Business Law Prof Blog

Securities Regulation and the Increasing Impact of Macroeconomic Forces on Stock Prices

The Wall Street Journal reported yesterday that macroeconomic forces are driving stock prices to move in a lockstep fashion more than ever, making traditional stock analysis based on an individual company's fundamentals less and less relevant.  If this trend continues, it may raise some interesting securities regulation questions.  For example, should companies be emphasizing the role of macroeconomic forces, and the increasing incidence of lockstep stock price movement, more in their disclosures?  What about event studies?  Should their value be discounted because information that is material about a particular company is less likely to move that company's stock price?  Or, is company-specific information simply less material?

SJP

How to Fix the "Broken" Financial System: Stop Trying to Fix It

According to Paul Volcker, the "financial system is broken."  Furthermore, with regard to limits on the abilities of regulators, he says: “Relying on judgment all the time makes for a very heavy burden whether you are regulating an individual institution or whether you are regulating the whole market.” 

He's right on that.  If we like markets (and I think we do), then we need to recognize we can't always regulate (or, for that matter, buy) our way out of some of these messes.  I am now firmly of the mind that we should have a five-year moratorium (minimum) on financial regulation.  This goes both ways -- nothing can be repealed and nothing can be added. 

I am of a mixed mind on the new financial regulations, but since they already passed, I say leave them alone and let the market adjust. Similarly, with regard to Sarbanes-Oxley, regardless of whether one likes it, it's part of the current market, and companies have adjusted to it.  So - leave it all alone. Regulators need to work with what they have, and businesses have to work with what is there.

I happen to think that we have a fairly solid system in place, but there are clearly some inherent potential pitfalls built into that system. I just think those pitfalls are primarily because the financial system is a (relatively) open market.  Markets involves people, which means that at every level (as a consumer, a seller, or a regulator) we are still, as Mr. Volcker puts it, "[r]elying on judgment all the time."  And no matter what we do, that's part of the problem.  

Unless, of course, we're living in The Matrix.  Then, who cares?

--Joshua Fershee

The Business of Food

Some recent headlines:

Corporate Lobbying Is Blocking Food Reforms, Senior UN Official Warns

Voices of Federal Food Safety Scientists and Inspectors: “[S]pecial interests and public officials all too often inhibit the ability of government scientists and inspectors to protect the food supply.”

Egg company knew of salmonella, investigators say: Iowa farm had more than 400 positive results during a two-year period

SJP

Business Associations Meets Employment Law

In my employment law course yesterday, I taught the North Dakota case Earthworks, Inc.v. Sehn (here). I use the case as part of my section on covenants not to compete, and I like it because it also provides a straight-forward opportunity to discuss statutory interpretation. Beyond that, it provides a great opportunity to discuss the need to view cases as a whole and not as topic specific, despite the name of the course or client context in which such cases arise.  That is, just because I was teaching the class in Employment Law, it is not solely an employment law case -- there are other issues, too.  

The non-compete clause in Earthworks arose as part of an agreement through which Earthworks bought Mr. Sehn's 50% stock holdings so that the other 50% owner, Mr. Marquart hold 100% of the remaining stock.  The non-compete agreement provided that Mr. Sehn would not compete with Earthworks in the state of North Dakota for two years.  

The applicable statute on non-compete clauses is as follows:

North Dakota Century Code 9-08-06. In restraint of business void - Exceptions.

Every contract by which anyone is restrained from exercising a lawful profession, trade, or business of any kind is to that extent void, except:

1. One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business within a specified county, city, or a part of either, so long as the buyer or any person deriving title to the goodwill from the buyer carries on a like business therein.

2. Partners, upon or in anticipation of a dissolution of the partnership, may agree that all or any number of them will not carry on a similar business within the same city where the partnership business has been transacted, or within a specified part thereof.

I provide the students with only the facts, the contract clause at issue, and the statute above to discuss how we might attack the problem.  I start with asking them which statute applies.  Many of my students haven't taken BA, so Marquart and Sehn look like partners to them -- thus a brief discussion of the differences between partners  and corporations.  (Some students noted that it doesn't matter, at least in one sense, because the scope of the non-compete agreement -- the entire state of North Dakota -- violates either paragraph of the statute, which is correct.) 

Next, we discuss the requirements for a valid North Dakota non-compete clause under paragraph 1.  We discuss whether the goodwill was purchased in the sale. Many students say no, again an opportunity to talk about corporate structure and what you get in a stock purchase.  Earthworks argued that goodwill did not need to be mentioned specifically because the sale of goodwill was implicitly part of the transaction.  The court agreed, quoting Bessel v. Bethke, 56 N.D. 1, 215 N.W. 868, 869-870 (1927):

Where one sells his stock he necessarily disposes of his interest in the good will of the business conducted by the corporation to the same extent as he parts with his interest in any other property of the corporation. And where, as in the instant case, he disposes of all his stock and severs his connection with a business that had been in a measure dependent for its success upon his skill or ability and contracts at the same time not to re-engage in the same business within an area permitted by the statute, he has, in fact, sold the good will within the exception, and the contract is valid.

Finally, we talk about the outcome of the case.  The court upheld the clause, but restricted the scope to the county as required by statute.  This gave us a chance to discuss the policy implications of rewriting the clause to repair the faulty portion (thus providing a legal result closer to what the parties seem to have negotiated) as opposed to the equally reasonable possible result of throwing out the entire non-compete provision because it violated the statute on its face.  (Note also that the latter becomes even more reasonable, in my view, given that both parties were "represented by an attorney."  Oops.) 

A lot of students seem to really enjoy seeing the overlap of their various course subjects and find it more exciting and realistic.  Some students, though, probably find the overlap between courses and topics frustrating.  I just hope this group of students still appreciate that real cases are not employment law cases, or civil procedure cases, or business associations cases -- they are client problems that those clients hire lawyers to address.

--Joshua Fershee

My Bio - Joel McTague

As Stefan indicated yesterday, I'll be guest blogging over the course of the next few weeks on Wednesdays.  His post pointed to my bio, so rather than bore you with a bunch of facts about me, I'll share my goal for the next few weeks.  So often in business law, we tend to concentrate on Delaware or MBCA states and ignore the other state law developments.  My goal is to bring some of those local flavors back to discussion to compare it to what we normally hear what the Court of Chancellory is doing, as well as potentially discuss some of the more esoteric areas of corporate law.

jmm

Olmstead

The Florida Supreme Court recently issued the Olmstead v. Federal Trade Commission case.  The case's holding is that F.S. 608.433 (4) allows a court to order a debtor to surrender "all right, title, and interest" in the debtor's single-member LLC to satisfy an outstanding judgment, unlike many other states where the sole remedy is a charging order.  Although the case was based on a single-member LLC, the Court's rationale could extend to multi-member LLCs as well.

This case is probably the death knell for single-member LLCs in Florida until the Florida legislature fixes the sole remedy issue.  Also, because this is a case of first impression in the United States under this type of wording of the statute, it may be precedential to other jurisdictions with similar wording. 

Maybe it's coincidental, but the IRS also issued their proposed regulations on the tax treatment of the Series LLC (available in other jurisdictions including Delaware where the sole remedy is a charging lien), which may be a good alternative.

JMM

Business Judgment Rule

In the first case of its kind that I'm aware of, a Florida court has held that the business judgment rule standards are different for different types of businesses.  In Hollywood Towers Condominium Association v. Hampton, a Florida appellate court said that the business judgement rules as it applies to condominium associations is "...courts must give deference to a condominium association's decision if that decision is within the scope of the association's authority and it is reasonable - that is, not arbitrary, capricious, or in bad faith". 

Under the business judgment rule in Florida for all other corporations, a director is protected under the business judgment rule unless the plaintiff also shows that the director's breach of his duties constitutes a knowing criminal violation, a transaction involving self-dealing, willful misconduct, recklessness, or an act/ omission committed in bad faith or maliciously. F.S. 607.0831.

If the case is not appealled or if appealled, upheald by the Florida Supreme Court, this lower standard for a business judgment rule may open the floodgates on condominium litigations.

jmm

Civil Discourse, Professionalism, and Blogging

At the risk of being late to the game and adding my two cents to the million dollar pot already created by some real heavy hitters, here's my take last week's blog explosion.  A blogger last week at Truth on the Market made a very personal explanation of the reasons he opposed President Obama’s tax plan that would raise taxes on those earning more than $250,000 annually. He explained his issues using specific and candid examples of his family finances to underscore where his money goes and why he (and others similarly situated) should not be deemed “super rich.” The blogosphere went nuts, and led to some thoughtful comments combined with many outrageous and very personal attacks (including threats) that led the blogger to stop posting completing. (Incidentally, I have decided to avoid naming the blogger because I respect his decision, at this point, to opt out.)  

From a content perspective, I often disagreed with the blogger, and I disagreed with much of his post that led to the explosion. However, I very much appreciated the post, and we all lose when what could be a productive discourse leads simply to people spewing bile and vitriol. It's one thing for people to tell someone they're wrong or misguided or even dumb; it's quite another to threaten and mock them.    

The personal and specific way in which the blogger explained his reasoning offered much to the debate. His post offered a clear and candid explanation of his position, which should have allowed for a real discussion of issues rather than simply providing the traditional forum for a rhetoric-slinging contest. (Not to imply that the original post didn't have it's own bit of rhetoric.) In the end, though, it mostly did neither. It’s too bad, too, because I think it had the chance to lead to a very honest discussion of the goals and objectives behind the tax plan, in addition to the methods of achieving those goals. There is value in understanding where others are coming from, even if we can’t quite get there ourselves.

I have friends of varying views of politics and economics, although (not surprisingly) we usually tend to share similar core values. The difference is often either the method to address our key issues or the priority we assign to those values we share. As a country, I think this describes us more often than we often recognize. Not everyone who is against the health care bill is against people having health care and not everyone who supports regulations on businesses is against business. Sometimes we just disagree (passionately) about how best to provide everyone good quality health care or improve the economy.

And I thought that was the point. We should be talking, debating and prodding to find the better options. That doesn’t mean we won’t think someone else is misguided, smug and pompous, or just plain wrong in the process, but we should still value the discussion, and each other, enough to keep things civil.

I, for one, am trying to engage more discussions of hot button issues (rather than less) in my classes. It’s often easier to avoid some of the thorny issues, but I think I would be failing part of my mission if I didn’t give my students a chance to discuss difficult issues in a learning environment. It’s simply not fair to turn them out into practice without giving them the opportunity to process and respond to those with whom they might adamantly disagree. It’s something they will see regularly, in the office, in court or the boardroom, and on the internet. From my experience, the vast majority of people can handle it, especially when they know the rules.

I now have a great example of how not to act, but the cost was simply too high.

--Joshua Fershee

On Bailouts, Lehman, and History

The lingering economic crisis has resurrected questions on the level of government involvement necessary to sustain the economy.  In particular, the issue of Lehman's demise (against the backdrop of the rescue of AIG and others) has garnered additional attention, with a Reuters piece in the NY Times positing yesterday that a package of $25 billion in shareholder warrants (to offset $25 billion in losses) could have saved the 121-year old Wall Street giant.  See "Are 'Bail-Ins' The Answer?", NY Times (Sept. 20, 2010).

But it would seem that a prerequisite to macro-economists, regulators, and creditors embracing maverick solutions in the future is a thorough understanding of what happened in the recent past.  Much light has been shed on the tumultuous fall of 2008 by a range of economic reporters seeking to reconstruct events at locales ranging from boardrooms to corporate jets to government offices.  That prose has supported the notion that the government "let" Lehman fail.

For example, in The Sellout, Charles Gasparino recounts Treasury's stance against rescuing Lehman ("I'm being called 'Mr. Bailout'" - Treasury Secretary Henry Paulson) and contemporaneous view at the Federal Reserve that government assistance was still feasible ("We could have done something if Lehman had a buyer," according to "one senior Fed official").

Meanwhile, In Fed We Trust by David Wessel details the unsuccessful offer by the Lehman CEO to the New York Fed to save the day by splitting the firm into salvageable halves, "if only the government would come up with $4 billion."  Mr. Wessel's version reiterates the government's dependence on a private sector solution but adds the following:

Despite all of Paulson's assertions, {Tim} Geithner, {Ben} Bernanke, and  {Fed official Kevin} Warsh all expected the Treasury to endorse a Bear Stearns-style loan by the Fed if Barclays and the Wall Street firms couldn't come up with enough money.  The numbers kept changing, but in the end, other Wall Street firms and the government would have to come up with roughly $10 billion to close a gap that would remain if Barclays did the deal.  The eight firms agreed to pitch in about $4 billion basically to protect themselves from the consequences of a Lehman bankruptcy.             

House of Cards by William Cohan tells a tale culminating in the refusal by the Fed to guarantee a portion of Lehman's assets:

The Barclays [bailout] deal required the blessing of the Financial Services Authority in London - the UK equivalent of the SEC.  So Paulson spoke with his UK counterpart, Alistair Darling, the Chancellor of the Exchequer, and to the FSA.  He then summoned McDade, Lehman's president...and told him...'Deal's off.  The FSA has turned it down.'  The FSA would not comment on its decision, but the reasons given...ranged from 'the overall size of the potential exposure'...to the fact that 'the FSA was looking for some kind of a cap to avoid a UK contagion, and the Fed had just said, "No assistance for Lehman."'          

Strikingly Mr. Bernanke recently told Congress that the Federal Reserve could not have prevented the Lehman bankruptcy in September 2008, while acknowledging that he may have without intention "supported this myth that we did have a way of saving Lehman."  See Sewell Chan, "Bernanke Says He Failed to See Financial Flaws," NY Times (Sept. 2, 2010).

Perhaps the primary lessons are that "government rescue" is eye in the beholder, and that economies have become so global as to elevate regulators everywhere.  Others may cite to the need for caution in press statements (and testimony before Congress), or the overall futility of poring over embers after a fire.  To me, the salient moral is that, despite election year rhetoric on bailouts and socialism, even intervention by the mighty Federal Government is conditioned upon the good faith cooperation of the private sector.  In these complicated times of internecine capitalism, such should serve as a guidepost for measures ranging from billion dollar bailouts all the way down to brokerage rules requiring internal enforcement.  And the Lehman disaster - whatever its proverbial last straw - must serve as a haunting reminder of what happens when both the regulators and the regulated fall victim to fears as ephemeral as public perception, or as indefensible as ideological intransigence.       

--JSC, 9/21/10     

Welcome Guest Blogger Joel McTague

I'm pleased to welcom Joel McTague to the BLPB.  He'll be guest blogging on Wednesdays for the next 30 days or so.  As usual, I'll leave the more detailed introduction to him.  In the meantime, you can view his bio here.

SJP

Conference Announcement: Fiduciary Duties in Closely Held Firms 35 Years after Wilkes v. Springside Nursing Home

Eric Gouvin, my friend from Western New England College School of Law, sent me the following conference announcement:

On Friday, October 15, the Western New England College Law and Business Center for Advancing Entrepreneurship will present a truly outstanding program examining fiduciary duties in closely held businesses.

In 1975, the Massachusetts Supreme Judicial Court decided the case of Donahue v. Rodd Electrotype, holding that shareholders in closely held corporations owe each other fiduciary duties similar to those owed by partners to each other.  The following year, the Court decided Wilkes v. Springside Nursing Home, Inc. to further refine that idea.  In the 35 years since those decisions, the law of business organizations and the law of fiduciary duties have evolved significantly.

This conference features leading scholars of business organization law discussing the impact of those cases in on the development of the law.  We will also have the lawyers who argued the Wilkes case on hand to provide the backstory on the case.

You may register for the event by contacting Ms. Jackee Gadson at (413) 796-2030 or by sending an email to lawandbusiness@wnec.edu .  Registration is $30 and includes lunch and refreshments.  For more information visit: www.wnec.edu/lawandbusiness

The schedule for the event looks terrific.  If you plan to be in New England in October, I would definitely recommend attending.

ECC

Lawsuits and Public Relations at Goldman

So Goldman takes another PR hit, as a reports come of a discrimination lawsuit (pdf) filed by three female plaintiffs.  The complaint alleges, among other things, that women have been paid less and promoted less, and that Goldman has a culture designed to promote men and devalue women in the work place.  The complaint also alleges a less-than-flattering description of a co-ed, company-sponsored trip to the strip club followed by an outright sexual attack.

As is to be expected, Goldman denies the claims.  The WSJ Deal Journal reports:

Goldman Sachs spokesman Lucas Van Praag said in a statement:

“We believe this suit is without merit. People are critical to our business, and we make extraordinary efforts to recruit, develop and retain outstanding women professionals.”

Okay, but how is the first statement linked to the second?  So such things can never happen because your business "needs people?"    Beyond that, this statement begs the question: "So how do you treat those you deem to be less-than-outstanding women professionals?"  

I would think, given the year that Goldman has had from a pubic relations perspective, that they could do better.  Then again, maybe they don't care that much.  

--Joshua Fershee 

More Thoughts on the Roberts Court and Business Law

My Akron Law colleague, Will Huhn, has put up a couple of interesting posts over at our Akron Law Cafe blog that I think will be of interest to readers here.  First, Prof. Huhn discusses three upcoming consumer claim preemption cases.  Will writes that:

More and more, it seems as if the business of the Supreme Court is … business!  In recent terms the Supreme Court has become obsessed with determining the extent to which federal statutes prohibit plaintiffs from suing manufacterers for fraud, defective design, and negligent failure to warn, all claims that arise under the common law of the states.

Next, Prof. Huhn reviews what he calls Three Giant Steps Backward for the First Amendment.  Specifically as to Citizens United, he opines:

The wealth that all Americans have struggled to create may now be used by a few Americans and foreign nationals to determine the outcome of American elections, reversing reforms first introduced by Teddy Roosevelt in 1907.

SJP