Business Law Prof Blog

Slightly Delayed "Live-Blogging" From the AALS

Over at the Glom, Gordon Smith recounts some of the discussion from the recent Business Associations Section meeting at the AALS Annual Meeting this past Thursday.  Like Gordon, I was particularly struck by the remarks of Delaware Chancery Court Vice Chancellor J. Travis Laster on the issue of Say-on-Pay.  Here is some of Gordon's summary (you can find his entire post here):

[I]s there room for a Delaware claim on executive compensation in the wake of Say on Pay? Teasing the assembled law professors, Vice Chancellor Laster suggested that the Delaware courts could decide to review pay decisions with a form of enhanced scrutiny (because that standard of review applies to situations involving structural bias), but he rightly observed that such a move would be comparable to Smith v. Van Gorkom in 1985…. The more likely path to a claim is one already being pursued by a number of plaintiffs lawyers, namely, going after a board of directors for waste of the corporate assets…. If you couple such a claim with a bad vote on Say on Pay, you might have something.

One of the other things that struck me from Vice Chancellor Laster's remarks was his statement (according to my notes) that the Delaware judiciary is very aware of the "Zeitgeist." This means that while subjecting compensation decisions to enhanced scrutiny may constitute a "thermonuclear explosion" in corporate law, Delaware may nonetheless get there if the threat of further federalization of corporate law in this area becomes great enough.

For those of you not familiar with Vice Chancellor Laster, here is a short video wherein he mentions that his preferred theory of the corporation is "utilitarian":

 

SJP

Strict Criminal Liability, Regulation, and Ben Franklin

Long ago, Ben Franklin warned, "Laws too gentle are seldom obeyed; too severe, seldom executed." Unfortunately, following massive environmental disasters (and financial disasters) legislators and regulators tend to respond to public outcry by seeking better ways to "put the bums in jail" without assessing the real problems.  

Building on this point, I wrote my article, Choosing a Better Path: The Misguided Appeal of Increased Criminal Liability after Deepwater Horizon, which was just published in the William & Mary Environmental Law and Policy Review (available here). In the article, I argue that increased criminal liability for energy company employees is not likely to be effective in preventing disasters like the blowout of BP Macondo well in the Gulf of Mexico.  And increased liability is simply not the best way. The abstract:

Despite the potential appeal of dramatically increased liability and sentences in the wake of environmental disasters like the Deepwater Horizon oil blowout in the Gulf of Mexico, this Article argues that more aggressive criminal provisions and enforcement related to environmental harms, up to and including strict criminal liability, are not likely to protect the environment better or lead to safer work environments. This Article first considers the history and legality of, and the rationale behind, policies designed to make it easier to convict allegedly responsible parties and also discusses the pursuit of increased liability in relation to disaster-related and tragedy-related events in the financial and criminal sectors. The Article then discusses the use of reduced burdens and strict liability in environmental law in both civil and criminal contexts, and argues that the use of strict liability is less effective than a negligence standard because it tends to reduce penalties, which can limit the direct punishment to violators, as well as the prophylactic potential of the laws. Finally, the Article concludes that, rather than reducing mens rea standards and increasing criminal liability, U.S. energy and environmental law needs to focus on encouraging proper risk assessment and risk management to promote safe and effective energy extraction and production while encouraging and protecting both the environment and the economy.

What's all of this mean?  There are no easy answers, but here's my conclusion: 

One of the greatest risks to the continued economic success of energy-related activities is an environmental disaster. As such, disaster avoidance is a benefit to all stakeholders: lawmakers, regulators, oil companies, and people generally have reason to support a safer energy industry. The first step, then, is to adopt a proper mindset to help avoid disasters. Rather than pursuing with vigor penalties to punish a future perpetrator or seeking creative ways to use obscure laws that have a slight chance of success, efforts should look to ways to prevent the next disaster.

This means carefully assessing risk, then developing plans and programs to minimize that risk. This is not something that can happen in a vacuum. It requires coordinated efforts from industry, government, and the public. We all must understand and appreciate the risks before us, then be prepared to accept the costs of our decisions.

--JPF

A Year in Review: Top Delaware Cases from 2011

The Delaware Corporate and Commercial Litigation Blog has posted Noteworthy 2011 Corporate and Commercial Decisions from Delaware’s Supreme Court and Court of Chancery.  As always, they provide useful and insightful information about Delaware cases, and the post and the blog are worth a read.  

Among the key cases they highlight are several that we at the BLPB have discussed.  As a year in review of the BLPB Delaware case discussions, here are a few:

In Re: Southern Peru Copper Corp. Shareholder Litigation here, here, and here

Air Products and Chemicals, Inc. v. Airgas Inc. here, here, and here

And my personal favorite, CML V, LLC v. Bax here, here, here, here, and here

I'm sure I have missed others, especially other cases my colleagues discussed, and I hope they will free to add (or create their own) year in review.

Happy 2012!

--JPF

The First Amendment Versus Corporate Law

The headline reads: Montana High Court Says 'Citizens United' Does Not Apply In Big Sky State.  I have not had a chance to read the entire 80-page decision, but I did want to share some thoughts that struck me when I read the headline--acknowledging that they may not be relevant to the particular dispute itself.

I have written here and here about my belief that Citizens United is more about corporate theory than the espoused First Amendment rights of listeners.  If nothing else, even if one gives great weight to the rights of listeners it seems difficult (if not impossible) to decide whether corporations fit within the narrow class of cases allowing for identity-based restrictions under the First Amendment without resolving the fervent corporate theory debate the majority and dissent in Citizens United engage in (all while claiming corporate theory is irrelevant).  In trying to unravel the mystery of this apparent inconsistency, I have noted that one explanation is the problems created by admitting corporate theory is dispositive--one of which is that this acknowledgement raises the very serious specter of these questions being more about state corporate law than First Amendment rights.  To that end, this quote from the [reluctant] dissent in the Montana case seems relevant: "Corporations are artificial creatures of law. As such, they should enjoy only those powers—not constitutional rights, but legislatively-conferred powers—that are concomitant with their legitimate function, that being limited liability investment vehicles for business."

SJP

Happy New Year!

If you want to spend a little time looking back at 2011, you might try going over to The Race to the Bottom and checking out Jay Brown's overview of Delaware's worst shareholder decisions for 2011.

SJP

Litigation Pointer: Don't Mess With the Judge's Holiday

The Financial Times headline reads: Rakoff accuses SEC of misleading federal court.  Stephen Bainbridge provides relevant commentary here and here.  I thought I'd provide a taste of Judge Rakoff's order (emphasis added; hat tip: WSJ Blog):

On December 16, 2011, the SEC filed its original motion before this Court … seeking a stay pending appeal. The SEC expressly made the motion returnable December 30, 2011. Nonetheless, in the interest of expediting consideration of the motion, the Court, sua sponte … promised to … consider the matter on a more expedited basis than that originally proposed by the SEC. … The Court then spent the intervening Christmas holiday considering the parties' positions and drafting an opinion, so that it could file it on December 27, i.e., the first business day after the Christmas holiday (well before the December 30th date on which the SEC had originally made the motion returnable and well before any further proceedings in the case).

On December 27th, at around noon, without any notice to this Court and without inquiring as to when the Court was going to issue its decision, the SEC filed an “emergency motion” in the Court of Appeals, seeking a stay pending appeal or, in the alternative, a temporary stay, and representing that the motion was unopposed by Citigroup….

As the reason for proceeding on an emergency basis, the SEC stated that Citigroup had only until January 3, 2012 to answer or move to dismiss the underlying Complaint, and that “[i]f Citigroup files its answer, denying some or all of the allegations in the complaint, or if Citigroup moves to dismiss, challenging the complaint's legal sufficiency, it will disrupt a central negotiated provision of the consent judgment pursuant to which Citigroup agreed not to deny the allegations in the complaint.” This statement would seem to have been materially misleading ….

There appears to have been a similar misleading of this Court….

Accordingly, the Court is filing this Supplemental Order, both to make the Court of Appeals aware of this background and to attempt to prevent similar recurrences. Specifically, the parties are hereby ordered to promptly notify this Court of any filings in the Court of Appeals by faxing copies of any such filings to this Court immediately after they are filed in the Court of Appeals. In addition, this Court will send a copy of this Supplemental Order, as well as the Memorandum Order that it supplements, to the Court of Appeals with a request that they be furnished to the motions panel hearing the stay motion on January 17, 2012.

SJP

 

The "Shell Company" Controversy: Energy Version

Earlier this week, I was quoted in a Reuters story about a large energy company's use of smaller a "shell company" in making leases for a potential shale play in Northern Michigan.  (MSNBC picked it up here, with the title: "Oil giant's shell game nets elderly farmers: Promises made, but not kept, and it's all legal." 

The article explains:

Legal scholars say the operation serves as an intriguing test case of the use of shell companies.

The tactics "raise moral and ethical questions about how entities can be used," says Joshua Fershee, a contract law professor at the University of North Dakota.

Others, including Chesapeake, defend the need to use shell companies and front companies - contractors with local ties who do business on behalf of a larger corporation. John Lowe, a professor of energy law at Southern Methodist University, calls it "business as usual."

(Side note: I'm really a business and energy law professor, not a contracts professor.) From the quote, it may appear that John Lowe and I disagree, but I don't suspect we do.  I stand by my quotes -- I do think the apparent use of a smaller shell company in this case raises some moral and ethical questions, as well as legal ones.  But I, too, believe that larger corporations can and should be able to use smaller companies for a variety of ends, including creating local ties and managing the larger entity's risk.  Still, there are boundaries. 

The MSNBC article title notes that promises weren't kept, but "it's all legal."  I'm not sure that's true in this case, but it's true it is legal to use smaller entities to manage risk.  That shouldn't be a problem. That doesn't mean it's legal to commit fraud.  So, for example, if the large entity created a small entity to take out leases and speculate on the land, it's probably legal. The entity can create a company to try new ventures like any of the rest of us.  If, on the other hand (and as an example), the entity created a small LLC, instructed the LLC to draft leases with specific flaws or otherwise use deceptive practices so that the entity would only need to pay if the shale play was viable, that could certainly be a problem.  

Furthermore, if the smaller entity was created to act as agent for the large entity, there may be liability for the larger entity as principal.  And if the smaller entity were an alter ego of the larger entity, there may be a veil piercing opportunity if the smaller entity doesn't have the funding necessary to cover its debts. (Whether veil piercing is proper here is different than whether it's possible.)

One of the complaints here is that the large entity used a small "local" company to entice landowners to do business with the local entity over other companies.  Of course, if it were so important that the landowner work with a local person solely, the landowner could contract for that protection by limiting transferability or adding some other change in control provision.  That would reduce the value of the lease, but if it matters that much, ask for it. If you take the local person at his or her word, then you have signed up for the risk that your ability to judge character wasn't that good. 

Ultimately, I can't tell whether this is a case of lessors wanting more than they bargained for or if it's a case of a large entity using a subsidiary lessee to speculate without taking on any concomitant risk. Frankly, it sounds like a little of both, but the facts available are limited.  

Last July, when Reuters published another of story in a series on the use of shell companies, I said this:

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

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

I'd add to that that even if it's not criminal behavior, it may be traditional civil fraud, and that creates liability for the perpetrator, too. I am not naive -- I have noticed that corporations and LLCs can do bad things, and because they are often larger and have more resources than individuals, the harm can be broader.  But people are not incapable of gathering information. At least some of the complaints about the "evil entity" are really complaints that we can't always get what we want.  Unfortunately that's true, but if we get what we bargained for, we don't have a lot of room to complain about the legality of entities, even if we did deal with a scummy person.  

--JPF

15% Contingency Fee Award Spurs Discussion

The Wall Street Journal Law Blog discusses the $300 million plaintiffs’ attorneys’ fees awarded by a Delaware court in the Southern Peru Copper Corporation Shareholder Derivative Litigation here.  (Our own Josh Fershee previously commented on the merits of this case here.)  Stephen Bainbridge noted a few days ago that “there are a lot of folks in Delaware who are happily expecting this decision to encourage plaintiffs to come back to Delaware.”  He quotes Jonathan Macey and Geoffrey Miller as explaining that “in Delaware well-intentioned judges can be expected to devise legal rules requiring that Delaware lawyers be consulted when important decisions are to be made. Moreover, if Delaware judges believe that the state judicial system well serves Delaware corporations, they will be more likely to approve rules that stimulate litigation in the Delaware courts.”  But the Macey and Miller quote that caught my attention was this one: “The members of the Delaware Supreme Court are drawn predominantly from firms that represent corporations registered in Delaware.”  Just for the fun of it I decided to search for this quote in other law reviews on Westlaw.  Here’s what I found:

1. The inability of any province to fashion a provincial jurisprudence is also a function of the manner in which judges are appointed. In Delaware, as in other states, judges are state appointees. This ensures that the state can choose judges who will be sympathetic to corporate managers. As Macey & Miller (1986, p. 502) observe, “[t]he members of the Delaware Supreme Court are drawn predominantly from firms that represent corporations registered in Delaware. The bar and the judiciary are tied together through an intricate web of personal and professional contacts.” As a result, Delaware “judges are specialized in resolving corporate law disputes and as a consequence, the state can offer firms access to a system of corporate law rules that is stable, predictable and sophisticated relative to that of other states” (Macey & Miller, 1986, p. 500). Moreover, because judicial appointments are a state matter, the state can decline to renew the appointment of a judge who does not decide cases in a manner suitably sympathetic to corporate concerns.  Douglas J. Cumming & Jeffrey G. MacIntosh, The Role of Interjurisdictional Competition in Shaping Canadian Corporate Law, 20 Int'l Rev. L. & Econ. 141, 157 (2000).

2. Although judges obviously are more isolated from interest group influences than legislators, Delaware's justices are likely to reflect the interests of the corporate bar. The most obvious source of sympathy is the judicial selection process. As described earlier, the Delaware bar plays a central role in selecting justices, and it can be expected to recommend individuals who have a natural affinity to the corporate bar. This natural inclination is amply borne out by even a cursory look at who is ordinarily selected to sit on the supreme court. Nearly all of the justices, both currently and as a historical matter, were members of the Delaware bar before donning judicial robes.  David A. Skeel, Jr., The Unanimity Norm in Delaware Corporate Law, 83 Va. L. Rev. 127, 158 (1997) (quoting Macey & Miller in accompanying footnote).

Not exactly ringing endorsements of objectivity.

SJP

The Inspiring Kindness of Larry Ribstein

If you haven't heard, Larry Ribstein passed away unexpectedly yesterday.  The outpouring of condolences reflects his immense stature in the academy.  As a relatively young scholar with overlapping interests, my own interactions with him were limited but nonetheless significant to me.  What I remember most is that he never allowed whatever ideological differences we may have had to stop him from taking the time to respond to my queries.  In fact, he even thanked me in one of his recent papers, and I can only attribute that to pure kindness--a little pat of encouragement--because I seriously doubt I could have added much of anything to his writing in light of his expertise and the brilliant scholars he clearly had close relationships with.  Thus, while there is obviously much in terms of scholarship that Larry is worth remembering for, what I will primarily remember him for is his inspiring kindness. 

SJP

PS--I think it is worth adding here, particularly in light of the recent civility tiff, that this willingness to spend time helping a young scholar regardless of ideology is something that I have witnessed emanating from a number of respected scholars throughout the academy (Stephen Bainbridge, in particular, comes to mind--but there are numerous others), and it is something that makes me feel very hopeful about our profession, and very grateful and proud to be a part of it.

Davidoff on "how globalization increasingly allows companies to avoid United States taxes and regulation."

Over at DealBook, Steven Davidoff has posted "The Benefits of Incorporating Abroad in an Age of Globalization."  Davidoff uses Michael Kors Holdings as a case study demonstrating how companies are incentized to incorporate abroad in order to take advantage of tax savings, decreased regulatory burdens, and a decreased threat of shareholder litigation.  He notes further that this is not an isolated case, as "[p]rivate equity firms have been buying American companies with significant foreign operations and reorganizing them as foreign corporations."  To the extent that this creates problems for the U.S., he suggests that "[p]erhaps it is time for the United States to adopt a tax system more in line with the rest of the world."  What I found more interesting, however, was his suggestion that "American investors may be investing in Kors and other companies incorporated outside the United States without appreciating that they are not subject to the same United States laws that other publicly traded companies are."  This seems to me to be the crux of the debate about whether corporate regulation generally follows a race to the bottom or the top.  The greater the likelihood that signifcant portions of the investing community do not properly value the jurisdiction of incorporation, the greater the likelihood that the race is to the bottom rather than the top.

SJP

Sticks and stones may break my bones ....

In case you've missed the name-calling drama playing out in the legal scholar blogosphere, here's a recap:

1. Stephen Bainbridge takes issue with John Coffee calling him (and Larry Ribstein & Roberta Romano) names (here).

2. My first reaction to this was that it was somewhat of an odd response, given how many times Bainbridge has seen fit to call people idiots and other names on his blog.  Matt Bodie beat me to the punch, however, here.

3.  Bainbridge responds by claiming it's okay to call people names in blog posts (here).

Personally, I'm unclear as to how a lack of civility is ever really defensible.  Bainbridge quotes Brian Leiter as saying (here):

Some philosophers with Kantian intuitions think that civility is always a general requirement of respect for persons, an intuition that I do not share, and for which I can not think of any compelling arguments, and many objectionable counter-examples, like those in the text: treating Nazis in Weimar with civility seems to me a moral failing on the part of their opponents, not a requirement of respect. Such a demanding conception of civility would also be incompatible with derisive polemics (think H.L. Mencken), which often play an important role in political and social life.

My answer is simply that the moral failing in the Weimar case would be to not hold the Nazis accountable.  Using their behavior as an excuse to act in an uncivilized manner yourself strikes me as simply another form of moral failing.  And saying that derisive polemics have worked in the past is not the same thing as saying that they represent the best way to get things done.  That's sort of like saying we shouldn't strive to keep our anger in check because it can sometimes serve as a proxy for clarity.

We are currently struggling as a nation with competing ideologies that sometimes make it seem like we might be stuck in standoff mode for much longer than is good for anyone.  A lack of civility has been blamed for inflaming this standoff, and I believe we have a responsibility as law professors to not place our stamp of approval on that type of behavior--in our scholarship or our blogging.  Of course, even those of us who agree with this ideal will frequently fall short (particularly in blog posts and during live presentations) because we are ultimately all human and therefore, I believe, all greatly flawed by definition.  Nonetheless, I believe civility is a goal worth striving for in all our affairs.

SJP

ADDENDUM (12/22): In re-reading my post, I realized that I left out what I hope would be obvious but may nonetheless be better stated affirmatively: If sacrificing civility could be shown to be somehow necessary in order to stop the Nazis, then I agree it would be a moral failing to cling to civility.  However, I consider this to be a false dichotomy and believe that it is possible to effectively oppose evil without sacrificing civilized behavior.  Obviously, much of this turns on one's definition of civilized behavior.  However, I think it is fair to say that one need not spit on someone or insult them in order to, for example, justifiably lock them up or even kill them in self-defense.  I realize I've now drifted far afield of the issue regarding civility in scholarship versus blogging, but re-reading my post just left such a bad taste in my mouth that I felt compelled to clear up any confusion I may have created.  I also acknowledge that I may yet be convinced that there are indeed situations where a choice must be made between civility and justice, but I'll leave that for another day.

Good Business: An "Unless" Clause Means What It Says

The North Dakota Supreme Court recently determined in Beaudoin v. JB Mineral Services, LLC, that an "unless" clause in an oil & gas lease means what it says.  That is, unless the lessee makes the a specified payment by a specified date, the lease terminates.  The provision at issue required:

1. Notwithstanding anything to the contrary contained in said lease, it is agreed that said lease shall terminate as of120 business days from date of notarized signature (hereinafter referred to as the Termination Date) unless Lessee, on or before said Termination Date, shall pay or tender to the Lessor(s), or any successor bank, as a Supplemental Bonus Payment, the sum of Forty Five Dollars ($45.00) per net mineral acre owned by Lessor(s) and covered by said Lease. The payment or tender of said sum may be made by cash, check, or draft, mailed or delivered to the Lessor(s) or to said bank on or before said Termination Date.

2. If said supplemental bonus payment is timely paid or tendered, then said lease shall be and continue in full force and effect according to its terms. If such sum is not timely paid or tendered, then said lease shall terminate and be of no further force or effect as of the Termination Date. It is understood and agreed that Lessee has the right to, but is not obligated to, make said supplemental bonus payment. In the event said supplemental bonus payment is not made as set forth above and said lease has been filed in the records of said County and State, it is agreed that Lessee shall promptly execute and file of record a release of said lease.

As the Court notes, the clause doesn't require to lessee to make a payment. It simply provides that the lease will end unless the lessee acts.  The Court also explained that "the 'unless' clause was developed for the benefit of the lessee, and is strictly construed against the lessee even though harsh results may occur."  

I like this -- it is a contract with a clause for a specific purpose, and the court is enforcing it with gusto. I would note, too, that this is not a case where a mistake was claimed or where the lessee tried to comply, but somehow erred.  This was a case where the lessee made an argument that if, "[c]arried to its logical extreme . . .[would mean] the lessee would be allowed to effectively extend the termination date indefinitely [without actually making the requirement payment]." 

In a time where where many landowners and others are expressing concern about how oil and gas companies are treating those with whom they do business, here's at least one example where the lessor is likely to get what he or she bargained for.

--JPF 

What constitutes and adequate law school ROI?

University of Louisville Law School Dean Jim Chen argues that law school graduates typically need to generate an annual income equal to three times their annual law school tuition in order for their investment in law school to leave them with adequate economic viability, assuming they incurred debt to cover the entire cost of tuition (and nothing more).  The National Law Journal has the story here.  Dean Chen's paper is available here.

SJP

More Citigroup Settlement Musings

I'm continuing my email interview with a journalist regarding Judge Rakoff's Citigroup settlement decision (see my prior post on this here), and among other things I was asked whether I was surprised by the SEC's decision to appeal the ruling.  Here is part of my response:

I was not surprised by the appeal, but it does set up an interesting conflict.  On the one hand, the SEC is likely correct that requiring an admission of facts in order for a settlement to be approved in these types of cases is unprecedented.  On the other hand, Judge Rakoff seems to be stating an obvious truth when he asserts that he cannot carry out his duty of determining whether the settlement is "fair, reasonable, adequate, and in the public interest" without some facts upon which to render this decision.  I think the following quote from Judge Rakoff's opinion is right on point:

"Here, the S.E.C.'s long-standing policy—hallowed by history, but not by reason—of allowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations, deprives the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact…. The S.E.C., by contrast, took the position that, because Citigroup did not expressly deny the allegations, the Court, and the public, somehow knew the truth of the allegations. This is wrong as a matter of law and unpersuasive as a matter of fact."

I think the Second Circuit will feel a great deal of pressure to overturn Judge Rakoff's decision, but it will be interesting to see how it resolves this issue if in fact it does reverse.

12/18 UPDATE: Prof. Bainbridge is surprised by the appeal.

SJP

A Note to the SEC: Don't Just Take Some Case and Hope

On Dec. 14, 2011, a reporter for ProPublica, Jesse Eisenger, wrote the following article for New York Times Dealbook: In Hunt for Securities Fraud, a Timid S.E.C. Misses the Big Game.  In it, he argues:

Does the Securities and Exchange Commission suffer from trialphobia?

Ever since Judge Jed S. Rakoff rejected the S.E.C.’s settlement with Citigroup over a malignant mortgage securities deal, the agency has been defending its policy to settle securities fraud cases. But the public wants a “Law & Order” moment, and who can blame them?

. . . .

But so far, there’s been no civil trial in a major case directly related to the biggest economic fiasco of our time: the financial crisis.

Two days later, the Dealbook, from authors Azam Ahmed and Ben Protess, provides this: S.E.C. Sues 6 Former Top Fannie and Freddie Executives, which reports that the SEC seems to have answered Mr. Eisenger's call:

The Securities and Exchange Commission has brought civil actions against six former top executives at the mortgage giants Fannie Mae and Freddie Mac, saying that the executives did not adequately disclose their firms’ exposure to risky mortgages in the run-up to the financial crisis.

The case is one of the most significant federal actions taken against top executives at the center of the housing bust and ensuing financial crisis. 

Obviously, this case would have been in works long before last Wednesday, so the timing is something of a coincidence, and it's not as though Mr. Eisenger is the first person to question where the SEC is on this. But I sure hope that this case is proceeding because the SEC thinks it's proper to move forward, and not because they think they need to bring a case, any case, forward.

I bristle at the idea that an agency, law enforcement or regulatory, would purse a case simply because "the public wants a 'Law & Order' moment."  I know, of course, that many prosecutors seek cases primarily to raise their profile and send a message, but that doesn't mean it's right.  I undertand what he's saying, but I don't care for Mr. Eisenger's recommended use of authority.  He explains:

To overcome its greatest fear, the S.E.C needs to realize that it can win even if it loses. A trial against a big bank could be helpful regardless of the outcome. It would generate public interest. It would put a face on complex transactions that often are known only by abbreviations or acronyms. Litigation would cost the bank money, too. And it could cast the way Wall Street does business in such an unflattering light that even if the bank won, it might bring about better behavior.

A trial would show boldness. And when the S.E.C. found itself at the negotiating table again, it would feel a new respect.

You don't earn respect by being a bully, by making people jump through hoops, or by making them expend resources just because you can. You may earn fear and you will almost certainly earn disdain, but that's not the same thing. 

I agree that the SEC shouldn't seek only cases it can win or settle. In fact, I think a lot of relatively "little guys" are getting forced into SEC fines and settlements right now, not because they necessarily did something wrong, but because they can't afford the fight. The SEC gets to report the settlements, which go down as wins over "corruption and fraud."  

And I think there may be value in pursuing some of the big guys for fraud because some of them probably committed fraud.  But you need to facts before you go hauling people into court.  I'm all for pursuing fraud vigorously, but I'm not willing to let any regulator decide to mess with people's lives just because the public thinks someone needs to pay.  Law enforcement and regulation only work if the right people pay for the wrongs they committed. So, SEC, don't just take some case and hope for it. Put together the right case, and then go for it.

--JPF

 

Buell on the Potentially Perverse Effects of Corporate Civil Liability

Samuel W. Buell has posted "Potentially Perverse Effects of Corporate Civil Liability" on SSRN.  Here is the abstract:

Inadequate civil regulatory liability can be an incentive for public enforcers to pursue criminal cases against firms. This incentive is undesirable in a scheme with overlapping forms of liability that is meant to treat most cases of wrongdoing civilly and to reserve the criminal remedy for the few most serious institutional delicts. This effect appears to exist in the current scheme of liability for securities law violations, and may be present in other regulatory structures as well. In this chapter for a volume on "Prosecutors in the Boardroom," I argue that enhancements of the SEC's enforcement processes likely would reduce the frequency of DOJ criminal enforcement against firms, an objective shared by many. Among other enforcement features, I address problems with the practice of accepting "neither admit nor deny" settlements in enforcement actions, a subject that has drawn greater attention since this chapter was published.

SJP

One More Thought -- Does Anyone Own the Packers?

Professor Bainbridge reasonably asked what I actually thought about whether the Green Bay Packers stock is a security. I said it's not under federal securities law, but that I think it should be.  Then I had one other thought -- who really "owns" the Packers?  Professor Bainbridge noted in his post Owning the Green Bay Packers, that his first weekend went well. Of course, as he has said, he really is the "proud owner of 1 share of stock in Green Bay Packers, Inc."  By his own standards, anyway, the good professor is not actually an owner of the Packers.  

Back in March of 2010, Professor Bainbridge let me know: Once more with feeling: Shareholders Don't Own the Corporation.  As he explained: 

There is no entity or thing capable of being owned. Granted, because the shareholders hold the residual claim on the corporation's assets, their deal with the corporation has certain ownership-like rights. But they have only those rights specified by their contract, as that contract is embodied in state corporate law and the firm's organic documents. 

So, to recap, the Packers sale of stock provides neither a security nor ownership of the Packers. So what is it?  The stock grants the right to attend an annual meeting and vote on a few things, but provides very few "ownership-like rights."  Is it really just an expensive piece of paper?  It must be a little more than that, because even though people feel good about a donation to Goodwill and other such groups, they don't frame the receipt. (Maybe some people do, I guess, but I'm assuming not.) 

Ultimately, then, it is this simple: Packers "stock" is a contract that provides the right to vote for the members of the Board of Directors, amendments to the Article of Incorporation, certain mergers or sales, and dissolution, at a price of $250 per vote.  

With that settled, on to the next issue:  With the Delaware Chancery Court having filled Chancellor Chandler's seat, when does Professor Bainbridge join the Packers board, as permitted under the bylaws? Assuming he'd accept such a nomination, consider that campaign launched.  Their quarterback is a West Coast guy.  Why not add a similarly situated director?

--JPF 

The World Economics Association on Pluralism

The World Economics Association recently published its first newsletter (here) dedicated to plurality.

A central theme that you will see emphasised throughout this newsletter is the issue of pluralism, the idea that there is more than one way to look at an issue. So why is pluralism important? …

The use of language to frame issues is important. Fairclough (1995) refers to “ideological-discursive formations” (IDFs) in which groups have their preferred terms. These serve to define debate in a way that supports their perspective. This may arise unintentionally, but the shift from “doctor and patient” to “service provider and consumer”, say, is still a redefinition of a relationship. If there is a dominant IDF whereby other alternatives are not heard, it can be seen as “reality”, “the truth”. Any alternatives that then arise may be labelled apocryphal or ideological. If there is poor communication across academic groups, as Kuhn suggests, then each group can, internally, see itself as owning the “truth” for its area. Implicitly, then, other groups’ perspectives are flawed or irrelevant.

This is not conducive to a pluralist approach. Perhaps we should all be saying that we are constructing artificial representations (analogies) of the real world. If we are not careful, we may believe that our models and theories do actually represent the real world. They don’t. They are simplifications and generalisations which, we hope, give us some insights into the real world. We need to be aware of the limitations of our perspectives and of the multitude of possible alternative perspectives which may be useful.

SJP

Is Stock in the Green Bay Packers a Security?

Building on my business law and the NFL geekdom:  The Green Bay Packers recently offered to sell 250,000 shares at $250 per share.  See here:  http://packersowner.com/.  The opportunity to own a portion of any major sports team is a big deal. Just ask Professor Bainbridge -- he even reconsiderd his allegiance to that team from Washington now that he is an owner of one share of the Packers. Of course, as merely a shareholder, he has no fiduciary obligations not to root for his old team.  There's just very little upside. 

The Packers Offering Document is available here.  The Packers make very clear:

The Common Stock does not constitute an investment in “stock” in the common sense of the term because (i) the Corporation cannot pay dividends or distribute proceeds from liquidation to its shareholders; (ii) Common Stock is not negotiable or transferable, except to family members by gift or in the event of death, or to the Corporation at a price substantially less than the issuance price, under the Corporation’s Bylaws; and (iii) Common Stock cannot be pledged or hypothecated under the Corporation’s Bylaws. COMMON STOCK CANNOT APPRECIATE IN VALUE, AND HOLDERS OF COMMON STOCK CANNOT RECOUP THE AMOUNT INITIALLY PAID FOR COMMON STOCK, EITHER TROUGH RESALE OR TRANSFER, OR THROUGH LIQUIDATION OR DISSOLUTION OF THE CORPORATION. 

The Offering Document further makes clear their view of the securities law issue:

Because the Corporation believes Common Stock is not considered “stock” for securities laws purposes, it believes offerees and purchasers of Common Stock will not receive the protection of federal, state or international securities laws with respect to the offering or sale of Common Stock. In particular, Common Stock will not be registered under the Securities Act of 1933, as amended, or any state or international securities laws.

Okay, but can they just do that?  I'll concede at the outset that it's unlikely a court would find this to be a security, but it's not (or shouldn't be) a foregone conclusion. Like partnerships or agency relationships, just because the participants disclaim something, it doesn't mean the court will agree.  As the court in Chandler v. Kelley, 141 S.E. 389 (Va. 1928), explained in the agency context, even where the parties "denied the agency . . . the relationship of the parties does not depend upon what the parties themselves call it, but rather in law what it actually is." 

Certainly it's true that the Packers stock could fail some elements of the Howey test, which says something is a security when there is "a contract, transaction or scheme whereby a person invests money, in a common enterprise, and is led to expect profits solely from the efforts of the promoter or a third party.” SEC v. WJ Howey Co., 328 US 293 (1946).  So here, the failure would be be that the purchaser is not led to expect profits.  

In 1985, the Supreme Court determined in Landreth Timber Co. v. Landreth, 471 U.S. 681 (1985):

[T]he fact that instruments bear the label “stock” is not of itself sufficient to invoke the coverage of the Acts. Rather, we concluded that we must also determine whether those instruments possess “some of the significant characteristics typically associated with” stock, id., at 851, 95 S.Ct., at 2060, recognizing that when an instrument is both called “stock” and bears stock's usual characteristics, “a purchaser justifiably [may] assume that the federal securities laws apply,” id., at 850, 95 S.Ct., at 2059. We identified those characteristics usually associated with common stock as (i) the right to receive dividends contingent upon an apportionment of profits; (ii) negotiability; (iii) the ability to be pledged or hypothecated; (iv) the conferring of voting rights in proportion to the number of shares owned; and (v) the capacity to appreciate in value.

The Packers' stock only has one of these characteristics -- the voting rights.  But stock comes with two essential rights:  economic rights and voting rights.  It's clear that non-voting preferred stock is still stock, even though the purchasers of that stock have given up their voting rights to enhance their economic rights.  Why can't it work the other way?  While I admit all "non-voting" stock I have seen has some conversion right or a right to vote if dividends are not paid for a certain period of time, it's not clear to to me it necessarily has to be that way.

Furthermore, under the Howey test, traditionally the "profit expectation" prong is very low. Tax-mitigation arrangements, for example, can be deemed securities.  It's really a question of whether there is some benefit conferred on the investor, not how the bottom-line profit is calculated.  The Packers' offering site provides this:

Postal Service Slow Down: Can't Credit Complaints Without Cash

My local paper, the inimitable Grand Forks Herald, provided this opinion piece today:  Stop the Postal Service’s ‘panic selling’.  The piece argues that the Post Office has refused to listen to thousands of complaints about the proposal to make financial cuts that will lead to slower mail delivery.  They argue:

These changes are coming too fast and with too little thought being put into them. Furthermore, they’re being driven not by any sense of the public good but simply by money — namely, the Postal Service’s financial crisis. ...

[T]he trouble is, the Postal Service is not just another business. It may be a quasi-private organization, but it’s also one with a centuries-old public-service mission: delivering America’s mail.

Perhaps, although it's my understanding that the Post Office isn't getting taxpayer funding. It seems to me this piece gives too much credance to complaints about the Postal Service's proposal without asking one more key question:  Are you willing pay enough to pay to keep the status quo? 

If not, the plan is the best option. And that's business, folks. 

--JPF