending the BOA-Merrill Lynch merger of the fall 2008 so as to turn eyes to the pending New York State Attorney General's complaint against BOA and two of its former officials.  That civil suit, lodged on February 4th, alleges fraud and manipulation on essentially the same facts underlying the SEC settlement.

The 15-page "Opinion and Order" of Judge Rakoff on the SEC suit is available at http://graphics8.nytimes.com/packages/pdf/business/BofAOpinion.pdf.  While its pointed critique of the Commission's efforts ultimately yielded to judicial deference for negotiated settlements ("In the exercise of...self-restraint, this Court, while shaking its head, grants the S.E.C.'s motion..."), the settlement's worth a read  for the references to Yogi Berra and Harlan Fiske Stone alone.

---JSC, 2/23/10   

Reform sliding backwards?

A recent Bloomberg.com item noted that lobbyists were targeting the proposal to align rules for 'brokers' and 'investment advisers' through the creation of one, fiduciary standard of care.  In addition to emphasizing the danger of stalled regulatory reform, the Bloomberg item focuses attention on a topic that has bypassed surreal on its way to sublime.

As background, the '34 Act spoke to broker-dealers and their agents; six years later, one of the legislative additions of 1940 addressed 'investment advisers,' who would be held to the higher, fiduciary-like duty towards customers.  For decades, the two regimes coexisted based upon distinctions between method of compensation (i.e., trade commissions defined brokers; advisory fees indicated investment advisers).

The famed "Tully Commission" of 1995 concluded, among other things, that "conflicts of interest persist" despite the compensation divide, and that some fee-based programs would serve the interests of broker-dealers.  In 1999, the SEC thus proposed to allow brokers to offer some services for a fee without coming under the adviser regulatory scheme.  In the related 2005 Final Rule, the SEC took the position that brokers could remain outside of the 1940 Act as long as they provided only "incidental" advice to customers and avoided more robust "financial planning services." 

In 2007, a suit by the Financial Planners Association led to the D.C. Court of Appeals striking down the SEC's distinctions. Wall Street lobbied for and received "interim" rulemaking from the SEC so that millions of broker-dealer accounts needn't be re-classified (and thousands of brokers dual-registered).  The interim SEC guidance provided that brokers could escape the demands of the '40 Act by avoiding "special compensation" and distinguishing broker-dealer and investment advisory activities; facing uncertainty and pressure from State regulators, some broker-dealers simply registered their sales force as both brokers and investment advisers.

An ensuing 2008 Rand Corporation study concluded (not surprisingly) that investors were confused as to whether they were dealing with a broker or an adviser.

In 2008 and 2009, successive Treasury reform plans called for the "harmonization" of the broker-dealer and investment adviser standards.          

That harmonization has languished in Congress, thus empowering lobbyists in 2010 to call for a return to the bifurcated world of 1999.  In normal times, this would be the point where Bugs Bunny holds up that sign to the 4th wall reading "SILLY, ISN'T IT?"  But with unprecedented investor losses, class action litigation, and overall low marks for Wall Street blooming since October 2008, the cry to perpetuate the confusion by excepting brokers from a higher standard of care just seems appalling.  The D.C. Court of Appeals, State regulators, a Republican administration, and a Democratic administration have all indicated the need for a solitary standard.  If Wall Street truly seeks to regain the trust of Main Street, a good first step would be in publicly confessing that the time for distinctions without difference has passed. 

---JSC, 2/23/10     

Would Open Trading Trump Rational Apathy?

In a recent New York Times online opinion piece, William D. Cohen discusses the significant stock sales that many high-level Goldman Sachs executives made in their own company during the worst part of the 2008 stock market fall.  Cohen states that if people had had real-time information about the sales made by Goldman’s executives, the market had known would have not looked favorably on the news.  I’m not so sure.
 
Although there are a number of potential downsides, I admit I am intrigued by the concept of making more real-time information available about trades by large shareholders and company employees. I’m not quite ready to agree with Henry Manne, et al., that insider trading should be permitted because it would send the market proper signals leading to more accurate stock price valuations (my apologies to all for the oversimplification), but perhaps more information would lead to better outcomes. 
 

Then again, it seems like Enron should have been discounted significantly, too, given that no one could seem to figure out exactly how they were doing so well. (For a great discussion on this topic, see William D. Henderson & Hon. Richard D. Cudahy, From Insull to Enron: Corporate (Re)Regulation After the Rise and Fall of Two Energy Icons, 26 Energy L. J. 35 (2005)).  In light of that, maybe no one would have noticed. After all, shareholders tend to be rationally apathetic, right? 

--Josh Fershee

Let's hope for sunlight on the Olympics...

...and on the processes of its governing body.  For while attention may presently be directed on its decisions addressing competitor safety, does anybody really understand how the International Olympic Committee determines the roster of "Olympic sports" ?

It was July 2005 when the IOC (via secret vote) decided to drop baseball and softball from the storied global stage, an event I was reminded of last week as I watched youngsters in thermal pajamas glide through the air sans trapeze in something called "half pipe."  The chief theories as to why baseball and softball met their demise centered on lack of worldwide participation and North/South American domination of the event.  While snowboarding is certainly a curious spectacle, is the novel competition any more global in allure or diversified in result?

Statistics reveal that between 1998 and 2006, only two countries (USA and Switzerland) won gold medals in men's half pipe, and that these same two nations, in fact, won 7 of all 18 medals awarded in the sport.  In fact, going into this year's contest (again topped by an American), only two continents had ever won medals in the competition.  By comparison, between 1992 and 2008, 6 nations from 4 continents took home medals in baseball.  Moreover, the figure of 39 contestants in this year's men's half-pipe air pageant is misleading:  All but 10 scored less than 35 out of 50, indicating an ambitious but less than Olympian field.

Which makes the 2005 decision on baseball all the more suspect.  And which magnifies the need for the IOC, a Swiss corporation representing over 200 individual nations, to engage in more openly deliberative processes.  Share some Board minutes.  Issue explanatory written decisions.  Show us more consistency and rule of law.  Earn higher scores from ancient Greece.

--JSC, 2/22/10

Is it true that "most of the American people don’t begrudge people success or wealth”?

This quote from President Obama has popped up in a number of places recently, including DealBook.  I have to admit that if this is true, it's news to me.  First of all, that would mean we've vanquished Envy.  Second, even if one were to add what I believe to be the necessary caveat "so long as they earned it honestly," I'm not sure it would be accurate.  I mean, unless you've been sleeping under a rock the last 10 years "honestly" nowadays almost has to come with a little asterisk noting something along the lines of "until we find out all those muscle-bound home runs were not just fueled by protein shakes."  Have I just let my cynicism consume me?

SJP

Sokol on Corporate Governance

D. Daniel Sokol has posted Competition Policy and Comparative Corporate Governance of State-Owned Enterprises on SSRN with the following abstract:

The legal origins literature overlooks a key area of corporate governance - the governance of state-owned enterprises (“SOEs”). There are key theoretical differences between SOEs and publicly-traded corporations. In comparing the differences of both internal and external controls of SOEs, none of the existing legal origins allow for effective corporate governance monitoring. Because of the difficulties of undertaking a cross-country quantitative review of the governance of SOEs, this Article examines, through a series of case studies, SOE governance issues among postal providers. The examination of postal firms supports the larger theoretical claim about the weaknesses of SOE governance across legal origins. In itself, the lack of effective corporate governance would not be fatal if some of the SOE’s inefficient and societal-welfare-reducing behavior could be remedied under antitrust law. However, a review of antitrust decisions on the issue of predatory pricing by SOEs reveals that antitrust is equally ineffective in its attempts to monitor SOEs. This Article concludes by identifying a number of devices to reduce the current inadequacies of both antitrust and corporate governance of SOEs.

ECC

Khong on Law and Economics

Dennis W. K. Khong has posted The Future of Law and Economics in the British Legal Academia on SSRN with the following abstract:

In this paper, I attribute the tepid reception of law and economics scholarship in British academia to the lack of sufficient ability in mathematical and statistical skills among British legal scholars. I offer some evidence of the importance of competency in these economic literacy skills for success in law and economics scholarship, by analysing journal editorship as a proxy for success. I then discuss how the institutional structure for legal and economic education in the UK leads to the lack of these essential economic literacy skills. And finally, I offer some suggestions on how, by establishing a doctoral programme in law and economics within the legal academia, the problem of law and economics scholarship may be overcome.

ECC

Fortney on Fiduciary Duties

Susan Saab Fortney has posted Leaks, Lies, and the Moonlight: Fiduciary Duties of Associates to Their Law Firms on SSRN with the following abstract:

This symposium article examines the fiduciary duties of law firm associates. After applying agency principles to the firm-associate relationship, the article analyzes specific duties and discusses cases involving alleged breaches of fiduciary duties by associates. It explores associate duties in the current legal, organizational, and socio-technological environment in which associates practice. The article closes with observations on the importance of firm principals considering the effect of firm culture on associate attitudes and conduct.

ECC