October 22, 2011
Reporting Back From the Ohio Securities Conference
Yesterday, I had the privilege of participating in a panel discussion at the 2011 Ohio Securities Conference entitled, "Dodd-Frank: One Year Later." A complete list of the panelists, along with a link to related material follows:
Eric Chaffee: The Dodd-Frank Wall Street Reform and Consumer Protection Act: A Failed Vision for Increasing Consumer Protection and Heightening Corporate Responsibility in International Financial Transactions
Stefan Padfield: The Dodd-Frank Corporation: More than a Nexus of Contracts
Geoffrey Rapp (moderator): Legislative Proposals to Address the Negative Consequences of the Dodd-Frank Whistleblower Provisions: Written Testimony Submitted to the U.S. House Committee on Financial Services
October 21, 2011
The Need for Accounting Knowledge in Law Practice
Those of us who teach or practice business law understand the value of having at least some knowledge of accounting principles. But some of my students are skeptical about the need to understand accounting, particularly if they don’t intend to practice in the areas where accounting is obviously important—tax, corporate, and securities law.
I’m putting together a list of other practice areas where at least some basic knowledge of accounting would be beneficial. Here are some examples:
- Law practice: Running a law firm or supervising the administrators who do
- Law practice: Responding to audit inquiry letters
- Family law: Child support and alimony determinations
- Criminal law: Prosecuting or defending white collar crime
- Employment law: Dealing with the compensation of employees, particularly executives
- Labor law: Negotiating union contracts (Any NFL or NBA fan knows what I'm talking about.)
- Administrative law: Rate approvals for regulated industries.
I would appreciate any suggestions you might have for additions to the list. Again, I’m looking for examples in areas other than tax, securities, and corporate law.
Coal is Here to Stay. Really.
In case there was any doubt, coal is not going anywhere as an energy source for the foreseeable future. Today it was reported that Peabody Energy, the American coal company, is inching closer to acquiring Australia's Macarthur Coal with a $4.9 billion takeover offer (the Peabody offer is backed by Macarthur's largest shareholder).
For all the discussion of banning coal-fired plants and endless restrictions to new coal plants, those who own the resources continue to have a market. And as restrictions rise in the United States, the market internationally for coal simply expands. I admit, I prefer other fuel sources in most instances, but the reality is that coal provides relatively cheap and abundant power. "Clean coal," at least to date, is aspirational, not reality. But cleaner coal is a reality, and we can be doing more with it.
According to the Energy Information Administration, "coal-fired plants contributed 43.3 percent of the power generated in the United States. Natural gas-fired plants contributed 23.4 percent, and nuclear plants contributed 18.8 percent." Nearly half of our power comes from coal, and in many areas, a cost-effective and efficient fuel switch is not readily available. We have already learned that over reliance on natural gas can be a disaster, as that fuel's price volatility is legendary.
At some point, we need to start getting rid of the oldest coal plants offline. There shouldn't be much argument about that. (Of course, sometimes there is.) Part of that plan should be to replace the worst old plants with far better new ones. New coal-fired plants aren't clean, but they are without question cleaner.
If we're going to burn coal, we should be burning it as cleanly and efficiently as is possible. And as of today, I've got $4.9 billion more reasons why I'm sure we're going to burn it.
New Study Showing Public Disapproval of Corporate Political Spending
The University of New Hampshire Survey Center, an independent, non-partisan academic survey research organization, published a study earlier this month reporting on public opinion regarding elections, with several focused questions regarding corporate political spending, related disclosures, and corporate influence in government.
The key findings related to corporations are listed below:
- Almost Two-thirds (61%) of likely New Hampshire Republican Primary voters strongly disagree with the Supreme Court decision that political spending by corporations and unions is a form of free speech protected under the First Amendment.
- Just under three-quarters of likely GOP New Hampshire Primary voters (73%) strongly support a law that would require corporations, unions, and non-profits to disclose their sources of spending when they participate in elections. 11 percent somewhat support such a law, 3 percent somewhat oppose it, 4 percent strongly oppose it, and 9 percent don’t know.
- Seventy percent of likely New Hampshire Republican Primary voters would be more likely to support a candidate for President or Congress if the candidate supported a law that would require corporations, unions, and non-profits to disclose their sources of spending when they participate in elections. 6 percent would be less likely to support a candidate, 6 percent say it would have no effect on their support, and 18 percent don’t know.
October 20, 2011
The Dominance of Business Law Scholarship (affirming what we've long suspected)
Out of curiousity, I ran a search earlier today for the top legal scholars on SSRN and came up with the following results:
Four of the top ten legal scholars write in business and business-related areas. Below are links to the most recent AND the most popular articles from each.
- Most Recent: Concentrated Corporate Ownership: Stock Pyramids, Cross-Ownership, and Dual Class Equity: The Mechanisms and Agency Costs of Separating COntrol from Cash-Flow Rights (co-authored book chapter; abstract unavailable)
- Most Downloaded: What Matters Most in Corporate Governance (co-authored article)
Abstract (of the 2009 version): "We investigate the relative importance of the twenty-four provisions followed by the Investor Responsibility Research Center (IRRC) and included in the Gompers, Ishii, and Metrick governance index (Gompers, Ishii, and Metrick 2003). We put forward an entrenchment index based on six provisions: staggered boards, limits to shareholder bylaw amendments, poison pills, golden parachutes, and supermajority requirements for mergers and charter amendments. We find that increases in the index level are monotonically associated with economically significant reductions in firm valuation as well as large negative abnormal returns during the 1990-2003 period. The other eighteen IRRC provisions not in our entrenchment index were uncorrelated with either reduced firm valuation or negative abnormal returns."
- Most Recent: Public Reporting of HAI Rates: What We (Mostly Don't) Know (posted 9/10/11)
Abstract: "Health-care associated infections (HAIs) kill about 100,000 people annually; many are preventable. In response, 18 states currently require hospitals to publicly report their infection rates and national reporting is planned. Yet there is limited evidence on the effects of public reporting on HAI rates, and none on what elements of a reporting plan affect its impact on HAI rates. I review here what little we know, emphasizing my own case study of Pennsylvania."
- Most Downloaded: Does Corporate Governance Predict Firms' Market Value? Evidence from Korea (co-authored article)
Abstract: "We report strong OLS and instrumental variable evidence that an overall corporate governance index is an important and likely causal factor in explaining the market value of Korean public companies. We construct a corporate governance index (KCGI, 0~100) for 515 Korean companies based on a 2001 Korea Stock Exchange survey. In OLS, a worst-to-best change in KCGI predicts a 0.47 increase in Tobin's q (about a 160% increase in share price). This effect is statistically strong (t = 6.12) and robust to choice of market value variable (Tobin's q, market/book, and market/sales), specification of the governance index, and inclusion of extensive control variables. We rely on unique features of Korean legal rules to construct an instrument for KCGI. Good instruments are not available in other comparable studies. Two-stage and three-stage least squares coefficients are larger than OLS coefficients and are highly significant. Thus, this article offers evidence consistent with a causal relationship between an overall governance index and higher share prices in emerging markets. We also find that Korean firms with 50% outside directors have 0.13 higher Tobin's q (roughly 40% higher share price), after controlling for the rest of KCGI. This effect, too, is likely causal. Thus, we report the first evidence consistent with greater board independence causally predicting higher share prices in emerging markets."
- Most Recent: The Corporate Governance Provisions of Dodd-Frank (posted 10/28/10)
Abstract: "This essay provides a brief overview of the seven principal corporate governance provisions of The Wall Street Reform and Consumer Protection Act of 2010 (better known as “The Dodd-Frank Act”)"
- Most Downloaded: Insider Trading: An Overview
Abstract: "Insider trading is one of the most controversial aspects of securities regulation, even among the law and economics community. One set of scholars favors deregulation of insider trading, allowing corporations to set their own insider trading policies by contract. Another set of law and economics scholars, in contrast, contends that the property right to inside information should be assigned to the corporation and not subject to contractual reassignment. Deregulatory arguments are typically premised on the claims that insider trading promotes market efficiency or that assigning the property right to inside information to managers is an efficient compensation scheme. Public choice analysis is also a staple of the deregulatory literature, arguing that the insider trading prohibition benefits market professionals and managers rather than investors. The argument in favor of regulating insider trading traditionally was based on fairness issues, which predictably have had little traction in the law and economics community. Instead, the economic argument in favor of mandatory insider trading prohibitions has typically rested on some variant of the economics of property rights in information. A comprehensive bibliography is included."
- Most Recent & Most Downloaded: Two Faces: Demystifying the Mortgage Electronic Registration System's Land Title Theory (posted 9/19/10)
Abstract: "Hundreds of thousands of home foreclosure lawsuits have focused judicial scrutiny on the Mortgage Electronic Registration System (“MERS”). This Article updates and expands upon an earlier piece by exploring the implications of state Supreme Court decisions holding that MERS is not a mortgagee in security agreements that list it as such. In particular this Article looks at: (1) the consequences on land title records of recording mortgages in the name of a purported mortgagee that is not actually mortgagee as a matter of law; (2) whether a security agreement that fails to name an actual mortgagee can successfully convey a property interest; and (3) whether county governments may be entitled to reimbursement of recording fees avoided through the use of false statements associated with the MERS system. This Article concludes with a discussion of steps needed to rebuild trustworthy real property ownership records."
The Legality of the Declaration of Independence--and How to Determine Legality
This is a little off the business law track, so please indulge me. American and British lawyers recently debated the legality of the U.S. Declaration of Independence. The BBC News story, which excerpts some of the arguments is here and a story in the Wall Street Journal’s Law Blog is here.
The Wall Street Journal concludes “A vote at the end of the debate, held at Benjamin Franklin Hall, reaffirmed the legality of the insurrection.” Two things strike me as wrong about that comment.
First, the debate was held in Philadelphia. It’s hardly surprising that an American audience supported the Declaration of Independence. For a slighlty less biased reaction, check out the comments to the BBC story. I like the comment which states that the Declaration was completely illegal and its signers were traitors, then concludes “and it was the most wonderful event which ever happened in the history of the New World Colonies and for the American people.”
But what really bothers me about the Journal’s conclusion is the idea that a popular vote can determine whether something is legal. I’ve noted a disturbing trend, particularly in discussions of constitutional law, to equate majority opinion with legality. One reason we have the rule of law is to protect the minority from majority rule. An action that violates the law does not become legal just because the public approves. And an action within the law does not become illegal just because the public disapproves.
The Declaration of Independence was a wonderful action and it may have been legal, but no popular vote can ever make it so. And I suspect the Founders would agree with me.
Defining the Rights and Responsibilities of Corporations
Whether corporations are immune from tort liability for violations of the law of nations such as torture, extrajudicial executions or genocide, as the court of appeals decisions provides, or if corporations may be sued in the same manner as any other private party defendant under the ATS for such egregious violations, as the Eleventh Circuit has explicitly held.
Over at the Huffington Post, Mike Saks opines:
[I]t would ... be quite odd for the Court, which found in Citizens United that the Framers intended the First Amendment to apply to corporate persons, to reject the concept when it comes to corporate liability for crimes against humanity under a Founding-era statute.
October 19, 2011
Redwood on Securities Litigation
James D. Redwood has posted To Make or to Mar: The Supreme Court Turns Away Another Securities Law Plaintiff on SSRN with the following abstract:
The United States Supreme Court, in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), once again denied a remedy to securities law plaintiffs and further restricted the implied private right of action under Securities Exchange Act Section 10(b) and SEC Rule 10b-5. In Janus, the Court held that one, and only one, person or entity can “make” a material misstatement under Rule 10b-5(b), namely that person or entity with “ultimate authority over the statement, including its content and whether and how to communicate it.” 131 S. Ct. at 2302. As a result, an investment adviser to mutual funds that issued misleading statements in investor prospectuses could not be held liable as a “maker” of those misstatements, notwithstanding substantial evidence indicating that the adviser made almost all management decisions for the funds and controlled almost every aspect of their work.
This article takes issue with the restricted meaning given by the Court to the word “make” and argues that the Court’s reading of the term was justified neither as a linguistic nor as a legal matter. Utilizing the dictionaries cited by the Court, the article plumbs the myriad meanings of “make” and reasons that the Court was not justified in substituting a “test” for a “definition.” The article also questions the Court’s holding that the funds and the adviser enjoyed separate corporate existences. Although such a “veil-piercing” analysis might be relevant had the plaintiffs proceeded on the theory that the defendants operated as a “single economic entity,” such an approach is inappropriate where, as here, the plaintiff’s claim sounds in fraud. Finally, the article suggests a “test” of its own for who is a “maker” and urges the Court to examine the benefit to the defendant from prospectus misstatements, rather than focusing on the artificial issue of who exercises “ultimate authority” over those misstatements.
-- Eric C. Chaffee
Murray and Hwang on L3Cs
J. Haskell Murray and Edward I. Hwang have posted Purpose with Profit: Governance, Enforcement, Capital-Raising and Capital-Locking in Low-Profit Limited Liability Companies on SSRN with the following abstract:
Described as a “for-profit with a nonprofit soul,” the low-profit limited liability company (“L3C”) is a relatively recent hybrid business entity form, designed to occupy the space between for-profit and nonprofit companies. The L3C is designed to prioritize charitable, educational and certain social purposes like a nonprofit while allowing investors to share in the company’s income and equity like a for-profit entity. L3Cs burst onto the corporate law scene in 2008 when Vermont legislators amended state LLC statutes, authorizing the formation of L3Cs, as a type of LLC, in that state. As of August 29, 2011, eight additional states and the federal jurisdictions of The Crow Indian Nation of Montana and The Oglala Sioux Tribe have passed similar L3C statutes. By the end of August 2011, 440 L3Cs were registered.
L3Cs have proved polarizing. Supporters of L3Cs tout the form as a solution for social entrepreneurs to pursue an overtly social mission and to access capital more easily from both nonprofit and for-profit sources. On the other hand, a number of vocal critics contend that other available legal forms make the L3C redundant and that the L3C is susceptible to abuse. In this article, we take a middle ground approach. We recognize the lack of clarity or flaws in the limited law surrounding L3Cs but believe the issues remediable. After detailing the history of L3Cs and the debates surrounding the form, we identify four main problem areas: (1) governance; (2) enforcement; (3) capital-raising; and (4) what we call “capital-locking.”
In response to these four main problem areas, we offer suggestions to make the L3C more workable for its socially-conscious managers, investors, and the public. First, we recognize that L3C managers are bound by social purpose primacy, but argue they should be given latitude vis-à-vis the business judgment rule to pursue profit-making that may ultimately serve the L3C’s social purpose. Second, from an enforcement perspective, we observe that social investors should have standing to sue to enforce adherence to the entity’s social purpose. Third, in addressing the capital-raising issues surrounding L3Cs, we reject the capital tranching model which suggests that traditional investors will able to obtain market-rate returns on the backs of social investors who may be asked to receive little or no returns. We consider such practices at odds with the social purpose primacy of L3Cs and may provoke a response by the Internal Revenue Service. To fill the gap in the capital structure left by the proposed absence of traditional investors we suggest that L3Cs make use of crowd-funding capital, in addition to funding from foundations, nonprofits, and other socially-conscious investors. Finally, we argue that capital committed by social investors to L3Cs, and profit stemming from that capital, should be locked into the “social stream.”
-- Eric C. Chaffee
The Zapata of Acquisitions?: Special Committees Must Act Like Third Parties
As noted in an earlier post, a Delaware court (pdf here) determined that Southern Peru Copper Corp.'s directors were improper (to the tune of $1.2 billion in damages) in following its special committee's recommendation to purchase Minera for $3.1 billion in Southern Peru stock. The court explained that the special committee violated its fiduciary obligations by not leveraging its position in the same way a third party would in that situation. The court explains:
In other words, the Special Committee did not respond to its intuition that Southern Peru was overvalued in a way consistent with its fiduciary duties or the way that a third-party buyer would have. As noted, it did not seek to have Grupo Mexico be the buyer. Nor did it say no to Grupo Mexico’s proposed deal. What it did was to turn the gold that it held (market-tested Southern Peru stock worth in cash its trading price) into silver (equating itself on a relative basis to a financially-strapped, non-market tested selling company), and thereby devalue its own acquisition currency. Put bluntly, a reasonable third-party buyer would only go behind the market if it thought the fundamental values were on its side, not retreat from a focus on market if such a move disadvantaged it. If the fundamentals were on Southern Peru’s side in this case, the DCF value of Minera would have equaled or exceeded Southern Peru’s give. But Goldman and the Special Committee could not generate any responsible estimate of the value of Minera that approached the value of what Southern Peru was being asked to hand over.
Note that the court here was evaluating this case for entire fairness, and not considering the applicablity of the business judgment rule. Here, "the defendants with a conflicting self-interest [had to] demonstrate that the deal was entirely fair to the other stockholders." They failed.
The court specifically states, "[T]here is no need to consider whether room is open under our law for use of the business judgment rule standard in a circumstance like this, if the transaction were conditioned upon the use of a combination of sufficiently protective procedural devices." In essence, the court (appropriately) declines to answer here whether there might be a similar circumstance where the court might treat a special acquisition committee like a special litigation committee. If so, in this instance, I'm thinking a Zapata-like test might be the right call.
That is, when (like in Southern Peru) "a controlling stockholder stands on both sides of a transaction" (to parallel Zapata):
First, the Court should inquire into the independence and good faith of the committee and the bases supporting its conclusions. . . . The corporation should have the burden of proving independence, good faith and a reasonable investigation, rather than presuming independence, good faith and reasonableness. . . . .
[Second, t]he Court should determine, applying its own independent business judgment, whether the [acquisition price was reasonable.] . . . The second step is intended to thwart instances where corporate actions meet the criteria of step one, but the result does not appear to satisfy its spirit, or where corporate actions would simply [ratify an improper valuation to the detriment of disinterested shareholders.]
On the one hand, this might be over broad and limit the ability of a company to take advantage of an opportunity uniquely available to it by virtue of the controlling shareholder. Still, it seems to me that, just as in Southern Peru, the court is capable of making this assessment. If the special committee can justify the transaction, then it should have before supporting the deal. If not, the court will take a closer look. Note that this would only apply where there was a controlling shareholder on both sides of the transaction, and not in other arm's length deals, where the business judgment rule is the proper test.
Perhaps this is giving the court too much of a role, but I think they got it right in Southern Peru, and that may translate in other contexts, too.
October 18, 2011
Pendulum Swing in the Market
At the end of the second quarter, Goldman Sachs reported a $1.85 per share earnings and Bank of America reported a per share decrease of $.99 after an $8.8 billion loss. Today, the tables have turned with the third quarter filings. Goldman Sachs is reporting a $.85 per share loss after a $428 million loss and Bank of America is reporting a $.56 per share gain after a $6.8 billion profit. The Bank of America turn around may be short lived, however, as the boost in earnings is due, in part, to certain asset sales boosting cash and "one-time accounting adjustments." Bank of America also remains exposed to investment risks ($485 million) in Greece. Goldman Sachs, on the other hand, attributes the deflated earnings to a bad investment in the Industrial and Commercial Bank of China that resulted in a $1 billion loss and low returns in other equities.
The switch in positions and the underlying reasons highlight the volatility that remains in the financial markets.
October 17, 2011
Readings on Capitalism
I’m a fan of capitalism, but I think it’s been so long since we’ve tried it that few in the United States remember what it is. Capitalism is not the same as government support of business. Far from it, true capitalism requires government to remain neutral and not try to determine the winners and losers. Subsidies and government bailouts are as far from capitalism as one can get, notwithstanding the recent claims in the media that “capitalism” caused the recent economic collapse.
So what is capitalism and what are its advantages? That topic is much too complicated for a blog post and, as a law professor, I’m not the most qualified person to expound on the subject anyway. I can, however, suggest a few resources for those who really want to know more about capitalism. I would start with the following three books. Each is very well written and none of them demand any technical expertise of the reader.
1. Milton Friedman, Capitalism and Freedom
2. Arthur Seldon, Capitalism (Unfortunately, this book doesn’t appear to be available for purchase by itself anymore, but you might find it in your local library. Otherwise, you will have to buy this.)
3. F. A. Hayek, The Road to Serfdom
Two other books worth reading if you’re interested in cutting through some of the nonsense that passes for political debate about economics are:
1. David R. Henderson, The Joy of Freedom: An Economist’s Odyssey
And, if you really want to burrow deeply, I suggest Ludwig von Mises, Human Action: A Treatise on Economics. But don’t go there unless you have a lot of time and are willing to work. It’s not an especially easy read.
Business-related cases and the Supremes
With the final round of 2011 oral arguments before the Supreme Court under way, I became curious to see what business and business-related cases are before the Supreme Court. The October/November calendar is available here. Below is a quick topical list with links to cases and supporting documents.
Insider trading statute of limitations
- Credit Suisse Securities v. Simmonds (to be argued Nov. 29th)
Copyright and patent issues
- the ability to revive a copyright-- Golan v. Holder (argued Oct. 5th)
- the ability to patent blood tests used to detect a breast cancer-indicative gene: Mayo Collaborative Services v. Prometheus Laboratories, Inc. (to be argued Dec. 7th)
- Kurns v. Railroad Friction Products Corp. (to be argued Nov. 9th)
- National Meat Association v. Harris (to be argued Nov. 9th)
Federal jurisdiction for private suits under the Telephone Consumer Protection Act
- Mims v. Arrow Financial Services, LLC (to be argued Nov. 28th)
Constitutionality of certain lawsuits under the Real Estate Settlement Services Act
- First American Financial Corp. v. Edwards (to be argued Nov. 28th)
Role of private arbitration under the Credit Repair Organizations Act
$1.236 Billion of Foreshadowing in Delaware
On October 14, 2011, Chancellor Strine issued the opinion, In re Southern Peru Copper Corporation Shareholder Derivative Litigation, C.A. No. 961-CS (Del. Ch. Oct. 14, 2011). As noted by Francis Pileggi, the opinion has more than 100 pages dedicated to explaining the myriad ways the company's directors breached their fiduciary duties.
When I first started reading the case, I couldn't help but think about receiving the opinion if I were an attorney on the case or one of the litigants. When I was in practice, it was FERC opinions or orders issued by an ALJ or the Commission, and I remember reading anxiously for hints in the first few paragraphs of where it was headed. This case had more than a billion dollars on the line, so I have to imagine everyone involved started reading it the moment they knew it was available.
So here's the start of In re Southern Peru Copper Corporation:
This is the post-trial decision in an entire fairness case. The controlling stockholder of an NYSE-listed mining company came to the corporation’s independent directors with a proposition. How about you buy my non-publicly traded Mexican mining company for approximately $3.1 billion of your NYSE-listed stock? A special committee was set up to “evaluate” this proposal and it retained well-respected legal and financial advisors.
The financial advisor did a great deal of preliminary due diligence, and generated valuations showing that the Mexican mining company, when valued under a discounted cash flow and other measures, was not worth anything close to $3.1 billion. The $3.1 billion was a real number in the crucial business sense that everyone believed that the NYSE-listed company could in fact get cash equivalent to its stock market price for its shares. That is, the cash value of the “give” was known. And the financial advisor told the special committee that the value of the “get” was more than $1 billion less.
Rather than tell the controller to go mine himself, the special committee and its advisors instead did something that is indicative of the mindset that too often afflicts even good faith fiduciaries trying to address a controller. Having been empowered only to evaluate what the controller put on the table and perceiving that other options were off the menu because of the controller’s own objectives, the special committee put itself in a world where there was only one strategic option to consider, the one proposed by the controller, and thus entered a dynamic where at best it had two options, either figure out a way to do the deal the controller wanted or say no.
As is probably clear, the special committee did not say no. And as you probably gathered, the court imposed roughly $1.236 billion in damages for their chosen course of action. There are 100 pages of explanation, but it was pretty clear where this one was going after about line four of the opinion.
October 16, 2011
"Poker for Law Students" Course Update
I've previously written about my desire to teach a "Poker for Law Students" course (here). To that end, I am always on the lookout for supporting documentation and course materials (as I've also previously blogged about here). So, just in case this sort of thing interests you I thought I'd pass on a couple of additional items I've come across recently:
1. A PokerNews item on "Poker Players and Entrepreneurs: A Compatible Match"