Business Law Prof Blog

It's Official: We Exist (Bainbridge Just Linked to Us)

Prof. Bainbridge (responding to our own Josh Fershee) asserts shareholders don't own the corporation.  While the post itself is relatively short, it provides links to a couple of his other posts that delve into the issue more deeply and are well worth a read if this sort of thing interests you (and if you are reading this, it likely not only interests you but actually qualifies as exciting).  For myself, I did a quick search of Delaware opinions on Westlaw ("shareholder" /s "owner of the corporation") and came up with this interesting quote:

It would threaten widely held investor expectations if a Delaware court were to decide that shareholders are outsiders, merely residual claimants, and not in some sense the “owners” of the corporation . . . .

UniSuper Ltd. v. News Corp., No. Civ.A. 1699-N, 2006 WL 207505, at *3 (Del. Ch. Jan. 19, 2006).

BTW, one of the comments to Prof. Bainbridge's post is arguably worth repeating here:

So, I don't own my home? I am only a holder of certain contractual rights contained in my deed. Wait until I tell the wife.

SJP

Erickson on Corporate Governance

Jessica Erickson has posted Corporate Governance in the Courtroom: An Empirical Analysis on SSRN with the following abstract:

Conventional wisdom is that shareholder derivative suits are dead. Yet this death knell is decidedly premature. The current conception of shareholder derivative suits is based on an empirical record limited to suits filed in Delaware or on behalf of Delaware corporations, leaving suits outside this sphere in the shadows of corporate law scholarship. This Article aims to fill this gap by presenting the first empirical examination of shareholder derivative suits in the federal courts. Using an original, hand-collected data set, my study reveals that shareholder derivative suits are far from dead. Shareholders file more shareholder derivative suits than securities class actions, the area of corporate litigation that has received nearly all of the scholarly attention. By writing off shareholder derivative suits, scholars have missed the distinct role that these suits play in corporate law, particularly in the area of corporate governance. Unlike traditional litigation, remarkably few of the suits in my study ended with monetary payments. Instead, these suits more commonly ended with corporations agreeing to reform their own corporate governance practices, from the number of independent directors on their boards to the method by which they compensate their top executives. These settlements reflect the rise of a new type of shareholder activism, one that has gone undocumented in the legal literature. Corporate governance has moved into the courtroom, and this development has important, and potentially troubling, implications for corporate law.

ECC

Escape from Icahn: The Road to Delaware

BusinessWeek recently reported that Lions Gate Entertainment Corp. is seriously considering relocating to the United States in the face of Carl Icahn’s attempts to increase his stake in the company.  Icahn is a well-known “shareholder activist” and apparently strikes such fear in the hearts of the board of directors that it is worth considering corporate relocation, even though the company is well aware it would likely face major financial penalties for such a move. 
 
Ironically, it is Icahn who has been using (or at least trying to use) corporate relocation to his advantage.  Icahn recently relocated the company American Railcar, Inc., from Missouri to North Dakota to take advantage of the state’s shareholder-friendly corporate law option, and has tried (unsuccessfully) to get other companies, Like Amylin Pharmaceuticals Inc. and Biogen Idec Inc. to follow suit. 
 
Perhaps I am more of a shareholder activist than I originally thought, but the idea of the board moving the company to avoid Icahn’s advances seems wrong to me. Not necessarily illegal, just wrong. Shareholders do, after all, get a vote on relocations like this, so shareholders can always object to the move if they disagree with the board.
 
A shareholder move seeking a greater voice in corporate governance seems proper to me because it is about the exercise of ownership rights.  A costly move initiated by the board to avoid a particular shareholder’s influence seems wasteful and more about self-preservation at shareholders’ expense than about good business judgment.  To me, this is one place where what is good for the goose, is not good for the gander. 
 
--Josh Fershee

Symposium Announcement - The Globalization of Securities Regulation: Competition or Coordination?

On March 5, 2010, the Corporate Law Center at the University of Cincinnati School of Law will host a symposium entitled: The Globalization of Securities Regulation: Competition or Coordination?  The web page describes the event as follows:

After the enactment of Sarbanes-Oxley in 2002, influential voices in the business, political, and academic communities expressed concern that the U.S. markets were losing their competitive advantage.  While a number of factors were identified as contributing to this decline, higher U.S. regulatory compliance costs and liability risks were, in particular, singled out.  Regulators, in turn, considered proposals that would ease barriers to entry. The 2008 financial meltdown increased awareness of the interconnectedness of markets and the importance of a coordinated approach toward securities regulation.  Thus, the Obama administration's Financial Regulatory Reform calls for raising international regulatory standards and improving international cooperation.  As policy makers, regulators and academics consider proposals for regulatory reform, how will these considerations—competition and coordination—play out?

Notably, our very own Eric Chaffee will be presenting at the symposium.  If you can't make it there, you can view the webcast on the web page linked to above.

SJP

What's "worse than a yuppie upset with how their frappuccino turned out"?

Apparently, "a yuppie with a gun who's unhappy with how their frappuccino turned out."  At least according to one barista who is quoted in this Wall Street Journal story about businesses confronting gun-toting customers.

SJP

Oh on Veil Piercing

Peter B. Oh has posted Veil-Piercing on SSRN with the following abstract:

From its inception veil-piercing has been a scourge on corporate law. Exactly when the veil of limited liability can and will be circumvented to reach into a shareholder’s own assets has befuddled courts, litigants, and scholars alike. And the doctrine has been bedeviled by empirical evidence of a chasm between the theory and practice of veil-piercing; notably, veil-piercing claims inexplicably seem to prevail more often in Contract than Tort, a finding that flouts the engrained distinction between voluntary and involuntary creditors.

With a dataset of 2908 cases from 1658 to 2006 this study presents the most comprehensive portrait of veil-piercing decisions yet. Unlike predecessors, this study examines Fraud, a long-suspected accessory to veil-piercing, as well as specific sub-claims in Contract, Tort, and Fraud to provide a fine-grained portrait of voluntary and involuntary creditors. And this study analyzes the rationales instrumental to a piercing decision.

The findings largely comport with our legal intuitions. The most successful civil veil-piercing claims lie in Fraud or involve specific evidence of fraud or misrepresentation. Further, claims not only prevail more often in Tort than Contract, but adhere to the voluntary-involuntary creditor distinction. Surprisingly, though, veil-piercing presents a greater risk to individual shareholders than corporate groups.

ECC

Complexity Does Not Necessarily Mean Evil

According to Reuters (via the New York Times), the SEC is building up its New York City office this year, planning to expand by about eight percent with the goal of “catching cheaters” and aggressively going after Wall Street “bad guys.”   The report goes on to note that hedge funds, in their quest to make money, are using complicated derivatives and credit default swaps more and more often. 
 
As someone who tends to be a big-time rule follower, I don’t care much for cheaters or people who take advantage of others (not to imply anyone else really likes those who do), but I am troubled by the implications in this story. 
 
The story implies that complicated financial transactions are somehow inherently designed to cheat and are therefore used by the “bad guys.”  I did a (very short) rotation through the derivatives group when I was in New York, and I can confirm that many derivatives and credit default swaps are, in fact, quite complicated. However, I cannot confirm that any of the projects I saw were designed by or for cheaters or bad guys.
 
There is no doubt that some cheaters and bad guys use complex transactions to hide their nefarious dealings, but this is not transitive.  Complex transactions are not used solely by cheaters and bad guys.  To the contrary, most such transactions are used by regular (albeit usually wealthy) people, who have their flaws, but are generally neither cheaters nor bad guys. 
 
I support cracking down on those abusing the system, and perhaps we can make the system more transparent in a way that both facilitates markets and reduces cheating.  I just don't think it is helpful or productive to view complexity in itself as an evil.  
 
--Josh Fershee

The Latest SEC Proposal on Short Selling

The short selling saga continues.  In 2005, the Commission's Regulation SHO eschewed strong medicine in favor of record keeping and operational changes; meanwhile, reformers called for (at least) the end of "naked" short selling.  Right before the financial crisis, the SEC did away with the exchanges' traditional 'uptick rule,' which had worked to contain downward price spirals. In 2008, market turmoil prompted outright bans on the short selling of the stock of certain financial companies.

Last week, the Commission proposed a rule that would implement a stock-specific circuit breaker whenever the issue dropped 10% in one day.  While the measure aims to prevent short sellers from driving down stock prices while according priority to "long sellers," it is nonetheless sure to spark more debate.  Overall, it just feels good to see the Commission back in the game of directly regulating stock exchange behavior.  For details on the proposal, see the text of the Chair's speech at http://www.sec.gov/news/speech/2010/spch022410mls-shortsales.htm.

---JSC, 3/2/10

 

Dear International Olympic Committee,

Wow!  What fun were the games of Vancouver.  Despite the fog, incessant medal counts, and a potpourri of sports seemingly created on a slow day at a railyard in MInsk, the spirit of sacrificial effort and noble competition somehow trudged on.

So don't extinguish the flame of American interest by relying on the courts to do your dirty work.  You know of what I speak - that indefensible exclusion of female ski jumpers from the games.  Last year, those athletes - who compete at worldwide championships in significant numbers and who have fought you on this issue for over a decade - sued for the right to be part of the Vancouver Olympics.  A Canadian court deferred to IOC rulemaking and kept the athletes out of the 2010 games.  See "A Tale of Two Lindseys" by Phil Taylor in the 3/1/10 Sports Illustrated.      

Which might be acceptable were it not for lofty principle #5 from the IOC Charter:  "Any form of discrimination with regard to a country or a person on grounds of race, religion, politics, gender or otherwise is incompatible with belonging to the Olympic movement."  See http://multimedia.olympic.org/pdf/en_report_122.pdf.

Now you may have gone too far.  You see, we Americans can get used to plenty.  Perfunctory IOC "investigations" into a victorious team popping champagne corks to celebrate victory.  Five different finishing times in the span of half-of-a-second. The occasional medal event involving a rifle or broom.    

But once you start asking the courts to interpret YOUR OWN rules, your partisan Committee is going to be disappointed faster than the landing on a half-pipe's 1040-degree double McTwist.  Do you really expect subsequent judiciaries to strain to reconcile a dedication to the progress of the female athlete with the illogical decision to keep female ski jumpers out of the big show?  The SI article quotes an IOC member, who in 2005 expressed safety concerns.  To be sure, a host of other inclusive sports (such as "half pipe") appear far more dangerous.  And surely some of these events (like "Woman's Skeleton") have nominal worldwide participation, at best.

Which is why there was a lawsuit in a British Columbian court.  "This is an organization that can do whatever it wants," aptly commented the current female ski jumping champion in the SI article.  Maybe for now.  At least until the right court forces the IOC to defer to its own written standards.

---JSC, 3/2/10       

Who Knew There Were Net Winners in the Madoff Scheme?

The Wall Street Journal reports that U.S. Bankruptcy Judge Burton Lifland (New York City) today ruled that “net winners” (those who withdrew more funds than their initial investments and later deposits) in Bernard Madoff's ponzi scheme were not entitled to recovery.
 
The opinion explains:  “Equality is achieved in this case by [looking] solely to deposits and withdrawals that in reality occurred. To the extent possible, principal will rightly be returned to Net Losers rather than unjustly rewarded to Net Winners under the guise of profits.”
 
I’m inclined to agree.  I am sympathetic to all of the victims of Madoff’s scheme, but to walk away with all of your principal (or more) from this fiasco is about as much as one could reasonably hope. This is especially true given what happened to the market in the time frame of the Madoff investments. 

Any investment carries risk, and one of those risks (unfortunately) is fraud. It seems proper to me that those who clearly lost the money they input on the deal should be first in line for recovery.

--Josh Fershee

When 1st Amendment and Privacy Rights Collide

A New York Times article from late last week described the criminal conviction (in absentia) by an Italian court of three current/former Google executives.  The charges stemmed from Google Video's 2006 online display of students in Turin bullying an autistic classmate.  While the clips were removed after complaints were lodged, the three executives were nonetheless convicted under an Italian privacy law and received six-month suspended sentences.  The defendants were simultaneously cleared of charges of defamation.

Google decried the decision and promised an appeal.  A European free speech advocate drew the analogy to a postman being jailed for delivering contraband.  Separately, American online providers have consistently maintained that internet companies serve merely as "bulletin boards" and are thus not responsible for the immediate removal of defamatory or otherwise offensive content.

While the case most immediately raises the applicability of EU law to online video-share services, the issue of censorship of offensive material seems more interesting.  Domestic online providers have traditionally maintained that such censorship is precluded by the sheer volume of material posted (and Congress has reinforced the view by legislating protection for electronic intermediaries). 

But businesses have begun crying foul over defamatory statements posted anonymously, and the press has occasionally highlighted online videos displaying violence.  As the decision by the Italian court demonstrates, the naked assertion of free speech rights - at least in the global forum - may not be enough to shield a company for failing to act quickly enough to censor content.  If internet providers do merely serve as the postman, then the day may be coming when they simply have to shelve some packages for review.

---JSC, 3/1/10           

Dent on Shareholder Rights

George W. Dent Jr. has posted The Essential Unity of Shareholders and the Myth of Investor Short-Termism on SSRN with the following abstract:

The separation of ownership and control publicized by Berle and Means in 1932 persists today. Domination of public companies by self-serving and ineffective executives costs America billions of dollars every year and contributed to the current economic meltdown. Repeated efforts to solve this problem – including the Sarbanes-Oxley Act, expanded disclosure duties, and more stringent requirements for director independence – have had little benefit and have sometimes made matters worse. The flaws in our corporate governance system are a growing problem for America's economy as disillusioned investors increasingly place their capital in other countries. Nonetheless, proposals for greater shareholder power have encountered criticisms: various shareholders have conflicting goals; shareholders favor a short-term perspective at the expense of the long-term health of companies; and shareholders lack the knowledge needed to play a positive leading role in corporate governance. This article refutes these charges. It shows that the objections to shareholder power are greatly exaggerated, often contradict elementary economic principles, and have no empirical basis; they are myths. The article delves into the latest research in financial economics to demonstrate that greater shareholder power is associated with better corporate performance in all respects, including those respects in which critics charge that shareholder influence would be detrimental.

ECC

Johnson on Securities Regulation

Jennifer J. Johnson has posted Private Placements: A Regulatory Black Hole on SSRN with the following abstract:

Many investors, including vulnerable senior citizens, are victimized each year in dubious securities offerings yet governmental regulators can do little to intervene. Utilizing the Rule 506 private placement exemption, promoters today can escape regulatory review by both federal and state securities officials. While states at one time served as "local cops on the beat" to protect their citizens, Congress in 1996 preempted state authority, thus creating a situation in which suspect investment schemes can proliferate below any governmental radar screen. This article questions the continued wisdom of this regulatory vacuum, especially in light of recent financial events.

This article reviews the legislative history of this preemptive statute, the National Securities Markets Improvements Act of 1996 (NSMIA), and concludes that the preemption of private placements either resulted from congressional misconceptions, back room politics arising from the
conservative deregulatory agenda of the decade, or both. After analyzing the regulations and the private placement market as it existed in 1996, and as it operates today, the article concludes that NSMIA's cogent preemptive force primarily impacts state authority over the smaller, most risky private placements. Combined with the lack of federal oversight, this statutory preemption creates a regulatory abyss that permits many questionable offerings to take place. In its zeal to deregulate, Congress left many investors with little, if any, governmental protection. This article proposes a
return to state supervision of designated private placements. This modest proposal would foster capital formation, protect investors, and provide for a more rational and efficient legislative framework to regulate private securities transactions.

ECC

Harris on Private Equity

Lee Harris has posted A Critical Theory of Private Equity on SSRN with the following abstract:

In the private equity world, partnership agreements have received praise from many corners for reducing the agency costs arising between the interests of fund managers and investors. This article sets out to assess contract design in private equity partnerships. The argument here is that the importance of many of these heralded contract design features has been overstated. Part II describes the legal rights of investors in private equity funds. By default, investors in private limited partnerships have limited rights to participate in day-to-day operations or challenge decisions of fund managers. As a result of this set of default legal rules, investors in these funds face a familiar agency problem. That is, fund managers may be emboldened to pursue their own self-interest at the expense of investor interests. Some have boasted that contract design resolves many of these major agency problems. Parts III and IV describe a few of the best private contractual arrangements that investors have used to overcome these legal and economic constraints. As will be shown, however, many of these contract design features have severe shortcomings. Contract design appears to be an uncertain solution to the problem of agency costs in private equity limited partnerships.

ECC

Nees on Oversight Liability

Anne Tucker Nees has posted Who's the Boss: Unmasking Oversight Liability within the Corporate Power Puzzle on SSRN with the following abstract:

This article explores the competing interests between director authority and accountability within the doctrinal developments underpinning the arguments for and against director oversight liability. The historic losses suffered by companies entangled in the web of subprime mortgages, collateralized debt holdings, and the ensuing credit crisis have brought the role of corporate directors as risk managers under renewed public scrutiny. Directors' authority and their accountability to shareholders are two critical pieces to striking the appropriate balance among the roles, rights, and responsibilities of directors, officers, shareholders, and other corporate constituencies who operate within the corporate power puzzle. Numerous shareholder derivative suits brought in the wake of such losses allege, among other claims, that directors breached their fiduciary duties by failing to provide adequate oversight of their companies' high-risk investments. Despite being a frequently pled claim, director oversight liability is somewhat of a legal myth because previous court language hinging liability on the presence of ignored "red flags" remains largely unexamined, undefined, and inapplicable to such cases. This article proposes an alternative judicial approach to analyzing director oversight liability by articulating a five-pronged, process-oriented test to define "red flags" and, thus, director oversight liability. By articulating a test for oversight liability that avoids the substantive review and second-guessing of board decisions disfavored in corporate law, this article advocates that an appropriate balance between director authority and accountability be struck.

ECC