Business Law Prof Blog

Are institutional investors the new sheriff in town?

Over at the Harvard Forum, Chad Johnson has posted "Too Big to Fail or Too Big to Change."  Johnson does a nice job of compiling much of the "they-knew-what-they-were-doing-and-it's-called-fraud" evidence, and bemoans the "lack of criminal prosecutions of, and absence of truly significant fines levied against, the senior executives and companies responsible for igniting the subprime meltdown."  Johnson asks: "Are large, systemically important institutions and their ilk too big to be threatened with sanctions that approximate the size of the frauds perpetrated against the public? Has 'too big to fail' transformed into 'too big to challenge?'"  He then goes on to argue that, whether due to unwillingness or inability, the SEC's failures here have opened the door for institutional investors to play a greater role in providing some accountability (the noteworthy recent Bank of America settlement may be further evidence of that).  Finally, Johnson concludes by noting that perhaps it's time to give institutional investors some of the enforcement tools the SEC has seemingly failed to utilize, such as a more expansive rights of action against secondary actors and greater extraterritorial reach.  The entire post is worth a read.

SJP

Verstein on P2P Lending

If the recent posts here and here haven’t sated you, Andrew Verstein, the Executive Director at the Yale Law School Center for the Study of Corporate Law, has written an interesting article on peer-to-peer lending. It is available here. Here’s the abstract:

Amid a financial crisis and credit crunch, retail investors have lent a billion dollars over the Internet, on an unsecured basis, to total strangers. Technological and financial innovation has allowed person-to-person lending to connect lenders and borrowers in ways never before imagined. However, all is not well with person-to-person lending. The entire industry is threatened by the SEC, which asserted jurisdiction in a fundamental misunderstanding of person-to-person lending. This Article argues that the SEC lacked adequate basis for regulating this market. More importantly, it shows that the SEC has made this industry less safe and more costly than ever, threatening its very existence. This Article takes the SEC’s misregulation as  an opportunity to theorize about regulation in a rapidly disintermediating world. A preferable regulatory scheme is then proposed, designed to preserve and discipline person-to-person lending’s innovative mix of social finance, microlending and disintermediation: regulation by the new Consumer Financial Protection Bureau.

Verstein focuses on two of the biggest P2P sites, Prosper.com and LendingClub  and considers their treatment under federal securities law. In an interesting digression, he also takes the revered Kiva.com site down a notch or two.

Verstein discusses how the P2P platforms changed in response to SEC pressure and argues that those changes have actually made them less safe for investors. Verstein's analysis is very good.I disagree with a couple of minor points he makes about whether P2P investments are securities, but, in his defense, he’s merely posing possible counterarguments to the SEC’s position.

I'm not so sure about Verstein's conclusion. I can't imagine that putting things in the hands of Elizabeth Warren at the CFPB is going to make things any better for P2P sites.

Well worth reading.

-Steve Bradford

Economist Debates

The Economist runs a series of debates, which allows expert and public input that I think is a worthwhile series.  The current debate is over this proposition: "This house believes that an economy cannot succeed without a big manufacturing base."  Here are excerpts from the experts:

For: Ha-Joon Chang: Faculty of Economics, University of Cambridge: 

While a simplistic "manufacturing good, services bad" viewpoint is unwarranted, we undervalue the manufacturing sector at our peril.

Against: Jagdish Bhagwati: Professor of Economics and Law, Columbia University:

Even if you wished to reduce the size of the financial sector, you would not have to go into manufacturing.

This is a series that is well worth a regular look. 

--JPF

Buell on Securities Fraud

Samuel W. Buell has posted What is Securities Fraud? on SSRN with the following abstract:

As Rule 10b-5 approaches the age of 70, deep familiarity with this supremely potent and consequential provision of American administrative law obscures its lack of clear conceptual content. The rule, as written, interpreted, and enforced, is missing a straightforward connection to, of all things, fraud. Fraud is difficult to define. Several approaches are plausible. But the law of securities fraud, and much of the commentary about that body of law, have neither attempted such a definition nor acknowledged its necessity to the coherence and effectiveness of doctrine.

Securities fraud’s lack of mooring in the concept of fraud produces at least three costs: public and private actions are not brought on behalf of clearly specified regulatory objectives; the line between civil and criminal liability is not acceptably sharp; and the law provides an at best weak means of resolving vital public questions about wrongdoing in financial markets. The agenda of this article is to illuminate and clarify the relationship between securities fraud and fraud, and to structure a law reform discussion that promises to make more explicit the connection between securities fraud remedies and the purposes of a regime of securities regulation; brighten the line between civil and criminal liability; and produce better understanding of what is being asked when, as so often these days, we wonder whether to label an important matter of market failure, “fraud.”

-- Eric C. Chaffee

Matheson on Entrepreneurship Law

John H. Matheson has posted Choice of Organizational Form for the Start-Up Business on SSRN with the following abstract:

Individuals embarking on new business ventures must choose a legal form under which to operate. They can form their business enterprises as sole proprietorships, general or limited partnerships, limited liability partnerships, limited liability companies, or corporations. State laws set forth the attributes of each organizational form. These include criteria for limited liability, centralized or decentralized management, transferability of interests, and duration of existence.

Before 1997, the issue of entity choice for the businessperson and legal counselor was tax-driven, and the determination to obtain passthrough tax treatment depended on the corporate resemblance test of the now-discarded Kintner Regulations. Under the Kintner Regulations, unincorporated businesses were taxed as corporations if they had more corporate than noncorporate characteristics.

On January 1 of 1997, the law of business organizations changed dramatically, when the United States Treasury Department's Simplification of Entity Classification Rules became effective. The current system, sometimes referred to as the, "check-the-box regulations," ended decades of manipulation of business organization forms to fit the requirements of the Kintner Regulations and obtain passthrough tax treatment. Only corporations and publicly traded organizations are taxed as separate entities. All other business organization forms have presumptive pass-through federal tax status. Check-the-box regulations reduced the impact of tax issues in the determination of the type of legal organization a business chooses to use.

This article introduces the basic business organization forms and some of the attributes of each that influence the choice of entity decision for the modern start-up business.

-- Eric C. Chaffee

Henning on Corporate Criminal Liability

Peter J. Henning has posted Should the Perception of Corporate Punishment Matter? on SSRN with the following abstract:

Corporations are a part of the community and accorded a range of rights similar - although certainly not identical - to those enjoyed by individual members, and so it is natural that they are understood as being bound by the same laws and social norms as any other individual. Yet corporate criminal liability has been criticized because no one individual can be held morally accountable for its misconduct, and therefore the argument has been made that an organization should not be subject to criminal sanctions. Perhaps the most cogent criticism of corporate criminal liability is that the only real punishment available against a corporation is a fine, which can be much more easily calibrated to redress any harm through a civil proceeding that does not require all the protections usually afforded in a criminal prosecution. In this article, presented at the David G. Trager Public Policy Symposium at Brooklyn Law School on “Sharing the Blame: the Law and Morality of Punishing Collective Entities”, I argue that criminal sanctions are appropriate for a corporation when the goal of the criminal prosecution is rehabilitation of the organization to change its corporate culture so that it can more effectively prevent future violations.

-- Eric C. Chaffee

Kaufman and Wunderlich on Securities Regulation

Michael J. Kaufman and John M. Wunderlich have posted Fraud Created the Market on SSRN with the following abstract:

Class actions are vital to protecting investors. Without class certification, individual damages may be de minimis, and investors would be unlikely to bring a securities fraud suit. This underenforcement allows those who defraud investors to skate liability and impugn the integrity of the marketplace. Presumptions of reliance facilitate classwide resolution of securities fraud claims. Under Rule 10b-5 for securities fraud the Supreme Court has presumed reliance to facilitate class actions where there is an omission in the face of a duty to disclose or where there is a fraud on the secondary market. The new frontier is whether federal courts should likewise presume reliance where fraud occurs on the primary market, giving rise to the fraud-created-the-market theory. Although some federal courts embraced the theory decades ago, a sharp conflict has arisen in the wake of the Court’s decision in Stoneridge Investment Partners v. Scientific-Atlanta, and the Third and Ninth Circuits have set the pace for rejecting the theory. In this Article, however, we show that the fraud-created-the-market theory is consistent with the fundamental bases for all presumptions in the law, comports with the Supreme Court’s interpretations of the federal securities laws as properly understood, and serves the investor-protection and market-integrity design of securities regulation.

We undertake a comprehensive definition and defense of the fraud-created-the-market theory and show why critics’ concerns regarding the presumption are unfounded. Properly understood, the fraud-created-the-market theory is about materiality and scienter - defendants should be held liable under the securities laws for committing fraud that is so material, without it, the securities never would have made it to market. In this regard, we show that a presumption of reliance for newly issued securities and the primary market is consistent with the Supreme Court’s collapsing the elements of securities fraud into a single inquiry whether the omission or misrepresentation was material. We build upon Professor Donald C. Langevoort’s fresh interpretation of the fraud-on-the-market presumption and his interpretation of Stoneridge, to show that the fraud-created-the-market presumption is grounded in the Court’s jurisprudence. We also find support for a judicially crafted presumption in the context of new issues in the securities laws themselves and in the common-law bases for presumptions. There is a pressing need for an answer to whether federal courts should adopt the fraud-created-the-market theory. The fraud-created-the-market theory will play an increasingly important role in actions against those involved in fraud relating to the issuance of subprime mortgage-backed securities.

-- Eric C. Chaffee

Natural Gas Bubble or Not? Either Way, It Matters

There is no consensus on whether there is a natural gas bubble about to burst; it depends on who you ask. Personally, I am starting to think much of the recent natural gas investment and deals are over valued, but I'm not sure it means a bad bubble burst is on the way. More on this soon, but try these as some example of what some are saying on the issue:

There's No Bubble In Natural Gas

Report: Federal Officials Fear Fracking Industry Bubble

A Big Bet on Exco and Natural Gas

--JPF

Technological Innovations in Legal Education

I graduated from law school almost 30 years ago. I and most of my classmates did not have computers. (I didn’t even have an electric typewriter.) Lexis and the world of computer research were in their infancy. No one had cell phones. Cable TV was still primarily for rural folk who couldn’t receive broadcast signals, and, as far as most of us knew, there was no Internet.

The world has changed dramatically, but legal education seems stuck in the 1950s. That’s why it’s always fun for me to attend the annual CALI Conference on Law School Computing, from which I just returned. I am actively involved in efforts to increase the use of technology in legal education, so I am aware of much that is going on, but the CALI conference provides an opportunity to see many innovations at once. Individuals and groups of people around the country are engaged in some very creative attempts to use technology to increase the effectiveness and, just as importantly, decrease the cost of legal education. Yes, contrary to popular belief, legal education does have its innovators.

Here, in random order, are just a few of the things people were talking about:

• The development of e-casebooks and statute books, many of which are or will be made available to students for free

• Innovative uses of video

to create hypotheticals students can watch

to simulate what happens when a lawyer walks into a partner’s office to receive an assignment

• Computerized legal lessons accessible not just on computers, but on phones and iPads.

• Legal apps for tablets and cell phones.

• The use of social media, such as Facebook, to increase communication among students and between professors and students

• Distance education courses bringing students from different law schools together in a single class

• Continued digitization of library resources

• The use of online platforms to facilitate collaborative scholarship

• Digitization of case law, statutes, and regulations to provide free alternatives to Westlaw and Lexis. Among other things, there’s a project afoot that would attempt to get all law, including state and local law, online, accessible through a single source.

• Digital annotation of student videos to provide quicker, cheaper feedback in clinical courses

Clearly, not all of these innovations will stick, and there will be new developments that we can’t anticipate, just as I couldn’t have anticipated when I graduated how integral the Internet would become. But it will be interesting to see how legal education will evolve over the next decade or two, and it seems clear to me that it must evolve.

-Steve Bradford

Engler on Sports Law and Tax Law

Mitchell L. Engler has posted The Untaxed King of South Beach: Lebron James and the NBA Salary Cap on SSRN with the following abstract:

In contrast to major league baseball, the National Basketball Association has a salary cap designed to provide every team an equal and fair chance of competing for the championship. The Miami Heat's recent incredible success in signing the game's three most hotly desired free agents, including mega-stars Lebron James and Dwyane Wade, therefore flies in the face of the NBA's attempted level playing field. How could one team so outmaneuver all the others in the sport which tried to eliminate such uncompetitive results via a salary cap?

As discussed in this Essay, the answer lies in the law of unintended consequences and perverse incentives. Some NBA teams are located in more attractive jurisdictions with nicer amenities or lower costs, such as taxes. In particular, Miami provides a highly-favorable climate both as to weather and taxes as Florida does not have a state income tax. In the absence of any salary cap limitations, teams in higher-tax jurisdictions could compete better with Miami for free agent players by offering higher salaries to offset the extra tax. But the NBA salary cap, by its very terms, blocks this usual free-market response.

Having flagged this perverse and unintended benefit to the no-tax clubs, this Essay then proposes an appropriate solution. Rather than scrapping the salary cap and restoring a competitive advantage to the wealthier clubs, a state tax adjustment to the cap amounts would remove the rich clubs' advantage without substituting an unintended benefit to the no-tax clubs. The salary cap amounts of no-tax teams simply should be reduced by a percentage equal to the highest state tax rate of any NBA team. After making this simple adjustment, this Essay then refutes more sophisticated arguments as to why the proposed adjustment might go too far. Among other points, this Essay highlights how Miami‘s tax advantage might extend beyond just Lebron's salary to include his extensive endorsement income as well. Expanding the analysis to such deeper level therefore highlights an even greater need for a state tax adjustment to the NBA salary cap.

-- Eric C. Chaffee

World Series of Poker (Law Reform) Update

Rep. Joe Barton just introduced HR 2366, the Online Poker Act of 2011 to Congress. Sarah Grant talked with Rep. Barton about the details.  (NOTE: Rep. Barton drops names about some of the top poker players on the hill.)

SJP

More Pro-Business Decisions From the Roberts Court

The question of whether the Roberts Court can properly be characterized as pro-business is back in the news, with four recent cases taking center stage.  In Wal-Mart v. Dukes and AT&T v. Concepcion the Court limited the availability of class actions.  As my colleague Will Huhn notes, in American Electrical Power Co. v. Connecticut:

[T]he Supreme Court held that the Clean Air Act preempts the federal common law of nuisance, and accordingly the states lost on that point.  The Court did not reach the question of whether the state law of tort is preempted by the Clean Air Act, and the case was remanded to the lower courts for a ruling on that issue.

(For an arguably related story, see: "Nuclear Regulatory Commission Colluded with Industry to Weaken Safety Standards.")

Finally, in Janus Capital the Court again chipped away at Rule 10b-5.  As Jay Brown describes it: "The opinion ... is a piece of political decision making, more in line with a legislature than a court."

An Associated Press story noted:

Robin Conrad, the head of the legal arm of the U.S. Chamber of Commerce, dismissed the notion of a pro-business court as "a silly myth" that was undercut by a record of as many victories as losses in cases of interest to the Chamber of Commerce. Yet Conrad acknowledged that the group won the three cases — the class-action disputes and a successful effort to block a climate change suit by six states — that were "easily the most important business cases of the term."

SJP

Article: Understanding Exclusion of the CISG

If you are interested in international business involving sales of goods, my friend and colleague Bill Johnson's article, Understanding Exclusion of the CISG: A New Paradigm of Determining Party Intent, 59 Buff. L. Rev. 213 (2011), is worth a look.  Here's an excerpt:

One increasingly important body of law that governs certain international sale of goods transactions is the United Nations Convention on Contracts for the International Sale of Goods (“CISG”). The CISG is an international treaty that has been ratified by the United States and is part of U.S. law. It automatically applies to certain sale of goods transactions. But when it applies or more specifically how it can be excluded has befuddled U.S. courts for the CISG’s entire history.

. . . .

This Article seeks to bring understanding where there is misunderstanding regarding effective exclusion of the CISG, including with respect to (i) the role that a choice­of­law clause ought to play in the analsyis and (ii) the obligation under the CISG to consider extrinsic evidence to determine the parties’ actual intent. To achieve that goal, this Article primarily analyzes four related but distinct items: (1) the text of the CISG itself, (2) the  travaux préparatoires, or drafting history, of the CISG, (3) the American Biophysics decision and the five cases cited as authority by the  American Biophysics court to support its incorrect conclusion, and (4) illustrative reasoning of U.S. courts that have engaged in analysis, some sound and some faulty, of a variety of other issues under the CISG.

--JPF

Does Your Law School Need More Celebrities?

One of the benefits of blogging for a relatively popular blog like this one is that I actually get pitched with various books, etc., to blog about.  One recent such pitch involved the book "Celebritize Yourself" by Marsha Friedman.  At first, my reaction was a negative one because I must admit to not having the greatest opinion of celebrity status in our modern world.  But then the following line caught my eye:

"To celebritize oneself is not merely to gain fame or fortune.  It’s to share one’s life experiences with other who may be in search of, and in need of, your wisdom.  That’s the guiding philosophy for becoming a celebrity."

While I have not read the book, I have taken a closer look at the content and felt like it may well be something worth sharing with our readers.  In particular, I thought about the need for many law faculties to promote themselves in a world where, for better or worse, USNWR rankings rule and reputations may not properly reflect actual productivity.  You can browse the table of contents here ("Look Inside") -- I think it's worth a look.

SJP

Would You Hire a Disbarred Attorney to Mediate Your Case?

That's just what former securities class action lawyer Melvyn I. Weiss is hoping, according to the New York Times Dealbook. Mr. Weiss was disbarred after pleading guilty in 2008 to making illegal kickback payments to his plaintiff-clients in securities litigation.

There are some possible ethical concerns with Mr. Weiss working as a mediator because he would be drawing on his legal experience. I have not done much research in that area, but I can see both sides of the issue.  I could imagine someone wanting Mr. Weiss's input, given his experience, but I just can't see hiring him as a mediator. Even if it's permissible for him to act as a mediator, it just doesn't seem like a good idea.  

Perhaps I am wrong and he brings something so unique to the table that it would make it worth hiring him.  I don't know what that would be, but I welcome any thoughts.

--JPF

When the SEC Should Apologize

Walter Pavlo has this to say at Forbes.com about the SEC's recent insider trading case against Dr. Sebastian De La Maza, which the SEC lost:

Look, you win some and you lose some.  When a defendant loses a case they stand before the judge and usually apologize for their behavior in order to get a lighter sentence.  It provides a sense of closure and respect for justice being served.  The SEC should issue its own apology to Dr. Sebastian De La Maza for wrongly accusing, and then defaming, an innocent man.  The jury has spoken….all we’re asking for is a little justice, to go with our justice system.  Dr. De La Maza has done nothing wrong and the record now reflects that.  All I’m asking is that the SEC’s website reflect that as well.

I am inclined to agree.  If the SEC wants to make bold statements about people before they prove the case, the SEC should correct the statements if a jury acquits. The SEC shouldn't need to apologize for what they allege in court; that's where they need to prove their case.  But pretrial media statements are not about proving their case. If they want to talk before the case, get it right, or fix it.   

--JPF

Practical Law Company Materials

A few months ago, I began receiving weekly updates on finance and corporate and securities law produced by the Practical Law Company. I’m sure the company sent me advertising at some point, but I didn’t check it out until one of our librarians convinced me to take a look. (The librarian in question also happens to be my fiancée, so I tend to listen to her a little more than our other librarians.) I was hesitant to add yet another service to the many products that already stream through my in-box: various daily and weekly updates on the law, blog posts, RSS feeds from newspapers and magazines. But this is something different, and I like it.

In addition to information on regulatory and other legal changes, the PLC update includes various checklists, practice notes, and samples from current deals. For example, my most recent Corporate and Securities Weekly Update includes practice notes on (1) reverse mergers, (2) structuring waterfall provisions in partnership and LLC agreements, and (3) merchant banking. My favorite recurring feature is something PLC calls the “risk factor of the week,” with actual risk factor language pulled from public filings. The weekly updates also include summaries of both public and private acquisition agreements, often featuring some of the contractual provisions in those deals.

Some of the practice notes, such as a recent due diligence checklist, don’t add much to what I already know, but would be very useful to students or inexperienced lawyers. Some of them, like the one on waterfall provisions, deal with topics I never touch on. But most of them are pretty interesting and, for a weekly, the quality is surprisingly good.

If you haven’t seen these, you might want to check them out. The Practical Law Company web site is here. In addition to the weekly updates, the web site has a variety of other content, including webinars, model documents, and handbooks. (As an academic, I don’t pay for the content I receive, so I’m not sure what PLC charges.)

-Steve Bradford

Elsaman on Corporate Social Responsibility in Islamic Law

Radwa S. Elsaman has posted Corporate Social Responsibility in Islamic Law: Labor and Employment on SSRN with the following abstract:

Islam is not only a way of worship; but also, an entire legal, economic, social, political, and commercial system. Hence, it affects every day behavior of its followers including business transactions. Also, Islamic law, almost, dominates most of the Muslim countries’ internal legal systems. Considering how Islamic business ethics affect corporate social responsibility can be useful to multinational corporations making their investment decisions in Muslim countries. This article discusses the general framework governing business ethics in Islamic law, giving perspective to labor standards.

-Eric C. Chaffee

Teaching Banking Law/Financial Institutions

The Glom has been hosting a fascinating Banking Roundtable.  While I have not yet read all the posts, I thoroughly enjoyed (and highly recommend) the one put up by Anna Gelpern.  She starts with a bang:

My version of letting no crisis go to waste is to assert that The Crisis is attributable entirely to the formerly niche status of banking and financial institutions in the law curriculum, which misled some of the best minds in the country to things like the Constitution and SOX, when we all should have been thinking about capital adequacy and systemic risk. But I digress. Bye-bye seminar caps, hello first-year lecture halls!

And then there are movie recommendations, which I am a huge fan of.  (Am I the only one that thinks the original Wall Street still has a place in a Sec Reg class?  Gekko: "The most valuable commodity I know of is information.")

SJP

More Than Half Way There

Paul Caron ranks the Top 35 blogs edited by law professors with publicly available SiteMeters for the most recent 12-month period (Apr. 1, 2010 - Mar. 31, 2011) here.  The cutoff for visits is 133,852.  By my count we here at the BLPB had 68,622 visits over the course of the past 12 months.  Thanks to everyone who has supported us.  Please don't hesitate to drop us a line with any suggestions for how we can keep you coming back.

SJP