April 23, 2011
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.
April 22, 2011
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.
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).
April 21, 2011
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.
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?
April 20, 2011
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 , 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.
April 18, 2011
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.
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.
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.
April 17, 2011
A Mere 150 Years Ago: The American Civil War
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."