Business Law Prof Blog

Is it true that "most of the American people don’t begrudge people success or wealth”?

This quote from President Obama has popped up in a number of places recently, including DealBook.  I have to admit that if this is true, it's news to me.  First of all, that would mean we've vanquished Envy.  Second, even if one were to add what I believe to be the necessary caveat "so long as they earned it honestly," I'm not sure it would be accurate.  I mean, unless you've been sleeping under a rock the last 10 years "honestly" nowadays almost has to come with a little asterisk noting something along the lines of "until we find out all those muscle-bound home runs were not just fueled by protein shakes."  Have I just let my cynicism consume me?

SJP

Sokol on Corporate Governance

D. Daniel Sokol has posted Competition Policy and Comparative Corporate Governance of State-Owned Enterprises on SSRN with the following abstract:

The legal origins literature overlooks a key area of corporate governance - the governance of state-owned enterprises (“SOEs”). There are key theoretical differences between SOEs and publicly-traded corporations. In comparing the differences of both internal and external controls of SOEs, none of the existing legal origins allow for effective corporate governance monitoring. Because of the difficulties of undertaking a cross-country quantitative review of the governance of SOEs, this Article examines, through a series of case studies, SOE governance issues among postal providers. The examination of postal firms supports the larger theoretical claim about the weaknesses of SOE governance across legal origins. In itself, the lack of effective corporate governance would not be fatal if some of the SOE’s inefficient and societal-welfare-reducing behavior could be remedied under antitrust law. However, a review of antitrust decisions on the issue of predatory pricing by SOEs reveals that antitrust is equally ineffective in its attempts to monitor SOEs. This Article concludes by identifying a number of devices to reduce the current inadequacies of both antitrust and corporate governance of SOEs.

ECC

Khong on Law and Economics

Dennis W. K. Khong has posted The Future of Law and Economics in the British Legal Academia on SSRN with the following abstract:

In this paper, I attribute the tepid reception of law and economics scholarship in British academia to the lack of sufficient ability in mathematical and statistical skills among British legal scholars. I offer some evidence of the importance of competency in these economic literacy skills for success in law and economics scholarship, by analysing journal editorship as a proxy for success. I then discuss how the institutional structure for legal and economic education in the UK leads to the lack of these essential economic literacy skills. And finally, I offer some suggestions on how, by establishing a doctoral programme in law and economics within the legal academia, the problem of law and economics scholarship may be overcome.

ECC

Fortney on Fiduciary Duties

Susan Saab Fortney has posted Leaks, Lies, and the Moonlight: Fiduciary Duties of Associates to Their Law Firms on SSRN with the following abstract:

This symposium article examines the fiduciary duties of law firm associates. After applying agency principles to the firm-associate relationship, the article analyzes specific duties and discusses cases involving alleged breaches of fiduciary duties by associates. It explores associate duties in the current legal, organizational, and socio-technological environment in which associates practice. The article closes with observations on the importance of firm principals considering the effect of firm culture on associate attitudes and conduct.

ECC

The Murky Rules of the Game After PUHCA

The Energy Policy Act of 2005 repealed the Public Utility Holding Company Act (PUHCA), in part to help spur infrastructure investment through mergers and acquisitions in the electricity sector.  Yet four years later, the mergers and acquisitions picking up steam in the energy sector are (according to the New York Times) primarily in the oil and gas area, not the electricity area. 
 
This is yet another indicator that the threat of regulation often has as great an effect on investment decisions than actual regulation.  Case in point: there is currently a renewable fuel standard (RFS), which requires a certain amount of U.S. fuel consumption to come from renewable sources (e.g., ethanol, biodiesel), but there is no such federal renewable electricity standard (RES) (there are, however, 29+ widely varied state requirements).  
 
Although the cynic in me might argue that oil and gas companies simply aren’t threatened by the relatively low mandated levels in the RFS (they aren’t), there is more to it than that.  The oil and gas companies have a better idea of the rules of the game in which they are playing, and they know there are less readily available options for their product than there are in the electricity arena.  Even if there were a significant carbon tax, gas companies (at least in the next decade) would not be competing in any significant way with other resources; they would just sell less of their resource. 
 
Not so on the electricity side, where electricity can come from a whole host of sources (coal, natural gas, nuclear, wind, solar, geothermal, hydro, etc.).  In addition, there is continuing uncertainty related to possible cap-and-trade and RES programs (both are included in H.R. 2454 – Waxman-Markey – which passed the House in 2009).  In fact, more than twenty-five renewable electricity mandates have been proposed in recent years, but all failed to get support from both the House and Senate in the same session.  In light of this, companies (and investors) have remained reluctant to make significant financial commitments in electricity infrastructure. 

If we’re really serious about electricity infrastructure investment, let’s tell the potential investors the rules. Now that PUHCA is gone, there should be a bunch more of them out there.

--Josh Fershee

"Capture" Still Matters

In the wake of the financial crisis, with its emphasis on "USA, Inc.," some may be tempted to think that issues of regulatory capture are so 2005.  But not according to Simon Johnson, who writes that "What we have now is not a free market.  It is rather one of the most complete (and awful) instances ever of savvy businessmen capturing a state and the minds of the people who run it.”  This is at least in part because the bailout favored a limited number of banking players, thereby created a playing field that is now “massively tilted in favor of these banks.”  This is precisely what I envisioned when I wrote my forthcoming Temple Law Review article, “Finding State Action When Corporations Govern” (Why blog, if not to occasionally shamelessly self-promote?):

The financial crisis of 2008 is blurring the lines between the State and the private sector. While painful, this process may facilitate a re-examination of the state action doctrine. This Article argues that corporations have for some time been increasingly taking on roles as pseudo-governmental actors without incurring the accountability to the people generally associated with state action. This is happening via new governance, and while the recent financial crisis may suggest that the problems associated with new governance are waning, the reality is that the corporate consolidations likely to follow in the wake of the downturn - together with the government's oft-stated desire to divest its bailout stakes in private companies as soon as possible - will result in even more powerful corporate actors with an even greater ability to govern.

By the way, I have to recommend another Johnson post—this one on Goldman allegedly going “rogue” in Europe by helping governments there hide their debt—if for no other reason than the quotes.  Here are two of my favorites:

“When the data are all lies, the outcomes are all bad – see the subprime mortgage crisis for further detail.”

“If [Goldman] is to be allowed back into this arena, it will have to address the inherent conflicts of interest between advising a government on how to put (deceptive levels of) lipstick on a pig and cajoling investors into buying livestock at inflated prices.”

SJP

You either have to be really wrong or really right (Get it?) to unite people against you like this.

Follow this link to find out why some say that "Everyone Hates The Citizens United Ruling."  Money quote: "The negativity cuts equally across party lines ...."

SJP

Citizens United: States

Thanks to the Business Law Prof Blog for a chance to share some thoughts.   As noted earlier, I teach at the University of North Dakota School of Law where I teach the Business Associations courses, Energy Law and Labor & Employment Law.  My research focuses on energy law and corporate law ( and both, where possible). 

I had the good fortune to arrive in North Dakota shortly after the state passed the North Dakota Publicly Traded Corporations Act, a shareholder friendly corporate law option supported by several shareholder advocates, including Carl Ichan.  There are many views (including mine) on the North Dakota Act (many of them negative, see, e.g., Prof. Bainbridge), but the Supreme Court's decision in Citizens United raises some new questions and new opportunities for discussion about the role of state corporations laws (including the North Dakota Act).

Regardless of one’s view of Citizens United, the case fundamentally changed the relationship between shareholders and the company.  That is, to the extent Citizens United changed corporations’ ability to use corporate funds in a political manner, corporations now have a power (at least arguably) not contemplated by their charters.  (It was not really necessary to consider as part of the corporate charter because such expenditures were generally viewed as not permitted.)  

This certainly was not lost on shareholder activists, who are already putting forth a plan to help ensure accountability and disclosure of corporate political activity.  Current action items include engaging companies directly to gather information and encourage disclosure, encouraging the SEC to consider rulemaking in this area, and lobbying Congress.

Beyond action at the federal level, it will be interesting to see how, if at all, the states respond.  In addition, the shareholder proxy-access provisions of the North Dakota Act could have some significant (and renewed) appeal to those concerned about corporate political spending.   After all, this is now an internal governance issue, which is a state-level issue. At least, that’s how I see it.

-- Josh Fershee

Friday's a big day...

...if you're gauging court scrutiny of SEC settlements.  Judge Rakoff of the S.D.N.Y. is set to issue his decision on the SEC's second attempt at settling allegations against Bank of America stemming from its 2008 merger with Merrill Lynch.  Last fall, the Judge rejected a settlement imposing a $33 million fine in a written decision that, while stating that such settlements are often accorded much deference, nonetheless called the deal unreasonable, inadequate, and detrimental to shareholders.  For details on the settlement presently being evaluated see http://www.sec.gov/litigation/litreleases/2010/lr21407.htm .

---JSC, 2/17/10 

Welcome Guest Blogger Joshua P. Fershee

We are very pleased to welcome Joshua Fershee to the blog.  Josh teaches Business Associations, Energy Law and Policy, Labor & Employment Law, and Property at the University of North Dakota School of Law.  I'll leave it to him to fill in the biographical details, but you can read his latest Ag Law post here.  Welcome aboard, Josh!

SJP

No more 10's from the American judges...

In the current Winter Olympics, viewers of the figure skating competition will see participants from each country perform their routines and receive numeric grades from ISU (International Skating Union) judges. The ISU, the ruling body in figure skating, is made up of member nations who elect members to the organization, which then operates independently to provide a neutral assessment.

Which begs the question why figure skating, and not United States credit rating judges, are funded in an independent manner. Since one of the causes of the financial crisis was undoubtedly inflated ratings accorded to toxic debt instruments, one remedy that deserves prioritized attention is the alteration of the corporate structure of the credit rating agencies.

             In the United States financial markets, debt obligations and debt instruments are given alphabet grades (AAA for the best, to D for the worst) by credit rating agencies (often termed “Nationally Recognized Statistical Rating Organizations” or “NRSROs”).  Unlike the judges in the ISU, the NRSROs are all separate companies that derive a significant portion of their revenue streams from the companies who create the debt instruments they rate.  Some of the largest NRSROs have parent companies/affiliates that issue public stock.

             Congress, the American economy, and the American public would be better served by passing a Bill which mandates that NRSROs: (1) take on the U.S. Government as a stakeholder; (2) earn a standard fee per rating; and (3) receive heavy fines when rated debt is not downgraded within a specified time of receiving relevant information.  Such legislation would greatly improve the independence and transparency of the credit rating agencies, and, through them, the debt market in general.

The economic crisis has proven that in the ratings game, the risk of conflicts of interest is simply too high.  By having each firm seeking a rating pay a standard fee, an NRSRO would be prevented from obtaining higher fees from repeat customers, thereby objectifying the process. Further, prohibiting the NRSROs from - directly or indirectly - issuing more stock to the public would have the effect of preventing both potential clients from becoming shareholders and profits from becoming the sole point of the business.  Finally, introducing the fear of regulatory fine would supplant and improve upon the current emphasis on ratings disclosure enforced by the SEC.   

One concern with such flattening of the fee scale cautions that some firms may still gain favored status because of the sheer volume of credit ratings they require.  However, in combination with the other provisions, the credit rating agencies should be in a position where their clients need them, and not vice versa.  Additionally, any concerns with government entanglements with private enterprise have surely been mooted by the events of 2008/2009, wherein nine of the largest banks took on the U.S. government as a shareholder (at approximately $25 billion of TARP money apiece); this month alone, a large financial services firm received approval to redeem its preferred shares owned by the government via the Bailout.   

The meltdown of the American economy has been well documented by the financial, legal, and academic communities. The general consensus is that some form of new legislation or regulation needs to be implemented in order to prevent such a calamity from recurring in the future. The consensus seems to stop there, and the range of proposed remedies has been diverse: create a consumer protection agency; regulate hedge funds; place limits on executive compensation; have the government become a shareholder in major domestic corporations; and provide additional more cash for those corporations.  Increasing regulation of the NRSROs is a straightforward and attainable solution that should appeal to both sides of the aisle.  It bears repeating that the dangers of impartial judging are with us still.  Indeed, the changes to money market fund regulation just announced by the SEC are intrinsically tied to NRSRO ratings.  Such targeted reforms might best be progressed through delay - specifically, until the underlying ratings model can be made more neutral through enhanced  regulation and partial ownership by the federal government. 

           

by Michael Capeci, Hofstra Law School Class of 2010,  and J. Scott Colesanti, 2/16/10

 

Unanimous Illusion

One of the downfalls I see in boardrooms is what Daniel Goldman writes about called 'unanimous illusion.'  Goldman defines this as a behavior that once a group adopts a belief, individual members are likely to believe it is true. All the more reason for directors to ask questions during board meetings on a broad range of topics of critical importance to their oversight role. This can drive explicit conversations. It takes courage to unveil painful truths. The board that balances a sense of unity with an openness to all relevant information can help to avoid group think. Remember - the collective mind is as vulnerable to self-deceit as the individual mind. Questions directors might ask when reviewing their decision  making process:

1. Do we have an individual assigned to play the Devil's Advocate.
2. To what degree do we ask probing questions from a place if insight.
3. Are we following a leader on the board with a very impressive background AND whose experience matches the decision at hand.

TEH    www.linkedin.com/in/tracyehouston

The SEC Money Market Fund Reforms

Remember those terrifying days of the Fall 2008, when even savings tucked away in money market funds seemed suddenly imperiled?  I recall with horror sitting in my faculty office and listening to the President announce that such funds would be federally protected (for a time).  Depositors and investors alike thus learned - indirectly - that fund managers may have dabbled with the exotic vehicles that had felled Wall Street's titans.  

The SEC recently announced reforms to the regulatory requirements of money market funds, and those reforms are encouraging on many levels.  Among other things, the reforms require money market funds to 1) maintain a minimum percentage of assets in "highly liquid securities," 2) observe percentage limits on investment in illiquid securities, 3) "maintain a stable net asset value per share in the event of shocks," and 4) observe a detailed disclosure protocol centering on both monthly reports to the SEC and web postings of portfolio holdings.  See http://www.sec.gov/news/press/2010/2010-14.htm.        

The rules must still sojourn through the rule adoption process and undergo a period of phase-in.  But the impact of the measures is dramatic.  To the market, the reforms represent a commitment to the isolation and eradication of a specific industry ill manifested between 2008 and the present.  In a debate on regulatory reform that has seen discussion of meltdown culprits range far and wide, it's refreshing to see one collateral consequence so vividly remembered and expressly addressed.

To fans of regulation, the reforms constitute a re-commitment to the notion of net capital limitations, a curb on excessive speculation that had been subordinated in the past decade as cries of warning/reform gave way to fears of stifled entrepreneurial creativity.

To those who study the SEC, the reforms represent the resurgence of an agency that has often taken a backseat to the Federal Reserve and Congress in proposing remedies to the economic crisis.

Last but certainly not least, to investors the reforms signal true concern for the nest eggs of so many.  It goes without saying that money markets remain the most conservative option available for those fearing reinvestment; to state it bluntly, to watch the vehicle fall prey to trendy speculation is akin to telling all casino patrons that they can't leave the table nor exit the casino with their chips.    

The one (perhaps unavoidable) drawback to the money market reforms appears to be their link to the credit rating agencies.  More on the continued reliance upon those agencies tomorrow...

---JSC, 2/15/10