Business Law Prof Blog

The Glom's Roundtable Series

Most of our readers have probably seen this excellent series of posts, but just in case you haven't--here are the links:

1.  Roundtable on Teaching Contracts

2.  Roundtable on Teaching Corporate Finance

3.  Roundtable on Teaching Banking/Financial Institutions

SJP

Video Game Case: A Pro-Business Decision, But Some Still Miss the Point

On June 27, 2011, the United States Supreme Court decided Brown v. Entertainment Merchants Association, which determined that video games are protected by the First Amendment and that a California law restricting sales of violent video games to minors could not "survive strict scrutiny."  As some readers may recall, I used to work in the video game industry, and I am on record supporting this outcome.

The majority opinion, written by Justice Scalia was unwavering in viewing video games as protected speech.  A concurrence, by Justice Alito and joined by Chief Justice Roberts, was less so.  The concurrence argued that the statute was improper, but that a properly drafted statute could withstand scrutiny.  Ultimately, though, seven Justices thought the California law was wrong, choosing instead the "pro-industry" position.  The video game industry is big business, too, with more than $10.5 billion in 2009 computer and video game sales.  

Despite being big business, the concurrence and dissent both bought in to the idea that violent video games are harmful to minors. From the research I have seen, links between video games and violence is correlative, not causative. (Justice Breyer's dissent provides appendices of listing research on studies concluding violent video games are harmful and not harmful, most of which, I admit, I have not reviewed.) It is not shocking to me that kids who tend to be violent are drawn to violent video games. The truth is that video games can serve as cathartic for some, and may prove detrimental to others. The same remains true of Madame Bovary. 

I can't help but note that the concurrence makes some similar assumptions to those who drafted the California law.  In his concurrence, Justice Alito says that the majority opinion is wrong and that "[w]e should not jump to the conclusion that new technology is fundamentally the same as some older thing with which we are familiar."  

I respectfully disagree.  In fact, we should not jump to the conclusion that new technology is fundamentally different than some older thing with which we are familiar.  The majority got it right.

--JPF

"Say on Pay" Results (Corrected 7-11)

The latest results on “say on pay” voting are in. As readers of this blog probably know, the Dodd-Frank Act added a new section 14A requiring “say on pay,” shareholder votes on the compensation of senior executives. In February, the SEC adopted a new Rule 14a-21 providing for such votes.

The Wall Street Journal reports that shareholders at 39 of 2532 companies conducting such votes voted against executive pay plans. At 71% of the companies, the executive pay plans received at least 90% support.

The policy implication of these numbers is unclear. Is the 98.5% approval rate a strong argument against requiring companies to go through this exercise? Or should we focus on the small number of companies where shareholders voted against management? Even at the latter companies, the vote won’t necessarily have any effect. Under the SEC rules, these votes are purely advisory. A company has no obligation to eliminate a pay plan rejected by the shareholders.

-Steve Bradford

Random Items

1. Ramseyer on "Why Power Companies Build Nuclear Reactors on Fault Lines" (HT: Bainbridge):

Tokyo Electric built its reactors as it did because it would not pay the full cost of a melt-down anyway. Given the limited liability at the heart of corporate law, it could externalize the cost of running reactors.

2. NYT: "We Knew They Got Raises. But This?":

Brace yourself. The final figures show that the median pay for top executives at 200 big companies last year was $10.8 million. That works out to a 23 percent gain from 2009.

3. Poker News: "Presidential Candidate Openly Campaigning for Poker Player Vote":

Former New Mexico Gov. Gary Johnson has set up a Web page targeting poker players. "Support me for President, and I'll support your freedom," Johnson is quoted as saying on the site.

SJP

Liberal Arts and Entrepreneurship

I ran across a fascinating article at Insider Higher Ed, the online journal of higher education. Many schools have programs on entrepreneurship, but Michael Snyder, the president of McPherson College, a small  liberal arts school in Kansas, is trying to make entrepreneurship a foundational part of McPherson’s program.

According to the article, Snyder “sees entrepreneurship, in all its forms, as the practical application of the traditional liberal arts education, and liberal arts colleges as the best places to develop the right mindset to take risks and innovate.” McPherson has created a fund to help students with entrepreneurial ideas, has started a weeklong entrepreneurship competition among student teams, has added courses and a minor in entrepreneurship, and has brought in an outside business professor as an entrepreneurial fellow.

I’m a strong believer in liberal arts education and, as Snyder recognizes, there’s a natural connection between liberal arts and entrepreneurship. The purpose of a liberal arts education is to train people to think for themselves in innovative ways, and that’s the foundation of entrepreneurship.

The full article is worth reading.

-Steve Bradford

A Colleague Lost: Rest in Peace, David Getches

David Getches, who was the University of Colorado Law School dean until last week, passed away Tuesday. Less than a month ago, he was diagnosed with pancreatic cancer. 

I had only met David a few times, but he is someone I will miss.  I knew about David long before I met him.  In law school, I was excited to take a Native American Law seminar, where I read a number of his writings. At that point, he was something of a rock star to me, in a scholarly sort of way. 

Over the past four years, I have had the privilege to serve as the University of North Dakota School of Law's Trustee to the Rocky Mountain Mineral Law Foundation, which is where I had the opportunity to meet David. We never talked much (I mostly watched and listened), but in my experience, he was someone who commanded respect, but never demanded it.

About this time last year I had the pleasure of sharing an airport shuttle with David back to Calgary (from Banff). I wanted to speak with him, but I did not want to bug him, either. I briefly re-introduced myself, then quietly went back to reading.  At one point, though, I decided to ask a question; I'm glad I did.  We had a nice conversation for the rest of the ride, where he shared with me some of his experiences as a, lawyer, law professor, and dean.  He talked as someone who truly loved his career, his family and friends, and his life.  

David's primary focus was Indian law and natural resources law, which is not directly relevant here. But David's expertise was far broader that those subject areas. As lawyer, a law professor, and law dean, he influenced the entire legal community, in addition to students and the academy, in way that will last well beyond his time with us.

Even after meeting David, he remains something of a rock star to me, and I'm honored to have spent a little time with him. My thoughts are with his family and friends.  He will be missed. 

--JPF

Stout on Derivatives Regulation

Lynn A. Stout has posted Derivatives and the Legal Origin of the 2008 Credit Crisis on SSRN with the following abstract:

Experts still debate what caused the credit crisis of 2008. This Article argues that dubious honor belongs, first and foremost, to a little-known statute called the Commodities Futures Modernization Act of 2000 (CFMA). Put simply, the credit crisis was not primarily due to changes in the markets; it was due to changes in the law. In particular, the crisis was the direct and foreseeable (and in fact foreseen by the author and others) consequence of the CFMA’s sudden and wholesale removal of centuries-old legal constraints on speculative trading in over-the-counter (OTC) derivatives.

Derivative contracts are probabilistic bets on future events. They can be used to hedge, which reduces risk, but they also provide attractive vehicles for disagreement-based speculation that increases risk. Thus, as an empirical matter, the social welfare consequences of derivatives trading depend on whether the market is dominated by hedging or speculative transactions. The common law recognized the differing welfare consequences of hedging and speculation through a doctrine called “the rule against difference contracts” that treated derivative contracts that did not serve a hedging purpose as unenforceable wagers. Speculators responded by shifting their derivatives trading onto organized exchanges that provided private enforcement through clearinghouses in which exchange members guaranteed contract performance. The clearinghouses effectively cabined and limited the social cost of derivatives risk. In the twentieth century, the Commodity Exchange Act (CEA) largely replaced the common law. Like the common law, the CEA confined speculative derivatives trading to the organized (and now-regulated) exchanges. For many decades, this regulatory system also kept derivatives speculation from posing significant problems for the larger economy.

These traditional legal restraints on OTC speculation were systematically dismantled during the 1980s and 1990s, culminating in 2000 with the enactment of the CFMA. That legislation set the stage for the 2008 crises by legalizing, for the first time in U.S. history, speculative OTC trading in derivatives. The result was an exponential increase in the size of the OTC market, culminating in 2008 with the spectacular failures of several systemically important financial institutions (and the near-failures of several others) due to bad derivatives bets. In the wake of the crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). Title VII of the Act is devoted to turning back the regulatory clock by restoring legal limits on speculative derivatives trading outside of a clearinghouse. However, Title VII is subject to a number of possible exemptions that may limit its effectiveness, leading to continuing concern over whether we will see more derivatives-fueled institutional collapses in the future.

-- Eric C. Chaffee

Misinformation About Lawyers As Directors

A Reuters special report (Shell Game) is making the rounds, and it has some interesting information.  The report is part of a series "exploring the extent and impact of corporate secrecy in the United States."  In it, the authors report that Wyoming Corporate Services is a company that creates "paper entities" for people to "hide assets."  The company has registered more than 2,000 companies, all at a single address in Cheyenne, Wyoming.

One thing that caught my eye was the claim in the report that

Wyoming Corporate Services will help clients create a company, and more: set up a bank account for it; add a lawyer as a corporate director to invoke attorney-client privilege; even appoint stand-in directors and officers as high as CEO.

That attorney-client privilege thing is not quite right. Just being a lawyer does not create privilege for actions of a director who happens to be a lawyer.  If a lawyer-director is somehow engaged to render a legal opinion, then privilege may attach, but having a lawyer-director at a board meeting does not mean everything discussed is privileged.  Here's one court's view in this context: 

The attorney-client privilege is a tenuous one, at best, with multifarious exceptions and conditions upon its applicability. Inasmuch as its enforcement impedes the search for truth, we think it may be stated with assurance, as a general principle, that the ethical and evidential strictures are brought into play only when a professional confidential relationship in its purest sense has been established. The attorneys selected by a client must, from one point of view, be dealing at arm's length with the client, as independent legal advisors, bearing in mind, of course, the fiduciary nature of the relationship. 

The relationship must be one which supports the reason for the ethical and evidentiary sanctions, that is, the public policy promoting full disclosure in the interests of obtaining sound and well-considered legal advice. When the attorney and the client get in bed together as business partners, their relationship is a business relationship, not a professional one, and their confidences are business confidences unprotected by a professional privilege.

Federal Sav. & Loan Ins. Corp. v. Fielding, 343 F. Supp. 537, 546 (D. Nev. 1972).

Not all courts will go that far, but just having a lawyer on a board of directors does not do what is implied by the Reuters report.

Lawyer-directors, to the detriment of their corporate clients, may affect the protection provided by the privilege. The privilege may be lost if the party seeking discovery can show that the communications in question were communicated in the role as director, and not strictly as a lawyer.

James H. Cheek, III & Howard H. Lamar, III, Lawyers as Directors of Clients: Conflicts of Interest, Potential Liability and Other Pitfalls, 22nd Annual Institute on Securities Regulation, Vol. 1 at 461, 483 (PLI Corp. Law & Practice Course Handbook Series No. 712, October 1990).

The other thing worth mentioning is that corporations and LLCs are not inherently evil.  Sure they can be used to help facilitate some bad things, but it doesn't take a corporation or an LLC to do evil. Individuals, sole proprietorships, and partnerships can all be pretty scummy, too. It has to do with the people running them, not an entity form.

I'm all for a little monitoring of bad behavior, but a some self policing can help, too.  Among the reasons people claim to want to form a company is to make it look like their operation is bigger or more established. Before doing business with anyone, we all need to do our due diligence. Check financials and get personal guarantees if that's necessary.  And if we don't care to check, then caveat emptor is still usually an appropriate rule.  And if we do check, and it's a well-played scam, well, it's not the entity that is the problem. It's criminal behavior, that happened because of the criminal, not the corporate code.  

--JPF 

Happy 4th of July

Happy Independence Day to all our American readers. (I know people outside the U.S. read this blog, but you're just going to have to bear with us today; it's a pretty big deal over here.)

Since this is a business law blog, don't forget all that American business people have done (and are still doing) to make our country great. What we have today is due in no small part to American capitalists and entrepreneurs, in addition to the heroes more commonly celebrated in the history books.

-Steve Bradford

Painter on Dodd-Frank

Richard W. Painter has posted The Dodd-Frank Extraterritorial Jurisdiction Provision: Was it Effective, Needed or Sufficient? on SSRN with the following abstract:

In Morrison v. National Australia Bank, the U.S. Supreme Court ruled in June 2010 that securities fraud suits could not be brought under Section 10(b) of the Exchange Act against foreign defendants by foreign plaintiffs who bought their securities outside the United States (so called, “f-cubed,” securities litigation). The Court held that Section 10(b) reaches only fraud in connection with the, “purchase or sale of a security listed on an American stock exchange, and the
purchase or sale of any other security in the United States.” Congress responded to Morrison with Section 929P of the Dodd-Frank Act, which gives federal courts jurisdiction over some similar cases if they are brought by the SEC or the Department of Justice (DOJ).

This article discusses alternative explanations for why Congress used extraterritorial jurisdiction language in Section 929P instead of directly addressing the reach of Section 10(b) on the merits, and whether as a result Section 929P does nothing more than confer jurisdiction on federal courts that the Morrison opinion already recognized courts have over all Section 10(b) cases. This article also discusses whether Section 929P reinstates for SEC and DOJ suits some of the case law in the courts of appeals that was overturned by Morrison, and if so, how that case law is to be applied. This article discusses whether Section 929P is retroactive, and how Section 929P likely will be used by the SEC and DOJ in insider trading and other cases. Finally, this article discusses whether Section 929P was necessary given the SEC’s already expansive enforcement authority under Section 10(b) and whether Congress should have taken the opportunity to address other more pressing post-Morrison issues in Dodd Frank. These issues include the status under Morrison of securities listed both in the United States and outside the United States, and the status of off-exchange traded security-based
swap agreements, as well as other private transactions where identifying a transaction location is not as easy as it is for exchange traded securities.

-- Eric C. Chaffee

Page on Mergers

William H. Page has posted Standard Oil and U.S. Steel: Predation and Collusion in the Law of Monopolization and Mergers on SSRN with the following abstract:

The Supreme Court’s 1911 decision in Standard Oil gave us embryonic versions of two foundational standards of liability under the Sherman Act: the rule of reason under Section 1 and the monopoly power/exclusionary conduct test under Section 2. But a case filed later in 1911, United States v. United States Steel Corporation, shaped the understanding of Standard Oil’s standards of liability for decades. U.S. Steel, eventually decided by the Supreme Court in 1920, upheld the 1901 merger that created U.S. Steel. The majority found that the efforts of the Corporation and its rivals to control prices in the famous Gary dinners had violated Section 1 of the Sherman Act when they occurred, but paradoxically insulated U.S. Steel from liability under Section 2. U.S. Steel was formed to monopolize the industry, but failed; it demonstrated its impotence by fixing prices with rivals instead of crushing them, as Standard Oil had done.

U.S. Steel’s interpretation and application of Standard Oil essentially ended governmental enforcement of section 2 until Alcoa. Economic scholars suggest that the case ratified “the most socially damaging of all mergers in U.S. history” and caused lasting harm to the American economy by making the crucial steel industry less competitive. Equally important, I argue in this essay, it harmed antitrust doctrine. In cases like Alcoa, it played a role in confusing in the law of monopolization under Section 2 of the Sherman Act. Moreover, by rendering Section 1 of the Sherman ineffective against monopolistic mergers, it contributed to the passage of Cellar-Kefauver Act’s amendment of Section 7 of the Clayton Act in 1950 and, indirectly, to the early misguided interpretations of that provision in cases like Brown Shoe and Von’s. In this essay, I will describe errors of U.S. Steel, the mistaken responses to those errors in post-New Deal antitrust, and role of competing ideologies in both. In a final Part, I argue that modern reforms should assure that both U.S. Steel’s errors and the excesses of the post-New Deal antitrust will not recur.

-- Eric C. Chaffee

Fried & Broughman on Venture Capital

Jesse M. Fried and Brian J. Broughman have posted Do VCs Use Inside Rounds to Dilute Founders? Some Evidence from Silicon Valley on SSRN with the following abstract:

Startup founders suing venture capital investors (VCs) often claim that the VCs forced the startup to accept follow-on financing from these same VCs at artificially low valuations, thereby diluting the founders. However, there is no evidence on whether VCs systematically use such “inside” rounds, rounds negotiated and financed by the firm’s existing VCs rather than by a new “outside” VC, to dilute founders. In a hand-collected dataset of 90 follow-on rounds in 45 VC-backed Silicon Valley firms, we find little evidence that VCs use inside rounds to dilute founders. Instead, our findings suggest that inside rounds are generally used as “backstop financing” for startups that cannot attract new money, and these rounds are conducted at relatively high valuations (perhaps to reduce litigation risk).

-- Eric C. Chaffee

Vasudev on Canadian Business Law

P. M. Vasudev has posted Stakeholders in the Canada Business Corporations Act: an Appraisal and Some Proposals on SSRN with the following abstract:

The stakeholder vision has emerged as an influential stream in corporate governance. In the English-speaking world, Canada was the pioneer in introducing a regulatory stakeholder regime. This article examines the Canada Business Corporations Act (CBCA) for its concern for non-shareholder groups, in particular, their inclusion in the remedies provided in the statute and the experience with it. After making a critical review of the CBCA stakeholder regime, the article proposes specialized agencies to deal with intra-corporate or stakeholder disputes in business corporations. The stakeholder remedy in the CBCA is egalitarian. It posits a doctrinal equality between shareholders and other constituencies. An issue with the stakeholder remedy the CBCA promotes and the stakeholder empowerment it attempts in this process is their ex post principle. It is about intervention after conflicts have arisen between corporate actors. The framework is derived, essentially, from private law ideas about disputes and resolving them through litigation. As a result, the stakeholder regime in the CBCA does not sufficiently adopt the institutional approach to lawmaking. Yet the CBCA regime is a positive beginning, which can graduate towards a more wholesome model, one with the stakeholder vision as an informing principle of governance.

-- Eric C. Chaffee

Does retail investor trust and confidence in the market matter?

That's a question that popped into my head while reading Jason Zweig's recent "Intelligent Investor" column: Why You Shouldn't Buy Those Quarterly Earnings Surprises.  Zweig writes that we should expect to see a number of upcoming positive earnings "surprises" because "[t]hey are predetermined in a cynical tango-clinch between companies and the analysts who cover them."  He quotes James A. Bianco, president of Bianco Research, as saying that "All the numbers are gamed at this point."  Why?  Because companies have an incentive to "guide" analysts to projections they can beat and analysts have an incentive to provide close but conservative projections that result in "surprises" that spur trading--thereby creating bank profits.  Zweig concludes that "the smartest investors realize the surprise is a staged event" and won't "believe anyone who tries to tell you that these fake surprises mean nothing but good times are ahead for the economy and the stock market."

SJP