Business Law Prof Blog

Sobering Numbers

Yahoo reports that the U.S. poverty rate is expected to increase to 15% for 2009.  When reflecting upon this number, keep in mind that a family of four living on $23,000 a year is not considered to be living in poverty.

SJP

Philanthropy as a Business Model: Comparing Ford to craigslist

At The Conglomerate, Gordon Smith notes some comparisons between Dodge v. Ford (pdf here) and eBay v. Newmark (pdf here). I certainly see the comparison (and I think his post here on the case and Christine Hurt’s earlier post here are great).  Still, I think I am a little more critical of the Dodge v. Ford analogy than Professor Smith. Here’s why:

In Dodge v. Ford, Henry Ford stated clearly that he was operating the business as he saw fit and that he was changing toward supporting philanthropic purposes. As the Dodge v. Ford opinion notes:

‘My ambition,’ declared Mr. Ford, ‘is to employ still more men; to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this, we are putting the greatest share of our profits back into the business.”

. . . .

The record, and especially the testimony of Mr. Ford, convinces that he has to some extent the attitude towards shareholders of one who has dispensed and distributed to them large gains and that they should be content to take what he chooses to give. His testimony creates the impression, also, that he thinks the Ford Motor Company has made too much money, has had too large profits, and that, although large profits might be still earned, a sharing of them with the public, by reducing the price of the output of the company, ought to be undertaken. We have no doubt that certain sentiments, philanthropic and altruistic, creditable to Mr. Ford, had large influence in determining the policy to be pursued by the Ford Motor Company-the policy which has been herein referred to.

Contrast this with Chancellor Chandler’s explanation of craiglist:

Nevertheless, craigslist’s unique business strategy continues to be successful, even if it does run counter to the strategies used by the titans of online commerce. Thus far, no competing site has been able to dislodge craigslist from its perch atop the pile of most-used online classifieds sites in the United States. craigslist’s lead position is made more enigmatic by the fact that it maintains its dominant market position with small-scale physical and human capital. Perhaps the most mysterious thing about craigslist’s continued success is the fact that craigslist does not expend any great effort seeking to maximize its profits or to monitor its competition or its market share.[fn6]

In further contrast to Henry Ford’s statements, in footnote 6 Chancellor Chandler provides a quote from craigslist’s CEO “testifying that craigslist’s community service mission ‘is the basis upon which our business success rests. Without that mission, I don’t think this company has the business success it has. It’s an also-ran. I think it’s a footnote.’”

Nonetheless, Chancellor Chandler, as Professor Smith points out, appears to see these cases in a similar light:

The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment. Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders.

Without getting into the appropriateness of the other moves taken by the majority owners of craigslist, I am inclined to think that craiglist’s explanation of their business model should sufficiently distinguish the mission – and business purpose – from that put forth by Henry Ford. That is, I have always been of the mind that Henry Ford could appropriately have defended his actions (or at least had a much stronger case) if he had never talked about doing anything other than building Ford into the strongest possible company for the longest possible term.

I see the problem for Henry Ford to say, in essence, that his shareholders should be happy with what they get and that workers and others are more his important to him than the shareholders. However, it would have been quite another thing for Ford to say, “I, along with my board, run this company the way I always have: with an eye toward long-term growth and stability. That means we reinvest many of our profits and take a cautious approach to dividends because the health of the company comes first. It is our belief that is in the best interest of Ford and of Ford’s shareholders.”

For Ford, there seemed to be something of a change in the business model (and how the business was operated with regard to dividends) once the Dodge Brothers started thinking about competing. All of a sudden, Ford became concerned about community first. For craigslist, at least with regard to the concept of serving the community, the company changed nothing. And, in fact, it seems apparent that craiglist’s view of community is one reason, if not the reason, it still has its “perch atop the pile.”

Thus, while it is true craigslist never needed to accept eBay’s money, eBay also knew exactly how craigslist was operated when they invested. If they wanted to ensure they could change that, it seems to me they should have made sure they bought a majority share.  

--Joshua Fershee

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If you'd like to do some guest blogging on the BLPB, please contact us via the link provided on the left side of this page.

SJP

The Next Scandal?

Benjamin Golez and Jose M. Marin recently posted the following abstract for “Price Support in the Stock Market” on SSRN:

The interplay of delegated portfolio management and asset management ownership generates a double agency problem that may result on trading to support security prices. We test this hypothesis analyzing the trading patterns of mutual funds affiliated with banks with the stocks of their controlling banks. We show that affiliated mutual funds tend to increase the holdings of the parent bank stock following a large drop in the stock price of the bank. Further, we provide evidence that these patterns of trading are not consistent with portfolio rebalancing into the banking sector, contrarian trading or timing skills. We also provide evidence that the patterns of trading are not information-driven. This leads us to conclude that affiliated mutual funds follow this strategy to support the price of the parent bank.

SJP

Helping Students Prepare for Practice

As part of my goal of better preparing students for day one of practice, I have been adding small projects to my larger classes to help supplement the doctrinal discussions.  One focus has been to add ethics and professionalism components to my courses beyond my continuing practice of pointing out and discussing ethical issues raised by our cases.  To that end, I started Business Associations I a little differently this year.

After discussing my course objectives, goals, and expectations for the course, and before discussing the first reading assignment, I passed out a single sheet to the entire class (about 60 students).  

Half the class was informed that they were colleagues in a law firm with Attorney S, and the other half of the class were colleagues in a law firm with Attorney K. I provided them the fact pattern and letter below, and told them that their colleague had either just sent or just received the letter. I then asked them to discuss in groups of three or four any concerns they had and any next steps they might want or need to take.  The Handout:

In May 2010, Mr. and Mrs. B went to Attorney K requesting that he prepare an insurance funded buy/sell agreement. Mr. and Mrs. B had been advised by Ms. H that an insurance funded buy/sell agreement was necessary. Attorney K prepared the insurance funded buy/sell agreement for Mr. and Mrs. B.

Later, Mr. and Mrs. B apparently questioned the need for the insurance funded buy/sell agreement. Mr. and Mrs. B retained the Mr. S to review this issue.

The following letter arrived in your office today:

Dear Mr. K,

Sometime last May, 2010, Mr. & Mrs. B approached your office, possibly with the assistance of Ms. H, requesting advice concerning a buy-sell agreement for their corporation. Since that time, Mr. and Mrs. B have questioned the need for the buy-sell agreement, since they are married, and are also the only shareholders in the corporation.

To be frank, Mr. K, my clients believe they were mis-advised, and intend to file a complaint with the state Disciplinary Administrator concerning your part in drafting the buy-sell agreement. However, if you were to simply refund your fee to them, in care of this office, I believe they may relent, and not file anything with the state Disciplinary Administrator.

I will need to hear from you no later than Monday, September 13, 2010, if this is acceptable to you. If we don't hear from you, we will assume that you would like to address this matter through the Office of the Disciplinary Administrator. If you have any questions, please do not hesitate to contact my office.

Sincerely,

Mr. S

The above fact pattern and letter are pulled from a state supreme court disciplinary case, and the case provides two subsequent communications that provide the rest of the exercise.  I, of course, did not tell them it was from a disciplinary case.  

The discussion was fairly lively, and the students raised a lot of interesting issues and questions. However, very little of the discussion focused on the "settlement attempt" made by Attorney S.  The discussion focused mostly on whether the buy-sell agreement should have been drafted and how to manage the potential harms from the case moving forward.  The discussion moving forward also focused largely on the facts, even as I provided the subsequent documents.  

This exercise helps frame important ethical and professionalism issues that students might not otherwise see (at least not in context), and it also provides a way to discuss the business of a law practice as related to a business law representation.  Part of the conversation focused on how one maintains a good law business, interacts with clients and other attorneys, and thinks about the possible repercussions of such an allegation.  Of course, it also provides the opportunity to discuss our obligations as professionals -- to our clients and the bar-- and the need to understand and embrace the rules of professional practice. Finally, it provides the opportunity to discuss the need to assess and investigate the merits of any claim BEFORE anything leaves the office.  

If you are interested in the exercise and/or the case, please let me know.  I am happy to share.

--Joshua Fershee

The SEC, Phony Promissory Notes, and Lead Helmets...

My first semester of law school was punctuated by an unusual tale in Torts class.  Under the rubric of 'contributory negligence,' the professor regaled us with a case involving a backwoods doctor and a naive soul suffering from migraine headaches.  The patient was told that he would have to wear a very heavy lead helmet to fend off Jupiter's rays; he did so until he collapsed and died of an aneurysm.  A judge subsequently threw out the malpractice lawsuit, essentially holding that the law cannot be everywhere, and it cannot always protect one from his own extremely poor judgment.

Twenty five years later, I still ponder the morose holding.  This past Spring, I recounted the story with my Securities Regulation class as a prelude to summaries of a host of SEC actions in which retail investors parted with significant monies because of truly incredulous sales pitches.  Some students readily argued that victims of such porous tactics belong low on the government's list of priorities (one student even recited the movie Wall Street: "A fool and his money were lucky to get together in the first place.").  Others aptly noted that the law cannot simply punish 'intelligent' frauds while forgiving the outrageous ones.

Which reminds us of the SEC's increasingly publicized war on Ponzi schemes and con games, an offensive that can be traced to the Madoff revelations of December of 2008.  A case highlighted on the Commission web site just last week details a "multi-million dollar offering fraud" in which alleged victims "unsophisticated in investments" reportedly purchased, among other things, fictitious promissory notes and "other side investments" from a host of related New Jersey companies, one of which is a tax preparer.  See SEC Litigation Release No. 21641 (Sept. 2, 2010).  The Commission's Complaint alleges representations that the notes were guaranteed by the FDIC, paid up to 11% a year, and were tax free "due to a loophole in the tax code."  Moreover, the allegations describe the notes as funding loans to doctors "that would be backed by Medicare reimbursement payments."  The Complaint further alleges fictitious doctors and forged documents and a wholesale lack of actual investments, assets or revenues; the "investment" monies are alleged to have been squandered by a defendant on personal debts, international travel, property taxes, and gambling debts.

As misstatements related to fictitious investments, the alleged fabrications still satisfy Rule 10b-5's "in connection with the purchase or sale of securities" requirement pursuant to a string of cases dating back decades (an exception to the Rule's standing threshold that never ceases to amaze me).  Moreover, the presence of an astronomical total of proceeds ($11 million) and an unspecified number of retired victims easily support the SEC's decision to file charges. 

But I can't help wonder if such plain vanilla frauds are best left to State prosecutors.

To be sure, the lead helmet cases are sad, and sadly persistent.  However, turning SEC attention to the more complicated schemes involving exotic investments, voodoo accounting and global schemes may just better serve the market as a whole.  It was the 1934 Congress that designed an agency (headed by Presidential appointees) that was to serve as creator of national policy on securities regulation; countless courts since have upheld the Commission's expertised rulemaking authoirty.  That agency has survived numerous administrations, pendulumic market swings, and a number of recessions.  The agency is soley positioned to look across markets and shores and look into financials and proxies.  The agency should arguably be vetting each meteoric rise for an inevitable fall, and the next trend that endangers both buyer and seller alike.  Likewise, it should by now also be focusing on the varied spate of Dodd-Frank duties that lie ahead, which require identification of 'systemically significant" enterprises and 'Tier 1' capital risk.   

Without condoning fraud or trivializing the pain of being hoodwinked, perhaps we are all best served by the SEC pointing its mighty guns at the daunting list of antagonists to stability that have been sighted but barely charted in the present recession.  A truly brave new start for the Division of Enforcement would entail a greater allocation of resources to the investigations of internecine transactions and wilfullly disregarded risk, while leaving to the local authorities the regrettably swallowed tales of Jupiter's moons and tax free, high-yielding, FDIC insured loans (backed by Medicare) from accounting firms to unidentifiable doctors.

---JSC, 9/7/10

Shareholders and CEOs: The Tail Wagging the Dog?

Over at CNBC, Gary Kaminsky writes that Oracle's courtship of former HP CEO Mark Hurd is something for shareholders to watch. Kaminsky argues that shareholders need to be concerned "about owning shares when the CEO is larger in stature than the company itself." 

This is an interesting take, but as financial advice (if that is what it is) it seems to me to be missing the point. It seems to me fine for investors to believe in a company with a certain CEO at the helm and not with another, just as it is fine for people to believe in the Minnesota Vikings with Brett Farve at the helm and not Tarvaris Jackson. These investors (or sports fans) may very well be right that the organization's potential is tied to a specific person. Then again, they may be very, very wrong. For a great sports example, consider the 1999 St. Louis Rams. Trent Green was signed to be their quarterback, and he tore his ACL in the preseason. A little-known quarterback from Northern Iowa name Kurt Warner steps in and calmly become a Super Bowl MVP. 

Maybe Oracle is in the process of signing their Drew Brees -- the once under-appreciated San Diego Charger who brought the New Orleans Saints a Super Bowl. Then again, maybe it will be more like the Cleveland Browns signing of Jeff Garcia (i.e., not good). 

The real problem with this analogy, of course (and Kaminsky's analysis in my view), is that it treats investors more like sports fans (and even sports gamblers).  In once sense, I suppose this is fine, but it seems to me that it validates the idea of investors as gamblers, which may be correct, but it doesn't make it right. 

--Joshua Fershee

Hoffman and Steinberg on Milberg Weiss

Lonny Sheinkopf Hoffman and Alan F. Steinberg have posted The Ongoing Milberg Weiss Controversy on SSRN with the following abstract:

In this paper we revisit the ongoing controversy surrounding the Milberg Weiss prosecution. Our paper responds to an important, recent empirical study by Michael A. Perino that claims to have found evidence to support the government’s assertion (made without evidentiary support) that class members were in fact injured by the payments Milberg made to the named representatives. Notwithstanding the carefully constructed and rigorous study Perino has authored, we argue that the evidentiary proof of harm he claims to have found simply cannot withstand scrutiny. We raise several methodological critiques of the study. Although we did not have access to Perino’s full data, we were able to replicate some of it by using the same database of securities class action settlements on which he primarily relied. The replication data results validate some of our hypotheses. Most critically, the replication data strongly suggests that the reason why fees may have been higher in the indictment cases is that the almost all were filed before the Reform Act went into effect. By contrast, the vast majority of cases in the replication sample of Perino’s non-indictment cases were filed in a later period when fees have been lower. Additionally, the replication data we report is not consistent with some of the descriptive statistical findings Perino presents. Specifically, we find no difference either in mean or median fee awards between cases in which the government alleged Milberg paid a kickback and all other cases. Beyond the study’s methodological difficulties, we also show that there are equally substantial reasons to be concerned about the inferential conclusions Perino draws from the data. The big take away that Perino offers at the end of his study - that the evidence contradicts the claim that kickbacks paid to the named plaintiffs were a “victimless crime” - is not supported by the data he has collected and reported. Far from demonstrating that kickbacks allowed Milberg to obtain higher fees, his study fails to rule out the possibility that other, entirely benign reasons could explain the higher fees Milberg received, including that the fees were earned by the results obtained in settlements of the indictment cases.

ECC