Business Law Prof Blog

Similarities Between the Financial Crisis and the Oil Spill

The Wall Street Journal ran an article yesterday on the lack of regulatory oversight of U.S. offshore drilling.  Any of these points sound familiar?

• The Minerals Management Service (MMS) has gradually shifted safety regulation to the industry over the course of the past decade.  Justifications include the belief that "everyone has a vested interest in being as safe as possible."

• Some employees cite a conflict of interest within the MMS (it is supposed to both regulate safety and promote growth).

• The Journal found many instances of the agency being alerted to safety problems but not following up.

• Both industry executives and regulators are cited as saying that "offshore operations have become so complicated that regulators ultimately must rely on the oil companies and drilling contractors to proceed safely."

SJP

D'Onfro on Consumer Protection

Danielle D'Onfro has posted TILA and a Uniform Law of Consumer Credit on SSRN with the following abstract:

This paper provides a cursory overview and criticism of predatory lending laws then proposes a Uniform Law of Consumer Credit (ULCC) to work alongside the Truth in Lending Act to provide a complete, behaviorally informed, system of consumer financial protection that strives to keep credit affordable and to encourage innovative credit products. It argues that a uniform law will create sufficient state-to-state consistency to reduce the need for federal preemption and thereby bring the benefits of federalism - protection from agency capture, legislative responsiveness and experimentation at the state level - into consumer financial protection. Finally, it suggests five starting principles for drafting a ULCC: Lleyellyn’s legal realism, the jurisprudence of unfair and deceptive acts and practices, rationalizing consumer credit contracts with the law of contracts, incentives for safe and affordable credit, and effective remedies.

ECC

Rebuilding Goldman’s Reputation Should Start with Cleaning up the Language

The Wall Street Journal reports that Goldman Sachs is vowing to rebuild the company’s image.  Chairman and CEO Lloyd C. Blankfein said that the past few weeks were both “difficult and disappointing.”  He went on to say, “Questions have been raised that have gone to the heart of our most fundamental value:  How we treat our clients.”  Regardless of your position on the SEC’s case, this is exactly right. 

In my first job after law school, my colleagues and I spent a lot of time reviewing e-mails, phone recordings, and other communications of traders, brokers, and others in the financial industry.  Not that I would ever say who was part of the review, but Goldman Sachs was explicitly not part of any of my reviews.  However, reading the e-mails of Goldman’s Fabulous Fab certainly brought back memories. 

To this day, I am still stunned by the kinds of things people will say in e-mail or recorded phone calls (not to mention the kinds of pictures, videos, and sound files they will forward) in an environment when they know: (a) everything is recorded, (b) everything is retained, and (c) everything may be reviewed by someone else, including the SEC.  Nonetheless, we continue to see things like this happen, and it's hardly isolated. 

It seems to me the compliance offices of these large financial institutions should be doing more than simply looking for front-running and other types of impropriety; they should also be helping to reinforce a professional work environment.  If people want to use derogatory or degrading terms, “use Army words” (as one member of my family would put it), or say generally mean things in their personal conversations, that’s their prerogative.  But their work-related communications, on work e-mail and phones, should have a different content and tone. 

I’m not saying that employers should be going through all private e-mails and looking to police employees’ thoughts.  However, in the financial industry, the employer is already going through the e-mails and phone calls to some degree.  Along the way, I’m simply arguing they might want to make clear the kind of professional environment they expect. 

I mean, heck, when I was a kid, my friends and I learned not to curse in front of our teachers and other grown-ups, even if we were talking like Eddie Murphy in Raw when we were alone.   Why?  Because we knew it was not tolerated by our teachers and parents.  In my view, especially in light of recent events, employers in the financial sector would be well-served to stop tolerating it, too.

--Josh Fershee

Gaining Some Perspective

Is it just me, or does there seem to be a strong positive correlation between how wealthy someone is and how much they complain about taxes?  Here's the not uncommon scenario:  I'm chatting with someone who makes a six-figure income.  They have a Lexus and a BMW in their two-car garage, which is attached to their nice home in an upper-middle-class neighborhood.  The cars are both good enough to drive their 2.5 kids to the local prep school.  And according to them the seemingly most important problem facing our country is over-taxation.

For some perspective, go here.

SJP

Questioning Buffett's Goldman Defense

When Warren Buffett speaks, people listen.  Undoubtedly, his recent strong defense of Goldman was music to that company's ears.  However, the apologia left me with some questions.

First, Buffett is quoted in the Wall Street Journal as saying, "I haven't seen anything in Goldman's behavior that makes it any more subject to criticism than Wall Street generally."  Is that actually a defense?  If so, looters around the world should be ecstatic so long as they are part of a mob.

Next, in the same article, Charlie Munger was quoted as blaming regulators for the "defective" financial industry.  Said Munger, again as quoted by the Journal, "When the tiger gets out and starts creating damage, it's insane to blame the tiger, it's the idiot tiger keeper" that deserves the blame.  With all due respect, I worked in a prison for 3 years and this is nothing more than a criminal's excuse:  "I wouldn't have taken her purse if she'd held on to it better."

Finally, there is Buffett's defense of the Abacus transaction itself.  As Larry Ribstein quoted Buffett on his blog:

Instead of needing to be told that a hedge fund manager who suggested which bonds should form the underpinnings of the Abacus collateralized debt obligation was also short the bonds, the investors should have relied on their own due diligence, Mr. Buffett said. "If I have to care who is on the other side of the trade, I shouldn't be insuring bonds," he said.

Ribstein went on to ask: "Any questions?"

Well, yes--I do have some questions.

(1)  How common is it for the person on the other side of the trade to have had a hand in creating the bundle of assets, and for that fact not to be disclosed?  It is one thing to assume there is someone taking a short position.  It is quite another thing when that person is akin to a type of insider.  This information may be out there somewhere and I may just have missed it.  If this is known to be a common occurrence, then I am very likely to change my position.

 (2)  Wasn’t overconfidence in our ability to assess risk one of the causes of the crisis?  Listening to some of the executives we’ve heard testify, you’d believe all investors needed to know was that they were going long in housing—because housing goes up forever.  The notion that one has enough information about an investment simply based on a review of financial data generally prepared by others, so as to preclude any need to worry about who is taking the short position to your long one (and regardless of what role they took in picking the underlying assets), strikes me as nothing short of hubris. 

(3)  Exactly how much Goldman stock does Mr. Buffett own?

SJP

Guest Post by Professor Douglas M. Branson - Women in Corporate Governance: Halfway Up From Nowhere?

Not quite.  Halfway?  Try 3 percent.  As late as 1997, there were no female CEOs in the Fortune 500.  Jill Barad at Mattel Toy was the first.  As late as 2002, there were only two.

Women are, or are soon to be, over 50 percent of the workforce.  Women are 50 percent of the middle managers.  Yet females make up only 8 percent of the corporate officers and 3 percent of the CEOs, despite constituting over 30 percent of the MBA and law graduates since the 1970s (40 percent since the 90s).

Why the disparity? Undoubtedly a glass ceiling allows women to see but not reach the highest rungs on the corporate ladder.  Yet, if it exists, any ceiling today is more permeable, with many cracks in it (18 million, according to Hillary Clinton,).

Today the trick for women who aspire to upward progress is to find out where the cracks might be:

Go Where They Aren't.  This is the twenty first century.  Fields that were not open to women even 20 years ago are today.  CEOs Susan Ivey (Reynolds America), Pat Woertz (Archer Midland Daniels), Paula Rosport Reynolds (ex-CEO of Safeco Insurance), Lynn Elsenhans (Sunoco), Ellen Kullman (Dupont) and Carol Bartz (Yahoo!) spent most of their careers in, respectively, tobacco, oil and gas, public utilities, petroleum, chemicals and information technology.  Beyond training in business and accounting, none of these women began their careers with specialized technical knowledge.

Be Financially Literate.  Many women who have reached the very top have done so in sales, or marketing (one, Anne Mulcahy at Xerox, in human resources) rather than in “line” jobs, those with bottom line profit and loss responsibility.  Male CEOs and board members, in particular, emphasize the necessity of line experience for women.  Line experience or not, a CEO will always have plentiful support in finance and accounting.  But as the careers especially of women CEOs whom corporate boards have deposed, such those of Jill Barad at Mattel or Carleton Fiorina at Hewlett-Packard, demonstrate, possession and application of some grounding is essential -- no matter what pathway led to the top or how much staff support one has.  No substitute exists for a basic familiarity with corporate finance, managerial accounting, supply and demand (economics 101) and capital markets.

Have Style.  The existing advice books, or most of them, are flat wrong when they suggest that women should act like their male counterparts (“lower your voice,” “take up golf,” “watch Monday Night Football”).  Aggressive or assertive behavior, imitating what they perceive males to do, may well derail a woman's career.  The days of “shoulder pad feminism” and Armani pants suits are gone. In upper management, corporations want executives, men or women, who represent their corporations well, anywhere and at any time.  Diplomacy, the ability to think strategically, and the ability to show a team oriented approach have supplanted the dated 1980s advice, if it was ever good anyway.

Develop a Reputation as a Problem Solver.  At Avon Products, CEO Andrea Jung evolved a strategy to retain hundreds of thousands of loyal Avon reps despite the relegation of “Avon calling” home sales to the whip and buggy era.  Charged with masterminding methods for making use of Dupont's products safer, Ellen Kullman had Dupont spawn an entire new division, Safety, that is Dupont's largest today. While at Chevron, Pat Woertz oversaw completion, on time and under budget, of an oil pipeline from Northern Alberta to Northern California.

While statistics show only a glimmer of progress, closer examination of the careers of 22 women who have actually become CEOs demonstrates that many more routes than used to, or that readily meet the eye, lead toward the corner office.    

Douglas M. Branson is the W. Edward Sell Chair in Law at the University of Pittsburgh.  He is the author of The Last Male Bastion - Gender and the CEO Suite at America's Public Companies (Routledge Press, 2010).

Airline Fees: Beyond the What

The New York Times reports that airlines collected $7.8 billion in fees last year, which probably doesn't surprise anyone who has flown recently (or paid attention to the news).  What strikes me as odd is that the Times article doesn't mention the impact of taxes on the increases in fees.  In 2009, the Times reported on the IRS revenue ruling that specifically stated luggage fees would not be subject to tax.  This was reported and discussed in a number of places, including Tax Prof Blog, when it happened.  

Perhaps this fact was deemed old news, but it seems to me with such a significant incentive to segregate non-taxable costs into fees, it remains highly relevant to explaining the "why," instead of just reporting the "what."

--Josh Fershee

The SEC and Hiring

Picking up on my co-editor's recent words on financial literacy at the law schools, meaningful reform at the SEC may best start at the law school recruitment level.  For after 20 years of Commission watching, I continue to be amazed by the slavish devotion to formality exhibited by the agency's human resources department.

To wit, today's law students - regardless of passion for the subject or practical experience - are keenly aware that the Commission (just like any large law firm) shall be predictably seeking to hire the top of the law school class.  This lemmings approach to filtering applicants leads the SEC to the very same students who win the beauty pageant of grades that commences around Christmas of the first year of law school and ceases sometime near retirement.  Inevitably, such forerunners are, at best, anticipating a brief "training period" employment with the Commission or, at worst, gobbled up by the largest Wall Street employers halfway through interview season.     

Each semester I encounter students who, despite acumen and desire, lose out to the simplistic approach of an agency that, despite a perennial wealth of applicants, seems to get outmaneuvered by market players each decade.  Without fail, a number of students in courses like Securities Regulation and Corporate Finance evidence a practical utility and an earnest hope to work for a regulator (e.g., the former hedge fund trader willing to explain the real value in a real time stock ticker; the former State examiner who's interviewed 100+ investors; the economics major who can readily distinguish between the boilerplate of a 10Q and a 10K; the part-time student who's worked in a stock loan department).  In fairness to the Commission, the Regional Offices outside of New York and Washington D.C. do seem more willing to value work experience and a corporate course load over high scores in Torts and Contracts.  But in those two largest offices, the message is clear:  Third year students ranked high in the class of a top law school shall be given the most serious consideration (and likely stand the only realistic chance at something called "The SEC Honors Program"). 

It may very well take stalwart leadership, a generation of creativity, and unfettered funding to completely reform the Commission.  But a large step towards it regaining composure can be made in a year by simply redirecting the hiring process to favor experience and desire over scores on tests gauging a first year law student's knowledge of generalized legal concepts.  Stated bluntly: Lighten up SEC, and give the students with focused skills a chance.

---JSC, 5/4/10

Is There Another Street Beyond Wall Street and Main Street?

Andrew Ross Sorkin at the New York Times today writes about Warren Buffett’s outspoken support for Goldman Sachs in the SEC civil suit.  Buffett explains that he doesn't see why it should matter which side of the deal Paulson was on because investment decisions should be made on the quality of the underlying securities, not who might be betting against them. (I happen to agree on this one.)  Buffett even argues that it may have been unethical for Goldman to disclose Paulson’s position because of their role in making the market. (I am less convinced on this.)  

Early in the article, Sorkin asks whether “we” have all been thinking about the Goldman case in the wrong way.  Sorkin then goes on to note that Buffett’s position might be conventional for those on “Wall Street,” but that it is a “contrarian” position on “Main Street.”  Thus, presumably, the “we” is Main Street.  

Later in the piece, Sorkin notes that many securities lawyers have said from the start that the SEC had a difficult case to make.  And, as has been noted a number of times, many blogs and other sources have been making this point about the complaint in various ways and for various reasons.  This got me to thinking: Is there another street beyond Wall Street and Main Street?

We have often heard the Wall Street versus Main Street dichotomy bandied about by politicians and pundits as though those are the only two (fictional as they may be) places in America.  But is it possible there is a third spot for lawyers, judges, and law professors?  The legal community, seemingly immediately, reacted to the Goldman complaint, reviewing, critiquing, and even attacking the complaint from all angles, none of which align directly with the apparently clear-cut views of Wall Street and Main Street. 

Perhaps there is a third Street in this fictional community, and maybe, just maybe, it’s called Law Street. If so, the Law Street view is not necessarily right or wrong, just different.  And different, in my view, is good.  

--Josh Fershee

Two legs, one leg, or none?

The SEC's fraud case against Goldman continues to generate insightful debate, on this Blog and others.  Issues of satisfying such storied Rule 10b-5 elements as materiality and deception are both real and intriguing.  For me, the threshold question remains the existence of a relevant security.  On this point, the Commission's Complaint of last month appears poised to satisfy courts by any of several approaches.  However, the exact finding by a court could simply trigger more debate on the Rule's requisites.

First, there's the argument that the CDO purchased by German bank IKB, as a "debt securit[y] collateralized by debt obligations," falls under the definitional sections of the '33 Act and '34 Acts.  Thus, one approach could be that the mere utterance of the shibboleth "CDO" satisfies the jurisdictional inquiry, particularly in light of the method of Goldman's marketing and the broad, remedial purposes of the securities laws.

Second, the investment in issue, a synthetic CDO, could qualify as a security in view of the notes issued by its holding vehicle.  This theory confesses some thorniness, as is illustrated by the Complaint's background on the transaction:

...[CDOs] are packaged and generally held by a special purpose vehicle ("SPV") that issues notes entitling their holders to payments derived from the underlying assets. In a synthetic CDO, the SPV does not actually own a portfolio of fixed income assets, but rather enters into C[redit] D[efault] S[waps] that reference the performance of a portfolio (the SPV does hold some other collateral securities separate from the reference portfolio that it uses to make payment obligations)(para. 13).

The "collateral securities" held by the SPV do not appear to be relevant.  And to declare all synthetic CDOs to be derivatives does not seem to fit the SEC's game plan.  The question thus becomes whether IKB's purchase of $150 million of notes on a synthetic CDO (i.e., not actually premised on tangible assets) qualify as securities-based swap agreements(covered by Section 10b of the '34 Act) or some other form of credit derivative (expressly removed from SEC reach by Congress in 2000).  

Courts have not issued direct guidance.  The most instructive decision may have been handed down by the Second Circuit in 2002.  Specifically, in Caiola v. Citibank, N.A., 295 F.3d 312, a sophisticated individual (quietly) engaged in synthetic option transactions to offset equity swap agreements. The defendant bank was alleged to have, at some point, secretly countered the complicated plan by effecting large trades that mirrored the plaintiff’s synthetic transactions. Finding Caiola’s equity swaps from the late 1990s were not securities (and thus not subject to Rule 10b-5 because of the effective date of the statutory amendment), the Court simultaneously concluded that the synthetic options fell within the 34 Act's statutory definition of securities.  The Second Circuit rejected Citibank’s contention that only an equity option would be covered by the definition, and not "an option based on the value of a security.”  The court thus embraced an expansive notion of securities but also avoided the tandem approach seemingly underling the SEC's present stance. 

Finally, there appears to be the straightforward argument that the credit default swaps entered into by Goldman and others are covered by Section 10b (i.e., as would have been the equity swap transactions in Caiola but for the effective date of the 2000 law).  As I noted briefly in a Blog entry last week, this theory suffers for lack of a victim: Unlike Caiola, who was party to both the swaps and index options transactions, IKB purchased the CDO, while others purchased related credit default swaps. 

The SEC Complaint sweeps broad by concluding with allegations of fraud "in connection with the purchase or sale of securities or securities-based swap agreements" (para. 73).  While both vehicles are detailed throughout the Complaint, I just don't see how both are connected to any fraud.  

----JSC. 5/3/10

A Little Perspective on United, Continental and the Outer Continental Shelf

United Airlines and Continental Airlines have agreed to merge into what will be the largest carrier (passing Delta Air Lines, which itself took the top spot after its merger with Northwest Airlines).  The deal apparently involves United’s parent (UAL Corporation) issuing shares worth $3.17 billion in the all-stock deal.  This is a large deal, to be sure, but the most recent cost estimates related to the BP oil disaster in the Gulf Coast make it look rather pedestrian by comparison.  Experts are estimating that the total costs of the disaster could be more than $14 billion. 

Airlines are significant companies to be sure, but energy companies are the real big fish (if you’ll excuse the metaphor in light of recent events). At least there is reason to believe BP has the resources to deal with the enormous costs of this disaster. To put a fine point on it, let’s review a few of the major energy mergers.  Way back in 1998, Exxon and Mobil merged in an $80 billion deal.  The BP-Amoco merger:  $48 billion.  In December 2009, Exxon Mobil completed another deal, acquiring XTO Energy for $41 billion. 

Oh, and while we’re on the topic of money, although we can’t know if it would have worked, that oil well shut-off device my co-blogger Stefan mentioned a short while back costs about $500,000.  

--Josh Fershee

Klock on Securities Fraud Prevention

Mark Klock has posted Lessons Learned from Bernard Madoff: Why We Should Partially Privatize the Barney Fifes at the SEC on SSRN with the following abstract:

Financial markets do not function well when fraud is pervasive. Around September of 2009, the investigations into the SEC examinations of Bernard Madoff Investment Securities, LLC were completed and released to the public. The simple facts reveal an alarming level of incompetence and lack of financial literacy on the part of the guardians of the integrity of our financial markets. I suggest two important tools for addressing these problems. One is to supplement enforcement of anti-fraud rules with more private attorney generals by expressly creating a private right of action for aiding and abetting violations of securities laws. This will foster a stronger culture of integrity and ethical conduct in the auditing profession. An additional tool is to increase financial literacy in our law schools which supply the regulators of our markets.

ECC

Wald on the Great Recession and the Legal Profession

Eli Wald has posted The Great Recession and the Legal Profession on SSRN with the following abstract:

Perhaps with historical hindsight, 2008–2009 will be remembered not for the Great Recession but as an inflection point for world history, the U.S. economy, and the legal profession. In the short run, however, the impact of the economic meltdown on the legal profession has been quite devastating: unprecedented layoffs, salary decreases, and hiring freezes resulting in an extraordinary number of unemployed law school graduates nationwide. The long-term consequences of the economic downturn are less certain. While some believe that the Great Recession will have permanent adverse effects on the legal profession, it is important to bear in mind that points of significant distress are at the same time moments of great opportunity, and that the legal profession, with its track record of adapting to changing practice realities while successfully maintaining its elite professional, financial, and cultural status atop U.S. society, may end up stronger than ever.

In a symposium issue titled The Economic Downturn and the Legal Profession published by the Fordham Law Review leading scholars of the legal profession begin the process of studying the impact of the Great Recession on various segments of the legal profession and on the bar as a whole, examining both the unique consequences of the economic downturn and their interplay with contemporary trends that were already underway before the recession hit. This introductory essay summarizes some of the insights explored in the symposium, situating them in the context of past moments of anxiety experienced by the profession, and discusses some emerging patterns and developments taking place in different segments of the bar.

ECC

Cluchey on Competition in Global Markets

David P. Cluchey has posted Competition in Global Markets: Who Will Police the Giants? on SSRN with the following abstract:

This article argues for the negotiation of a multilateral agreement on competition law. Globalization has made the need for a strong international competition law framework particularly compelling. The work examines the history of efforts to encourage and to support bilateral and multilateral cooperation and convergence, as well as harmonization of substantial competition law and procedures. In that context, the work considers the prospects for negotiating such an agreement under international institutions. The article contends that the United Nations Conference on Trade and Development (UNCTAD) represents the most appropriate venue for the negotiation of such an agreement but only if the UNCTAD members, particularly the developing country members, can resolve their ambivalence about the importance of competition law to the successful economic development of their countries. The argument asserts that UNCTAD must clarify its thinking on the relation between competition and development, and begin by revising the United Nations Set of Principles and Rules on Competition and its Model Competition Law to reflect current best practices.

ECC