July 30, 2011
Coates on Citizens United
John Coates has posted "Corporate Governance and Corporate Political Activity: What Effect Will Citizens United Have on Shareholder Wealth?" on SSRN. Here is the abstract:
In Citizens United, the Supreme Court relaxed the ability of corporations to spend money on elections, rejecting a shareholder-protection rationale for restrictions on spending. Little research has focused on the relationship between corporate governance – shareholder rights and power – and corporate political activity. This paper explores that relationship in the S&P 500 to predict the effect of Citizens United on shareholder wealth. The paper finds that in the period 1998-2004 shareholder-friendly governance was consistently and strongly negatively related to observable political activity before and after controlling for established correlates of that activity, even in a firm fixed effects model. Political activity, in turn, is strongly negatively correlated with firm value. These findings – together with the likelihood that unobservable political activity is even more harmful to shareholder interests – imply that laws that replace the shareholder protections removed by Citizens United would be valuable to shareholders.
July 29, 2011
More on Say-on-Pay
I recently posted some figures on the outcome of the say-on-pay shareholder votes mandated by the Dodd-Frank Act and new SEC Rule 14a-21. (This one has not been invalidated by the D.C. Circuit.) The Harvard Law School Forum on Corporate Governance and Financial Regulation has published a much more thorough analysis by Michael Littenberg, a partner at Schulte Roth & Zabel LLP. Among other things, he breaks down the vote by market capitalization, industry, and Institutional Shareholder Services recommendation. He concludes that “most companies made it through . . . [say-on-pay] . . . unscathed in 2011.” Definitely worth reading.
Oil Extraction Spin-offs: Take Two
I mentioned the other day that I was adding another take to my thought that it was good thing that ConocoPhillips and Marathon were spinning off their oil exploration and extraction businesses. I still think that it could be a good thing, but I also think it may not be so great, especially if aggressive pursuit of company executives for environmental crimes (rather than more rigorous oversight of safety processes) is going to be the model moving forward. So, here's an excerpt from a rough draft of my paper that argues reducing mens rea requirements in environmental crimes is not likely to be effective in reducing the risk of environmental harm (the paper will also suggest a few alternatives that may be more effective):
[D]iluting mens rea requirements [for executives companies responsible for environmental disasters] could have the effect of increasing risk taking by those charged with oversight of the very activities that the laws were designed to make safer. The risk is that those who are likely to be risk averse to criminal sanctions will leave the field all together (to work in other less risky arenas), while leaving those who are undeterred by the risk of jail time in positions of power (and potentially greater positions of power). In fact, there may be some indication this is happening right now.
In July 2011, ConocoPhillips announced that it would be splitting its company into two separate entities, one that explores for and produces oil, and another that refines the oil. This followed the January 2011 move by Marathon Oil to the same thing. Marathon’s spin-off, Marathon Petroleum Corp., which is the refining company, starting trading July 1, 2011.  On the one hand, separating these operations into separate companies could be a good thing. The executives of these entities will now have a more focused business model, and the concerns of each part of the business are now less likely to compete with one another. Further, the companies may be better focused on their own expertise.
These companies are splitting to isolate the risk of the extraction process; at least, that is part of the equation. On the one hand, splitting the entity in two may be reasonable and sensible business planning and risk management. By spinning off the exploration company, the resulting refining company is giving up the opportunity to participate in the upside of the spun off company, and is eliminating the related risk. If the entity’s decision makers believe that is best, there is little reason to question the decision on that basis.
An inherent risk of this division, though, is that the resulting exploration-and-extraction entity will take along with it executives and other leaders who are not appropriately risk averse, and thus increase the likelihood of disaster. This is not because executives or employees who are in the exploration and extraction industry are generally unlawful or poor risk assessors. But, as the risk of punishment increase (and inappropriately aggressive pursuit of criminal penalties increase) in the industry, there is a parallel risk that executives who are appropriately mindful of the law will be inclined to work in industries where an executive’s actions more likely control how and whether an executive will face criminal sanctions.
 Cf. Craig S. Lerner & Moin A. Yahya, ‘Left Behind’ After Sarbanes-Oxley, Regulation, at 44, 47 (Fall 2007) (stating that strict liability penalties could increase the number of executives for whom “criminal laws are just another cost of doing business”).
 See id.
 See Chris Kahn, Oil Giant ConocoPhillips To Split into 2 Companies (“This is so positive for [ConocoPhillips]. Everyone should stick to one business.”) (quoting Oppenheimer & Co. analyst Fadel Gheit).
 See, e.g., Stephen M. Bainbridge, Dodd-Frank: Quack Federal Corporate Governance Round II, 95 Minn. L. Rev. 1779, 1812 (2011) (“There is no more basic question in corporate governance than ‘who decides.’ . . . Corporate law generally adopts what I have called ‘director primacy.’ It assigns decisionmaking to the board of directors or the managers to whom the board has properly delegated authority.” (footnotes omitted)).
 See Lerner & Yahya, supra note 1, at 47
 See id.
July 28, 2011
The SEC, the D.C. Circuit, and the Rule of Law
Earlier this week, Steve posted an interesting list of many of the recent cases the SEC has lost in the D.C. Circuit (including the latest proxy access case). Steve closed by noting that "an agency has to work really hard to lose this much," and that he was "inclined to think that the SEC simply doesn't care enough about the rule of law." That may be true, but if a lack of respect for the rule of law is an issue here (and that's a big "if"), then I'd like to add that the D.C. Circuit may also be deserving of some criticism. Steve himself notes that "the Financial Planning case is just bad statutory interpretation by the court." To that one can add Brett McDonnell's comments regaring the proxy access case that I posted here (remember, we are talking about the court concluding that the SEC acted arbitrarily and capriciously):
The SEC's documents proposing and finalizing the rule are about extensive as I have ever seen from that agency, and they had voluminous comments from all sides to help guide them. The D.C. Circuit cherrypicks areas where it asserts the SEC didn't do enough. It will almost always be possible to do that with any agency rulemaking. Requiring that level of deliberation could well make the task of rule-writing for Dodd-Frank more daunting still. This opinion is little more than the judges ignoring the proper judicial rule of deference to an agency involved in notice-and-comment rulemaking and asserting their own naked political preferences. Talk about judicial activism.
To this I would also add Jay Brown's take:
In some respects, the DC Circuit's decision … is a grave disappointment. The SEC has the authority to adopt an access rule, that was confirmed in Dodd-Frank. The rule was carefully crafted and vetted over a year long process. The panel, however, didn't like the rule and imposed an almost impossible burden on the SEC. It wasn't enough, for example, for the SEC to conclude that access could benefit boards and point to some studies making that point. Instead, the Agency had to rely on the right studies. The opinion criticized those used by the SEC but did not do the same with respect to those on the other side. In other words, it is clear that the court agreed with one side but not the other. One way or another that panel was going to strike down the rule. That the DC Circuit would issue a political decision is no real surprise. The circuit is full of judges who likely were too controversial for their home state senators to nominate. Without senators in Congress, DC has no politicians who can object to the White House nominees. As a result, the White House has a free hand and can more easily appoint controversial idealogues…. What the case shows is how far behind the courts are with respect to the evolution of the corporate governance process. Two of the [three] judges on the panel were appointed by President Reagan at the height of the law and economics movement. That was the hey day of deregulation and the view that the market can resolve all issues. The shallowness of that philosophy was brought home in the most recent recession. But it is clear that this panel views interference in the management prerogative with disfavor and does not need much excuse to overturn it.
Business Law Teaching Opportunities
My law school, the University of Nebraska-Lincoln, is looking for two new faculty members in the business law area—one to teach in the Business Associations area and another to direct a new Entrepreneurship Clinic. Here’s the description:
The University of Nebraska College of Law invites applications for three tenure-track faculty positions focusing on teaching in several areas, including business associations as well as other transactional law courses such as corporate finance and governance, transactional skills courses, securitization, venture capital, entrepreneurship, trusts and estates, and federal estate and gift tax. The College also invites applications for a tenure-track faculty position to direct its Entrepreneurship Clinic. The Director will be involved in the design of this new clinic and will be the supervisor of third-year law students.
If you’re interested and aren’t totally put off by the thought of working with me, or if you know someone who’s interested, the contact person is Professor Richard Moberly, Chair, Faculty Appointments Committee, University of Nebraska College of Law, Lincoln, NE 68583-0902, or send an email to email@example.com. Don’t contact me; after two consecutive years on our appointments committee, I have escaped through the simple expedient of taking a research sabbatical.
July 27, 2011
The Swashbuckler Problem: Rethinking Increased Liability
I have been a critic of BP and their role in the Deepwater Horizon disaster that dumped to 4.9 million barrels of oil into the Gulf Mexico, but that doesn’t mean I think we need a vast set of new laws to help avoid the problem in the future. In my research for a current project questioning the value of drastic new laws increasing penalties, while reducing the mens rea requirements, for environmental law violations, I came across an interesting article about Sarbanes-Oxley that I thought was worth passing along. Regardless of your views on Sarbanes-Oxley, it’s worth a look.
The article is ‘Left Behind’ after Sarbanes-Oxley, by Craig S. Lerner (George Mason University) & Moin A. Yahya (University of Alberta), and the pdf is available here:
The “Left Behind” from our title is an allusion to the series of novels that are based on the religious doctrine of Rapture — that is, the doctrine that believers will, “in the twinkling of an eye,” be taken body and soul into heaven. Left behind here on earth, according to this view, will then be the unbelievers and the unrighteous. Likewise, albeit on a rather more mundane note, we propose to ask whether, in the wake of criminal laws such as Sarbanes-Oxley, certain kinds of corporate executives may decide to flee the scene and, if they do, what sort of men and women will be left behind. We suggest that there may not only be growing numbers of risk-averse “bean counters,” there may also be an emerging class of entrepreneurs whom we call “swashbucklers.” These men and women have no special regard for the strictures of the criminal law and they may thrive in the post-Sarbanes-Oxley world.
More on this project later, but suffice it to say, my project has made me question a number of assumptions, and articles like the one above have me rethinking my views on a number of things, including this post from a few weeks ago.
July 26, 2011
Levinson on Workplace Privacy
Ariana R. Levinson has posted Workplace Privacy and Monitoring: The Quest for Balanced Interests on SSRN with the following abstract:
This article describes some of the difficulties for employers and employees resulting from advancing technology. It briefly describes some of the technology available to employers with which to monitor employees. The article then provides an overview of the primary sources of law governing employer monitoring and employee privacy, such as the Electronic Communications Privacy Act, state statutes providing for notice of monitoring or protection of the integrity of personnel records or lawful off-duty activity, the tort of invasion on seclusion, and the Fourth Amendment. The article concludes by offering suggestions for attorneys who represent employers, employees, or unions and are interested in addressing these issues. Attorneys and their clients can advocate for federal or state legislation, address these issues in collective bargaining or through private policies, or become involved in educational efforts.
-- Eric C. Chaffee
July 25, 2011
The SEC and the D.C. Circuit
The Court’s recent opinion in the proxy access case has received a lot of attention. Here are some posts from others reacting to that decision: Steve Bainbridge, Gordon Smith, J. W. Verret, Larry Ribstein. Steve Bainbridge has a summary of other responses here. I won't add to that ample commentary. But it seems the SEC is on a real losing streak in the D. C. Circuit. Here are the losses in the last dozen years that I’m aware of. I haven’t done extensive research, so there might be more.
- Business Roundtable v. SEC (“Business Roundtable II) (D.C. Cir. 2011)
SEC’s adoption of proxy access rule violated the Administrative Procedure Act because the SEC “inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.”
- American Equity Investment Life Ins. Co. v. SEC, 613 F.3d 166 (D.C. Cir. 2010)
SEC’s adoption of a rule excluding fixed index annuities from the Securities Act exemption for annuity contracts violated the Securities Act because the SEC failed to adequately consider the effects of the rule on efficiency, competition, and capital formation
- Financial Planning Ass’n v. SEC, 482 F.3d 481 (D.C. Cir. 2007)
SEC rule exempting certain brokers from the Investment Advisers Act was inconsistent with the Act
- Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006)
SEC attempt to regulate hedge fund advisors was inconsistent with the Investment Company Act and with the SEC’s own prior interpretations of the Act
- Chamber of Commerce v. SEC (Chamber of Commerce I), 412 F.3d 133 (2005)
SEC’s adoption of corporate governance rules for mutual funds violated the Administrative Procedure Act because the SEC didn’t adequately consider either the cost of the rules or alternatives to the rules.
- Chamber of Commerce v. SEC (Chamber of Commerce II) , 443 F.3d 890 (D.C. Cir. 2006)
SEC again violated the Administrative Procedure Act by readopting the same rules approximately two weeks after the prior opinion
- Teicher v. SEC, 177 F.3d 1016 (D.C. Cir. 1999)
SEC order barring individual convicted of securities fraud from becoming associated with an investment adviser exceeded its statutory authority.
That list doesn't even include the first Business Roundtable case, 905 F.2d 406 (D. C. Cir. 1990), that held that the SEC exceeded its statutory authority under the Exchange Act in adopting the one share,one vote rule barring exchanges and NASDAQ from listing common shares with unequal voting rights.
You may not agree with the D.C. Circuit’s position in all of these cases. My personal opinion is that the Financial Planning case is just bad statutory interpretation by the court. But it seems to me that an agency has to work really hard to lose this much. J. W. Verret argues that the most recent opinion illustrates that the SEC “is an agency with too many lawyers and not enough economists.” With this string, I’m more inclined to think that the SEC simply doesn't care enough about the rule of law.
Policy Paper: Ineffective Federal Transmission Policy
As regular readers know, I do much of my writing in the energy area, often considering how energy regulation and legislation could or does impact energy markets and businesses. While I don't expect that the energy sector has the same appeal for all business-law types, it is my hope that, at least once in a while, there is something of value in energy-related posts for readers of varying interests. I truly believe that our energy future is our business future. Admittedly, there is also an element of self-promotion here.
With that said, the Center for Energy and Environmental Law at the University of Connecticut School of Law posted a policy paper of mine this week, Reliably Unreliable: The Problems with Piecemeal Federal Transmission and Grid Reliability Policies (pdf).
Here's a part of the executive summary:
In the past, electricity was considered a local concern, but over time major portions of the electrical grid have become regional, national, and even international in scope. Electricity regulation has evolved into a complex web of multijurisdictional oversight, and this evolution has created both tensions and opportunities. National legislation and regulation have helped increase reliability, diversify the fuel mix for electricity generation, and create a more open market for electricity. However, national regulation designed to enhance open markets also created opportunities for abuse. In addition, the increasing level of federal oversight has led to conflicts between state and federal entities as the traditional sense of local control over siting and delivery of electricity has been eroded.
. . . .
There is no shortage of effort at the state, regional, and federal levels to improve [electricity grid] reliability and safety. Unfortunately, in many cases, the efforts have been competitive with other energy-related policies (such as climate change initiatives and renewable energy mandates), and jurisdictional conflicts have obstructed, rather than facilitated, many such efforts. It is time for Congress to provide clear authority to someone to make and coordinate changes. A failure to act to preserve and improve the safety and reliability of our electric system would be a costly and avoidable failure. And that is something no one can afford.
July 24, 2011
Alces on Corporate Governance
Kelli A. Alces has posted Beyond the Board of Directors on SSRN with the following abstract:
The law of corporate governance places the board of directors at the top of the corporate decisionmaking structure. So, accountability for corporate decisions rests primarily on the shoulders of part-time employees who lack the time and thorough knowledge of the firm necessary to perform the board’s duties effectively. Corporate governance scholarship is similarly preoccupied with the board of directors. Scholars have debated whether to enhance or diminish the board’s authority within the firm, but all accept that a board of directors should preside over corporate decisionmaking. This Article argues that scholars on both sides of the debate have missed the mark. The modern board of directors is ineffective to achieve its purposes. The time has come to envision a world beyond the board of directors.
In the modern public corporation, the board has been marginalized in favor of the powers exercised by the firm’s investors and senior officers. That reality is the product of market choices and is part of the natural evolution of corporate governance. Modern regulatory responses to various corporate scandals stand in the way of that sensible evolution toward more effective corporate governance. While the board structure we have now may be the product of prior market choices, it is the law, not the market, that preserves the vestigial board of directors’ role at the top of the corporate hierarchy. This Article argues that obstacles to the evolution of corporate governance should be removed and sketches a path that evolution may take leading to the eventual elimination of the board of directors. Eliminating the board of directors would mark a fundamental shift in the understanding of corporate governance, but, at the same time, would realign the law of corporate governance with the natural evolution the market has already initiated.
-- Eric C. Chaffee
Cooper and Kovacic on Behavioral Economics
James C. Cooper and William E. Kovacic have posted Behavioral Economics: Implications for Regulatory Behavior on SSRN with the following abstract:
Behavioral economics (BE) examines the implications for decision-making when actors suffer from biases documented in the psychological literature. These scholars replace the assumption of rationality with one of “bounded rationality,” in which consumers’ actions are affected by their initial endowments, their tastes for fairness, their inability to appreciate the future costs, their lack of self-control, and general use of flawed heuristics. We posit a simple model of a competition regulator who serves as an agent to a political overseer. The regulator chooses a policy that accounts for the rewards she gets from the political overseer – whose optimal policy is one that focuses on short-run outputs that garner political support, rather than on long-term effective policy solutions – and the weight she puts on the optimal long run policy. We use this model to explore the effects of bounded rationality on policymaking, with an emphasis on competition and consumer protection policy. We find that flawed heuristics (e.g., availability, representativeness, optimism, and hindsight) and present bias are likely to lead regulators to adopt policies closer to those preferred by political overseers than they otherwise would. We argue that unlike the case of firms, which face competition, the incentive structure for regulators is likely to reward regulators who adopt politically expedient policies, either intentionally (due to a desire to please the political overseer) or accidentally (due to bounded rationality). This sample selection process is likely to lead to a cadre of regulators who focus on maximizing outputs rather than outcomes.
-- Eric C. Chaffee
Wilmarth on Dodd-Frank
Arthur E. Wilmarth Jr. has posted The Dodd-Frank Act's Expansion of State Authority to Protect Consumers of Financial Services on SSRN with the following abstract:
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) created the Consumer Financial Protection Bureau (CFPB) and delegated to CFPB the combined rulemaking and enforcement authorities of seven federal agencies that previously were responsible for protecting consumers of financial services. Congress decided to establish a single federal authority dedicated to consumer financial protection after federal banking agencies failed to protect American homeowners from unsound and predatory lending practices during the housing boom that occurred between 2001 and 2006. Federal regulators allowed lenders to make more than 10 million high-risk mortgages during those years. When the housing bubble burst in 2007, unsound mortgages triggered millions of foreclosures, caused widespread bank failures and forced the federal government to adopt an unprecedented bailout program to stabilize the financial system.
Congress recognized that many states tried to stop predatory lending by enacting and enforcing consumer protection laws during the housing boom. However, two federal banking agencies – the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) – issued preemptive regulations that barred the states from enforcing their consumer protection laws against national banks, federal savings associations, and their subsidiaries and agents. Preemption enabled large national banks and federal thrifts to become leading providers of high-risk mortgage loans, with devastating consequences.
In response to the problems created by federal preemption, Dodd-Frank expands the lawmaking and law enforcement authority of the states in the field of consumer financial protection. Title X of Dodd-Frank empowers CFPB to issue regulations that establish a federal “floor” of consumer protection and authorizes the states to provide additional substantive safeguards to consumers. Dodd-Frank also permits state officials to enforce the statutory provisions of Title X as well as CFPB’s regulations and applicable state laws.
Dodd-Frank abolishes the OTS, limits the preemptive authority of the OCC and clarifies the states’ authority to enforce their consumer financial protection laws against national banks and federal thrifts. Under Title X’s new preemption standards, (i) state consumer financial laws apply to national banks unless they prevent or significantly interfere with the exercise of national bank powers; (ii) the OCC has authority to preempt state laws only on a case-by-case basis and only if its preemption determinations are supported by substantial evidence; (iii) state laws generally apply to the subsidiaries, affiliates and agents of national banks; and (iv) state attorneys general are authorized to enforce non-preempted laws against national banks through judicial enforcement proceedings.
By enabling states to construct additional safety measures on top of the federal “floor” of consumer financial protection, Title X of Dodd-Frank affirms the longstanding role of states as “laboratories of regulatory experimentation” in identifying emerging threats to consumer welfare and designing new legal rules to counteract those threats. In addition, the supplemental enforcement authority granted to states under Title X allows state officials to act as “normative entrepreneurs” by protecting their citizens from unfair, deceptive or abusive financial practices in situations where CFPB or other federal agencies might fail to act. Finally, the independent lawmaking and law enforcement powers delegated to the states by Title X provides important safeguards against the potential risk that CFPB could be “captured” over time by the financial services industry.
-- Eric C. Chaffee
Sarra and Pritchard on Securities Class Actions
Janis P. Sarra and Adam C. Pritchard have Securities Class Actions Move North: A Doctrinal and Empirical Analysis of Securities Class Actions in Canada posted on SSRN with the following abstract:
The article explores securities class actions involving Canadian issuers since the provinces added secondary market class action provisions to their securities legislation. It examines the development of civil liability provisions, and class proceedings legislation and their effect on one another. Through analyses of the substance and framework of the statutory provisions, the article presents an empirical and comparative examination of cases involving Canadian issuers in both Canada and the United States. In addition, it explores how both the availability and pricing of director and officer insurance have been affected by the potential for secondary market class action liability. The article suggests that although overall litigation exposure for Canadian companies remains relatively low when compared to their U.S. counterparts, Canadian issuers that have listed their shares in the U.S. face considerable uncertainty as to the extent of their exposure to securities class actions. Through analysis of case law in both jurisdictions, the article highlights the crucial role of liability caps relating to costs in the decision of which jurisdiction to file suit.
-- Eric C. Chaffee
Bushee, Jung, and Miller on Selective Investor Access to Management
Brian Bushee, Michael Jung, and Gregory Miller have posted “Do Investors Benefit from Selective Access to Management?” on SSRN. Here is the abstract:
We examine whether investors benefit from “selective access” to corporate managers, which we define as the opportunity for investors to meet privately with management in individual or small-group settings. We focus on two potential opportunities for selective access advantages at invitation-only investor conferences: formal “off-line” meetings outside of the webcast presentation and CEO attendance at the conference. We find significant increases in trade sizes during the hours when firms provide off-line access to investors and after the presentation when the CEO is present, consistent with selective access providing investors with information that they perceive to be valuable enough to trade upon. We also find significant potential trading gains over three- to 30-day horizons after the conference for firms providing formal off-line access, suggesting that selective access can lead to profitable trading opportunities. While we cannot conclusively determine that managers are providing selective disclosure in these off-line settings, our evidence does suggest that selective access to management conveys more benefits to investors than public access even in the post-Reg FD period.