Business Law Prof Blog

The Quantum Mechanics of Delusion

Which assertion is more delusional?

1.  When government enacts problematic laws we should focus on the government.

2.  When government enacts problematic laws we should focus on the corporations that lobbied for the laws.

Geoffrey Manne asserts the latter is delusional here.  Personally, I think the most delusional view may be that government and corporations can be neatly isolated from each other, so that our only choice is to pick one or the other. I've written a bit about that here.

SJP

Not Business as Usual this November 12

I turned 40 today and frankly did not spend a lot of time with business law issues. 

In a few spare moments, though, I took a quick look at significant legal cases from today. That search yielded exactly one:  Epperson v. Arkansas, 393 U.S. 97 (1968), in which the Supreme Court declared unconstitutional an Arkansas law banning teaching evolution in public schools.  Not bad, in my view.

Back to business law on Monday. 

--JPF

Koehler on the Foreign Corrupt Practices Act

Mike Koehler has posted The Facade of FCPA Enforcement on SSRN with the following abstract:

The rise in Foreign Corrupt Practices Act ("FCPA") enforcement actions has been well documented. Against the backdrop of aggressive enforcement and the resulting multi-million dollar fines and penalties is the undeniable fact that, in most instances, there is no judicial scrutiny of the FCPA enforcement theories. The end result is that the FCPA often means what the enforcement agencies say it means. Because of the "carrots" and "sticks" relevant to resolving a government enforcement action, FCPA defendants are nudged to accept resolution vehicles notwithstanding the enforcement agencies’ untested and dubious enforcement theories or the existence of valid and legitimate defenses. The end result is often the facade of FCPA enforcement.

This article discusses various pillars that contribute to the facade of FCPA enforcement and highlights that the FCPA, during its decade of resurgence, is being enforced like no other law. This article does not argue, or even suggest, that every FCPA enforcement action is unwarranted or that no company or individual has ever violated the FCPA. Rather, this article demonstrates that a significant majority of recent FCPA enforcement actions are a facade"including those that allege clear instances of corporate bribery"yet are resolved without FCPA anti-bribery charges.

The facade of FCPA enforcement matters. Even though the resolution vehicles typically used to resolve an FCPA enforcement action are not subject to judicial scrutiny and the vehicles do not necessarily reflect the triumph of the enforcement agencies’ theories, in the absence of substantive FCPA case law, these privately negotiated resolution vehicles have come to represent de facto FCPA case law. The facade of FCPA enforcement also breeds inefficient overcompliance by risk averse business actors fearful of enterprise–threatening liability because of the enforcement agencies’ untested and dubious theories. Because the factors that contribute to the facade are being modeled by other nations when enforcing their own bribery laws, the facade of FCPA enforcement is a global issue affecting a broad segment of the marketplace.

Identifying and acknowledging the existence of a problem is a necessary first step to crafting solutions. This article exposes the facade of FCPA enforcement, argues that addressing the facade and subjecting FCPA enforcement actions to greater judicial scrutiny is in the public interest, and encourages more FCPA defendants to challenge the enforcement agencies and further expose the facade of FCPA
enforcement.

ECC

Business Law Prof Blog Seeks Business Law Prof (Loosely Defined) to Blog

Interested?  Please drop us a line using the links to the left.

SJP

KB Homes CEO Sentencing Today for Backdating Options

In a very short piece on NPR's Marketplace this morning, I opined on the possible sentencing of Bruce Karatz, the former CEO of KB  Homes.  The piece (here) is certainly a reasonable attribution of what I said, although, in true law professor fashion, my answer was a lot longer and more nuanced than it may appear.  

First, my quote was that Karatz "didn't take the money from anybody and that's the real harm. And so the calculation should be zero."  What I was referring to was that the harm calculation for sentencing purposes is based in the fraud calculation.  The U.S. Probation Office appears to have calculated that at zero (per the WSJ), and given the uncertainty in making such a calculation in backdating cases, I'm comfortable with that determination.  For a more elegant description, consider Prof. Ribstein's post at Truth on the Market (here). 

My comment was related to the sentencing calculation, not that there was no harm at all. Thus, I support punishment for the offense; I just think the dollar amount of the calculation is speculative enough that I agree with the Probation Office’s apparent calculation that there was no loss.  For more on that, see here in the Wall Street Journal.  

He broke the rules and should be punished; I just don’t agree with the calculation. I also don’t agree with any of the calculations related to drug-offenses. Using a monetary bright-line test for drug offenses or white collar crime results in outrageous sentencing possibilities in both situations, and I find it fundamentally flawed.  Unfortunately, it appears judges are more willing to buck the system for white collar criminals than drug offenders.  That’s wrong, too, but I can’t justify harsher sentences for white collar crime just because some courts get it wrong somewhere else.

As for the lack of harm, it’s at least arguable that because there is disclosure, investors can figure out what they are getting in backdating cases through various disclosures. And if directors think the officer has taken too much in compensation, they can either lower future compensation or otherwise deal with offending executives, to the extent they did not already calculate the backdating into the expected compensation package.  Absent self-dealing, that is the role of the directors — if they don’t see a harm, then there isn’t a harm.  

This is a tough case, and I appreciate the opposing views.  I just like more certainty than I see here when talking about jail time.

[UPDATE:  The court chose to go with five years of probation and eight months of home detention, as reported here.]

-JPF

"Fairness" as a statute....

A recent "DealBook" posting by Andrew Ross Sorkin of The New York Times notes another wave of SEC insider trading cases (this one highlighted by recent charges targeting railway employees who either did or didn't use unlawful means in divining a takeover).  The piece aptly points out that the crime remains undefined by statute and seemingly cabined only by the "fairness" notion that spawned the prohibition in 1961.   

To me, while the question of where the line is drawn between legitimate and other means of obtaining a trading advantage is timeless, I dream of having three questions on insider trading answered by those in charge:

1.  What distinguishes a civil 10b-5 case from a criminal one?

Popular wisdom suggests that the answer lies in the size of the profits (and hence the enormity of the damage).  Avid fans of this sport suspect that criminal cases often have little to do with size.

2.  How can "attempted" insider trading be covered by Rule 10b-5 when the Rule requires an actual purchase?

Case law to date has seemingly included only settlements, thus rendering the legal question ultimately unavoidable.

3.  If resources are scarce, why target railway workers, in-laws, and roomates?

Part of the answer lies in strategies attending fact patterns (i.e., "insiders" who are charged are no doubt advised of the success rate of the "classic" theory of liability).  But do contested cases centering on non-employees (what the Chiarella Court called "complete strangers" to the market) simply risk unsettling court blessing of a crime that is not to be found in the U.S. Code?  Recall that the entire Misappropriation Theory rested delicately upon a finding of "feigned fidelity" by a corporate outsider to his law firm.  To continually revisit this gray area arguably succeeds first in questioning whether the prohibition should apply solely to Board members, broker-dealers, and stock exchange personnel.

Overall, maybe a compass of "fairness" - like the beehive hairdo and hula hoops - should be left in 1961.

---SC, 11/9/10              

Freedom of Contract in Delaware LLCs: Use It or Lose It

As Francis Pileggi and Larry Ribstein have already more than amply explained, the Delaware Court of Chancery has determined that creditors of an insolvent LLC do not have standing to pursue a derivative claim against the LLC.  CML V, LLC v. Bax, C.A. No. 5373-VCL (Del.Ch. Nov. 3, 2010) (pdf here).  The court determined that, unlike similarly situated creditors of Delaware corporations, LLC creditors have no such right. 

As Mr. Pileggi explained, the court acknowledged that other courts have allowed creditor suits against insolvent LLCs, but Vice Chancellor Laster declined to follow along with that determination.  This seems like the right outcome to me.  If the legislature intended to put that language into the statute they could have, but they didn't.  Or they could have at least used language that parallels the corporation law, but again they did not.  

This is reminiscent of some of the LLC veil piercing statutes and cases. Minnesota and North Dakota, for example, specifically incorporate the state's corporate veil piercing laws.  Wyoming, at least as of 2002, did not have such language in the statute, but the state's court nonetheless incorporated veil piercing principles.  (H/T Profs. Klein, Ramseyer, & Bainbridge) But they probably shouldn't have.  

In my first summer law firm job, one of the partners I worked with was skeptical of LLCs because he didn't trust the body of law and whether the entity would be treated like a partnership or a corporation(and when).  I have retained that skepticism, even though there is significantly more law on the subject today than there was ten years ago.  

My skepticism doesn't mean I don't like LLCs.  In fact, I think they often make a lot of sense.   I just think lawyers (and their clients) should be a lot more careful about considering what they want when they enter contracts.  I always tell my students -- don't rely on veil piercing if you want a personal guarantee.  At least at negotiation, insist on a personal guarantee.  If you can't get one, then assess the situation and move forward with eyes wide open. Same here -- as both VC Laster and Prof. Ribstein explain, there are contractual options to protect LLC creditors in Delaware. Don't forget to use them if you want them. 

That, or try to persuade your Delaware legislator to change the law.  

--JPF

Business Entity Overview

Steve Cook, an associate at the law firm of Douglas K. Cook in Mesa, Arizona, sent me a link to a recent overview of business entities that is up on the firm's blog and may be of interest to readers of this blog.  You can find it here.

SJP