May 1, 2010
More Goldman (Because the Oil Leak Is Just Too Depressing)
I have enjoyed reading Josh's recent posts (here and here) on the Goldman case. If I'm reading him correctly, I think his argument against finding fraud boils down to: (1) ACA did their own portfolio assessment, so "the buck stops with ACA"; and (2) If we find the omission of Paulson's role material, we'll be on a slippery slope to holding the influence of horoscopes material. Putting aside my lingering questions about how many of the facts being discussed may actually go to reliance rather than materiality, I respectfully disagree with both points.
It seems to me our difference of opinion as to the sufficiency of ACA's own portfolio assessment may boil down to a difference of opinion as to the efficacy of valuations generally. As I've stated previously, I would expect any reasonable valuation expert to bring their post-due diligence enthusiasm for an investment to a screeching halt (at least momentarily) if it were disclosed to them that the investment had been created under the influence of another investor planning to short the investment. As for the slippery slope, I'll just say I have faith in our ability to restrain ourselves from rushing on to horoscopes if we find the omission here material.
But in some sense, who cares what Josh and I think? As I've suggested elsewhere, in a perfect world we would be collecting hard data from valuation experts. To the extent our opinions do matter, they suggest dismissal on the basis of materiality should not be forthcoming, given that such a motion should be granted only where no reasonable investor would find the fact material.
PS--For a good review of BP's history of (at least in the words of one former engineer) putting cost-cutting and profits ahead of safety and the environment, go here. As for me, as much as it pains me to forgo my 5% BP rebate card, and as difficult as it may be to avoid the ubiquitous and often cheaper BP stations, I do plan on going elsewhere for gas. I completely understand if readers will view this as an utterly futile and perhaps even misguided act.
April 30, 2010
Rensberger on Law Student Transfers
Jeff Rensberger has posted The Tragedy of the Student Commons: Law Student Transfers and Legal Education on SSRN with the following abstract:This research examines law student transfers. It aims to accomplish two things. First, it sets out some basic data on law student transfers. Using data collected from the last three editions of the ABA Official Guide to Law Schools, it quantifies some of the characteristics of transfer students based upon the characteristics of schools that are net gainers and net losers of transfers. While we do not know the individual characteristics of transfer students (such as their entering credentials, ethnicity, or law school GPA), one can ascertain the general flow of the population of transfers by looking at the schools that they come from and the schools to which they go. Some of the results are not surprising (the flow is in the direction of schools having higher U.S. News rankings and toward those with higher LSAT medians), but other findings are less expected (the flow of transfers is distinctly away from private schools). Even as to results which conform to what one might have expected, this research demonstrates and quantifies what many in the academy have supposed.
The second aim of the article is to make a preliminary assessment of whether high volumes of law student transfers are a good or a bad thing. Much of the discussion among law schools on this point to date has been parochial. Transfers are good for some schools and bad for others; those whom receive transfers think they are good and those who lose them think they are bad. I attempt to rise above a purely self-interested viewpoint in order to examine whether the gain to the winners exceeds the loss to the losers. My thesis is that in the aggregate transfers cost the losing schools more than they benefit the gaining schools. The result is an inefficient taking of a common resource due to its being unprotected and underreported by the ABA and the US News ranking system, thus the title of the piece.
Goldman Rephrased: What if Paulson Had Been Long?
In considering a thoughtful comment to my prior post on this issue, I took a look again at the SEC complaint to see if the argument changed my mind. In pertinent part, the comment says, "The prospectus basically says this entity is being set-up to allow investors to buy into synthetic CDO positions. It doesn't say the entity is being set-up so that a customer of GS can take a large short position and the investors are just a convenient way for GS to accomplish this." This view largely parallels the SEC complaint. I agree that is one way of looking at it, but it begs the question: Is Paulson's role material: (1) because of his actual role or (2) because of his role AND he planned to take a short position?
I have a hard time believing that if Paulson were long, this case would have any merit. (And, the fact that someone might take a short position on any portfolio, it seems to me, is a given.) If that is the case, why does it matter to investors relying on the flipsheet whether Paulson had influence one way or another. The investor was not relying on Paulson -- the investor was relying on ACA. Or perhaps it is material how ACA made their decision. Must it be disclosed if one of ACA's decisionmakers discusses some of the items at issue with his really smart wife? How about if he reads his horoscope daily and uses that as part of the process? I don't think so.
At the end of the day, Goldman and Paulson wanted (needed?) ACA. As the complaint notes, ACA recognized the significance of putting their name on the transaction and was comfortable with the portfolio (stating that the final portfolio "[l]ooks good"). ACA could have (and presumably would have) walked away if they didn't like the underlying transaction. It appears to me they had final say, which means they had the authority, not Paulson. To me, materiality should rest on authority, or at least some other showing that somehow ACA was actually or constructively unable to make a decision contrary to Paulson. The fact that they chose not to make a contrary decision is not sufficient to show Paulson's role was material in this context.
Perhaps ACA should have checked out the horoscope. Today's Taurus horoscope, anyway, might have been very helpful: "The people around you are mostly self-interested for the time being, so see if you can just rely on yourself for now."
April 29, 2010
Did the W. Va. miners die in pursuit of the "American dream"?
This past weekend, President Obama declared that the Massey miners died in pursuit of the American dream. It seems clear this statement was meant to be extremely supportive of the miners--and appears to have been taken that way by those most impacted by the tragedy. Nonetheless, I found it somewhat provocative. When those miners risked their lives daily in those mines, did they view themselves as pursuing the American dream? Or, did they see themselves as taking one of the few opportunities available to them to put food on the table, etc.? I honestly don't know the answer to that question, but I do think pursuing the American dream means something more than just being employed in America. What other options were available? How realistic was the opportunity for advancement? Was profit being generated by skimping on safety and, if so, did the miners participate in that profit?
It may be that the answers to those questions would lead us all to conclude that these miners were indeed risking their lives to pursue the American dream. But for now, at least one commentator has a different view.
The Price of Oil
The estimate of daily leakage in the Gulf of Mexico has risen from 1,000 to 5,000 barrels per day. Meanwhile, the Wall Street Journal reports U.S. regulators do not require, and BP did not employ, a safety device required by both Norway and Brazil, which could have protected against the leakage.
April 28, 2010
Chesterman on Business Activities in Conflict Zones
Simon Chesterman has posted Lawyers, Guns, and Money: The Governance of Business Activities in Conflict Zones on SSRN with the following abstract:
paper argues that the norms governing businesses in conflict zones are
both understudied and undervalued. Understudied because the focus is
generally on human rights of universal application, rather than the
narrower regime of international humanitarian law
(IHL). Undervalued because IHL may provide a more certain foundation
for real norms that can be applied to businesses and the individuals
that control them.
The first part will briefly describe the normative regime that is set up by human rights and IHL. Part two looks at the specific situation of conflict zones and efforts to regulate some of the newer entities on the scene, in particular private military and security companies. Part three then sketches out a regime that focuses not on toothless regulation but on a model of governance that combines limited sanctions with wider structuring of incentives.
Gelter on European Corporate Law
Martin Gelter has posted Tilting the Balance between Capital and Labor? The Effects of Regulatory Arbitrage in European Corporate Law on Employees on SSRN with the following abstract:
This Article examines the consequences of regulatory arbitrage in European corporate law on the position of employees. Two innovations of secondary EU law, namely the possibility to create a European Company (“SE”) out of existing firms and the Directive on Cross-Border Mergers, have made regulatory arbitrage with respect to employee involvement in existing firms possible. While these instruments require the merging firms to negotiate with employees about their representation rights as a precondition to the merger, a closer analysis of the law and recent experience show that the protection accorded to existing employee participation systems is incomplete. There can be little doubt about some potential advantages of regulatory arbitrage, such as the possibility to avoid excessive regulation. However, the possibility of an “erosion” of employee participation systems (such as codetermination) undermines their economic function, which is to foster long-term commitment. This Article takes a broad view on the role of labor in corporate governance and also addresses other mechanisms affected by regulatory arbitrage opportunities that are potentially relevant for the position of employees, such as the degree to which management is directly or indirectly influenced by shareholders, and directors’ duties in general and in takeovers in particular. It suggests that controlling shareholders, whose presence characterizes corporate governance structures in much of Europe, are in a good position to exploit arbitrage opportunities to the disadvantage of other groups, including labor.
With All Due Respect to Beyonce: If You Don’t Like It, Then You Shouldn’t Put Your Name On It
Okay, so I admit I am feeling a little left out of the Goldman conversation. So here goes: I concede I may be missing something, but I am not sure I see the fraud. I see behavior I don’t like, and a company I might not want to work with in the future, but that's the extent of it.
The complaint alleges, among other things, that “ACA would have been reluctant to allow Paulson to occupy an influential role in the selection of the reference portfolio because it would present serious reputational risk to ACA, which was in effect endorsing the reference portfolio. In fact, it is unlikely that ACA would have served as portfolio selection agent had it known that Paulson was taking a significant short position instead of a long equity stake in ABACUS 2007-AC1.”
To me, as to investors, it looks like ACA is the one who didn’t hold up their end of the bargain. That is, Goldman’s role appears unseemly, and perhaps Paulson’s role, too, but ACA was the group that was to assess and select the portfolio. According to the flipbook, ACA investments “are approved by a heavily experienced investment committee.” Other than the SEC’s statements, I don't see anything showing ACA did not do their own portfolio assessment. Thus, the buck stops with ACA.
The SEC seems to imply that Paulson had veto power, rather than merely the chance to provide input. But there is no indication ACA didn’t take responsibility for the selection decisions, even if they did decide to let Paulson provide significant input. In fact, as the complaint states, ACA told Goldman,” [F]or us to put our name on something, we have to be sure it enhances our reputation.” But that goes to how ACA looks in the marketplace, not whether ACA thought the investment was a good idea.
I get the sense that Paulson was well respected, but is it really the case that Paulson’s intent to invest was a significant factor (perhaps the significant factor) in deciding whether the items were, in ACA’s view, good for the portfolio? If so, isn’t that still ACA’s failure? Furthermore, if Goldman must disclose Paulson’s role as an advisor, do they also need to provide disclosure of other sources considered by ACA’s committee? Other people they may have consulted, newspapers reviewed, blogs read?
I see why ACA might (should?) be angry with Goldman and/or Paulson, but from what I see, ACA signed off on the product. They independently analyzed (or should have) the items in the portfolio. The items ACA ultimately included in the portfolio were all items they could review and consider on their own. Either they liked it, or they didn’t. If they didn’t, they shouldn’t have put their name on it.
April 27, 2010
"In connection with" and the SEC's Goldman Complaint
Is anyone else confused over which "security" the alleged misrepresentations were "in connection with" for purposes of Rule 10b-5? Early in the Complaint, the Abacus CDO appears to be the security in question. But near the conclusion, the reader learns that the fraud was in connection with "securities or securities based swap agreements" (suggesting that the applicable security may be the credit default swap, whose purchaser was not the alleged victim).
Could Goldman be saving such an argument as a possible defense?
April 26, 2010
Video Games & Corporate Governance Nostalgia
The United States Supreme Court has agreed to review Schwarzenegger v. Entertainment Merchants Association, a challenge of California's law that bans selling violent video games to minors. The Ninth Circuit upheld the district court's decision that the struck down the ban. This case is of particular interest to First Amendment buffs because it follows closely after United States v. Stevens, which ruled that animal cruelty videos are protected by the First Amendment.
This case is particularly interesting, to me, however, for some different reasons. My first job after college was working for the Interactive Digital Software Association, the predecessor organization to the Entertainment Software Association. The organization formed in the early 1990s in the wake of threats from Senators Lieberman and Kohl to regulate content in the video game industry. (Incidentally, one of the games that got them excited was Night Trap, a CD-based computer game featuring the late Dana Plato of Diff'rent Strokes. It was more silly, than scary, in my opinion.) In lieu of government action, the industry created its own rating system, run by the Entertainment Software Rating Board, which provides the ratings still found on most video games today.
That entry-level job, which was before law school, was my first introduction to all of the formalities of a corporation. It was in that job that I first, on any practical level, gained an appreciation for the process of non-profit governance, fiduciary duties of board members, the process of coordinating board action, antitrust concerns when bringing industry leaders together, and the role politics play in the business world. It also gave me something of an insider's view of maintaining and operating a self-regulatory organization.
That experience, even though it preceded law school, is fundamental to my appreciation of how the law works (and why) with regard to corporate governance. Before law school, I knew how a lot of things worked in running an organization; after law school, I was able to appreciate why (and sometimes, notice what should have been done instead of what was). In addition to examples from practice, I sometimes share stories from that job with my students. This allows me to share the frustrations business people may have with their lawyers, and in the same context, explain what needs to happen to ensure compliance with corporate formalities and obligations.
I try to encourage my students to help bridge the gap between business and law, and to try to view problems from the businessperson's perspective. If we understand what the businessperson wants, sometimes we can help them find a proper way to do it. And if we can't, we can at least explain why. We need to be collaborators as often as possible, not perpetual naysayers.
So, I am curious how the case will be decided because, from a business perspective, I once had an interest in the outcome. And, from a legal perspective, I am curious to see if violent video games, which are artistic endeavors that provide ample disclosure of their content, are afforded the same protections provided to videos of animal cruelty. (I guess it's clear I maintain my pro-industry views on this issue.)
Moment in Time
I was fortunate enough to attend the President's speech on financial regulation reform in New York City last Thursday. The presentation was not quite the scolding or plea described by the media; while targeting lobbyists and misleading press, the President spread blame across various sectors (public and private) for the Crisis while inviting Wall Street to participate in the cure. More importantly, the 25-minute outline was often interrupted by applause, clearly indicating that the hour of tangible remedy has finally arrived.
The President's reform outline disclosed a number of concrete proposals, including:
- The creation of a consumer protection agency
- Regulation of credit derivatives
- The implementation of limits on the size and proprietary trading activities of banks (the "Volcker Rule")
- The inclusion of 'say on pay' provisions for shareholders
- The creation of a fund to facilitate the winding down of insolvent entities
Other areas of focus are said to include:
- SEC funding
- Hedge fund regulation
- The harmonization of standards of care for brokers and investment advisers
- The creation of an inter-agency council to detect systemic risk
- The consolidation of banking regulation
- The regulation of credit rating agencies
Reasonable minds can certainly differ over the breadth of (and thresholds for) Wall Street reform. But it would seem that the days of casual reliance on Comedy Central or Fox news for news summaries must be abandoned. Concurrently, there is a duty on all of us in academia to propel a meaningful discourse on changes that may shape banking, homeownership, investment and speculation for years to come.
For those who would rush to adopt all proposals, there's the uncomfortable fact that net capital rules, a ban on abusive short selling, and an array of regulators all predated the Crisis.
For every pundit who would predict weeds growing on Wall Street, there's the ugly truth that industry bonuses and intensified lobbying efforts are currently near record proportions (thus belying threats of layoffs and office moves).
Perhaps the cause is best elevated - and attendant fears best defused - by a TIME magazine quote the President included at the climax of his NYC speech:
"Through the great banking houses of Manhattan last week ran wild-eyed alarm. Big bankers stared at one another in anger and astonishment. A bill just passed ...that would reduce all U.S. banking to its lowest level."
The TIME quote was from June 1933, and it referenced the FDIC.
April 25, 2010
Pan on the Duty to Monitor
Eric J. Pan has posted Rethinking the Board’s Duty to Monitor: A Critical Assessment of the Delaware Doctrine on SSRN with the following abstract:Does a board breach any of its fiduciary duties when its inattention or inaction leads to harm to the corporation? The duty to monitor addresses this question by imposing liability on directors for failing to respond to signs of wrongdoing, illegality or other harmful activities. Because the duty to monitor imposes liability based on what the board failed to do, however, it is difficult to define the scope of liability. A natural dilemma exists in evaluating a director’s degree of loyalty (or care) based purely on the fact that there was an absence of action by such director. When adjudicating claims alleging inattention or inaction by a board, a court faces the uncomfortable task of exercising its own independent judgment that the board should have done something instead of remaining still and silent. At the same time, the duty to monitor serves as the best means the law has to ensure that directors are attentive and vigilant against the occurrence of harm to the corporation. To the extent we believe board should, and expect boards to, perform a substantial role in managing the corporation it is appropriate to impose on boards a robust duty to monitor. Ideally, little should affect the corporation without the knowledge, consent or consideration of the board. Delaware courts, however, have defined too narrowly the scope of the duty and have made it undesirably difficult for plaintiffs to bring forward duty to monitor claims.
Hoffer on PIPE Financing
Douglas Hoffer has posted Quagmire: Is the SEC Stuck in a Misguided War Against PIPE Financing? on SSRN with the following abstract:
A popular non-traditional capital formation option is the “PIPE” deal: Private Investment in Public Equity. Over the last ten years, companies raised more than $100 billion using PIPE transactions. The Securities and Exchange Commission (“SEC”) has increased its regulatory oversight of PIPE transactions as they have become more popular. The SEC believes that some PIPE investors who take a short position in a PIPE issuer’s publicly traded shares violate Section 5 of the Securities Act by selling unregistered securities, and that PIPE investors who trade on knowledge of an impending PIPE transaction are guilty of insider trading. The purpose of this article is to demonstrate that the SEC’s aggressive enforcement against PIPE deals is misguided both because it is based on flawed interpretations of the law and because it ignores the benefits of PIPE financing. Although most of the existing scholarship on PIPE financing shares the SEC’s negative views, these articles have ignored the benefits and exaggerated the risks associated with PIPE financing. This article makes the case for PIPE financing by fully considering its benefits and risks.
Travis on Employment Law
Michelle A. Travis has posted What a Difference a Day Makes, or Does It? Work/Family Balance and the Four-Day Work Week on SSRN with the following abstract:This Article considers the growing reliance that four-day work week advocates have placed on work/family claims. It begins by analyzing whether a compressed work schedule may alleviate work/family conflicts, and more importantly, for whom such benefits are most likely to accrue. While studies consistently find that many workers experience lower levels of work/family conflict when working a compressed schedule, the research also suggests that workers with the most acute work/family conflicts may be the least likely either to obtain or to benefit from a four-day work week design.
Nevertheless, the political climate surrounding the four-day work week provides a unique opportunity for action. This Article therefore considers how legal regulation might be used to shape four-day work week initiatives as a work/family balance tool. In particular, the Article considers how reflexive law proposals might contribute to the four-day work week debate. While existing reflexive law models typically rely on the creation and exercise of procedural rights vested in individual workers, this Article explores an under-developed alternative that would instead vest procedural rights primarily in workers as a group. The Article uses California’s extensive four-day work week regulations and the Federal Employees Flexible and Compressed Work Schedules Act to illustrate this “collective reflexive” approach, and to explore what this type of regulatory model might offer advocates who are seeking to facilitate greater work/family balance for those who may need it the most.
Pan on International Financial Regulation
Eric J. Pan has posted Challenge of International Cooperation and Institutional Design in Financial Supervision: Beyond Transgovernmental Networks on SSRN with the following abstract:
paper explores the case for a global financial regulator. It first
identifies two problems with how legal scholars viewed the international
financial architecture before the financial crisis. International law
scholars mistakenly thought that informal transgovernmental networks
could serve as the heart of an international regulatory framework. In
fact, the international financial architecture proved incapable of
preventing or managing the causes and effects of the recent financial
crisis. The reason why is the second problem. Financial law
scholars did not speak out more strongly before the crisis about the
limitations of the international financial architecture. They focused
their attention on the coordination and harmonization of rules and
standards in areas of accounting, securities, and bank capital adequacy,
but did not resolve the problems of prudential supervision of
cross-border financial institutions and systemic risk regulation. The
failure of states to provide for an international legal regime capable
of conducting prudential supervision of cross-border financial
institutions proved to be one reason why the international financial
architecture could not address the spread of financial instability.
This paper sets forth an international administrative law model for international financial regulation. It advocates the creation of an international body that has the power and resources to supervise cross-border financial institutions, demand action by national supervisors, promulgate supervisory standards, conduct inspections, and initiate enforcement proceedings. Acknowledging possible objections to an international administrative law model, particularly those related to the protection of state sovereignty and democratic accountability, this paper argues that an international administrative agency is the best solution to the problem of global financial regulation.