January 07, 2012
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":
January 06, 2012
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.
January 04, 2012
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:
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.
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."
January 03, 2012
A Ribstein Legacy: Politics, Scholarship, and the Value of Discourse
Last month, there was something of a squabble with Professors Ribstein, Romano, and Bainbridge on one side and Professor Coffee on the other. The squabble highlighted some differences in views among some of the truly elite business law scholars -- mostly about the value of securities regulation and how Professor Coffee characterized the views of the others -- which I found interesting because I agree with all of them about some significant portion of business law. The squabble had scholarly, as well as political, overtones. A summary of the difference of opinion is here and the conclusion is here and here.
The passing of Larry Ribstein has caused me to reflect on what his scholarship meant to me as a developing business law professor. I agree with most of Ribstein's writing about LLCs and corporate obligations, and this agreement represents an evolution in my way of thinking about entity governance and operations. What is particularly appealing to me about this is that, from his blog posts, I get that sense that Professor Ribstein and I were not necessarily on the same page politically. Nonetheless, even when I disagreed with what seemed to be the motivations for his thinking, I usually thought his analysis was right.
His writing on LLCs and "uncorporations" had a particularly profound impact on how I view business entities because he helped (and perhaps caused) me to think about the value in multiple options among enitities. He explained how the LLCs and corporations are different in their respective histories and how those histories should inform the law's view of each entity. In his book, Rise of the Uncorporation he explains, at page 6:
Uncorporations are characterized by their reliance on contracts. This is an aspect of uncorporations’ partnership heritage, as partnerships are contracts among the owners. . . . In contrast, corporate law is mainly couched in mandatory terms. . . . [T]he corporation’s special regulatory nature emerged from its historical roots. The corporation initially was a vehicle for government enterprises, monopolies, or franchises.
See more of his thoughts on this here. It was, in part, Professor Ribstein's writings that spurred me to write the short piece, LLCs and Corporations: A Fork in the Road in Delaware? (Harvard Business Law Review Online).
As I think about it, through their books, articles, and blogging, Professors Ribstein and Bainbridge have probably had more of an influence on my views of corporations and LLCs than anyone, even though I tend to disagree on any number of political issues. I suspect part of it is that I like to be engaged by people with different views, and I want them to have the chance to change my view. If I'm not questioning my rationale, I'm not learning. Changing my mind doesn't happen that often, but it does happen. In turn, I hope to be given the same opportunity to influence others from time to time.
This is just one more small reason, among many large ones, why Larry Ribstein will be missed.
January 01, 2012
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.
December 31, 2011
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.
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.
December 29, 2011
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.
December 24, 2011
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.
December 24, 2011 in Corporate Governance, Current Affairs, Government and Business, International Business, Investing, Mergers & Acquisitions, Musings, Politics, Securities Markets, Securities Regulation | Permalink | Comments (0)
December 17, 2011
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.
December 16, 2011
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.
December 15, 2011
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.
December 12, 2011
A Reason People Hate Corporate Lawyers or Why the Packers Should Be an LLC
On Friday, I asked whether the sale of Green Bay Packers stock should be considered a security. A few people asked whether I really think the Packers stock could be a security. The answer, under Wisconsin law, is almost certainly no, especially given that that Green Bay Packers, Inc., "is organized as a Wisconsin nonprofit stock corporation." And that's probably the case for almost any other state, too, and under federal law.
But just because the outcome is pretty clear, it doesn't mean that there aren't policy implications that are worth thinking about. I think the biggest one is this: lawyers and business people should say what they mean. Mixing marketing and corporate law is not always a good idea. I find it more than a little silly that the cover of the Packers offering documents says:
Green Bay Packers, Inc.
Common Stock Offering Document
COMMON STOCK DOES NOT CONSTITUTE AN INVESTMENT IN “STOCK” IN THE COMMON SENSE OF THE TERM. PURCHASERS SHOULD NOT PURCHASE COMMON STOCK WITH THE PURPOSE OF MAKING A PROFIT.
So, you see, the word stock without quotes is different than stock with quotes. In my view, you shouldn't call something stock if it's not stock, even if you can under securities laws. There's no doubt that the Landreth court, interpreting Forman, said that stock is not a security just because the company said it issued stock:
[I]n Forman we eschewed a "literal" approach that would invoke the [Securities] Acts' coverage simply because the instrument carried the label "stock." Forman does not, however, eliminate the Court's ability to hold that an instrument is covered when its characteristics bear out the label.
Now, before these cases, one could argue that something labeled "stock" is always a security, as per § 2(1) of the 1933 Act:
"The term `security' means any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, . . . investment contract, voting-trust certificate,. . . or, in general, any interest or instrument commonly known as a `security.' " 15 U. S. C. § 77b(1).
In Landreth, the court cited Louis Loss, Fundamentals of Securities Regulation 211-212 (1983), providing the following excerpt:
It is one thing to say that the typical cooperative apartment dweller has bought a home, not a security; or that not every installment purchase `note' is a security; or that a person who charges a restaurant meal by signing his credit card slip is not selling a security even though his signature is an `evidence of indebtedness.' But stock (except for the residential wrinkle) is so quintessentially a security as to foreclose further analysis."
And, in fact, before Landreth, SEC v. C. M. Joiner Leasing Corp., 320 U. S. 344 (1943) indicated that notes or bonds could possibly be deemed securities "by proving [only] the document itself." The Forman court said that interpretation was dictum as to stock, and the Landreth confirmed that was not true for stock (leaving that question as to notes and bonds "until another day"). Thus, the Supreme Court said, we must look to the economic realities to determine whether stock is a security.
Which bring me back to this: If the Packers are really just selling a $250 (plus handling) certificate (suitable for framing), they shouldn't call it stock. And they shouldn't start their offering letter: "Dear Future Owner of the World Champion Green Bay Packers." It should say: "Dear Future Owner of a Certificate saying 'World Champion Green Bay Packers.'"
In my view, the Packers are using the sense of ownership to secure investors and people who have a connection with the team. I think that's fine; I actually rather like the idea. But I don't like the idea that they can use the term stock, the sense of ownership, provide voting rights and the opportunity to attend Annual Meetings, restrict gifting or sales, and then disclaim that what they are selling is a security simply because the primary upside is that past purchases helped "ensure the team survived and remained in Green Bay" and the new purchases will fund an "expansion [that] has been designed to keep the crowd noise in the stadium and maximize our home-field advantage."
So, I admit my argument is largely academic (a luxury I have), but I do think there is value in not allowing people to muddy the waters. Suppose, for the sake of argument, the Packers committed a massive fraud and used the money to invest in Greek debt. The debt tanks, the Packers can't have a stadium upgrade, and the home field advantage begins to fade. The team suffers, and shareholders sue under 10b-5. The court says, nope, you didn't buy a security because you only had voting rights, without ecomomic rights. The court would probably be right under Landreth (notice my continuing, apparently unavoidable, hedge). And it would be reasonable under the actual terms of the offering document, if you read it. But it would still make a bunch of lawyers and judges look like jerks.
To me, this would all be better done as an LLC, with a granting of an owership unit clearly defining the terms. Then it's plainly (or should be) contractual, and it's not stock, and we have very little problem with confusion with traditional stock or other securities. Frankly, isn't that confusion the main reason the Packers are calling it stock? I think so. This is just one more reason we should start respecting and using the LLC for creative entities, and leave the off-the-rack stuff for corporations.
[Update: Professor Bainbridge wanted an answer to the real question of whether Packers stock is a security. My answer is that I don't think a federal court would find this to be a security, especially with the appropriate disclaimers that have been made. But I reserve my right to think they should. In the interest of full disclosure, I am a life-long Lions fan.]
December 11, 2011
Beneish, Marshall & Yang on Collusive Directors
Messod Daniel Beneish, Cassandra D. Marshall, and Jun Yang have posted "Why Do CEOs Survive Corporate Storms? Collusive Directors, Costly Replacement, and Legal Jeopardy" on SSRN. Here is the abstract:
We use an observable action (non-executive directors’ insider trading) and an observable outcome (the market assessment of a board-ratified merger) to infer collusion between a firm’s executive and non-executive directors. We show that CEOs are more likely to be retained when both directors and CEOs sell abnormal amounts of equity before the delinquent accounting is revealed, and when directors ratify one or more value-destroying mergers. We also show that a good track record, higher innate managerial ability, and the absence of a succession plan make replacement more costly. We find retention is less likely when the misreporting is severe and directors fear greater litigation penalties from owners, lenders, and the SEC. Our results are robust to controlling for traditional explanations based on performance, founder status, corporate governance, and CFOs as scapegoats. Overall, our analyses increase our understanding of the retention decision by about a third; they suggest that financial economists consider collusive trading and merger ratification as additional means of assessing the monitoring effectiveness of non-executive directors.
December 08, 2011
De Angelis on the Importance of Internal Control Systems in the Capital Allocation Decision: Evidence from SOX
David De Angelis has posted "On the Importance of Internal Control Systems in the Capital Allocation Decision: Evidence from SOX" on SSRN. Here is the abstract:
I examine the effect of information frictions across corporate hierarchies on internal capital allocation decisions, using the Sarbanes-Oxley Act (SOX) as a quasi-natural experiment. SOX requires firms to enhance their internal control procedures in order to improve the reliability of financial reporting across corporate hierarchies. I find that after SOX, the capital allocation decision in conglomerate firms is more sensitive to performance as reported by the business segments. The effects are most pronounced in conglomerates that are prone to information problems within the organization, such as conglomerates with more segments and conglomerates that restated their earnings in the past, and least pronounced in conglomerates that still suffer from material weaknesses in their internal controls after SOX. In addition, I find that conglomerates’ productivity and market value relative to stand-alone firms increase after SOX. My results support the argument that inefficiencies in the capital allocation process are partly due to information frictions across corporate hierarchies. My findings also shed light on the importance of SOX on the efficiency of capital allocation decisions in large firms.
December 06, 2011
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.
December 05, 2011
Weekend Reading: On Politics, Poetry, and Finances
I had the opportunity to spend some time on a plane with Sunday's New York Times Magazine this weekend. It was a particularly good read. Here are some highlights that have some applicability to business and business law:
Mitt Romney’s campaign has decided upon a rather novel approach to winning the presidency. It has taken a smart and highly qualified but largely colorless candidate and made him exquisitely one-dimensional: All-Business Man, the world’s most boring superhero.
The excessive love of individual liberty that debases our national politics? It found its original poet in Ralph Waldo [Emerson]. . . .
The larger problem with [“Self-Reliance”], and its more lasting legacy as a cornerstone of the American identity, has been Emerson’s tacit endorsement of a radically self-centered worldview. It’s a lot like the Ptolemaic model of the planets that preceded Copernicus; the sun, the moon and the stars revolve around our portable reclining chairs, and whatever contradicts our right to harbor misconceptions — whether it be Birtherism, climate-science denial or the conviction that Trader Joe’s sells good food — is the prattle of the unenlightened majority and can be dismissed out of hand.
“A man is to carry himself in the presence of all opposition,” Emerson advises, “as if every thing were titular and ephemeral but he.” If this isn’t the official motto of the 112th Congress of the United States, well, it should be. The gridlock, grandstanding, rule manipulating and inability to compromise aren’t symptoms of national decline. We’re simply coming into our own as Emerson’s republic.
[T]he bottom line is simple: Europe’s problems are a lot like ours, only worse. Like Wall Street, Germany is where the money is. Italy, like California, has let bad governance squander great natural resources. Greece is like a much older version of Mississippi — forever poor and living a bit too much off its richer neighbors. Slovenia, Slovakia and Estonia are like the heartland states that learned the hard way how entwined so-called Main Street is with Wall Street. Now remember that these countries share neither a government nor a language. Nor a realistic bailout plan, either.
This article on the Euro also notes that Lord Wolfson, CEO of Next (a European retailer) is offering a £250,000 prize to anyone who can "answer the question of how to manage the orderly exit of one or more member states from the European Monetary Union." The PDF announcement is here. Why does this matter? As the Times Magazine article explains:
Q: Will the euro survive?
It’s a dangerous question to ask out loud. Suppose a credible rumor spread throughout Greece that, rather than accept the harsh terms of another bailout package, the government was plotting to revert to the drachma. Fearing the devaluation of their savings, Greeks would move their money somewhere safer, like a German bank. The Greek banking system would then, in all likelihood, implode.
But Greece’s economy is too small for an isolated collapse to cause any significant damage throughout the continent. (Even a collapse confined to Greece, Ireland and Portugal couldn’t take down Europe.) So the concern about a run on the Greek banking system is largely about whether a panic might spread to Spain or — worse — Italy, which could topple Europe’s financial system.
If you have any ideas on how to orchestrate a reasonably smooth exit of one or more countries from the European Monetary Union, you could line your pockets with some British currency, while stabilizing European markets. That'd be a good day's work.
December 04, 2011
Campbell on Normative Justifications for Lax (or No) Corporate Fiduciary Duties
Rutheford B. Campbell Jr. has posted "Normative Justifications for Lax (or No) Corporate Fiduciary Duties: A Tale of Problematic Principles, Imagined Facts and Inefficient Outcomes" on SSRN. Here is the abstract:
Corporate fiduciary duty standards are at an all time low.
Normative justifications offered to support lax corporate fiduciary duty standards, however, are weak. The justifications fail adequately to provide a persuasive reason for abandoning the economic principle widely applied in society, which is to hold actors accountable for the economic loss caused by their actions. Such accountability is thought to provide an incentive for efficient conduct.
This paper offers a critical analysis of two arguments for allowing corporate managers to act without accountability for the full economic loss caused by their mismanagement. The two arguments have been largely unchallenged and today garner broad support from influential quarters.
One argument is that corporate managers should not be accountable for a lack of due care in their decisions, and the justification for this position is a claim that eliminating the duty of care obligation provides an incentive for managers to take value creating risks on behalf of the company and its shareholders. The second argument is that corporate managers should be free to allocate and re-allocate unlimited amounts of corporate wealth among various corporate stakeholders, and this position is justified by a claim that such a rule provides an incentive for the investment of efficient levels of firm specific capital by the corporate stakeholders who provide monetary and human capital to corporations.
The normative justifications offered in support of these arguments depend on multiple, essential factual assumptions that not only are unproven empirically but also are counterintuitive and seem to get only more factually improbable when unpacked and analyzed closely. In short, these factual assumptions – which heretofore appear largely to have been accepted without question or analysis – amount to a thin reed and do not meet the burden that should be required of those who propose abandoning or broadly limiting corporate managerial accountability.
A strong version of corporate fiduciary duties provides an economic incentive for efficient and fair outcomes.
December 03, 2011
Judge Rakoff and the Citigroup Settlement Rejection
A journalist asked me some questions via email regarding Judge Rakoff's rejection of the Citigroup settlement. (DealBook has the opinion, as well as an overview, here.) Here are a couple of my responses:
I believe Judge Rakoff’s obvious frustration with the SEC practice of routinely entering into these sorts of agreements where the other side neither admits nor denies any wrongdoing is part of a growing trend. One might even go so far as to see a connection to the Occupy Movement, which at least in part seems to be protesting a perceived “crony capitalism” wherein government regulates big business by way of wink-and-nod processes that leave both sides happy and the average citizen worse off. (I’m not alone in making this connection. Jonathan Macey had this to say at Politico (HT: Bainbridge): “The victory that Rakoff gave to the Occupy Wall Street movement Monday came from the federal courthouse — not far from Zucotti Park, the lower Manhattan headquarters of OWS.”; “Adopting the language of the Occupy Wall Street movement, Rakoff ruled that if judges do not have enough information on which to base their decisions, then the deployment of judicial power ‘serves no lawful or moral purpose and is simply an engine of oppression.’”)
I am somewhat ambivalent about the decision. On the one hand, I recognize that there are good reasons for entering into these types of settlements. Defendants like Citigroup have strong incentives to settle without admitting any wrongdoing in order to avoid those admissions being used against them in later private proceedings. Meanwhile, the SEC has strong incentives to settle because of the costs and risks inherent in litigation. On the other hand, while the agreements appear to make sense for the SEC and the defendants, it is much less clear whether they make sense for shareholders and the public. The SEC suggests that there would be much less money available to return to investors if its power to enter into these sorts of agreements were to be curtailed. One may question, however, whether the routine use of these agreements does not in some way foster more injury to investors and the public in the long run, since there is at least some message being sent to the alleged wrongdoers in these cases that they will avoid any meaningful personal penalty for similar conduct in the future. One particular issue that I think needs to be examined more closely is the public’s perception of these settlements. I have heard the SEC defend its practices in these cases by saying they support investor confidence. I’m not so sure about that, and if the SEC is making decisions based at least in part on that presumption it is something that should be empirically tested. Personally, I think the public has grown more and more suspicious of these deals—so I find that particular justification to carry little weight, if it doesn’t in fact cut the other way.