February 13, 2010
The Market is Efficient, Except When It's Not
The Wall Street Journal has a report today about a study by Professor Joseph Grundfest and doctoral candidate Nadya Malenko, which concludes many companies manipulate earnings to meet or exceed quarterly expectations by, perhaps legally (but certainly suspiciously), rounding up their numbers more frequently than not (and significantly more frequently than one would predict). As Somnath Das, an accounting professor at the University of Illinois at Chicago, points out in the article, this really shouldn't surprise anyone--given the incentives managers have to exceed expectations, all the judgment calls required/allowed under the accounting rules, and the often relatively small amounts that can move results from four tenths to five tenths of a cent per share. And yet, as the article also points out, the market routinely moves in dramatic fashion in response to quarterly earning reports that exceed or miss projections by one cent per share.
February 12, 2010
Lipshaw on Business Lawyering Judgments Jeffrey M. Lipshaw
Jeffrey M. Lipshaw has posted The Venn Diagram of Business Lawyering Judgments: Toward a Theory of Practical Metadisciplinarity on SSRN with the following abstract:
relationship of pure and mixed business and legal judgment can be
modeled in a Venn diagram. The question is who is capable of making
judgments in the overlap. Businesspeople are not competent to assess
the legal implications, and not inclined merely to trust the decision
to lawyers. Lawyers, on the other hand, are usually successors to a
particular method of organizing the world, and members of a closed
discipline. By nature of the very concept of a judgment, it must occur
privately in a single conscious mind, no matter how the judgment is
ultimately communicated, shared, or adopted by others. The implication
for lawyering and legal education is that some of the old canards about
leaving business judgment to the business people must fall away.
There are three sub-themes. First, there is no "collective judgment." Practical judgment does not occur in some communitarian ether, but in a mind. The closest we have come to a science of judgment is the exploration of consciousness and cognition, both of which remain tough nuts. There is still no scientific explanation of consciousness; it is subject to what Thomas Nagel referred to as the "explanatory gap." It is fair to say that if there is anything to the idea that consciousness is irreducible, judgment is next in line Could we pour all the relevant facts and authorities into a legal computer, and have it provide us with advice such that we could not determine, in a blind test, that it came from a computer and not a human being? Indeed, an inquiry into prospective judgment overlaps traditional questions whether anything actually constrains a judge's decision. It seems intuitively correct when we take the issue of judgment out of adjudication and consider it prospectively that our judgments are neither pre-ordained by some kind of formula nor wholly random. We need to assess rule following in the non-adjudication context, and for that I turn to work in cognitive science and the law.
Second, the judgment in the overlap is interdisciplinary. Business judgment depends far more on the argument from merit, versus legal judgment, which depends far more on the argument from authority, and a particular kind of authority at that. What, then, does it means to be an expert in the overlap of the diagram? We need to define a new professional discipline: the field of metadisciplinarity. Being a metadisciplinarian takes one to a higher order skill than mere interdisciplinarity: it means being an expert in the making of interdisciplinary judgments, which in turn invokes the role of metaphor and analogy in our cognitive abilities.
Metadisciplinarity recruits such basic cognitive abilities that the task of learning it is never going to be easy. It requires that its practitioners understand that human beings are "meaning-making machines," employing what the cognitive scientists call "cognitive integration" or "blending" (of which metaphor is a prime component). Metadisciplinary lawyers will not merely understand the fact of cognitive blending, but also approach it empathetically.
Crucial conversations are high stake and high emotional conversations that affect your board operations. The results of these conversations could have a huge impact on the direction of the company. As a result, some element of your organization could be forever altered for better or worse. The increased complexity of the business world today means that boards need to have more of the difficult conversations. Areas that might be considered difficult are:
1. Giving the CEO feedback about her/his behavior.
2. Talking to a board member who behaves offensively or makes derogatory comments.
3. How, as a board, do we need to improve in our risk oversight role.
4. Critiquing the board in its skill level and looking to the future to improve with new candidates.
What areas does your board need to have a crucial conversation?
February 11, 2010
Urban Legend, Sweetheart Deal or Necessary Balance Sheet Cleansing?
Indy Mac Fails. FDIC sells assets to Goldman insiders. Goldman insiders make money. Rinse, spit and repeat.
I am not an idiot! (Except when I am.)
Prof. Bainbridge thinks you are an idiot if you like "socialism." Some good stuff in the comments.
Personally, I had a similar reaction to all the buzz surrounding Megan Fox's thumb. But my reaction was more along the lines of: If the human race perished tomorrow, would the universe really consider it a loss?
February 10, 2010
Board Evaluation: Good, Bad and Ugly
Though many public companies are required to do an annual board evaluation, there is no rule that says they have to do it right. Many boards have found their way through the board evaluation process and are looking for the next step. Part of the presentation I give to audiences that want to learn more is a good, bad and ugly review on board evaluation. Bottom line – there is always room for improvement. Questions directors might ask when reviewing the board evaluation process:
1.Is the board evaluation part of a strategic management system to guide measurement and improvement of board performance?
2.Does it include compliance, functional, behavioral and attitudinal questions?
3.Do we have a 'board centric' approach that includes the board having control over the process and a facilitator to help the board create an action plan to address areas that need improvement?
February 9, 2010
The SEC Agenda
The New York Times today published a very complimentary article about the rejuvenated SEC Division of Enforcement. Cases are being brought faster, lawyers are studying complex investments, and four new units are dedicated to asset management, securitization, municipal securities and trading abuses.
But the questions about SEC priorities still persist. The fifth new Enforcement unit reportedly focuses on the Foreign Corrupt Practices Act - a law that has gone in and out of fashion for years and, as the 2009 Siemens case illustrated, is sometimes enforced against foreign companies even in the presence of a similar domestic prohibition.
Moreover, just yesterday a federal court judge expressed continued concerns over a Commission settlement with Bank of America, questioning the size of the monetary penalty as well as the document's description of the facts underlying the deal.
Clearly, in the wake of the credit crisis and the Madoff scandal, the SEC is implementing a serious repair strategy. Still, with lingering budgetary constraints and attendant perceptions of political interference, what the watchdogs look for (in both violations and sanctions) has perhaps never been more critical.
February 8, 2010
The SEC's mighty cease and desist authority
Since 1990, the Securities and Exchange Commission has possessed the authority to order respondents to cease-and-desist from present or future violations. The power is plenary; Professors Coffee and Sale have noted that the authority entitles the SEC to order the respondent to "cease the violation, disgorge profits, and take affirmative steps to comply with the securities laws."
The question thus becomes, why would the Commission ever seek criminal authority from Congress? Or the duty to register and examine hedge funds and private equity firms? Continually beset by budgetary problems and employee turnover, the SEC enjoys a mighty advantage in being able to demand monies and structural concessions premised upon the assertion that market wrong is about to occur. The statutory cease-and-desist order reaches all persons (i.e., not just registrants), may be based upon the Commission's belief that a violation will occur, and requires less of a showing of proof than the case for an injunction (which must normally establish a likely future violation). Under section 8A(c) of the Securities Act, the SEC even owns the right to issue a temporary order without a hearing in order to prevent "substantial harm to the public interest."
For a recent release describing a Commission cease-and-desist order (upon consent by the respondent and without admitting or denying guilt), see http://www.sec.gov/news/press/2010/2010-21.htm. Among other things, the Order demonstrates the dangers of financial service providers selectively disclosing investment performance information and, specifically, inconsistently marketing funds invested in subprime mortgage-related investments. In the end, the respondent trust company/bank - although legally exempted from the registration requirements of both the Investment Advisers Act and Investment Company Act - was ordered to cease violating securities law anti-fraud provisions Sections 17(a)(2) and (3) of the Securities Act. The Order noted "remedial acts" including the respondent's replacement of senior personnel, review of its internal procedures, and agreement to pay $250 million to compensate investors, thus brightly signaling that any reports of the death of SEC actions in response to the credit crisis are greatly exaggerated.
Directors as Leaders and Followers
I have a database of ninety different leadership styles that have been the subject of countless studies and articles. That said, why is there so little information on followership? With the increased scrutiny directed at boards in the U.S., I began to wonder about when directors are leaders and when they are followers. Some questions directors can ask themselves on this topic are:
1. To what degree does the board lead verses follow in the strategic planning process?
2. How does the board discriminate the difference between being right and being relevant on matters of corporate governance?
3. Are we failing to treat changes in our environment seriously because we don't think they can effect us?
February 7, 2010
Speaking of quarterbacks and intents...
Headline-grabbing Trojans football Coach Lane Kiffin sent shockwaves through amateur sports last week when he announced that he had obtained an "oral" commitment from 13-year old, 7th grader David Sills to attend USC in return for a scholarship. Master Sills will not be eligible to actually sign a Letter of Intent until 2015, but, as The Daily News highlighted in an article yesterday, NCAA rules don't currently prohibit college football coaches from engaging in unwritten deals.
The trendy "oral commitment" appears to be the junior varsity version of the famed Letter of Intent, a curious undertaking at best. The NCAA web site describes the agreement as such:
The National Letter of Intent (NLI) is a binding agreement between a prospective student-athlete and an institution in which the institution agrees to provide a prospective student-athlete who is admitted to the institution and is eligible for financial aid under NCAA rules athletics aid for one academic year in exchange for the prospective student-athlete's agreement to attend the institution for one academic year. All colleges and universities that participate in the NLI program agree to not recruit a prospective student-athlete once he or she signs an NLI with another college or university. Therefore, a prospective student-athlete who signs an NLI should no longer receive recruiting contacts and calls and is ensured an athletics scholarship for one academic year. The NLI must be accompanied by an institutional financial aid agreement. If the prospective student-athlete does not enroll at that institution for a full academic year, he or she may be subject to specific penalties, including loss of a season of eligibility and a mandatory residence requirement.
The definition assumes the presence of a writing, ties fulfillment of the contract to standards of academic performance and financial need, limits the term to one-year, references penalties only for the student and reveals a mission of minimizing recruitment efforts. While Coach Kiffin's "deal" may simply represent hype, the larger issue of promises by colleges to young athletes continues to be a nasty business. Caselaw - which sounds in both torts and contracts - centers on conflicts arising when athletes are either not granted starting positions or cut from the team while still provided full tuition (e.g., evidencing vastly incompatible intents between the signatories).
It is of course folly to imagine that successful sports teams don't actively court youth. Hockey great Bobby Orr was identified by the Boston Bruins when he was 12; a Houston Astros scout discovered Mets ace Johan Santana when the leftie was 15. But observers can note that judges don't necessarily take a college's sprint towards a child star in stride. As a federal court stated back in 1994, the "tension" between amateur athletics and professional sports is such "that it may no longer be wished away," as the dreams of America's youthful athletes are filled with "so much money that a sea of green washes away the vestigial illusion that major college sports are not simply a farm system for the professional leagues." Fortay v. Univ. of Miami, 1994 US Dist LEXIS 1865. Overall, one is reminded of the jovial (yet haunting) quip of sportscaster Bob Uecker: "I loved little league baseball so much, I'd have played for free."
Paust on Corporate Responsibility
Jordan J. Paust has posted Human Rights Responsibilities of Private Corporations on SSRN with the following abstract:
Article discusses the human rights responsibilities of private
corporations. Part I addresses how decisions and activities of
multinational corporations impact human rights. Part II examines
corporate liability under human rights laws by examining trends in
judicial decisions in the United States and foreign states and human
rights instruments. Part III explores the types of human rights
deprivations that multinational corporations might cause. This Article
concludes by predicting that there will be increasing scrutiny of
corporate deprivations of human rights at the domestic, regional, and