Business Law Prof Blog

Lynn Stout on Cultivating Conscience

I just came across a recent new book from Lynn Stout: Cultivating Conscience: How Good Laws Make Good People.  Here's part of the summary:

Drawing from social psychology, behavioral economics, and evolutionary biology, Stout demonstrates how social cues--instructions from authorities, ideas about others' selfishness and unselfishness, and beliefs about benefits to others--have a powerful role in triggering unselfish behavior. Stout illustrates how our legal system can use these social cues to craft better laws that encourage more unselfish, ethical behavior in many realms, including politics and business. Stout also shows how our current emphasis on self-interest and incentives may have contributed to the catastrophic political missteps and financial scandals of recent memory by encouraging corrupt and selfish actions, and undermining society's collective moral compass.

Given that one of the reviews describes it as "a blistering attack on the 'law and economics' school," I have to admit that I'm quite looking forward to reading it.

SJP

Soccer, the Capitalist Sport

The NFL is worried that the collapse of collective bargaining will, God forbid, result in competition for players who are free to go wherever they want and demand as much pay as the market will bear. The concern, in other words is that the NFL owners will have to forego what Steve Bainbridge calls their “quasi-socialist cartel” and deal with the competition of a free market.

It shouldn’t surprise anyone that the NFL has embraced a socialist business model. The sport of football (our “football,” not the sport everyone else in the world knows as football) is itself socialist. Soccer (the real “football”) is the real capitalist sport.

American football is as command-and-control as one can get. The football coach acts as General Secretary, assisted by his Central Committee, the assistant coaches. This small group provides detailed instructions to each player for each play. The role of the players, the proletariat, is to blindly follow those instructions; in fact, the success of the entire enterprise depends on their obedience to the coach’s central planning. Some teams (Indianapolis comes to mind) grant discretion to quarterbacks, the factory managers, to deviate from the fearless leader’s instructions, but only to substitute one of the General Secretary’s plays for another. Success depends on synchronization of the entire group, and individual innovation is frowned upon.

Soccer is entrepreneurial. Set plays occur only occasionally. The coach gives the players a general plan, but what actually happens on the field is the result of individual innovation in reaction to play. During play, the coach provides very little input. (Notice how little most soccer coaches even yell to their players from the sidelines.) Just as a capitalist business must adjust to market conditions, the soccer team must adjust instantaneously to what the other team is doing.

The ultimate irony is that soccer is relatively unsuccessful in capitalist America but extremely successful in socialist countries.

-Steve Bradford

Could NFL Draft Day Science Help Boards of Directors?

Slate.com has an article (here) about a company called Achievement Metrics that is using college football players' post-game interviews to predict whether they will be successful professional players. Achievement Metrics analyzes speech of potential NFL draft picks, seeking certain traits including "conceptual complexity," "need for power," and "deliberativeness."  If you are interested in any of the process that goes into the NFL draft (or sports drafting generally), the Slate.com article is really worth a read.  

The basic premise is rooted in social science that has been used for years to track political speech in an effort to understand the state of mind of various world leaders.  As the Slate article notes, the process has been used to try to predict the likelihood someone is a terrorist. A paper on that subject is here (pdf): "The Distinctive Language of Terrorists."  

Achievement Metrics explains their offerings to NFL teams this way: 

The Science Of Risk Prediction

• Identify players with the right combination of on-field talent and off-field character.
• Minimize the risk of player selection errors with Achievement Metrics.
• Provide teams, organizations, insurance underwriters, financial service institutions, and sponsors the tools to make more fully informed decisions.

I can't help but think this kind of analysis might be just as helpful (or more) in the process of picking CEOs, senior executives, and investment managers. I'd be very interested in knowing what this kind of analysis might tell us about someone like David Sokol or Donald Longueui, for example.  After all, NFL teams are putting a lot of money their behind their players, but publicly traded companies are putting a lot of big money behind their executives on behalf of their shareholders.  

We can't substitute science for human judgment in all cases, but it sure would be nice to have another tool to help a board of directors in their decision-making process.  After all, to stick with an NFL analogy, every board (and NFL team) wants to make sure they aren't about to hire their version of Matt Millen.  To this Detroit Lions fan, that's about as bad as it could get. Then again, at least Millen was, as far as I can tell, honest.  Honestly that bad, but still honest. That doesn't appear to be the case for some other key exectives.  

--JPF

"[W]e no longer have free market capitalism and we no longer have a democracy."

David Stockman, the blunt-talking former Michigan Congressman and Director of the OMB during the Reagan administration[ says that w]hat now exists at the heart of the U.S. economy … is "crony capitalism" - a system that benefits and even rigs the system in favor of America's banks and bankers at the cost of average Americans.

Go here for more.

SJP

The Latest on David Sokol

Berkshire Hathaway’s audit committee has released a report on David Sokol’s Lubrizol trading. The report concludes that Sokol misled BH and that Sokol’s purchases of Lubrizol violated BH policy. Steve Bainbridge has a good discussion, with a link to the full report, here.

I don't think Mr. Sokol's legal troubles are likely to disappear anytime soon. I really wish I were a BH shareholder so I could could attend the shareholder meeting this Saturday in Omaha. Should be interesting.

-Steve Bradford

Insider Trading: Government Abuse and Government Waste

The Wall Street Journal has a very interesting story on what it’s like to be under investigation for insider trading. It focuses on Craig Drimal, who recently pleaded guilty in the Galleon case. Among other things, the government improperly recorded phone calls in which Drimal and his wife discussed intimate personal details completely unrelated to the investigation. Judge Richard Sullivan refused to suppress all of the recordings because of this violation, but called the government’s action “nothing short of disgraceful.” I agree.

This leads to a broader point—the misallocation of government resources by financial regulators. One doesn’t have to accept Henry Manne’s views on insider trading to believe that there are many financial practices much more damaging to investors and the economy. Yet, the SEC continues to aggressively pursue even the puniest insider trading case while Bernard Madoff takes billions from investors and the economy almost collapses because of the mismanagement of financial risk. The SEC keeps asking for more money, but until they get it, wouldn’t it make sense to allocate what it has to where the real economic damage is being done—the investigation of real financial fraud? And why should Congress give them more money if they're not capable of prioritizing what they have?

-Steve Bradford

Denial Preserves Reputations on Wall Street

In May of last year, Goldman Sachs was under fire because of the bank's "dueling goals." The New York Times reported that no one had "accused Goldman of anything illegal involving WaMu, National City, A.I.G. or the other clients it bet against," but that potential conflicts of interest built into Wall Street’s business model were a significant part of related investigations at both the state and federal levels.  

At the time, I wrote that "[j]ust like auto mechanics, restaurants, and other service industries, Goldman is in a market with significant competitors for clients. If most clients actually care about Goldman’s behavior (a point about which I am not entirely clear), Goldman will either have to convince them that they have changed or the clients will go somewhere else."

Steven Davidoff, the Deal Professor at the New York Times Dealbook, answers my question today about whether most clients care about the behavior of Goldman and other similarly situated companies.  He says, quite simply: No.  As he puts it: "Reputation is dead on Wall Street." 

Apparently, Wall Street companies no longer face the same reputational concerns that auto mechanics, restaurants and other service providers face.  Again, Davidoff explains:

Why does reputation no longer matter?

The reason is unfortunate and partly attributable to why we got into the financial crisis. People simply don’t matter as much on Wall Street as they used to. Instead size and technology carry the day.

The Deal Professor makes several compelling points, but I'm still not sure reputation doesn't matter. To keep with my auto mechanic example:  it's not as though everyone loves auto mechanics and thinks they are all trustworthy. To the contrary, it's my sense that people often think their mechanic is trustworthy, but also think that many (if not most) are not. Perhaps that's true with Wall Street, too.  It may be that most of the people who continue to do business with Goldman still think they are getting a honest deal, even if others are not.  

After all, back in 2007, Kerry K. Killinger, former Washington Mutual CEO, said in an e-mail explaining why he didn't want to hire Goldman: “I don’t trust Goldy on this. They are smart, but this is swimming with the sharks.”

So maybe it is that reputation still matters.  It's just that a huge group of high-powered executives are in serious denial that what they are hearing about their investment bank is true.

--JPF

Internet Bubble, Redux?

The New York Times reports that Founders Now Take the Money and Maintain Control.  Hot start-up companies are reaching our to investors, and getting a strong response that allows the companies, and their founders, to raise big dollars, all while maintaining control.  The article explains:

For every Facebook, Groupon or Zynga, known for its Farmville game, there are scores of lesser-known start-ups like Mr. Morin’s that are raising millions in financing at steep valuations, turning computer programmers into paper millionaires overnight.

Part of the reason is supply and demand, as a wave of capital chases a limited supply of deals. But a more tectonic shift is at work in Silicon Valley. Investors are putting a significant premium on young, visionary entrepreneurs who grew up with the Internet and now seem best positioned to direct the future of the social and mobile Web. Generally in their mid-20s or early 30s, today’s start-up founders are becoming more assertive in funding rounds, securing better terms and, in many cases, cashing out part of their investments well before an initial public offering.

It makes sense that people with the vision may be the best people to manage the company and take it forward.  That said, it also make sense that they may be the wrong people when the job fundamentally changes.  Managing a relatively small start-up is very different from running a multi-billion dollar industry leader.

I can't help but think this new round of internet excitement is a lot like that last one.  But this time, the founders are keeping control.  I'm not sure investors are doing any better at picking winners or losers, but at least this time, a lot of the founders (to some degree, anyway) will go down with their respective ships.  

--JPF

Buffett's Bodyguard

It’s not quite business law, but it is about one of America’s business icons.

The Omaha World Herald has an interesting article about Dan Clark, who provides personal security for Warren Buffett. When Clark first met Buffett, Buffett’s door was wide open and Buffett himself came to the door. Berkshire Hathaway now pays over $300,000 each year for Buffett’s personal security. And I guess it shouldn’t surprise anyone familiar with Buffett, but Clark doesn’t even have a written contract. He says, “Mr. Buffett and I have always done business on a handshake based on trust.”

Definitely worth reading.

-Steve Bradford

Revlon Duties Are Inapplicable When Control Stays in the Market (But Which Market?)

Steven Davidoff has a nice post up over at DealBook, explaining why the NYSE board likely remains under no duty to sell itself to the highest bidder despite what appears to be an active bidding process between Nasdaq and the Deutsche Borse.  He notes, however, that the particular facts may raise at least one interesting issue under Delaware law:  Does the location of the market matter if a board is relying on the proposition that there is no duty to sell to the highest bidder because, as the Time & QVC courts put it, control stays in "a fluid aggregation of unaffiliated shareholders representing a voting majority—in other words, in the market"?  Notes Davidoff:

[E]ven under current case-law, there is a thread of an argument that the Revlon doctrine should apply to the NYSE/Deutsche Börse transaction. The reason is that the combined NYSE/Deutsche Börse will be incorporated in the Netherlands. In acquisitions involving foreign reincorporations, there is a tendency for “flowback.” American shareholders will sell their shares simply because they do not want to own shares of a foreign company. Shares will flow back to the foreign exchange.

In other words, is the relevant market the global market or just the US market?  Interesting question.  My guess is that if a Delaware court were confronted with the issue, it would rule in favor of finding no meaningful change of control where ownership was effectively transferred from the US public market to some foreign public market--if for no other reason than there does not appear to be anything in the underlying opinions to require such a distinction, and to recognize such a distinction would limit directorial discretion ... something Delaware courts are generally loathe to do absent some compelling necessity.  Not to mention the fact that flowback appears to be more about what shareholders do with their ownership stakes in the new combined entity after the deal is consummated, as opposed to what they are forced to accept in the first instance.  Perhaps most importantly, no wasted control premium appears to be implicated by the current deal.  Then again, a surprising decision in this line of cases would not really be anything new.

SJP

DRAFT: Poker, Securities, Etc.

DISCLAIMER:  The following is a draft of a post I've wanted to put up for the last few days but wherein I have been unable to find the time to nail down some of the relevant law.  Therefore, you should read the following as a "Is this correct?" post.

Steve's earlier post on crowdfunding reminded me of a post I wrote a while back on the securities implications of "ChipMeUp," a website that allows people to stake poker players in particular tournaments.  You can read the post here.  Here's the most relevant part:

What makes staking poker players (which is nothing new) a bit more interesting under the Howey test than staking authors or ballplayers is the question of whether you would be relying solely on the efforts of the poker player for your profit.  In other words, we quickly get into the age-old poker debate: Is poker predominantly a game of skill or luck?  Interestingly, two recent state court decisions have come out on the skill side (see here and here).

The recent DOJ indictment of various online poker sites again raises the issue of whether poker is predominantly a game of skill--but not as centrally as one might think.  First, the main thrust of the indictment is the allegation that the sites violated the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA).  If the underlying facts hold up, this is not a claim that implicates the question of skill in poker because applicability of the UIGEA apparently boils down to the placing of bets and wagers and defines the same as "the staking or risking by any person of something of value upon the outcome of a contest of others, a sporting event, or a game subject to chance."  Well, not even the staunchest advocate of poker being predominantly a game of skill would dispute that it is nonetheless "subject to chance" (insert here latest bad-beat story).  It should be noted here that the UIGEA does not appear to make playing online poker illegal--it merely prohibits financial institutions from transfering funds in connection therewith (and the facilitation thereof via fraud--which is apparently the ultimate relevant charge against the sites).  It is also worth noting that it was deemed necessary to expressly exclude at least some securities transactions from this definition.

However, the indictment does also include allegations of running an illegal gambling business.  I assume that this charge is being brought under the Illegal Gambling Business Act of 1970 (18 U.S.C. § 1955), and here the issue of poker as a game of skill seems to be more centrally implicated.  The act defines illegal gambling as, among other things, "a gambling business which … is a violation of the law of a State or political subdivision in which it is conducted."  It further expressly identifies "pool-selling, bookmaking, maintaining slot machines, roulette wheels or dice tables, and conducting lotteries, policy, bolita or numbers games, or selling chances therein" as illegal gambling, though it does not limit illegal gambling to those activities.

Putting aside for the moment the question of where the activity of online poker is being conducted, at least some states do define illegal gambling as including games where chance predominates (thus, the court cases linked to in my excerpt from the ChipMeUp post).  So, perhaps the question of skill in poker is raised under the indictment via this route (though this strikes me as unlikely).  Some states, like Ohio, specifically name poker as a form of gambling--but I think the better view here is that unless they have expressly extended those statutes to cover online poker, the definition should be deemed to cover only home games occurring within the state that are not subject to the statutory exemptions and similar activities.  I believe support for this view can be drawn from the recent events in the state of Washington, where the legislature specifically addressed online poker via statute.  (Cynics will note that this legislation was apparently not intended to battle the evils of gambling, but rather to protect land-based casinos--until recently some of the strongest opponents of regulated online poker.)

To the extent the issue of skill in poker is raised under the indictment, it seems to me one easy way to prove that (IMHO) skill predominates in poker is to get the University of Alberta Computer Poker Research Group to compare the results of a bot that plays completely randomly against the bot that currently employs the most skill in its decision-making.  Given a large enough sample size, one should be able to identify the portion of winnings attributable to skill.  Even given the likelihood that a bot is unlikely to be able to implement all the skills of a live poker player, I'd still bet (say, 50 cents ... one time) that skill predominates.

Finally, if you believe this indictment constitutes some combination of a waste of taxpayer dollars or an offense against freedom, you might want to consider joining the Poker Players Alliance.  (In the interest of full disclosure, I am a chip-carrying member.)  Even if it turns out that the illegal money laundering charges hold up under the current indictment, which would lead me to support prosecution, I still don't believe merely playing poker online should be criminalized.

SJP

Reality Shows About Small Businesses

Thank goodness the Amazon EC2 crash didn’t take down the most important sites, such as this blog. Even mighty Amazon can’t stop me!

The Wall Street Journal today has an interesting article on reality shows that focus on small businesses. I had never thought about it in those terms, but many of the cable shows I watch—Pawn Stars, American Pickers, Dog the Bounty Hunter—focus on small businesses. 

All of those shows can teach us interesting lessons about the problems in small businesses. American Pickers, with its incessant focus on finding a profitable big-ticket item to keep the business going, illustrates the importance of cash flow. The tension among the family members who own the business in Pawn Stars is a classic illustration of the interpersonal problems small businesses, especially family-owned small businesses, must overcome. And, as the Journal notes, the ineptitude of the younger generation shows the need for a succession plan. Dog the Bounty Hunter illustrates—well, I’m not sure exactly what it illustrates, other than the lesson that all of these shows provide: small businesses are most likely to succeed if their participants love what they’re doing.

All that’s needed to make these shows even more realistic is some full-blown litigation: Dog and his wife divorcing and fighting for control of the business; Frankie and Mike arguing about whether the business should make a distribution; estate issues when Rick’s dad dies. (If you don’t get any of these references, the fault is mine, not yours. I obviously watch far too much cable TV.)

And let's only hope that the Wall Street Journal's conclusion is right--that these shows might breed a new generation of entrepreneurs among the kids watching.

-Steve Bradford

Feeling Gassy: High Prices Do Not Equal Fraud

The federal government is putting together a task force to investigate fraud in energy markets.  Attorney General Eric Holder announced the formation of the Oil and Gas Price Fraud Working Group to "monitor oil and gas markets for potential violations of criminal or civil laws to safeguard against unlawful consumer harm."  The announcement continues:

“Rapidly rising gasoline prices are pinching the pockets of consumers across the country,” said Attorney General Holder.   “We will be vigilant in monitoring the oil and gas markets for any wrongdoing so that consumers can be confident they are not paying higher prices as a result of illegal activity.   If illegal conduct is responsible for increasing gas prices, state and federal authorities should take swift action.”

Pander, pander.  I'm assuming someone will check into the "pinched pockets" of Verizon customers who no longer get the same deals when renewing their phone contracts as they once did.  And, of course, Apple consumers, must be getting pinched.  With profits up 95% how can the Justice Department ignore the magical, gravity defying Apple?  According to one report,

"The numbers have gotten too big to ignore as Apple defies the law of gravity with 83 percent year-over-year revenue growth," JP Morgan analysts said. "In our view, Apple is the magical growth story in large-cap tech."

Gas prices are high around the world.  In a rare move, on Wednesday, Chinese truckers protested the high fuel costs in Shanghai. Everybody, it seems, is irritated by the costs of fuel.  But that doesn't make it fraud. I'm not saying there isn't fraud in some energy markets, but price fluctations in a relatively open and global market are hardly shocking.  If we want to control prices, then we should have the government buy all the country's fuel to level prices.  Or we could all take measures to hedge and lock in prices. But we don't. Most of us prefer to buy in the spot market. 

On March 2, when the prevailing view seemed to be $4 per gallon gas by the 4th of July, I wrote that I thought gas prices would hit $4 per gallon by Memorial Day.  We're almost there in most of the country, and already there in a few places.  I never said I wanted to be right on that (quite the contrary), but it's what I expected.  I didn't make that prediction based on my anticipation of massive fraud.  It's just my sense of the market. 

I am speaking later today at The Third Annual Biofuels Law and Regulation Conference, “Exploring Cutting Edge Legal Issues at the Nexus of Bioenergy,” at University of Illinois at Urbana-Champaign’s Illini Union about renewable fuels and the psychological hurdles that are impeding our process of fuel switching from oil as our primary transportation fuel.  Without ignoring the enormous technological hurdles we have remaining, it is clear to me we think we can still manage oil -- from exploration to extraction to market -- in a way that is entirely unrealistic, especially as world demand has grown.

Don't get me wrong.  I'm all for ferreting out fraud. I just don't see high prices in a global market as very good indicator that fraud is occurring.  And I think our efforts, on the fraud front and on the energy policy front, would be better focused somewhere else. 

And, for what it's worth, I don't think we'll see $5 per gallon gas this summer (but it might get close).

--JPF

CWRU School of Law Hires New Dean

Case just announced that it has picked Lawrence Mitchell to be its new law school dean.  This is obviously a great hire, and I look forward to the already impressive business law program at Case only getting better as a result.  Case certainly qualifies as a nearby neighbor of Akron, and I actually live closer to Case than Akron (my wife, Dr. Maria Pagano, is on the faculty of Case's Department of Child Psychiatry)--so this post should be read as a shameless plug to receive more personal invitations to all future business law events at the law school.

Since I did not comment on the controversy surrounding Case's dean search earlier, I'd also like to say that I would have considered Bradley Smith to be a great hire as well--despite the fact that we clearly see a number of things differently.  I don't believe, however, that this controversy ever rose to the level of that surrounding the hiring, de facto firing, and subsequent re-hiring of Erwin Chemerinsky at UC Irvine.  Had the situations been more similar, I would have fully expected the academy to have been just as critical of Case as it was of UCI--regardless of ideology.  Having said that, I suspect that Brad will soon land a deanship somewhere (if that is what he wants) and he should be an asset in that position wherever he ends up.

Finally, I want to note that we do screen comments here at the BLPB.  So, you should fully expect me to delete all comments related to how beneficial it must be for my wife, in terms of dealing with me, to be a part of Case's Department of Child Psychiatry.  We all know it's true, so there's no point in making a fuss about it.

SJP

Delaware Complaint Against David Sokol

We have previously noted here, here, and here the saga of David Sokol and Berkshire Hathaway.  Sokol, you will recall, bought stock of Lubrizol Corporation before recommending that Berkshire purchase the company, and booked a substantial profit when Berkshire did buy Lubrizol. My previous posts focused on Sokol's potential liability for insider trading under federal securities law.

A shareholder derivative action has been filed alleging that Sokol's actions breached his state law fiduciary duties to Berkshire. Here is a copy of the complaint. It's also available on Westlaw (2011 WL 1471274).

Steve Bainbridge has posted an excellent analysis of the issues under Delaware law. He explains why Sokol's trading could be taking a corporate opportunity and violate Sokol's duty of loyalty. Steve's analysis, as usual, is precise and I agree with what he says.

But note how the claim that stock trading is a corporate opportunity differs from the usual corporate opportunity case. In the usual corporate opportunity case, an insider who takes a corporate opportunity deprives the corporation of the opportunity. If, for example, an officer buys Blackacre, the corporation is unable to buy Blackacre. If the officer signs a contract to sell widgets to a customer, the corporation cannot sells its widgets to that customer.

That usually isn't true in the stock trading context. Sokol's purchases of Lubrizol stock did not deprive Berkshire of the opportunity to purchase Lubrizol stock, and, in fact, Berkshire did purchase Lubrizol stock. Has Sokol really "taken" a corporate opportunity if the opportunity is still there?

-Steve Bradford

Boring, Stable Utility Companies Command Modest Premiums

The New York Times Dealbook notes that the global power company AES is acquiring DPL (energy-related law and business are filled with acronyms).   DPL is the parent company of Dayton Power & Light.  DPL will be purchased at an 8.7% premium ($30 per share) in the $3.5 billion cash deal, which also included AES taking on $1.2 billion in DPL debt. Similarly, Duke Energy paid a mere 6.4% premium for Progress Energy in a $13.7 billion deal earlier this year.

Power companies have long been known as solid, stable investments, but not typically as ones that will lead to significant and exponential returns.  There have been exceptions, with Enron as the most notable, and we all know how that turned out.  But generally, power companies are known as stable investments that have limited returns, but also provide (relatively) limited risk. 

Given that wise investors should diversify their portfolios, I am always amazed that there seems to be a sense that utilities are not great investments or that they don't provide much upside.  Over time, solid, stable growth is typically a very serious asset.  Nonetheless, we still see headlines like this:  PPL no longer the stable, boring investment it once was.  The article explains: 

In the second quarter [2009], PPL Corp. lost $7 million. The following quarter, the diverse energy conglomerate earned $20 million - still 90 percent less than a year ago.

That vertigo-inducing ride wouldn't have happened 15 years ago when Pennsylvania Power & Light Co. was a fully regulated utility.

Under that system, in which regulation took the place of the market, utilities were almost guaranteed to recoup expenses. They were permitted to tack on a fixed profit and get it all back in rates paid by customers. For investors, utility stocks were never known for dramatic growth and were often sought for stability and steady income.

Stupid stable investments. Who wants those? 

--JPF

Crowdfunding and the SEC

Last week, Mary Schapiro, the Chairman of the SEC, announced that the SEC plans to review the impact of its regulations on capital formation for small businesses. We discussed that announcement here and here.

Among other things, Chairman Schapiro’s letter promised to address crowdfunding. Crowdfunding, sometimes known as micro-finance, raises capital through very small contributions from a large number of investor. For example, the Sustainable Economies Law Center has petitioned the SEC to create a new Securities Act exemption for offerings of $100,000 or less, provided that no single investor invests more than $100. The SEC has filed this proposal and is receiving comments on it here. [Confession: Until I began working in this area, I didn't realize one could petition the SEC to adopt an exemption.]

Crowdfunding is already widely used in contexts arguably not involving the sale of securities. For example, the website Kickstarter allows people to solicit money for “creative projects” like films, technology, or music. Contributors don’t receive any equity interest in the projects, but rewards such as a copy of the CD produced, a visit to the set, film credit, and so on. Another site, Kiva,  uses crowdfunding to make loans to projects around the world.

A crowdfunding exemption from the registration requirements of the Securities Act would allow entrepreneurs to give investors an equity interest in return for such capital contributions.

Such web sites are impossible under current law. The closest thing I have seen in the United States is ProFounder, which does offer a share of revenues in return for investors’ contributions. ProFounder tries to fit its offerings within the SEC’s Rule 504 exemption by limiting the size of any offering to $1 million or less and by limiting access to friends, families and others with whom the entrepreneur has a preexisting relationship. (The latter restriction is designed to avoid the exemption’s prohibition of general solicitation.) ProFounder also limits the number of investors in any given state, in an attempt to use state limited offering exemptions to avoid state registration requirements.

What’s the argument for a crowdfunding exemption? Obviously, an offering isn’t any safer just because a large number of people invest small amounts. And people who invest small amounts aren’t necessarily sophisticated enough to protect themselves; in fact, smaller investors are probably less sophisticated on average. The policy rationale, to the extent there is one, is that, even if it’s a bad deal, each investor won’t lose much. The loss is tolerable.

This argument for an exemption if investors can afford to lose the money isn’t as novel as it sounds. It essentially underlies Regulation D’s designation of investors as “accredited” if they meet specified income or net worth limits.

I have been working on an article on crowdfunding and hope to have a draft completed in the next month or two, depending on how exam-grading goes. I will post an SSRN link on the blog when it’s available.

-Steve Bradford

Round 2: Another Judge Gets It Right on Professionalism

Sometimes lawyers lose their minds.  Fortunately, this time, Judge Melgren kept his.  In a pending case in Kansas, the defendant's counsel made a motion for a continuance because one of the key attorneys was expecting his first child during what was likely to be the time frame of the trial schedule. Plaintiff's counsel refused to agree to a revised schedule.

As Judge Melgren noted, "Regrettably, many attorneys lose sight of their role as professionals, and personalize the dispute; converting the parties’ disagreement into a lawyers’ spat."  Here is more from Judge Melgren (from the order here):

First, Plaintiffs make a lengthy and spirited argument about when Defendants should have known this would happen, even citing a pretrial conference occurring in early November as a time when Mr. Erman “most certainly” would have known of the due date of his child, and even more astonishingly arguing that “utilizing simple math, the due date for Mr. Erman’s child’s birth would have been known on approximately Oct. 3, or shortly thereafter.”  For reasons of good taste which should be (though, apparently, are  not) too obvious to explain, the Court declines to accept Plaintiffs’ invitation to speculate on the time of conception of the Ermans’ child.

. . . .

Certainly this judge is convinced of the importance of federal court, but he has always tried not to confuse what he does with who he is, nor to distort the priorities of his day job with his life’s role. Counsel are encouraged to order their priorities similarly.

Defendants’ Motion is GRANTED.  The Ermans are CONGRATULATED.

I, for one, think he nailed it.

--JPF

Bankruptcy Judge Takes Mortgage Lenders to Task

Gretchen Morgenson of the New York Times reports that Judge Elizabeth W. Magner, a bankruptcy court judge in the Eastern District of Louisiana, has had enough with sloppy mortgage lenders and their foreclosure processes.  On April 7, Judge Magner issued an opinion related to a case in which Lender Processing Services tried to foreclose on a couple who was current on a workout plan approved by the court in 2007.  Oops.  

Morgenson explains the case background:

The first problem arose when the Lender Processing software was not updated to reflect that the Wilsons were operating under a payment plan approved by a bankruptcy court. Then, the couple’s checks were not posted to their account by a lawyer for their lender, who inexplicably held onto the checks.

Says Judge Magner: 

ONE too many times, this court has been witness to the shoddy practices and sloppy accountings of the mortgage service industry. With each revelation, one hopes that the bottom of the barrel has been reached and that the industry will self correct. Sadly, this does not appear to be reality.

It looks to me like Lender Processing Services and a certain lawyer are going to face some serious consequences.  Here are a some quick practice tips, (hopefully) as a refresher:  

(1) DO NOT deposit checks that are not yours into your account. Commingling, in case you may have forgotten, is still bad.  Very bad.  

(2) DO deposit checks you receive for clients in the appropriate account.  Holding on to money that isn't yours, is also bad, and will cause serious problems for your client, which will eventually be a serious problem for you.  

--JPF

A Mere 150 Years Ago: The American Civil War

From Yahoo:

The Kentuckian mused about the outcome: "Homes destroyed, lives destroyed ... I don't think you're going to get rid of bigotry. I think we have a long way to go. And I think our country is still healing."

SJP