July 2, 2011
Cleveland Versus Wall Street: The Movie
Swiss film director Jean-Stéphane Bron's film (spoiler alert), Cleveland Versus Wall Street, presents the mock version of the trial that was never allowed to happen in the case of City of Cleveland v. Ameriquest (and 20 other banks), wherein Cleveland alleged that the banks' financing of sub-prime mortgages constituted a public nuisance leading to the foreclosure crisis in Cleveland. The lawyers are Joshua R. Cohen, a partner at Cleveland’s Cohen Rosenthal & Kramer who was the plaintiffs lawyer in the real case, and Keith R. Fisher, a financial regulatory lawyer who is of counsel at Ballard Spahr in Washington, D.C., and orignally served as an adviser to the filmmakers on the details of banking law. The mock trial was argued before a retired local judge and a jury of area residents, and the witnesses were a combination of Cleveland residents and financial experts.
July 1, 2011
Management Inflation in the NBA
If you read anything about the NBA lockout today, read this: Arturo Galletti looks at the numbers:
• Player's salaries have stayed even with inflation. Essentially this means their pay has not been going up.
• Owners have been increasing their spending. Management's operating costs (per their own numbers) have been going up at five times the level of inflation (that's a lot).
• Even in the ideal case for the owners with the new CBA these problems will repeat themselves in 2020.
• The Owners are asking the players to take a pay hit to make up for bad management practices.
In fact, it was the only thing I read on the NBA lockout today, but it was worth a look. I can't vouch for the accuracy of the math estimates, but I will say that my gut tells me the point is on track. Galletti argues:
The simple takeaway . . . is that Player Salaries and NBA Revenues are growing exactly at the US inflation rate (score one for economists everywhere!). Team expenses are growing at a ridiculous five times that. The owners must know this. A new labor deal will not fix that.
I am not one who thinks it's all management's fault when a business tanks or who thinks it's all labor's fault when costs are too high. It's much more complicated than that, although most reports you read seem to imply it's one group OR the other, not both. However, when it comes to this problem, and most sports leagues, I am inclined to think it is more on the owners. Here's why: to my knowledge, not one major sports league has struggled financially because of a lack of effort or talent on the part of the players. (The XFL is hereby officially exclude from "major" sports league.) And I don't think you can fault a player for taking a big contract when it's offered any more than you can fault a Wall Street executive.
For sports leagues, it has been a marketing problem, a rules-related problem, a cost problem, etc. These are management concerns, not player concerns. The salary cap exists because most owners could not control themselves without limits. Notice that some owners can keep costs in check -- Minnesota Twins, Oakland A's -- when there is not a salary cap, but not most. In a contract-based employment environment, if management over pays, it highlights management mistakes, because there is no avoiding the costs incurred until the contract runs it's course. (As opposed to an at-will situation where you just fire people when costs are too high -- I'm talking about you investment banks.)
The are a lot of legitimate things to question about high-paid athletes, but for me, an inability to control league expenses is simply not one of them. Personally, I am not that stressed about the NBA situation. But I do care of about the NFL. We Detroit Lions fans have earned the chance to enjoy a little hope for the coming season.
Douglas Irwin's Peddling Protectionism
This is going to mark me as a real finance geek, but I just finished reading Peddling Protectionism: Smoot-Hawley and the Great Depression, by Douglas A. Irwin. Irwin is an economics professor at Dartmouth who has authored a number of books and articles on trade, tariffs, and the Great Depression.
Peddling Protectionism is both a history of the Smoot-Hawley Tariff Act and an examination of its consequences. The best part of the book, in my opinion, is the political history in the first chapter. Irwin really brings the debate to life, providing a close look at the involvement of Congressman Hawley, Senator Smoot, President Hoover, and the many other players in the political process. It's amazing how close the tariff bill came to failure; I wonder how U.S. economic history would have changed if we had no Smoot-Hawley
Irwin’s analysis of the economic consequences of the bill is also interesting, and convincing. Some of it might be a little difficult for readers without at least some background in macroeconomics, but most of the discussion is accessible to general readers. Marshaling a variety of statistics, Irwin concludes that Smoot-Hawley was not responsible for the Depression, but certainly exacerbated it. He also finds that, “although . . . [Smoot-Hawley] . . . was not the principal reason for the general outbreak of protectionism that so damaged world trade in the early 1930s, it was a contributing factor.” And it most certainly was a major factor in diverting international trade away from the United States.
It’s almost impossible to have a debate about international trade without Smoot-Harley coming up; it is the bête noire of free trade advocates. (Irwin begins the book with Al Gore's invocation of Smoot-Hawley in his 1993 debate with Ross Perot on Larry King Live.) That makes this book required reading for anyone interested in international trade.
June 30, 2011
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.
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.
June 29, 2011
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:
While a simplistic "manufacturing good, services bad" viewpoint is unwarranted, we undervalue the manufacturing sector at our peril.
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.
June 28, 2011
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
June 27, 2011
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:
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.
June 26, 2011
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