Saturday, February 28, 2015
This seems to have been a great week for business stories with a touch of the absurd.
First up, we have Footnoted.org's fantastic catch in Goldman's 10-K. Apparently, Goldman now has a new risk factor:
[O]ur businesses ultimately rely on human beings as our greatest resource, and from time-to-time, they make mistakes that are not always caught immediately by our technological processes or by our other procedures which are intended to prevent and detect such errors. These can include calculation errors, mistakes in addressing emails, errors in software development or implementation, or simple errors in judgment. We strive to eliminate such human errors through training, supervision, technology and by redundant processes and controls. Human errors, even if promptly discovered and remediated, can result in material losses and liabilities for the firm.
We can only speculate as to what specific, as-yet-undisclosed, human error prompted this disclosure, but if I had to make a bet, my money would be on an email address auto-fill mistake that is now the subject of some behind-the-scenes settlement discussions, the details of which will only come to light if negotiations fail and a public lawsuit is filed.
Next up, we have a Hunger-Games inspired video created by Morgan Stanley for its branch managers' meeting. The 10-minute long video depicts branch managers forced to compete to the death to maintain their positions. Apparently, Morgan Stanley shelved the video (which cost $100K to produce) out of concern that it displayed a certain callousness towards the actual real life people who were losing their jobs. So, now, of course, to demonstrate its sensitivity, Morgan Stanley has launched an internal investigation to discover the identity of the person who leaked the video.
Also, the Supreme Court decided Yates v. United States, concerning whether the disposal of undersized fish counted as the destruction of a tangible object intended to impede a federal investigation, in violation of the Sarbanes-Oxley Act. The Court held that it did not. Others have explored the implications of Yates for Obamacare and the case against Dzhokhar Tsarnaev's friends, but I'm far more interested in the headlines the case inspired, including In Overturning Conviction, Supreme Court Says Fish Are Not Always Tangible, Supreme Court: One Fish Two Fish Red Fish Blue Fish (a reference to Justice Kagan's dissent, which cited Dr. Seuss), Fisherman let off the hook in U.S. white-collar crime ruling, High Court SOX Fish Ruling Cuts Hole In Prosecutors’ Net, Supreme Court Throws Prosecutors Overboard in Fisherman Case, Supreme Court tosses ‘fishy’ conviction of Florida fisherman into the drink, and my personal favorite, Cortez case: Small fish, wide net.
Last but not least, the dress may be blue - but it's been nothing but green for the British retailer that sells it. (BuzzFeed didn't do so badly, either; it had to increase its server capacity by 40% to handle dress-related traffic.)
Saturday, February 21, 2015
One of the enduring debates in corporate law concerns whether shareholder empowerment promotes short-termism - i.e., temporary boosts in stock prices that can only be achieved at the expense of longer-term value-building projects, like research and development. Related to this debate is the argument - championed by, among others, Margaret Blair and Lynn Stout - that directors cannot/should not be solely concerned with shareholder wealth maximization; instead, their role is to mediate among various firm stakeholders. This is because a firm cannot thrive unless it offers a credible commitment to its employees and other corporate constituents that they will not be ousted the moment it appears profitable to do so. In other words, in order to induce employees and other stakeholders to invest valuable human capital in the firm, these actors must believe that the firm is committed to them - that shareholders are barred from, for example, insisting on downsizings or outsourcings or what-have-you the moment it appears that doing so will create a share price bump.
Martijn Cremers and Simone Sepe weigh in on this debate in a new paper, Whither Delaware? Limited Commitment and the Financial Value of Corporate Law(summarized here), where they conclude that protections for incumbent management - in the form of strong antitakeover statutes - are associated with higher firm values, in firms where long-term commitment is particularly necessary for profitability. In particular, they classify Delaware as a state where antitakeover protections are not strong, and find that incorporation in Delaware reduces firm value for companies that rely on long-term relationships, as compared to states where antitakeover protections are stronger. The basic idea here is that when management is insulated from shareholder pressures and the market for corporate control, management can more credibly commit to longer term projects and relationships that may not be immediately profitable.
The findings are, of course, extremely interesting and merit further analysis, but I have some difficulty with the premise that underlies their study, namely, that Delaware's antitakeover protections are weaker than those in the comparator states. Most obviously, one of the ways that the study classifies a state as "managerial" is if it has a business combination statute that prohibits transactions between an acquirer and target for 5 years. While it's true that Delaware's antitakeover statute is not quite as draconian - Delaware prohibits combinations for only 3 years as opposed to 5, and can be avoided if the acquirer increases its holdings from under 15% of the target to 85% in a single tender offer - the reality is, as has been documented elsewhere, Delaware's antitakeover law is more than sufficient to block hostile acquisitions.
Given that, antitakeover statutes that are even more extreme than Delaware's because they include a 5 year limitation instead of a 3 year one are gilding the lily; it's not clear why firms incorporated in those states should offer any more of a credible commitment to long-term stakeholders than firms incorporated in Delaware. And by my count, the study classifies 10 states as "managerial" based solely on this criterion, including New York and New Jersey.*
Additionally, the study is based on an analysis of firm value before and after reincorporation - in and out of Delaware, or in and out of the comparator states. But most reincorporations are associated with particular transactions that can be expected to affect firm value (a point which has been used to criticize post-reincorporation-value studies in the past, as Cremers and Sepe acknowledge in their paper). So I have to wonder whether there are some other factors that are driving the reincorporations and the selection of jurisdiction, and those other factors are having the observed effect.
*32 states have business combination statutes along these lines, making it even more unlikely that the 10 states identified as "managerial" according to this criterion (i.e., based on the 5 year rather than 3 year limit) actually offer any special signaling value regarding management's long-term commitments.
Saturday, February 14, 2015
The news this week in shareholder rights is that GE joined the list of companies that have voluntarily enacted their own bylaws permitting large shareholders to nominate directors to be included on the company proxy.
GE's action comes in the midst of a publicly-announced campaign by the New York City Comptroller to gather support for shareholder-enacted bylaws that would do roughly the same thing. (And a very ugly battle over such bylaws at Whole Foods, as Marcia previously posted.)
In that context, GE’s move seems like something of a Trojan horse. By enacting its own bylaw, GE preempts any attempts by shareholders to do so. Meanwhile, because the bylaw is director-enacted, GE can yank it at any time – like, if it feels there’s a coherent movement that threatens the current board’s dominance. In fact, this strategy was recently on display when Rupert Murdoch announced an unsolicited takeover of Time Warner. The first thing Time Warner’s board did was to repeal a director-enacted bylaw that permitted shareholders to call special meetings.
As a result, I’m not quite yet ready to call this a great win for shareholder democracy.
Saturday, February 7, 2015
In their new paper, Rating Agencies and Information Efficiency: Do Multiple Credit Ratings Pay Off?, Stefan Morkoetter, Roman Stebler, and Simone Westerfeld study whether it benefits investors to have more than one rating agency rate a particular security.
They find that when multiple rating agencies rate a particular tranche of a mortgage-backed security, not only is the initial rating more accurate, but the agencies devote more efforts to ongoing surveillance, increasing the accuracy of the rating over the life of the tranche. They conclude that the increased efforts are traceable to a healthy competition among agencies; as the authors put it, “Since their activities are directly bench-marked to their peers’, rating agencies are induced to show more effort with regard to their monitoring obligations than observed for single-rated tranches.”
One of the reasons the paper is interesting is because Dodd Frank and the SEC implementing regulations impose new restrictions on conflicts of interest within credit ratings agencies, basically forbidding anyone from the business side from having any involvement with the ratings themselves. In light of Morkoetter et al’s conclusions, I do have to wonder whether at least some business-side involvement with the ratings process creates a healthy sort of competition.
Morkoetter, Stebler, and Westerfeld also find that of the three major ratings agencies, Moody’s was consistently the most conservative both at issuance and over a tranche’s lifetime (which, they conclude, may be why Moody's has a very small market share of single-rated tranches). That would certainly explain why S&P was first sued by DoJ (although Moody’s may be next), but it seems inconsistent with the allegation – offered by DoJ both in its complaint and in the stipulated facts in the S&P settlement – that S&P routinely relaxed its ratings criteria to be more like Moody’s.
Saturday, January 31, 2015
Jonas Heese has posted an interesting paper to SSRN, Government Preferences and SEC Enforcement, where he argues that the SEC goes easy on firms that contribute significantly to employment in a particular area. He finds that the effect is magnified in presidential election years in swing states, and for firms that are headquartered in districts senior congresspersons who have SEC oversight responsibilities. This effect cannot be explained by the hypothesis that labor-intensive firms simply have better accounting; according to Hesse, they actually have worse accounting than other comparable businesses (which may in fact reflect their knowledge that the SEC is less likely to target them). He concludes, essentially, that the SEC is responding to political/voter pressures to take a hands-off approach to firms that are responsible for providing jobs.
One of the interesting points he makes is that this kind of pressure is independent of “special interest” lobbying; rather, this kind of pressure is a result of government actors responding to voter preferences.
The paper is available for download here.
Saturday, January 24, 2015
The Second Circuit just split from the Ninth in Stratte-Mcclure v. Stanley, 2015 U.S. App. LEXIS 428 (2d Cir. N.Y. Jan. 12, 2015) regarding whether a company violates Section 10(b) - and is subject to private lawsuits - for failure to disclose required information. The holding would be well-positioned for a Supreme Court grant except that it was not outcome determinative, functionally insulating the decision from Supreme Court review. But this is definitely a split to watch in the future.
[More under the jump]
Saturday, January 17, 2015
In their new article, Litigation Discovery and Corporate Governance: The Missing Story About the ‘Genius of American Corporate Law,’ Érica Gorga and Michael Halberstam argue that the U.S.’s unique, liberal discovery standards in private civil litigation have had an important role in shaping the content of corporate law.
They make a number of interesting claims in the paper, including that civil discovery provides detailed data for courts and regulators to use when creating legal standards, and that the omnipresent threat of civil discovery forces corporate managers to run their companies with more care: they must engage in extensive internal monitoring and recordkeeping in order to protect themselves should a dispute arise. Additionally, the internal process of having attorneys and other experts review documents in anticipation of litigation – even if the documents are never turned over to the plaintiffs – generates information that assists managers, in their monitoring roles, and assists gatekeepers – attorneys, experts, etc – in understanding both the specific firm targeted and the industry in general. Gorga and Halberstam also argue that the standards for adequacy of corporate internal investigations – which themselves play a growing role in corporate governance – are informed by the standards set by civil discovery in litigation. Finally, the authors argue US Style corporate governance and securities laws cannot be easily exported to legal systems that do not have civil discovery, because civil discovery is a necessary part of the US’s ex post enforcement mechanism.
I found the paper very interesting, and I agree that discovery is critical to a regime that depends on private ex post litigation to enforce legal rules. That said, I think the authors do not give sufficient weight to the argument that corporate managers – aware of civil discovery – are incentivized to keep records to the bare minimum necessary to establish that they met their obligations. Board meeting minutes, for example, are often extremely sparse, describing the basic agenda and topics covered, but giving no sense of the color and tenor of the discussion. High level corporate officers have been known to refuse to use email at all for fear of generating incriminating electronic trails. There are limits to managers’ ability to protect themselves this way – modern business often requires electronic communication, and god knows every litigator has, at one point or another, dug up the incriminating email trail that finishes with someone saying “DELETE THIS.” But the point remains that the possibility of discovery can be just as much of an incentive for managers to create misleadingly exculpatory paper trails as to engage in careful monitoring.
Saturday, January 3, 2015
Okay, fine, that’s not what the Second Circuit formally held, but to be honest, I can’t read this decision any other way.
I’ve blogged about this issue before here, here, and here. Basically, the situation is this: In the class action context, there is frequently an issue as to whether the named plaintiff’s own individual claims against the defendant are sufficiently similar to the claims of the rest of the class so as to allow the named plaintiff to sue in a representative capacity. Historically, these issues have been resolved via Rule 23 of the Federal Rules of Civil Procedure, which, among other things, requires a court to decide whether there is “commonality” among the class members, whether the common issues predominate over the individual ones, whether the named plaintiffs’ claims are typical of those of absent class members, and whether the named plaintiff will serve as an adequate representative for the absent class members. Rule 23, of course, is only invoked after there has been substantial discovery, and certification determinations under Rule 23 frequently include expert analysis.
In the wake of the mortgage crisis, more and more courts began making these determinations on the pleadings, framing the question not in terms of class certification, but in terms of whether the named plaintiff has "standing" to bring claims on behalf of absent parties, as I discussed in more detail here. The issue has basically been that if an investment bank underwrites multiple RMBS offerings, and I buy an RMBS issued by a particular trust backed by a particular pool of mortgages, how can a court be certain that my claims are similar enough to purchasers of different RMBS issued by a different trust, backed by different mortgages, such that I should be permitted to represent those purchasers in a securities class action against the underwriter?
Courts have been unwilling to go the traditional route and wait until a class certification hearing to make this decision; instead, they have been seeking to limit a named plaintiff’s ability to represent absent RMBS purchasers. They have been fundamentally troubled by the idea that a purchaser of one RMBS could represent all purchasers not only of that RMBS, but of multiple other RMBS, with face values totaling in the billions of dollars. Courts have come up with a variety of bright-line rules limiting how the class can be defined, at the pleading stage - for example, some courts have held that plaintiffs may only represent purchasers of RMBS from the same trust; others have held that plaintiffs may only represent purchasers of RMBS from the same tranche within a trust.
That orientation has spread to other kinds of claims - similar disputes have arisen in the context of false advertising, for example, where a single misrepresentation is alleged to have been plastered across multiple similar products. (Say, a false representation that ice cream flavors are "natural," appearing on chocolate, vanilla, and strawberry - is it necessary that the plaintiff have purchased neapolitan in order to represent absent purchasers of all three flavors?).
[More under the jump]
Saturday, December 27, 2014
That markets are less than perfectly efficient is hardly a controversial proposition; indeed, several examples of notable market efficiencies were presented to the Supreme Court this past Term when it considered the continuing vitality to the fraud-on-the-market challenge in Halliburton. Many of those examples, however, are several years old - which is why it was so amusing for me to see two new instances of dramatic inefficiencies just in the last month.
First, the New York Times published a piece, How Our Taxi Article Happened to Undercut the Efficient Market Hypothesis, explaining how publication of an article on falling medallion prices sent the stock price of Medallion Financial - a company that issues loans secured by taxi medallions - tumbling. This was surprising because information about taxi medallion prices is public, so the stock should not have been reacted to the news. Josh Barro, author of both pieces, speculates that the price drop may have occurred because some of the information in his article may have been difficult for investors to obtain, particularly since false information regarding medallion prices had been (inadvertently) circulated by the New York Taxi and Limousine Commission.
(Which, by the way, suggests that courts are correct to be wary of the "truth on the market" hypothesis - the argument often advanced by securities fraud defendants that even if their statements were false, it was canceled out by publicly available truthful information. In the case of Medallion Financial, the false information apparently dominated over truthful information, at least so long as the truthful information was piecemeal and required effort to gather.)
The second example of market inefficiencies occurred when President Obama announced that the U.S. would be resuming diplomatic ties with Cuba. The news sent the price of the Herzfeld Caribbean Basin Fund soaring, because that fund invests in companies that stand to benefit from improved diplomatic relations. It also, apparently, boosted the price of any company that even appeared to be associated with Cuba, including shares of Cuba Beverage, which makes energy drinks and has nothing whatsoever to do with Cuba, the country. The Wall Street Journal article on the subject offers other examples of similar sorts of investor confusion.
Also, here is a blue Christmas tree that has been decorated to look like the Cookie Monster:
Saturday, December 20, 2014
Joshua Fershee has previously noted that men and women experience careers in business differently. If women want to get to the top, they often have a longer haul than men.
Previous research has also shown that women are evaluated negatively for seeking raises (an attitude that Microsoft's CEO inadvertently seemed to endorse) and that (at least in the tech industry) performance reviews of women tend to be more critical than those of men, and include more personality-based criticism.
Now a new study in the Harvard Business Review shows that men and women have very different expectations regarding how they balance their careers and their personal lives when they graduate from Harvard Business School – and men’s expectations are more accurate than women’s.
According to the study, in general, men who graduate from HBS expect their careers will take precedence over their spouses’ careers – and they turn out to be right. Women expect that their careers will have equal importance – and their hopes are dashed. (It should be noted that men’s responses differ along racial lines; men of color tend to expect a more equal division of career precedence).
The authors conclude:
Whatever the explanation, this disconnect exacts a psychic cost—for both women and men. Women who started out with egalitarian expectations but ended up in more-traditional arrangements felt less satisfied with how their careers have progressed than did women who both expected and experienced egalitarian partnerships at home. And in general, women tended to be less satisfied than men with their career growth—except for those whose careers and child care responsibilities were seen as equal to their partners’. Conversely, men who expected traditional arrangements but found themselves in egalitarian relationships were less satisfied with their career growth than were their peers in more-traditional arrangements, perhaps reflecting an enduring cultural ideal wherein men’s work is privileged. Indeed, traditional partnerships were linked to higher career satisfaction for men, whereas women who ended up in such arrangements were less satisfied, regardless of their original expectations.
Which is why I watched this video made by Columbia Business School students with both amusement and sadness:
(Warning: The video contains explicit language and sexual innuendo. Perhaps that's more of an advertisement than a warning? Anyway, yeah, the lyrics are pretty explicit so, you know, go in with that expectation.)
Anyway, the basic theme of the video is that the women proclaim that they will not tolerate sexism and double standards, they will not tolerate being told that they should be nicer or less abrasive, and they will still succeed in business regardless of the obstacles placed in their path. I appreciate and applaud the attitude and determination, but the reality is – as the HBS study concludes – it’s not simply about women’s determination and goals. So long as women work within institutional structures that place higher values on male contributions - when even professors are more likely to offer guidance and mentoring to white males over women and people of color - women can be assertive and produce high quality work, but their individual determination not to back down in the face of criticism won't solve the problem.
Saturday, December 13, 2014
Professor Lucian Bebchuk runs the Harvard Shareholder Rights Project, which helps investors filed proposals to be included in corporate proxies under Rule 14a-8. The Project has filed several precatory proposals to express shareholders' views that corporations should destagger their boards, arguing that research demonstrates that declassified boards improve corporate returns.
In a new paper posted to SSRN, SEC Commissioner Daniel Gallagher and Professor Joseph Grundfest accuse the Project of making misleading statements regarding the benefits of declassified boards. They suggest that Harvard could be vulnerable to lawsuits by shareholders or the SEC under Rule 14a-9, which forbids false statements in proxy solicitations. The paper, with the provocative title “Did Harvard Violate Federal Securities Law?” is discussed in the Wall Street Journal here.
The basic argument made by Gallagher and Grundfest is that the proposals misleadingly cite only research in favor of declassified boards, and fail to cite contradictory research.
Now, I have to say, I’m trying to evaluate how this claim would proceed if brought by a private shareholder, and I don’t like its chances. First, as Gallagher and Grundfest admit, the proposals are precatory – so even if they succeed, they only have an effect if the corporate directors bow to investor pressure and choose to destagger the board. Gallagher and Grundfest argue that this is sufficient “causation” to constitute a Rule 14a-9 violation by analogizing to a case where management lied in response to a precatory shareholder proposal, and the court ordered a re-vote. But that case seems obviously distinguishable, because in that instance, the damage wrought by the misstatement was, in effect, damage to the right to offer proposals in the first place. And the shareholder had few options other than a truthful revote as a means of vindicating that right.
Here, of course, because the ostensibly misleading proposal is submitted by shareholders, and misstatements are not being used by management as a way to thwart shareholders, it's difficult to see what concrete harm the alleged misstatements are actually causing. Moreover, there are a variety of remedies for false statements beyond a private lawsuit: management can exclude proposals that are misleading, counter with its own information when opposing the proposal, or simply ignore the vote.
Apparently aware of the weaknesses in their causation theory, Gallagher and Grundfest also argue that these precatory proposals have a substantive effect sufficient to satisfy the causation requirement because proxy advisors like ISS often recommend voting against corporate directors who fail to declassify a board after a shareholder vote in favor of declassification. Corporate directors may therefore feel pressure from ISS and vote in favor of declassification after a shareholder vote on the subject.
This chain of causation seems speculative, to say the least. First, not only are ISS’s actions independent of the initial proposal, ISS’s threats are only going to matter if there’s a contested director election, and there usually isn’t one. Even if votes are withheld from a director in a majority-vote corporation, the director will only actually lose his position if the Board accepts his resignation – which it may choose not to do if it concludes the voting was based on a misleading proxy proposal.
Second, the information that’s allegedly omitted here – countervailing research on a contested subject – is publicly available. Leaving aside how that affects the analysis of the legal element of materiality (an omitted fact is only material if it affects the “total mix” of information available to shareholders, including public-domain information), if ISS pressure is a key step in the chain of causation, well, ISS is a sophisticated entity, as are the investors it advises – all of whom are no doubt capable of identifying and evaluating the research for themselves.
Finally, no damages would be available in a private action (because there’s no chance of a shareholder demonstrating loss causation). The only remedy would be for a court to undo a vote in favor of the proposal and possibly order the re-staggering of a board – once again, difficult to imagine given the attenuated causation involved and the public nature of the omitted information.
That said, I’m fascinated by the fact that Commissioner Gallagher has chosen to fight this battle not in his capacity as Commissioner, but as the co-author of a paper posted to SSRN.* (The paper claims, one suspects disingenuously, Gallagher and Grundfest are not taking a position on the merits of declassification; they simply want to ensure that proxy proposals are truthful.) Despite the paper’s suggestion that the SEC could bring an action against Harvard, the authors openly admit that the SEC’s policy has not been to challenge statements made in these proposals, but simply to allow corporate managers to refute them in proxy materials. If anything, the goal of the article seems to be more about intimidating Bebchuk into altering the wording of his proposals (or intimidating Harvard into reining him in - the paper spends a bit of time on Harvard's responsibility for the Project), giving ammunition to corporate boards to resist such proposals, and firing a shot across the bow of proxy advisory firms that recommend in favor of such proposals. Commissioner Gallagher has long sought greater regulation of proxy advisors – winning new SEC guidance on the subject in June. In this article, Commissioner Gallagher seems to be dropping a hint that they should revise their recommendations or be subject to further investigation and regulation.
*Who does he think he is, a Delaware judge?
Saturday, December 6, 2014
Particularly in the context of benefit corporations, a lot of us have used this space to talk about whether corporate directors are in fact required to adhere to a shareholder-wealth-maximization norm. The flipside of this inquiry is to ask what shareholder wealth maximization means from the shareholders' viewpoint.
In his article Fictional Shareholders: For Whom are Corporate Managers Trustees, Revisited, Daniel Greenwood uses the term “fictional shareholders” to describe the mythical share-value-maximizing shareholder to whom corporate directors are theoretically beholden, who does not possess any interests, values, or priorities beyond shareholder wealth maximization.
One of the most striking examples of the “fictional shareholder” notion can be found in the D.C. Circuit’s opinion in Business Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011), where the court rejected the SEC’s proxy access rule in part on the ground that some shareholders might put forth director-nominees for the “wrong” reasons – i.e., reasons specific to their idiosyncratic interests outside of their status as shareholders, unrelated to corporate wealth maximization. See generally Grant M. Hayden and Matthew T. Bodie, The Bizarre Law and Economics of Business Roundtable v. SEC.
Of course, in real life, shareholders do in fact have interests other than increasing prices of the shares they own in an individual company. They may care about shares they own in other companies, or care about things unrelated to shares entirely – like the environment in which they live, the wages they are paid for their jobs, the prices they pay for goods as consumers, and so forth. These varied considerations may "maximize" their wealth overall, even if they do not maximize the value of shares in any specific company.
Which is why I found this article so interesting. The AFL-CIO is objecting to Wall Street’s practice of paying out deferred compensation to executives who depart for government. Deferred compensation packages are intended to encourage employees to remain with the company; the compensation is forfeited if the employee leaves for a competitor. So why should it be accelerated for government? (Copies of the letters sent by AFL-CIO can be found here.)
Andrew Ross-Sorkin, adorably, believes the practice encourages “public service” even if it doesn’t benefit shareholders.
I believe the practice - at least in the eyes of the firms that employ it - likely directly maximizes shareholder wealth in particular companies by maintaining close ties between Wall Street and regulators. Not in crude sense that government regulators “go easy” on Wall Street firms because they wish to curry favor or repay a debt, but in the more subtle sense that firms believe that if they maintain lines of communication and friendly relationships between themselves and their regulators, they can persuade regulators to adopt Wall Street priorities and sensibilities. And, of course, when Wall Street firms have close ties to regulators, they can use friendship and informal networking to obtain information and cooperation – the case of Rohit Bansal is simply an extreme example. (Probably Mary Jo White is more typical – after she left public service to work at Debevoise, she was accused of using her government connections to assist John Mack in avoiding SEC penalties for insider trading.)
So AFL-CIO’s objection, to me, does not come from its status as an adviser to investment funds investor seeking the highest possible value for their shares. It comes from its status as a union federation, with members who have interests outside of their status as shareholders.
AFL-CIO tacitly acknowledges as much. In its press release describing its objections, it writes, “Unless the position of these companies is that this is just a backdoor way to pay off a newly minted government official to act in Wall Street’s private interests rather than the public interest, it is very difficult to see how these policies promote long-term shareholder value.”
Which is another way of saying that if these employees do act to further Wall Street’s interests, then they do promote shareholder value.
So that leads to the question – is it legitimate, for the AFL-CIO to object to these practices, even if they increase the value of the pension fund's holdings? Do corporate managers have any obligation to consider such objections, if they are not motivated by a desire to maximize wealth at a particular firm?
And what if the AFL-CIO did decide to call the banks' bluff by filing a lawsuit claiming that compensation incentives to decamp for government service do not benefit shareholders? Would the directors have to admit that they hope for benefits like regulatory forbearance, or could the directors claim that, a la Andrew Ross-Sorkin, such pay practices provide a public benefit and represent a mark of good corporate citizenship?
Saturday, November 29, 2014
When commenters look back at the financial crisis, many blame the ratings agencies, at least in part - and in particular, the dominance of a small number of firms (Moody's, S&P, and - distantly - Fitch). This is why, for example, the SEC has been criticized for erecting barriers that prevent other agencies from earning the coveted NRSRO label.
Which is why I found this story regarding an apparent effort by Moody's to eliminate a competitor so fascinating. According to the WSJ:
Moody’s Corp. doesn’t often give away its thoughts free of charge.
But the ratings firm made an exception recently, issuing an unsolicited credit rating to National Penn Bancshares Inc., a small community bank it had never assessed before.
Moody’s grade was lower than one issued just weeks earlier by Kroll Bond Rating Agency Inc., which the bank had hired to rate a new bond.
Kroll contends Moody’s deliberately lowballed its rating—a move that could have ripple effects through the market for National Penn’s bonds—to scare other small banks into hiring it for future deals.
“It seems this was nothing less than intimidation,” said Kroll President Jim Nadler. “Investors and issuers are worried that Moody’s, if it’s not paid their ransom, will continue doing this until they bully their way into the market.”
A Moody’s spokesman said the firm’s unsolicited rating for National Penn was due to the relatively large size of the debt deal for a regional bank. “We thought our opinion would be helpful to market participants,” he said....
Moody’s never met with National Penn senior management. Instead, Moody’s analysts sifted through public disclosures, listened to earnings calls and read news articles, Mr. Tischler said. These types of situations, with no participation from the rated issuer, are “definitely the minority,” he added.
Moody’s hadn’t rated a U.S. bank with assets under $10 billion all year. In its eight-paragraph rating rationale from Oct. 31, Moody’s said National Penn’s “acquisition appetite” for troubled banks “poses risks for creditors,” calling into question the management’s strategy. Few detailed financials were mentioned in the initial Moody’s rating.
Now, this is not the first time Moody's has been accused of this kind of behavior. In Jefferson County School District No. R-1 v. Moody’s Investor’s Services, Inc., 175 F.3d 848 (10th Cir. 1999), for example, the plaintiff alleged that Moody's publicized an unsolicited low-ball rating as punishment to an issuer for failing to hire Moody's to rate the deal. In that case, the Tenth Circuit held that ratings are opinions subject to First Amendment protection, and dismissed state law tort claims as well as federal antitrust claims.
It raises really interesting questions, because on the one hand, many observers believe that "ratings shopping" - the practice of one issuer going to different agencies until it receives the rating it wants - corrupts ratings and contributed to the financial crisis. So we want to encourage agencies to rate securities even when an issuer has chosen a different agency - which necessarily means protecting them from lawsuits by disgruntled issuers. On the other hand, the last thing we want is for agencies to use ratings as a means to exclude competitors from the market.
The reality is, the best system would be one in which the issuer itself did not get to choose the agency (or, more creatively, perhaps one in which the rater itself was forced to invest in the securities it rates) - but despite proposals, we haven't been able to adopt a workable system to make that happen (as demonstrated by the fact that investors will sue the agencies for issuing unreliable ratings even as they continue to rely on them as a cornerstone of their investment policy).
Thursday, November 27, 2014
As regular readers know, I research and write on business and human rights. For this reason, I really enjoyed the post about corporate citizenship on Thanksgiving by Ann Lipton, and Haskell Murray’s post about the social enterprise and strategic considerations behind a “values” message for Whole Foods, in contrast to the low price mantra for Wal-Mart. Both posts garnered a number of insightful comments.
As I write this on Thanksgiving Day, I’m working on a law review article, refining final exam questions, and meeting with students who have finals starting next week (being on campus is a great way to avoid holiday cooking, by the way). Fortunately, I gladly do all of this without complaint, but many workers are in stores setting up for “door-buster” sales that now start at Wal-Mart, JC Penney, Best Buy, and Toys R Us shortly after families clear the table on Thanksgiving, if not before. As Ann pointed out, a number of protestors have targeted these purportedly “anti-family” businesses and touted the “values” of those businesses that plan to stick to the now “normal” crack of dawn opening time on Friday (which of course requires workers to arrive in the middle of the night). The United Auto Workers plans to hold a series of protests at Wal-Mart in solidarity with the workers, and more are planned around the country.
I’m not sure what effect these protests will have on the bottom line, and I hope that someone does some good empirical research on this issue. On the one hand, boycotts can be a powerful motivator for firms to change behavior. Consumer boycotts have become an American tradition, dating back to the Boston Tea Party. But while boycotts can garner attention, my initial research reveals that most boycotts fail to have any noticeable impact for companies, although admittedly the negative media coverage that boycotts generate often makes it harder for a companies to control the messages they send out to the public. In order for boycotts to succeed there needs to be widespread support and consumers must be passionate about the issue.
In this age of “hashtag activism” or “slacktivism,” I’m not sure that a large number of people will sustain these boycotts. Furthermore, even when consumers vocalize their passion, it has not always translated to impact to lower revenue. For example, the CEO of Chick-Fil-A’s comments on gay marriage triggered a consumer boycott that opened up a platform to further political and social goals, although it did little to hurt the company’s bottom line and in fact led proponents of the CEO’s views to develop a campaign to counteract the boycott.
Similarly, I’m also not sure of the effect that socially responsible investors can have as it relates to these labor issues. In 2006, the Norwegian Pension Fund divested its $400 million position (over 14 million shares in the US and Mexico operations) in Wal-Mart. In fact, Wal-Mart constitutes two of the three companies excluded for “serious of systematic” human rights violations. Pension funds in Sweden and the Netherlands followed the Fund’s lead after determining that Wal-Mart had not done enough to change after meetings on its labor practices. In a similar decision, Portland has become the first major city to divest its Wal-Mart holdings. City Commissioner Steve Novick cited the company’s labor, wage and hour practices, and recent bribery scandal as significant factors in the decision. Yet, the allegations about Wal-Mart’s labor practices persist, notwithstanding a strong corporate social responsibility campaign to blunt the effects of the bad publicity. Perhaps more important to the Walton family, the company is doing just fine financially, trading near its 52-week high as of the time of this writing.
I will be thinking of these issues as I head to Geneva on Saturday for the third annual UN Forum on Business and Human Rights, which had over 1700 companies, NGOs, academics, state representatives, and civil society organizations in attendance last year. I am particularly interested in the sessions on the financial sector and human rights, where banking executives and others will discuss incorporation of the UN Guiding Principles on Business and Human Rights into the human rights policies of major banks, as well as the role of the socially responsible investing community. Another panel that I will attend with interest relates to the human rights impacts in supply chains. A group of large law firm partners and professors will also present on a proposal for an international tribunal to adjudicate business and human rights issues. I will blog about these panels and others that may be of interest to the business community next Thursday. Until then enjoy your holiday and if you participate in or see any protests, send me a picture.
November 27, 2014 in Ann Lipton, Conferences, Corporate Finance, Corporate Governance, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Haskell Murray, International Business, Marcia Narine, Securities Regulation, Social Enterprise | Permalink | Comments (0)
Saturday, November 22, 2014
I have something of a follow-up to Haskell's earlier post.
While companies like Wal-Mart will be open on Thanksgiving - a decision that has garnered no small amount of public criticism- others have conspicuously declared that they will be closed, in order to allow their employees to spend time with their families.
Now, you can call this a sincere commitment to employees' well-being if you like, but my cynical brain views this as a standard share value-maximizing decision - whether management has decided that adverse publicity would harm the brand, or that employees who get holidays off are less likely to agitate for higher wages, or that regulators are less likely to step in if the business makes some minimal concessions to employee welfare, it's still a decision that's about benefitting the bottom line. If nothing else, it can be cast that way - which is precisely why, precisely as has been frequently argued on this blog, it's difficult to understand why the separate concept of a benefit corporation is necessary, except to the extent it represents the ultimate in marketing commitment. Or maybe some corporate directors just don't want to have to come up with a shareholder-value-maximizing lie about the reasons for their decisions, even if it would be easy to do.
The Thanksgiving-holiday debate also fascinates me because of the way in which it calls to mind Hillary Sale's concept of corporate "publicness" - the idea that corporations, as large and powerful actors in society, are viewed as public institutions, and suffer when they fail to conduct their affairs with that understanding. The corporations that have declared that they will not be open on Thanksgiving seem to be responding to this "publicness" concept.
But that just raises the question, how much does "publicness" represent anything different than the types of pressures that have always existed to force corporations to behave as better corporate "citizens"? Corporations have always had to fear that customers or employees would turn against them, or regulators would try to control them, if they did not behave appropriately; why are today's corporations any different?
Perhaps it's simply because modern corporations are too powerful to regulate via traditional mechanisms. Public shaming and appeals to (certian classes of) shareholders appear to be the only levers of control available - or, at the very least, in a world where it is expected that regulation is unnecessary, scrutiny of corporations as public actors is a natural response. Mariana Pargendler argues that corporate governance has only arisen as an important issue in corporate theorizing as a result of the deregulatory bent of modern America - because there is no political appetite for direct regulation, people who would prefer direct regulation instead turn to corporate governance arguments as a second-best solution for controlling corporate behavior.
I suspect this is accurate. Once upon a time, if we were concerned that workers were being unfairly pressured to work over the holidays, we might consider using direct regulation to remedy the problem. Today, the idea seems extremely remote, if not utterly impossible. Public shaming seems the only viable alternative, in hopes that either shareholders or customers will display enough distaste for corporate policies that managers decide to voluntarily reform.
Saturday, November 15, 2014
Back in 2011, Judge Rakoff famously delivered a blistering indictment of the SEC's enforcement tactics when he rejected the SEC's settlement with Citigroup over a CDO alleged to have been designed to fail.
The decision was immediately appealed (and ultimately reversed), but was pending before the Second Circuit for over two years. During that time, other district judges followed Rakoff's lead, scrutinizing the SEC's settlements more closely.
Judge Rakoff's criticism was incredibly influential, or perhaps just captured a zeitgeist regarding the lack of serious sanctions against large financial institutions in the wake of the mortgage crisis - the SEC even announced it would revise its "no admit-no deny" settlement policy as a result.
After the Second Circuit reversed Judge Rakoff, he reluctantly approved the Citigroup settlement - but with a footnote warning (1) that the SEC would simply bring more cases administratively to avoid any court review at all, and (2) that such administrative decisions might be unconstitutional.
Judge Rakoff seems a bit prescient in that respect, because the SEC has openly stated it plans to bring more administrative cases - and the data shows that's apparently a smart move, since its administrative judges, at least recently, deliver victories to the Commission 100% of the time. (I can't tell whether the data controlled for the types of cases likely to be brought administratively versus in court). Meanwhile, Judge Rakoff has continued to criticize the SEC - most recently in a speech lamenting the trend toward administrative trials, in part because federal appellate review is deferential.
Most recently, Justice Scalia, joined by Justice Thomas, penned a statement respecting a denial of certiorari in an insider trading case, in which he openly challenged the notion that the SEC may administratively interpret a statute in a manner that deserves deference from courts enforcing the crininal laws. That argument may be a bit far afield from Judge Rakoff's legally, but the policy concerns are similar - Judge Rakoff, too, extolled the virtues of having a federal court oversee the agency's conduct and guide the development of the law.
(One can't help but notice that this argument seems to have no purchase when private plaintiffs make it in reaction to boilerplate arbitration agreements concerning statutory claims. But I digress.)
To be sure, there are obvious distinctions between these issues. After all, the SEC's decision to bring cases administratively may just be a function of new powers granted to it after Dodd-Frank, and may not reflect any desire to avoid scrutiny by judges like Rakoff. Moreover, the new administrative cases do not concern mortgage-misconduct or even the misconduct of big banks - many involve insider trading, like the case that inspired Justice Scalia's statement. Finally, Justice Scalia's statement goes well beyond the SEC, and could potentially extend to many administrative agencies.
Nonetheless, it's very hard not to suspect that Rakoff and other judges of his ilk play some role in the SEC's calculus when deciding where to prosecute a case. And the throughline of all of this, for me, is that the criticisms of the SEC all look like variations on the ongoing accusation that the SEC (and federal prosecutors) prefer easy wins in insider trading cases to aggressive policing of large financial institutions. (It is, in a way, the same debate that is dividing the Commission right now regarding penalties to be imposed on Bank of America for crisis-related misconduct.) Judge Janice Rogers Brown on the DC Circuit just yesterday delievered a similar attack on the SEC, writing that more accountability and openness is required because "Financial institutions and their regulators now frequently operate under a haze of public distrust fueled by repeated regulatory failures and massive, opaque and unaccountable bailouts. The public now has good reason to doubt the rigor of our financial systems’ reliability and oversight."
So I can't help but wonder how much Judge Rakoff's attack in 2011 is continuing to reverberate throughout the system.
I also have to say, the questions posed in the Scalia opinion are fascinating. There has long been a palpable tension in courts' interpretation of Section 10(b) between their desire to narrow the statute for private claims, and their desire to broaden it for SEC claims. In Stoneridge Investment Partners v. Scientific-Atlanta (2008), for example, the Supreme Court dismissed the plaintiffs' Section 10(b) claims by focusing on the element of reliance - applicable in private actions but not SEC actions - which set up a significant divide between the types of conduct that can form the basis of private actions, versus the types of conduct the SEC can target. The Fourth Circuit then started on a path of interpreting the statute differently for criminal claims (one suspects because it was really trying to distinguish government from private, rather than civil from criminal).
If Justice Scalia's argument wins the day, will we see a proliferation of interpretations of 10(b) - public civil, criminal, and private?
Saturday, November 8, 2014
On Tuesday, in my Financial Crisis seminar, we discussed the types of securities claims that have been filed by investors in mortgage-backed securities. I opened by telling my students that one of the critical takeaway points is the importance of civil procedure. The substance of the law matters, sure, but (as I posted when discussing class action standing), cases are won and lost on procedural grounds.
Case in point: Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, which was argued before the Supreme Court on Monday. (Transcript here.) Omnicare concerns the question of opinion-falsity in the context of claims under Section 11 of the Securities Act of 1933.
Section 11 of the Securities Act imposes strict liability on issuers who include false statements of material fact in registration statements. In a case called Virginia Bankshares, Inc. v. Sandberg, the Supreme Court held that even expressions of opinion may count as “material facts” for the purposes of the securities laws – such as, for example, a proxy statement that recommends a merger as “fair” to shareholders. In Omnicare, the Supreme Court will decide what, exactly, it means for a statement of opinion to be false. Essentially, the dispute is about whether a statement of opinion is only false if it is subjectively disbelieved by the speaker (i.e., if the speaker claims a price is “fair” while secretly believing the price is not fair) or whether a statement of opinion can be false even if the speaker believes it to be true, but the opinion lacks a basis in fact (i.e., the speaker genuinely believes the price to be fair, but has not made any investigation into fairness and so the opinion lacks a factual basis).
Monday's oral argument had a lot of back and forth about specific states of mind and various types of implied representations. After all, when you issue an opinion in the context of a securities offering, isn’t there an implied factual representation that you have a basis for that opinion, that’s independent of the speaker’s state of mind? On the other hand, if a statement does lack a factual basis, isn’t that strong evidence of subjective disbelief?
And while all of these are interesting existential questions, the really important issue – and what oral argument touched upon – is pleading.
The question of opinion-falsity tends to come up in three different types of private claims under the securities laws.
First, it comes up in the context of Section 11, which imposes strict liability for false statements in registration statements.
Second, it comes up in the context of Section 14, which imposes liability for false statements in proxy statements. Most circuits have held that Section 14 liability is rooted in negligence.
Third, it comes up in the context of Section 10(b), which imposes liability for intentionally or recklessly false statements in connection with securities transactions.
Because Section 10(b) requires a showing of scienter, the issues in Omnicare are largely rendered moot for claims under that statute – the plaintiff will have to show intentional or reckless behavior anyway, so “subjective disbelief” gets folded into the scienter inquiry.
Where the “subjective disbelief” issue really makes a difference, therefore, is in the context of Section 11 and Section 14.
Section 14 claims are subject to the heightened pleading requirements of the Private Securities Litigation Reform Act. That statute requires that plaintiffs plead, with particularity, facts creating a “strong inference” that the defendant acted with the required state of mind. Some courts have held that negligence is not a state of mind, so this provision does not apply; even if it is, it's often not a difficult one to plead, even under the PSLRA.
Section 11 claims are not subject to heightened pleading under the PSLRA – they are subject to ordinary standards under the Federal Rules. Normally, because Section 11 is a strict liability statute, plaintiffs need only plead claims in accordance with Rule 8. But most circuits agree that when a Section 11 claim “sounds in fraud” – when the plaintiffs seem to be claiming that defendants’ actions were intentional or reckless – then Section 11 claims will be subject to Rule 9(b) pleading standards. And though there’s a circuit split on the issue, many courts would agree that Rule 9(b) also requires that plaintiffs plead facts giving rise to a “strong inference” of fraud.
If “subjective disbelief” is required to show opinion-falsity, courts are likely to treat that as the equivalent of fraudulent intent, and require heightened pleading for Section 11 and Section 14 claims.
Moreover, for securities claims, all discovery is stayed pending the resolution of a motion to dismiss. That means that the plaintiffs must not only plead fraudulent intent in great detail, but they must also do so without discovery.
The upshot of all of this is that one of the most significant aspects of Omnicare isn't what it means for an opinion to be false, and it isn't the duties imposed on issuers of securities – it’s whether plaintiffs bringing claims under Section 11 and Section 14 are going to be subject to heightened pleading requirements. This is especially true because the boundaries between what counts as “opinion” and what counts as “fact” are very fuzzy – a point that was made in oral argument. After all, as I previously posted, the Second Circuit believes that even financial statements are only “opinions.” If just about anything can be considered an opinion, a requirement that opinions be "subjectively disbelieved" will functionally raise the pleading standards for Section 11 and Section 14 claims across the board.
(Now, the Second Circuit also tried to stake out an odd middle ground, holding both that opinion statements must be “subjectively disbelieved” to be false, and that this “subjective disbelief” is something other than fraudulent intent. That holding has caused much confusion in the district courts, and it’s difficult to imagine a similar holding coming out of the Omnicare case; and even if Omnicare dodges that point, if the Court holds that "subjective disbelief" is required, the Second Circuit's view is going to come under considerable pressure.)
In other words, the sleeper issue in this case isn't the substance of the law - it's procedure.
Saturday, November 1, 2014
(demonstrating that variety isn't always a good thing)
Well, Halloween was yesterday, but the chocolate-y remains will last for ... at least another 5 3 2 hours. Which brings me to this article on how, despite increases in chocolate prices, sales of chocolate continue to rise:
Chocolate candy sales for last Halloween hit $217 million, up 12 percent from the year before, the consumer market research firm Packaged Facts reported in September. For all of 2013, the American market for chocolate grew 4 percent, to $21 billion in sales. But chocolate lovers took a hit this summer, when Hershey and Mars announced price increases of 8 percent and 7 percent... But don’t expect higher prices to dampen sales, analysts said....
Chocolate makers have also adopted a marketing strategy that is increasingly driving sales: the variety bag, a single package filled with several different types of bars. Mars said sales of the variety bag it introduced a few years ago (with Milky Ways, Three Musketeers and such) grew by 14.5 percent in 2012, accounting for 54 percent of its total Halloween sales growth, and have remained strong.
Scientists who research how our brains respond to food have another term for variety: the smorgasbord effect (as in stuffing yourself at Chinese buffets). Studies show that we quickly acclimate to any food or flavor we’re eating, causing the brain to register a feeling of fullness. Variety delays this process by keeping food exciting.
Okay, look, I'm not denying that we habituate to certain flavors, or that variety packs can introduce consumers to things they wouldn't otherwise buy. But people buy big bags of smaller candies for a reason: To distribute. And in that context, they like variety not because they get bored with one flavor, but because as a Halloween candy-giver, you want to give trick-or-treaters a choice. You never know which kid will hate almonds or love dark chocolate or which kid (uh, kid, yes, we'll go with kid) treats peanut butter cups as a meal replacement. Variety packs are an easy way of making sure you offer the best treats in the apartment complex no matter who shows up at your door. I'd rather buy two variety bags than 10 bags of different single-type candies just to give trick or treaters a choice.
I mean, if I bought 10 bags of candies to make sure I catered to every kid's idiosyncratic tastes, I'd have the equivalent of 8 bags left over. Which would be... terrible.
Yes. Terrible. That's totally the word I was looking for.
Saturday, October 25, 2014
Minor Myers and Charles Korsmo have a new paper that compares fiduciary duty merger litigation to appraisal litigation to determine whether fiduciary duty claims add any value for shareholders.
After scrutinizing takeover challenges between 2004 and 2013, they find that the larger the deal, the more likely it is to be targeted in a fiduciary duty class action. By contrast, whether there is a smaller merger premium – regardless of deal size – does not appear to be correlated with class action litigation. Appraisal litigation, however, works differently; plaintiffs who bring appraisal claims tend to do so when the merger premium is low, regardless of deal size.
They also found that fiduciary suits are not associated with an increase in merger consideration. I.e., they do not generate statistically significant benefits to shareholders.
Myers and Korsmo conclude from this that fiduciary duty class actions are not usually based on merit, and that such actions are brought for their nuisance value. They recommend changes to the structure of fiduciary litigation, such as allowing investors who acquire stock after the deal announcement to serve as lead plaintiff, and switching to an opt-in model.
But there’s a wrinkle that comes in the form of a paper by C.N.V. Krishnan, Steven Davidoff Solomon, and Randall S. Thomas. That paper compares fiduciary merger litigation brought by different plaintiffs’ firms, and concludes that not all firms are created equal. Specifically, the top plaintiffs’ firms target more suspicious transactions, and when the litigation is controlled by these firms, the class members are more likely to win an increase in merger consideration. They also find that top firms prosecute actions more vigorously, in measurable ways.
Obviously, these two papers, put together, raise an interesting question: what would happen if the Myers/Korsmo study were conducted with a view to the identity of the lead plaintiff’s law firm? Would they see the same results? And if the problem here is just that there are better and worse law firms, is that something that can be addressed via more exacting standards for the award of attorneys’ fees?
(Okay, full disclosure - one of the top plaintiffs' firms in the Krishnan et al study is my former firm, BLBG. But hey, I didn't do the study - I'm just reporting the results.)
Saturday, October 18, 2014
The Columbia Journalism Review blog reports:
Since 2008, one particular federal government agency has aggressively investigated leaks to the media, examining some one million emails sent by nearly 300 members of its staff, interviewing some 100 of its own employees and trolling the phone records of scores more. It’s not the CIA, the Department of Justice or the National Security Agency.
It’s the Securities and Exchange Commission. …
All that effort was for naught. Despite the time and resources that have been poured into them, none of the SEC’s eight investigations in the past six years have uncovered the leakers.…
The article further points out that the SEC’s pursuit of leakers has ramped up in the wake of the financial crisis, and it has no problem with leaks (if you call them “leaks”) when the leaks make the agency look good.
The SEC’s argument is that it needs to protect against the release of market moving information, and I'm quite sympathetic to that point, but the leaks involved here seem to be at least in part about concealing internal problems or dissension within the agency.
Considering how at least two Commissioners have recently spoken out about their dissatisfaction with the SEC’s enforcement efforts (not to mention the best SEC speech ever), I tend to be sympathetic to the argument that sunlight - or at least less intimidation - is in order.
(Also, if they can't catch their own leakers.... )