Business Law Prof Blog

Connecting the Dots; Back to Square One

1.  It was not too long ago that arguing that corporations effectively ran the government was quite fashionable.

2.  In light of the recent financial crisis and the emergence of USA, Inc., that is not so much the case anymore.

3.  However, Peter Fox-Penner, in a post over at The Baseline Scenario, notes that "the measures taken to prop up the U.S. financial system have made the largest banks even larger, while small banks are failing at record levels."  He then goes on to ask: "[C]an a firm be too big to regulate?"  (HT: Kristina Melomed.)

4.  Between TARP-exit and industry consolidation, I expect concerns about who is really in charge will re-emerge sooner rather than later.

5.  At the very least this will hopefully mean that my soon-to-be-published article--"Finding State Action When Corporations Govern"--will avoid being named the worst-timed article ever.

PS--For further evidence that New Governance remains a timely topic, check out Pies, Beckmann & Hielscher, "Competitive Markets, Corporate Firms, and New Governance - an Ordonomic Conceptualization".  Here's the abstract:

The purpose of this article is to develop an ordonomic conceptualization of corporate citizenship and new governance that (a) provides a framework for positively explaining the political participation of companies in new governance processes and (b) does not weaken but instead strengthens the functional role of corporations as economic actors in the market system of value creation. To this end, we develop our ordonomic approach in a critical discussion of Milton Friedman’s stance on the social responsibility of business in three steps. (1) The ordonomic perspective on the economics ethics of competitive markets argues that the social responsibility of business does not lie in maximizing profits but in addressing societal needs through the mutually advantageous creation of value. (2) The ordonomic approach to the business ethics of corporate actors claims that corporate firms can use moral commitments as a factor of production. (3) The ordonomic perspective on the process ethics of new governance holds that companies can act not only as economic actors but also participate as political and moral actors by taking ordo-responsibility in processes of new governance. This role of corporate citizens in the new governance does not weaken but, instead, strengthens the role of business firms as economic agents for value creation.

SJP

Adler on Environmental Law

Jonathan H. Adler has posted The Record of the Roberts Court in Environmental Cases: Pro-Business or Pro-Government? on SSRN with the following abstract:

Drawing upon a preliminary analysis of the Roberts Court’s decisions in environmental cases prepared for a January 2009 Santa Clara Law Review symposium on “Big Business and the Roberts Court,” this essay assesses claims that the Roberts Court has shown itself to be particularly “pro-business” and hostile to environmental protection. A review of all eighteen environmental cases decided by the Roberts Court in its first four years finds little evidence of any “pro-business” inclination. Victories for business interests are balanced by losses. The Roberts Court’s environmental decisions may provide evidence for something else, however: a tendency to side with government agencies and state interests. While there is little evidence the Roberts Court is “pro-business” or “anti-environment,” there is some evidence to suggest it is “pro-government.”  

ECC

Howson on Chinese Corporate Law

Nicholas Calcina Howson has posted Corporate Law in the Shanghai People's Courts, 1992-2008: Judicial Autonomy in a Contemporary Authoritarian State on SSRN with the following abstract:  

In late 2005 China adopted a largely rewritten Company Law that radically increased the role of courts. This study, based on a review of more than 1000 Company Law-related disputes reported between 1992 and 2008 and extensive interactions with PRC officials and sitting judges, evaluates how the Shanghai People’s Court system has fared over 15 years in corporate law adjudication. Although the Shanghai People’s Courts show generally increasing technical competence and even intimations of political independence, their path toward institutional autonomy is inconsistent. Through 2006, the Shanghai Court system demonstrated significantly increased autonomy. After 2006 and enactment of the new Company Law, a new, if partial, limitation on institutional autonomy seems to be at work, as the Shanghai People’s Courts refused to accept or adjudicate claims explicitly permitted in the revised 2006 statute but not yet elaborated in Supreme People’s Court Regulation. This reaction is perverse, as the same Courts had liberally adjudicated the same claims before 2006 without any statutory or Supreme People’s Court Regulatory authorization. That strange dynamic illustrates the bureaucratic embeddedness of the People’s Courts in China’s modified authoritarian system and how such entrenchment can divert or constrain the progressive autonomy won by the same Courts in the formal legal system. The conclusions have positive and negative aspects. On the positive side, there is significant momentum toward ever-increasing competence and autonomy of the People’s Courts in Shanghai, at least for the application of corporate and commercial law. On the negative side, a familiar paradox may be at work: with formal substantive law and institutional “modernization” promised and even partially delivered alongside equally apparent failures in the exercise of judicial autonomy, the result may be to de-legitimize the very institutions offered by the state and ruling Party as twin pillars of “modern” governance and “rule of law.

ECC

Barnhizer on the Legal Academy

David Barnhizer has posted Redesigning the American Law School on SSRN with the following abstract:  

American law schools are an integral part of a vertically integrated system of production in which the end product is lawyers. Law schools are having rapidly increasing problems “selling” their “products” to potential employers/purchasers. Even if the law schools do not voluntarily cut back on the numbers of admitted students some states will decide there should be no public subsidy for educating students for employment areas such as law where there is no demand. Even though many private law schools will be affected negatively, publicly-funded law schools will also be dramatically affected due to declining state budgets and competition for scarce resources from areas of public expenditure with far more powerful lobbying support and, in fairness, greater and more demonstrable and immediate needs. For publicly funded law schools there is significant danger in the fact that there is no shortage of lawyers in America after decades of rapid expansion.

Several potential shifts in ABA accreditation standards and policy will have significant implications, including approval of credit for distance learning, rapid movement toward assessment of law schools based on what are called “output” measurements, and even a decision that scholarly productivity measures are an inappropriate factor for the American Bar Association (contrasted with the AALS) to rely on in assessing the accredited status of a law school. These three accreditation prongs will have enormous effects that include significant faculty reductions, higher faculty workloads, changes in tenure standards, and large-scale eliminations of the traditional law school research library. For the (many) law schools that choose to remain oblivious to the altered operational context, their adaptations will be ones developed in a crisis context as their applicant pools shrink, angry graduates are increasingly unable to find employment even while faced with educational debt equivalent to a home mortgage, and less expensive competitive institutions emerge that offer alternative approaches to legal education.

ECC

Do the Redskins deserve an antitrust exemption?

The Supreme Court is considering a request from the NFL for a form of antitrust exemption.  In light of this, I thought I'd link to a prior post in which I asked whether Chief Wahoo deserves an antitrust exemption.

SJP

Is this business judgment?

At the first hearing of the Financial Crisis Inquiry Commission yesterday, Jamie Dimon, chief executive of JPMorgan Chase & Co., said a crucial blunder was "how we just missed that housing prices don't go up forever."  I don't actually believe this.  I think the correct statement is more along the lines of some form of rational herding.  But if we take that statement at face value, then it seems to me to suggest a great claim that the business judgment rule shouldn't apply.  To say that you invested in instruments dependent on housing prices rising indefinitely to be successful strikes me as saying you entered into precisely the type of no-win transaction not protected by the business judgment rule.

Another "defense" floating around is that, while people knew housing prices weren't going to keep rising forever, the underlying financial instruments were so complex that no one realized the magnitude of the risks they were taking.  Again, this strikes me as a failure to exercise business judgment.  In order to exercise business judgment you must have some basis upon which to weigh costs and benefits.  You can be wrong about your estimates, but entering into transactions knowing you don't know the risks looks like abdication of management responsibilities to me.  Again, rational herding arguments may save the day here for corporate managers.

Finally, what about loyalty?  If we accept that executives (1) entered into transactions whose success depended on housing prices rising indefinitely and (2) the underlying financial instruments were too complex for them to understand, then doesn't (3) they believed that even in the worst case scenario (whatever that was) they would be able to cash in and cash out personally before the excrement hit the fan = a duty of loyalty violation claim?

SJP

Introducing Guest Blogger Tracy Houston

Tracy Houston will be joining us as a guest blogger for the next month or so.  Tracy is a board consultant and I look forward to reading about her perspective on various corporate governance topics.  Her LinkedIn page is here, and I will leave it to her to fill in the details of her bio in her first post tomorrow.  Welcome, Tracy!

SJP

Bankers and Bebchuk on Compensation

Chief executives from top banks are on Capitol Hill today, testifying in an inquiry into what caused the financial crisis.  Although I am sure that they are not that keen on discussing compensation, they faced questioning on that topic.  Indeed it is impossible to separate compensation from other banking policies that led to the collapse. 

As we digest the bankers' testimony, it might be useful to compare their views on compensation with those expressed by Lucian Bebchuk in the paper he posted on SSRN, "Regulating Bankers' Pay."

Here is the abstract:

This paper seeks to make three contributions to understanding how banks’ executive pay has produced incentives for excessive risk-taking and how such pay should be reformed. First, although there is now wide recognition that pay packages focused excessively on short-term results, we analyze a separate and critical distortion that has received little attention. Equity-based awards, coupled with the capital structure of banks, tie executives’ compensation to a highly levered bet on the value of banks’ assets. Because bank executives expect to share in any gains that might flow to common shareholders, but are insulated from losses that the realization of risks could impose on preferred shareholders, bondholders, depositors, and taxpayers, executives have incentives to give insufficient weight to the downside of risky strategies.

Second, we show that corporate governance reforms aimed at aligning the design of executive pay arrangements with the interests of banks’ common shareholders — such as advisory shareholder votes on compensation arrangements, use of restricted stock awards, and increased director oversight and independence — cannot eliminate the identified problem. In fact, the interests of common shareholders could be served by more risk-taking than is socially desirable. Accordingly, while such measures could eliminate risk-taking that is excessive even from shareholders’ point of view, they cannot be expected to prevent risk-taking that serves shareholders but is socially excessive.

Third, we develop a case for using regulation of banks’ executive pay as an important element of financial regulation. We provide a normative foundation for such pay regulation, analyze how regulators should monitor and regulate bankers’ pay, and show how pay regulation can complement and reinforce the traditional forms of financial regulation.

MJB

Backer on Corporate Legal Theory

Larry Cata Backer has posted The Drama of the Corporate Law: Narrator Between Citizen, State and Corporation on SSRN with the following abstract:  

The allure of a narrative of business law continues to prove irresistible. It is even more so in a contemporary regulatory context in which the separation between politics and economics, law and governance, and political and economic actors becomes fuzzier. Within this dynamic context, spinning a narrative of economic collectives can serve as an important source of the constitution of social institutions, like corporations. This essay reviews David A. Westbrook’s recent contribution to this endeavor, Between Citizen and State: An Introduction to the Corporation (Boulder, CO: Paradigm Press, 2007). Westbrook seeks to situate the corporation between property and institution, and then again between social and political institutions inside the framework of American law and policy. That American framework, for Westbrook, is fundamentally ambiguous, melding elements suggesting corporations as autonomous social organs that have unsettled relationships with both individuals who have legally recognized stakes in them and with the organs of the political state which simultaneously assert legally recognized regulatory stakes. Westbrook queries what he describes as a weakness of our political thought that produces a deeply traditional academic corporate law, which an essentially conforming and conservative community of legal academics seeks to theorize away. This review essay examines this deeply conservative and tightly focused narrative world within the larger narrative of unconventional corporate entities and markets - the mafia and the yakuza. Westbrook’s call for a dramatic understanding of law in the American narrative context becomes a promising analytic method that reveals not so much the weakness of political thought as a play within a play without a script. Westbrook’s narrative offers elaborate tales of domestication and privatization of that portion of the economic sector that is capable of governance, of property that is animated - like the creation of Frankenstein - and of entities that are better understood as beyond citizen and state. The narrative of yakuza and mafia suggest both the limits and character of the conventional narrative of the American corporation so masterfully recounted by Westbrook. The three stories together constitute a wider universe of power-reality that also emphasizes the malleability of reality and the power inherent in controlling the parameters of narrative. The managerial character of narrative in the legitimating context of law stories becomes the great moral of Westbrook’s tale as much as the autonomy of human activity, and its complex inter-connections, is from the yakuza and mafia stories.

ECC

Joo on Corporate Legal Theory

Thomas Wuil Joo has posted Narrative, Myth and Morality in Corporate Legal Theory on SSRN with the following abstract:

This article, prepared for the Michigan State Law Review's "Business Law and Narrative" symposium, analyzes corporate legal theory's use of myth as a rhetorical device. Corporate legal theories offer competing stories about how and why corporations originate and how they operate. The leading theories do so by maintaining that the abstraction we call a corporation can be decomposed into constituent human individuals, who serve as characters in stories of corporate origins and ongoing corporate action. Narratives that justify the existence of social institutions serve a rhetorical purpose sometimes referred to as “myth.” Corporate legal theories serve to justify the existence of corporations and certain approaches to the role of regulation, the role of markets, and the relative roles of managers, directors, shareholders, and other corporate stakeholders.

Theories of the corporation perform this function by reference to fundamental moral preferences about the role of the state, the rights of the individual, and her relationship to society. The dominant corporate legal narratives in American law, then, have significant moral and ideological content. This analysis of legal theory as narrative myth shows that law does not simply impose ideology, but influences ideology through the use of rhetorical conventions. Law appeals to existing ideology, but also attempts to remake ideology, though it can only do so incrementally, in recursive fashion, by taking advantage of its relationship to existing beliefs.

ECC

Lambert on Insider Trading

Thomas A. Lambert has posted A Middle Ground on Insider Trading on SSRN with the following abstract:

The debate over insider trading usually proceeds in all-or-nothing terms: either all insider trading should be permitted by law or none should. This article argues that the law should permit insider trading that decreases the price of an overvalued security or equity, but should prohibit insider trading that would increase that price. The reason for the different treatments is that over-valued equities often have a long-term negative effect on shareholders while the long-term effect on undervalued equities is ambiguous.  

ECC

Tough Times Ahead for the CFPA...

The reform bill passed by the House before Christmas (H.R. 4173) would establish a new Consumer Financial Protection Agency.  As was noted at the time of its approval, the CFPA's jurisdiction would not reach entities regulated by the S.E.C. or banks with more than $10 billion in assets.  As described by Paul Krugman of The New York Times last week ("Bubbles and Banks"), the agency - even in its scaled back form - would "help stop deceptive lending practices."

The agency is far from a done deal.  H.R. 4173 passed in the House by a mere 21 votes; faltering support among Democrat Senators foretells of further concessions, at the least.  Last Fall, a group of over 70 law professors submitted a letter of support for the new agency.  Interested parties can follow the fate of the agency at the Consumer Law & Policy Blog, found at www.clpblog.org .

--JSC, 1/12/10        

Still Hazy After All These Years

Part of the call for reform in the wake of the financial crisis has sounded in the yearning for agency consolidation.  But mergers of regulatory entities, even undertaken in quiet times, can be painfully slow ordeals.

Take, for example, the universally applauded merger of the enforcement divisions of the National Association of Securities Dealers and the New York Stock Exchange to form FINRA (the "Financial Industry Regulatory Authority").  Completed in July 2007, the deal necessitated the combination of two thick and storied rulebooks, the NASD Manual and the NYSE Constitution and Rules.  Further complicating matters were the distinctly different markets to be overseen (Floored and cyberpspacetrading facilities), NASDAQ's 2006 conversion to a national securities exchange, and the transformation of "seats" on both entities into stock in the last decade.

The end result? It's now 2010, and the official "FINRA Manual"/Consolidated FINRA Rulebook is actually a checkpoint on the research road to guidance groupings referred to as "FINRA Rules," "NASD Rules," "Incorporated NYSE Rules" or "Incorporated NYSE Rule Interpretations."  No one is accusing the nation's largest regulator of broker-dealers of sloth in its efforts at combining regulations, but the fact remains that the synergy of 1) cultural differences between the two market centers, 2) market complexities, 3) the SEC rule approval process, and 4) FINRA's shifting priorities have pushed a process that at one time was hoped to be completed in 18 months into its fourth year.

All of which serves as a reminder as both Congress and effected agencies throw around terms like "consolidation" and "harmonization".  While it may be politically savvy to cut vague products in twain  (e.g., by distinguishing securities-based derivatives from commodities-based derivatives), or seemingly expedient to cross-train examiners (e.g., by declaring a sole fiduciary standard for both brokers and investment advisers), sometimes it may be simply more efficient to keep the responsibility intact at one agency or one subdivision thereof and promise its rival the next opportunity that arises.

--JSC, 1/12/10 

   

 

Speaking of Credit Rating Agencies

Since Scott's post from earlier today brought up the problem of credit rating agencies, I thought I'd mention that Chris Sagers and Thomas James Fitzpatrick IV have posted the following abstract and related article on SSRN.

During the past forty years, the simultaneous, symbiotic growth of financial innovation, disintermediation and deregulation has created an environment with extremely complex, opaque investment instruments. That system has now collapsed. At the very center of the crisis are a small group of shadowy but very powerful private corporations, the so-called "credit rating organizations" (CROs) such as Moody's and Standard & Poor's. Their very purpose was predict risks like those that have now caused systemic collapse. There is currently no significant regulatory oversight of CROs, notwithstanding the literally de jure regulatory power they possess and the systemic repercussions of credit ratings. There also happens to be surprisingly little theoretical justification for their very existence or for the hope that they would produce valuable and otherwise unavailable information. Even if there were such a basis, it so happens that an extensive empirical literature studies the CROs, and it has failed to find evidence of such value sufficient to justify the CROs' significant costs.

But the problem inherent in the nature of informational intermediation is basically one of industrial organization, and, as we will explain at length, it seems very thorny. No policy tool currently in force and none of those with any serious political feasibility would come close to dealing with it, and those more abstract proposals that might are both fairly politically implausible and raise serious problems of cost and uncertainty. In short, our purpose is to argue that capital markets currently contain a much more serious institutional flaw than has been recognized.

MJB

Sundahl on Export Controls on Space Technology

Mark Sundahl has posted Export Controls and Human Spaceflight: A New Age of Reason? on SSRN with the following abstract:

Export controls on space technology are notoriously strict in the United States, where all space technology is deemed to be munitions and is therefore subject to the burdensome International Traffic in Arms Regulations (ITAR) – even if the technology is purely commercial in nature. The burdens of ITAR are a particular threat to the global operations of U.S. companies engaged in the human spaceflight industry. As action from the Obama administration is awaited in this area, promising indications of a more reasonable application of ITAR are emerging. For example, Bigelow Aerospace announced in April of 2009 that the United States Directorate of Defense Trade Controls (DDTC) had responded favorably to its commodity jurisdiction request to ease its regulatory burden under ITAR. Prior to this decision, the presence of foreign nationals on a Bigelow space station would have been treated as an “export” of space technology under ITAR – thus requiring a license from the DDTC in addition to other burdens. Bigelow Aerospace’s successful commodity jurisdiction request has removed these obstacles and, as a result, has breathed new life into the private spaceflight industry. However, whether the ruling will be extended to the companies that will transport private passengers into space remains to be seen. The DDTC’s ruling in this case may signal a broader shift in the application of ITAR. At a minimum, the ruling is an encouraging indication of the DDTC’s sensitivity to the needs of the commercial spaceflight industry, which could result in the continued relaxation of export controls over commercial space technology. The DDTC ruling is also of interest to scholars of administrative law as an example of how discretion granted to administrative agencies can serve to remedy flaws in federal law when political dynamics prevent Congress from providing the remedies itself.

ECC

The Wall Street Bonus Fairy Comes This Week...

…even though corporate America hasn’t lost any teeth.  And the money expected to be left under the pillow, by all estimates, shall be breathtaking.

Apart from the inherent unfairness of a select class being gifted so much in these troubled times, there exist the practical considerations of how little corporate law has changed in response to the now 18-month old Crisis.

The business judgement rule remains largely intact.  And the “say-on-pay” proposal first statutorily proposed by Senator Obama (and later forced on bailed out companies by President Obama) survives as a non-binding shareholder vote on executive compensation in H.R. 4173 (Section 2002 of “The Wall Street Reform and Consumer Protection Act of 2009”).

That Bill, awaiting discussion in the Senate in the New Year, also proposes but a compromised version of the Consumer Financial Protection Agency that arguably exempts from agency jurisdiction the most relevant banks.

On a broader scale, our balkanized systems of regulating banks and brokerages remains intact, with minor modifications.  We might see one less alphabet agency in the banking mix, but, on the securities side, lawmakers refused to even consider the mild move of merging the SEC and CFTC.  If anything, the addition of the “Financial Services Oversight Council” (to be staffed by delegates from, among others, the Fed, Treasury, OTS, SEC, FDIC and CFTC) risks more fragmentation and delay in oversight.

Separately, the credit rating agencies are still not subject to the system of review and oversight that governs broker-dealers and investment advisers.  Such distinction can hardly be blamed on the SEC: Already scandalously out-paced in resources, the agency - which may soon be expected to take over the oversight of thousands of hedge funds - has watched its open and oft-repeated call for self-funding go unheeded.

Which leads one to wonder, just how bad must things get before Congress takes meaningful action to restore confidence in the securities markets?  Personally, I’m placing a copy of H.R. 4173 along with a $5 bill under my pillow.  Hopefully the tooth fairy will take them back and leave a law with teeth…

 --JSC, 1/11/10

Letsou on Corporate Governance

Peter V. Letsou has posted the following abstract and related article on SSRN:

Since the 1930s, the United States federal government and the individual states have shared the responsibility for regulating the governance of public corporations. In general, the states have regulated the substance of corporate governance, while the federal government has focused on regulating the communications of public corporations with investors and securities markets. This Article explores three topics related to this shared responsibility for corporate governance regulation: First, it discusses, in greater detail, the basic division of the authority to regulate corporate governance between the United States federal government, on the one hand, and the individual states, on the other; second, it explores how this division of authority has evolved since the 1930s; and third, it offers some thoughts on the future of this shared regulatory responsibility, concluding that, there is little to fear, and much to gain, from retaining the current system of shared regulatory responsibility.

ECC

Gross and Pekarek on the Bank Broker-Dealer Rule

Jill Gross and Edward Pekarek have posted the following abstract and the related article on SSRN:

This article evaluates the Financial Industry Regulatory Authority’s (FINRA) proposal to adopt a modified version of NASD Rule 2350, known as the “bank broker-dealer rule,” which, if approved by the SEC, would be designated as FINRA Rule 3160 within FINRA’s Consolidated Rulebook (the proposed rule change). The proposed rule change ostensibly seeks to prevent FINRA member firms, who offer broker-dealer products and services through contractual “networking arrangements” with financial institutions – both on and off the premises of those institutions – from undertaking certain business practices that might tend to confuse or harm financial institution customers. The proposed rule change also aims to prevent customer confusion by, inter alia, ensuring that certain disclosures are made to affected customers so they can understand and appreciate the distinction(s) between the financial institution’s products and services and those sold by the broker-dealer affiliate.

ECC