Saturday, May 30, 2009


Alene-Jeff Congrats and further best wishes to Jeff and Alene Lipshaw, who are now celebrating their 30th wedding anniversary (?!!) in Santorini, Greece.  I know they are having a good time.  And we are happy for them!  [Alan Childress]

UPDATE:  Thanks, Alan - this is this year's alternative to the Law & Society confab in Denver.  Damn!  And who's the dorky guy with the beautiful woman?  [Jeff Lipshaw]

May 30, 2009 in Food and Drink, Hot Topics, In-House, Lipshaw | Permalink | Comments (1) | TrackBack (0)

Thursday, May 28, 2009

Sotomayor and Diabetes

Posted by Jeff Lipshaw

I have nothing to say about the nomination, and very little reaction, other than this seems to be a perfectly fine nomination of a perfectly fine judge who has the temerity not to have a consistent set of beliefs that manage to satisfy every interest group on all poles of every issue.

Our family did, however, get a good yuck out of the Type I diabetes issue, as Judge Sotomayor appears to be the first Type I diabetic to be nominated to the Court, as summarized here in the New York Times.  For the uninformed, Type I diabetes mellitus (also known as juvenile diabetes) is an autoimmune disease in which the body's antibodies attack and kill (permanently) the insulin producing cells in the islets of Langerhans in the pancreas.  Insulin is what allows the body to process glucose.  Type I diabetes is a permanent condition (presently) requiring the intradermal injections of insulin for the patient to survive (hence, "insulin dependent").  It is different from Type II diabetes in which pancreatic function is decreased but not killed off.  There appears to be a genetic predisposition to auto-immune diseases (like psoriasis or rheumatoid arthritis or Type I diabetes), and it's thought that a virus triggers the disease.  There is presently no cure. 

One out of every six hundred people is Type I diabetic.  If you have a diabetic sibling, you have a 5% chance of being diabetic.  We have three children, ages 25, 22, and 20.  All three have Type I diabetes.  My daughter has lived with it for sixteen years.  All three of my children are healthy and successful (presently one in the MFA program in theater at Columbia, one entering med school at Michigan in the fall, one finishing his sophomore year at Stanford).  Other notable Type I diabetes included Jay Cutler, the new quarterback of the Chicago Bears, and Mary Tyler Moore. 

The idea that Type I diabetes is a political issue is just ludicrous.  Justice Scalia seems to be a tad overweight (possibly a candidate for Type II!), and we know very little about the thyroid issues, or atherosclerotic condition of the other justices.  Do any of the male justices have male urinary syndrome that might cause them to go running for the loo during an argument (in which case FloMax will help)?  I'm thinking that restless leg syndrome might be a problem too.

I do appreciate the chance to say that with care and discipline Type I diabetes is a chronic disease that families can manage very, very well, and there isn't a single thing in the world that a Type I diabetic can't do.  But feel free to make a contribution to the Juvenile Diabetes Research Foundation.

UPDATE:  My wife reminds me there's something a Type 1 diabetic can't do, and that's go into combat.  I'm okay with that.

May 28, 2009 in Hot Topics | Permalink | Comments (1) | TrackBack (0)

Monday, May 11, 2009

Tulane Ranks #2 Among U.S. Law Schools In Only Rankings Done By Student Surveys

Posted by Alan Childress
So obviously the methodology is more valid than that of U.S. News & World Reports, which ignores consumer satisfaction and instead surveys the ... competitors' chair of their hiring committee???  What kind of statistical method is that? Who are the ad wizards behind that sort of academic ranking?  Maybe there's a reason you never see the infamous Coke-Pepsi taste test done by asking the head of Pepsi's personnel department what she thinks about drinking a Coke.  (She is against it. She candidly ranks Coke's taste as way lower than that of the radioactive barium milkshake they give you to gulp just before you take abdominal xrays.  Pepsi now ranked as number one soft drink.)

Tulane is the Number Two Party Law School in the country.  Woo hoo. See this site, as tipped by TaxProf.  Which begs the question, how fun must Arizona State be, to outrank us?

May 11, 2009 in Hot Topics | Permalink | Comments (0) | TrackBack (0)

Wednesday, February 18, 2009

A Member Of The Club

The controversy generated by the District of Columbia Bar's attack on Avvo continues. Carolyn Elefant has questioned whether her mandatory bar dues should be spent pursuing litigation that she opposes. An Avvo -related web page has posted the following threatening letter from the Bar's counsel. I wonder, as did Carolyn, whether the Bar should be trying to shut down the flow of accurate and publicly-available information and whether my dues should fund that effort.

I have been a dues-paying member of this Bar for 34 years and was a bar employee for over 17 years. It has been my experience that the Bar is run by and for the insiders (consisting of the large firms who wish to share in the leadership and the entrenched Bar executives).  If you do not subscribe to the views of and show fealty toward the leadership, you simply do not exist. Any of my attempts to bring an issue or an injustice to the Bar's attention (such as the forced removal of a member of the Board on Professional Responsibility for the crime of focusing on the public interest) have met with stony indifference at best and "how dare you" at worst.

I remain a member because I must but am constantly reminded of the wit and wisdom of Groucho Marx.

See this related post from Simple Justice. (Mike Frisch)

February 18, 2009 in Hot Topics | Permalink | Comments (1) | TrackBack (0)

Tuesday, January 6, 2009

Metaphor, Risk, and Judgment

Posted by Jeff Lipshaw

Two colleagues walked into my office yesterday and told me they had thought of me when reading the Michael Lewis/David Einhorn essay that purports to explain exactly what went wrong with the financial markets in the Sunday New York Times. David Zaring and Frank Pasquale have weighed in on the Lewis/Einhorn piece (Zaring = "kneejerk/post-hoc moralizing"; Pasquale = "smart commentary"); like Fred Tung, I think I have to go with David's balloon-popping of the "I-Told-You-So" School, and thank David as well for reminding me Turnerbrasilxapuriweb to go back to Joe Nocera's article about Nassim Taleb and the "Value at Risk" algorithm in the Sunday NYT Magazine.  (The problem, for me, with Sunday Magazine articles is that part of our paper gets delivered on Saturday, and the magazine gets stored in a hermetically-sealed container for twenty-four hours so that I have a pristine crossword puzzle to do on Sunday morning.  I jump right to the crossword (do not read The Ethicist or William Safire, do not pass GO)). 

It's not enough to say "see, I was right" because some lucky bastard always manages to take the long shot bet.  My prime example of this is Edward Yardeni.  He's still in business, despite having predicted the end of the world as a result of the Y2K crisis. The link is to a CNET article dated January 4, 2000 when it appeared that, indeed, the world had not collapsed, not the U.S., which had spent trillions, and not even Italy, which showed up on most people's charts as completely unprepared for the turn of the clock!   I love this - here's what it looks like when you've bet the farm on doomsday, and doomsday doesn't happen:

In a statement posted Sunday on his own Web site,, one of the more outspoken doomsayers on the Y2K problem, said he is "impressed and pleased by the smooth transition into 2000 so far." He also said the risk of disruptions to global supply chains, which was his No. 1 concern, now seems less likely to occur.

He also said that if no "significant" problems occur by the end of this month, he will admit he was wrong about a Y2K global downturn.

In the statement, Yardeni credited the IT community for a successful century date change as well as Y2K preparedness efforts by John Koskinen, the U.S. government's leading Y2K man.

Of course, this doesn't account for Italy.  (Per the CIA in October, 1999:  "Russia, Ukraine, China and Indonesia are among the major countries most likely to experience significant Y2K-related failures. Countries in Western Europe are generally better prepared, although we see the chance of some significant failures in countries such as Italy.")  But who cares when you've made a bundle in consulting and appearance fees.

The lead-in to Nocera's piece, a quote from Peter Bernstein's introduction to his work on risk, Against the Gods, capsules this nicely:

The story that I have to tell is marked all the way through by a persistent tension between those who assert that the best decisions are based on quantification and numbers, determined by the patterns of the past, and those who base their decisions on more subjective degrees of belief about the uncertain future. This is a controversy that has never been resolved.

Books are starting (again) to stack up on my desk, but they all seem to tie back into my thesis about the irreducibility of judgment (and rule-following).  Take Harold Schulweis' book, Conscience:  The Duty to Obey and the Duty to Disobey.  It's an argument, drawn on several Jewish sources (e.g. Abraham's argument with God about saving Sodom and Gomorrah), that our own conscience can override what seems to be God's dictate.  How can that be?  And if it's so (and, by the way, it seems that way to me!), how do you decide when to obey and when not to obey?  If you are allowed to argue with God, then you probably ought to be able to argue with the results of the Value at Risk algorithm.  But when God or the entire financial community are telling you X, it's really hard to do Y!  Then when you do Y, and it turns out you were right, were you wise or insane but lucky?

I'm also reading Mark Turner's Cognitive Dimensions of Social Science. Turner (pictured above) is a leading theoretician in cognitive science.  This is fascinating stuff - he's taking apart Clifford Geertz's iconic article "Deep Play" on the Balinese cockfight, not from an anthropological standpoint, but the standpoint of trying to theorize how human beings evolve new meanings.  The key here is culturally developed categories (how our minds classify data) and metaphor or analogies that disturb them.  Moreover, we blend meanings from separate "influencing spaces" into a new meaning.  The hypothesis is that the so-called "double-scope blend" in which two wholly separate influencing spaces determine a new meaning is the critical evolutionary development that makes us human.  I think of it this way.  My dog associates my putting on my coat with going for a walk.  My understanding is that is a single-scope blend of meaning.  A double-scope blend, on the other hand, is the metonymy (or is it synecdoche) of, say, the cockfight.  Natural cockfights and Balinese social structures don't have much to do with each other until they are blended to have a new meaning in which the victorious chicken says something about its owner.  (Think about your affiliation with your favorite sports team.)  Modern humans do double-scope blends; no other creatures do.  (That sounds like a testable hypothesis to me, by the way.)

In short, if the sensory data of the world takes on meaning to a human being through a process of blending - of metaphor and analogy - what does that say about the tension Bernstein identifies?  And is being right in your prediction of the future any evidence of the superiority of the mental processes that produced it?

January 6, 2009 in Hot Topics | Permalink | Comments (1) | TrackBack (0)

Monday, December 22, 2008

Fifth Circuit Upholds $14M Judgment Against N.O. Prosecutors' Office For Brady Violation In Capital Case: A Million For Every Year In Prison, And A Deathbed Confession By The ADA Just Before Execution

Posted by Alan Childress

This eye-catching summary [and link to Friday's opinion on the U.S. Fifth Circuit website] by Robert McKnight, appellate practitioner and publisher of the Fifth Circuit Civil News and its daily updates:

Thompson v. Connick, No. 07-30443 (5th Cir. Dec. 19, 2008) (King, Stewart and Prado): A jury awarded $14M in compensatory damages on finding, in a case under 42 U.S.C. § 1983, that the district attorney's office in New Orleans precipitated, by deliberate indifference to its obligation to train employees on their obligations under Brady v. Maryland, a failure to provide exculpatory blood-typing evidence from an armed robbery for which the plaintiff was convicted in April 1985. The same prosecutors accurately predicted that the April 1985 conviction would dissuade Thompson from testifying on his own behalf (in order to avoid impeachment with the conviction) in his trial a month later for a different armed robbery that ended in a murder. Thompson was convicted in the second trial and was sentenced to death. "Eighteen years later -- and one month before [Thompson's] scheduled execution -- Thompson's investigators uncovered the exculpatory evidence that indisputably cleared [him] of the armed robbery charge." The murder conviction was also set aside, on the ground that the prosecutors' misconduct deprived Thompson of his right to testify at that trial. When retried for the murder, Thompson was acquitted. The district court added about $1M in attorney's to the jury verdict, and denied the defendants' post-judgment motions. Holding: Affirmed for the most part. Among other holdings in a 48-page opinion, the Court held that Thompson's claim was not time-barred, that sufficient evidence supported the jury's verdict, that the withholding of evidence was not the unanticipated action of a single rogue prosecutor, that the jury instructions (and an answer to a jury question) on deliberate indifference were adequate, that the damages were not excessive, and that the fee award (which was half of what Thompson's counsel asked for) was not an abuse of discretion.

The only reversal was on the district court's erroneously naming of several individual defendants in the judgment, including former DA Harry Connick (yes, the father of the crooner).  One eye-popping fact repeated from page 2 of Judge Prado's opinion is well worth adding to the list within Andy Perlman's excellent summary of our faith in the death penalty system: 

Eighteen years later—and one month before his scheduled
execution—Thompson’s investigators uncovered the exculpatory evidence that
indisputably cleared Thompson of the armed robbery charge. Thompson was
then retried for the murder and found not guilty.

One month.

The Times-Picayune news story on the case also reports that "Thompson's defense team learned that the prosecutor, an assistant to former District Attorney Harry Connick, confessed while dying of cancer that he had suppressed the lab report." Luckily, and before that, "a month before his last scheduled execution date, an investigator found a piece of microfiche containing a 1985 lab report that indicated he could not have committed an attempted armed robbery for which he had been convicted before his trial in Liuzza's slaying." After this research find, a friend of the deceased ADA reported to defense attorneys the ADA's confession and executed an exculpatory affidavit, about five years late.

A month. 

Update:  The movie will reportedly star Matt Damon and Ben Affleck. If it were Bruce Willis in The Player, the month would be cut much closer:  "The traffic's a bitch."

Update 2: McKnight tells me that the dying ADA's friend and former coworker eventually received a public reprimand for his own failure to properly report the confession (he should have reported it timely to the court, not years later and just to the DA and defense counsel). Actually it was a barroom, not deathbed, confession. And the ADA had not himself properly reported the Brady violation at all before he died in 1994, so my characterization of it as a deathbed confession [as if he really fixed the situation he created] was unduly charitable.  Here is the 2005 discipline opinion on the friend, by the Louisiana Supreme Court.

December 22, 2008 in Hot Topics | Permalink | Comments (5) | TrackBack (0)

Thursday, December 4, 2008

Indiana Law Receives $35 Million Naming Gift; University Foundation Provides 100% Matching Funds

[posted by Bill Henderson]

Mauer Today is pretty special.  Indiana Entrepreneur Michael Maurer (IU Law '67) has donated $35 million to the Law School, henceforth renaming it the Michael Maurer School of Law.  During the press conference, Indiana University President Michael McRobbie reported that the gift is eligible for Indiana University matching funds, "effectively doubling the $35 million gift."  This builds upon the $25 million Lilly Foundation gift we received last year, which also resulted in additional matching funds from the University. 

Michael ("Mickey") Maurer stated that scholarship money he received as a second year student at Indiana Law, which came from a law firm with several successful alumni, was the inspiration for the gift.  The full story from the Indiana Business Journal (a publication Maurer owns) is here.

December 4, 2008 in Hot Topics | Permalink | Comments (2) | TrackBack (0)

Saturday, November 22, 2008

Online Graduate May Sit For Massachusetts Bar

The Massachusetts Supreme Judicial Court has granted permission to a graduate of an online law school, waiving the requirement of graduation from an ABA accredited school. The applicant's qualifications:

In July of 2002, Mitchell received his undergraduate degree, a bachelor of science in law, from Concord, and in July, 2004, he received his juris doctor degree from the same institution. In connection with the law degree, Mitchell graduated with "highest honors," and was the class valedictorian. Following his graduation, he sat for and passed the California bar examination, and was admitted to the bar of California in November, 2004. He was admitted to practice before the United States Court of Appeals for the First Circuit in December, 2004, and before the United States District Court for the Central District of California in March, 2005.

The court concluded:

The record contains quite specific information about the required and elective courses that Mitchell took as a law student at Concord--the course subjects, an overview of topics covered, and the legal texts and authors that were used--as well as a description of the extensive online research resources that were available to him. Our review of these materials indicates that Mitchell's core course of study, and legal research resources, were substantively very similar to the core content offered by ABA-approved law schools. See Osakwe, 448 Mass. at 92-93. Moreover, and of great importance, the record reveals that Mitchell achieved an exemplary degree of success as a law student. Thus, he won "outstanding achievement" awards in three of his first year courses, an award for best oral advocate and best brief in his moot court exercise in the third year, and over-all academic honors in all four of his law school years, graduating with highest honors and as valedictorian of his class in July of 2004. [FN10] Finally, we find the following factors significant: (1) the State of California, through its bureau for private postsecondary and vocational education, had specifically approved Mitchell's law school, Concord, to grant a juris doctor degree at the time Mitchell was a student; (2) Mitchell has taken and passed the California general bar examination and did so the first time he took it; (3) Mitchell has taken and passed the multistate professional responsibility examination with a scaled score well above that required by the board (see note 3, supra ); (4) he has been admitted to practice both in California and before the United States Court of Appeals for the First Circuit; and (5) Mitchell, who has represented himself throughout this case, filed briefs and gave an oral argument in this court that were of commendable quality, providing us with a concrete and positive illustration of his skills in legal analysis, legal writing, and advocacy. In sum, we are persuaded that in Mitchell's case, the underlying level of purpose of our ABA approval requirement--to insure an appropriate level of legal education--has been met.

There was a dissenting opinion:

Here, because of present ABA standards, there is no imminent ABA approval.   Ante at,. Indeed the court states that the ABA process of reviewing its current standards has just begun.  Ante at. In addition, the plaintiff here does not state that he was somehow unaware of the hardships he could face when he chose to enroll in an unaccredited law school. See Matter of Tocci, supra at 545, 547 (denying waiver to sit for bar examination even though fact that applicant had to attend different law school from accredited one he enrolled in was not his fault; applicant made informed decision to attend unaccredited law school and recognized difficulty he would face).
      The plaintiff points out, among other things, that his career made it more convenient to attend law school online and that his law school was significantly less expensive than traditional law schools. These considerations are hardly extraordinary. Many people give up careers, or attend law school while working full-time, all the while incurring great costs to themselves, financially and otherwise. Presumably part of the calculation of those who choose to incur those costs is that, to do otherwise, would be to incur a risk they would rather not take.
      Finally, I conclude that the court's claim that it can limit its holding to the circumstances in this case is illusory. We do not know when the ABA will complete its review or, more importantly, what the result will be. The review for the current 2006 ABA standards began in 2003. As noted, the new ABA review has just begun. In the interim, I am concerned with the potential for having to assess large numbers of graduates from other online law schools.

The case is Mitchell v. Board of Bar Examiners, decided November 20, 2008. (Mike Frisch)

November 22, 2008 in Hot Topics | Permalink | Comments (3) | TrackBack (0)

Thursday, November 20, 2008

Religion and Money: Pushing a Point Too Far

Posted by Jeff Lipshaw

Daniel Henninger, who comes out from behind the black curtain of the Wall Street Journal editorial page each week, had a column today that had me nodding in agreement until the last overstated conclusion.

My thesis has always been that neither economic models nor legal models will supply judgment; there's something irreducible about judgment that requires engagement with fundamental assumptions about the way the world works.  Models, for example, of risk and reward, only describe pieces of the world, not the world itself.  So Henninger is correct when he says that the three Rs of responsibility, restraint, and remorse "are the ballast that stabilizes two better-known Rs from the world of free markets:  risk and reward."

I'm okay with that.

But then:

Northerners and atheists who vilify Southern evangelicals are throwing out nurturers of useful virtue with the bathwater of obnoxious political opinions. . . . The point for a healthy society of commerce and politics is not that religion saves, but that it keeps most of the players inside the chalk lines.  We are erasing the chalk lines.

Huh?  The challenge in 2008 is not to save boardrooms and management suites by fundamentalist appeals to Jesus before taking each decision.   I'm not aware of anything in the Sermon on the Mount directly on point when I'm trying to figure out an optimal debt level.  And why Southern evangelicals?  My daughter and son-in-law were married at the Society for Ethical Culture on the Upper West Side of New York City, no doubt within shouting distance of a couple Northerners and atheists.  Amazingly enough, there are a few of us (even here in Cambridge) who know that Adam Smith wrote both The Wealth of Nations and A Theory of Moral Sentiments.

No, the real challenge is demonstrating the practice of wisdom, which is something different either than adherence to a risk algorithm, davening each morning and afternoon, or singing on Sunday mornings in the choir.  There's no doubt that religion can provide the source of a moral code, but I'm troubled by one that might say that God caused the Dow to fall 4,000 points to punish atheists, homosexuals, and East Coast liberals.

November 20, 2008 in Hot Topics | Permalink | Comments (0) | TrackBack (1)

Wednesday, November 5, 2008

The Learning President

Posted by Jeff Lipshaw

Back in March, 2007, before I owned an Obama button (which I acquired the day of the New Hampshire primary, when I did a hour or so of phone bank calling, ugh), I posted something on the mastery or learning mindset.  It came from Stanford Professor Carol Dweck, and I summarized it as follows:

The thesis is that there is an additional outlook, or mindset, wholly unrelated to intelligence, that frames how we look at problems.  The distinction is between a "fixed mind-set" that sees intelligence as static, and a "growth" or "mastery" mind-set that sees intelligence as something that can be developed.  The fixed mind-set about wanting merely to be smart, but the mastery mind-set is about wanting to learn.  As a result, if you simply are smart but not a learner, you would have a tendency to discount effort, avoid challenges, give up easily in the face of obstacles, and be defensive, particularly about making mistakes.  Learners, on the other hand, like challenges, persist in the face of setbacks, embrace effort, and tend to find lessons in mistakes.  I thought one of the conclusions in a diagram of the model was interesting - it generalizes that fixed mind-set confirms a deterministic view of the world but a mastery mind-set gives a greater sense of free will.

Over at PrawfsBlawg, Ken Simons offers up the thesis that part of the reason Barack Obama won was because of his "academic temperament."   I think he's on to something, but I don't think the right answer is academic temperament.  With all due respect, I've met a lot of law professors, and a lot of non-law professors, and I'm still not convinced there is a greater likelihood you have the mastery mind-set because you are a law professor. 

What I think I responded to in Obama from the very beginning is what Laurence Tribe describes in his touching essay today:  "Barack Obama's unique ability to explain and to motivate, coupled with his signature ability to listen and to learn."

Honestly, I don't recall, at least since Kennedy, a learning President.  And I'm not sure about Kennedy, because I think his personal peccadilloes might have disqualified him.   

November 5, 2008 in Hot Topics | Permalink | Comments (1) | TrackBack (0)

Sunday, October 12, 2008

Greed, Fear, and Morality: Walking and Chewing Gum?

Posted by Jeff Lipshaw

I'm off to Springfield, Massachusetts at the end of the week to participate in the Entrepreneurship in a Global Economy symposium at Western New England College's Law and Business Center for Advancing Entrepreneurship. I will be discussing my somewhat contrarian and deliberately provocative essay "Why the Law of Entrepreneurship Barely Matters."

A while back I wrote a lumbering piece with a point that seems to me more apparent now than it did when I published it in 2005:  the law (I was focusing on contract law) is not a particularly good tool for addressing radical uncertainty.  When it comes time to make difficult predictions about a highly contingent future, the process of judgment is so complex that it overwhelms the law's linguistic model. Imagine writing a contract that depends on the twentieth move of a game of chess that has yet to begin.  In theory, it's possible, but in practice, we still don't know if it's merely impractical or impossible.  And chess is simple compared to life.

I have joked over and over again (I apologize for it) that I like to work at the intersection of Kantian philosophy and venture capital, and Thomas Friedman's column in today's New York Times brought me back to the thesis.  He quotes a friend to the effect that nature is just chemistry, biology, and physics, and you can't spin it, bribe it, or sweet talk it.  In Kantian terms, that is the heteronomous world in which we live, of physical cause-and-effect of which we must necessarily be a part.  Friedman's point is the same one I tried to make in a late footnote to the lumbering piece:  markets are very much the same as nature.  "At their core markets are propelled by fear and greed.  They're just the balance at any given moment of those two impulses."  I believe that as well.  There's little that is moral about markets, just as there is little that is moral about physics.  Nor do we really, after all is said and done, want to eliminate fear and greed.  It's what sustains our bodies, and Kant was enough of an empiricist, I think, to believe that if there was a soul, the only way you could know anything about it was because it was housed in a body.  Or to put it in terms of Jewish lore:  we have a "bad" impulse, the yetzer hara, by which we lust and amass, and a good impulse, the yetzer tov, by which we love and contribute, and we can't live (or live well) without either of them.  The Aristotelians looking for a golden mean should like this as well.  In present terms, it leaves me equally repulsed by unrepentant free market apologists and by blame-seeking moralists.  (The need to "blame" somebody for the current crisis is an interesting exercise in teleology as well, but that is for another time.  Suffice it to say that innocent people losing savings in market crashes is as almost as troubling as innocent people dying in airplane crashes, and reconciling either one is a tough philosophical issue.)

What does this have to do with entrepreneurship?  Again, to quote Friedman on the coming global workout of this credit bubble:  "The workout promises to be painful, complicated, and protracted.  Government will have to do its part.  But it must regulate the excesses without smothering the underlying innovative, entrepreneurial and risk-taking attributes of our economy, which are what will ultimately bail us out - as they always have."

So my project as a business person and lawyer of some worldly experience, and as a teacher of lawyers, has been a tad contrarian:  suggesting to business lawyers that they ought to approach their task with some amount of modesty about their role in dealing with radical uncertainty.  (It's hard to get a feel for what I mean if all you do is read cases, or even litigate cases.  That is merely structured second-guessing.)  The lawyer's role not trivial, but it's not the be-all that law and economics would suggest by the notion of an "incomplete contract" (think back to my chess example) as though the idea of a complete contract does any helpful intellectual work at all.  And that's just law!  Ethics is another ball of wax.  Unless the proposal is that we go back to pre-Industrial Revolution agrarian society, somebody has to make our iPods and laptops and hybrid cars and get all that stuff to Whole Foods, and industry, even when it's done well and responsibly, is a dirty business that calls on us to make tough choices.

What I really love about the juxtaposition of lawyers and entrepreneurs is this jarring contrast in the approach to uncertainty.  At the behest of my son, I've been wading through Gore Vidal's dense historical novel, Burr.  Burr was a practicing lawyer to the end of his life, and, in the novel, the young clerk in his office who narrates the story wants to know if he should take the bar exam.  Burr says he should because he will certainly pass.  The narrator replies, "But I don't want to be a lawyer."  Burr responds, "Well, who does?  I mean what man of spirit?  The law kills the lively mind.  It stifles originality.  But it is a stepping-stone. . . ."  Why does the micro-law of entrepreneurship barely matter?  Because it can barely contain the wide-ranging orientation to change and innovation in the face of uncertainty that is the mark of an entrepreneur.  Effective lawyers to entrepreneurs, like effective lawyers to business people, and like effective ethicists dealing with the workings of amoral markets, have to be able to walk and chew gum.

October 12, 2008 in Hot Topics | Permalink | Comments (0) | TrackBack (0)

Friday, October 10, 2008

Financial Crisis, Governance, and Stock Performance

Posted by Jeff Lipshaw

I was working away this morning and trying not to look at the Dow when a thought struck me.  Back when I was fighting the governance wars from the inside, arguing from the board's standpoint why having poison pills and classified boards made sense (at least in the right hands), there were several studies done linking good governance to share performance, the most famous being the Gompers/Metrick/Ishii study.  I was not (and am not) statistician enough to know if the study was good; all I can say is that my intuition was and is that things like technology, cost productivity, barriers to entry, business savvy, and things like that would have a lot more to do with share price than whether there was a poison pill or the shareholders had the right to call a meeting.  Moreover, I'm not sure how you would factor out those differences among companies other than to say it all evens out in a big enough sample.  As I said, I'm not statistician enough to do the work myself.

What occurred to me was the question whether, if I had a portfolio of the "best governed" companies on October 9, 2007, at the very height of the stock market, and kept that portfolio unchanged for one year, how would it do?  Given that I performed this little empirical study from the laptop in my den, don't have the individual governance scores on any survey (CGC from ISS, or whatever GovernanceMetrics puts out), and couldn't do the regressions and correlations even if I did (but I did leave a phone message for Bill Henderson), I simply went to the website of IR Global Rankings, and took the thirty companies it ranked best in corporate governance practices (listed below the fold), found their historical closing stock prices on Yahoo! Finance for each of October 9, 2007 and October 9, 2008, assumed a portfolio of one share of each, and looked at how the portfolio performed.  (Other methodology disclosures also below the fold).

Here are the results:

Decline in "good governance" portfolio:              50%

Decline in S&P500 Index Fund                            42%

Decline in NYSE Composite Index Fund               43%

Decline in Dow Jones Industrial Average             39%

Within the good governance portfolio, every stock declined.  The best performers were Bayer AG (17% decline), Procter & Gamble (12% decline), and Global Payments (11% decline).  The worst performers were ICA (93% decline), Wachovia (93% decline), Banco BPI (71% decline), and Life Time Fitness (70% decline).  (I did not check to see if these numbers were adjusted for splits, but I assume so.)

But you'd still be better in index funds than picking stocks based on the IR Global Rankings of good governance practices.

Continue reading

October 10, 2008 in Hot Topics | Permalink | Comments (3) | TrackBack (1)

Tuesday, September 30, 2008

Sloshing Capital

Posted by Jeff Lipshaw

If you want some sane commentary these days, try reading David Brooks in the New York Times.  His column yesterday on the defeat of the bail-out bill was entitled "Revolt of the Nihilists."  Here's a taste:

We’re living in an age when a vast excess of capital sloshes around the world fueling cycles of bubble and bust. When the capital floods into a sector or economy, it washes away sober business practices, and habits of discipline and self-denial. Then the money managers panic and it sloshes out, punishing the just and unjust alike.

What we need in this situation is authority. Not heavy-handed government regulation, but the steady and powerful hand of some public institutions that can guard against the corrupting influences of sloppy money and then prevent destructive contagions when the credit dries up.


September 30, 2008 in Hot Topics | Permalink | Comments (2) | TrackBack (0)

Piercing The Corporate Veil In Ohio

The Ohio Supreme Court issued a decision today that modifies the court's position on piercing the corporate veil. The decision is summarized on the court's web page:

In a decision announced today, the Supreme Court of Ohio held that when a plaintiff pursuing a civil lawsuit against a corporation seeks to “pierce the corporate veil” (bypass the corporate structure and recover damages directly from a shareholder), the plaintiff must show that the shareholder used its control of the corporation “in such a manner as to commit fraud, an illegal act, or a similarly unlawful act.”

The 6-1 decision, written by Chief Justice Thomas J. Moyer, modified one part of a three-prong test for piercing the corporate veil this Court established in a 1993 decision, Belvedere Condominium Unit Owners’ Assn. v. R.E. Roark Cos. Inc. [See below for an explanation of the three-prong Belvedere test.] The effect of today’s ruling was to deny an attempt by Kimberly Dombroski, a policyholder whose claim for coverage was denied by Community Insurance Company (CIC), a wholly owned subsidiary of WellPoint Inc., to pursue recovery directly from WellPoint for her claimed physical and emotional injuries arising from alleged bad faith denial of coverage by CIC.

(Mike Frisch)

September 30, 2008 in Hot Topics | Permalink | Comments (0) | TrackBack (0)

Saturday, September 27, 2008

The AIG Deal

Posted by Jeff Lipshaw

This is what it feels like when you are on the inside of a deal.  Can it really be that the AIG bail-out is old news, since trumped by the bigger bail-out bill, the WaMu seizure and sale, the McCain debate cancellation, the screaming session at the White House, the actual debate, and rumblings about Wachovia?

As Steve Davidoff pointed out eons ago, there was a problem with the original structure of the deal between the Fed and AIG in that it appeared to involve giving warrants to stock not yet authorized by a shareholder vote.  AIG then pulled back with a press release and 8-K suggesting that it and the Fed had gone back to the drawing board.  Also kudos to Steve.  He predicted the final form:  "I am curious to see how the parties get around this — perhaps by issuing out preferred with equivalent voting and dividend rights?"

The deal as struck now involves the Fed getting 100,000 shares of non-redeemable and perpetual convertible preferred stock.  Until the shareholders vote to authorize enough shares of AIG to permit conversion of the preferred stock into 79.9% of the common equity, the Fed holds preferred equity with a liquidation value of $500,000 (that's right, five hundred thousand dollars), but with rights to vote and receive dividends that are as if the Fed owned 79.9% of the common equity.  I haven't gone back to look at the AIG certificate of incorporation, but I'm assuming it had "blank check preferred" powers, meaning that the shareholders had granted to the board the right to issue preferred shares on whatever terms the board deemed appropriate without an amendment of the certificate of incorporation.

So.... I take back what I said about the Fed not actually owning AIG.  It does.  And it will, because there is no provision for the redemption of the preferred shares if the loan is paid back.  Moreover, the only risk to the Fed is that AIG goes into bankruptcy before the shareholder vote, because at that point it only has a $500,000 liquidation preference.  On the other hand, it still has security interests in all the valuable AIG subsidiaries in the event of a default on the primary loan.  What I haven't found yet is what consequence, if any, would follow from the shareholders not approving the amendment to the certificate authorizing the additional stock.

By the way, for all you populists out there, or others interested in class warfare demagoguery, I was curious just who the bailed-out fatcats were.  In short, who are the shareholders we are rescuing with our money?  There's a lovely little website out there called that gives the institutional shareholder make-up of public companies, as well as the companies that institutions own.  It turns out that the fatcats being rescued (at least as of June 30) are anybody who has an interest in these and other elitist institutions:  Fidelity, Vanguard, TIAA-CREF, New York State Common Retirement Fund, CALPERS, the New York State Teachers Retirement System, the Teachers Retirement System of Texas, the Public Employees Retirement System of Ohio.  I could go on and on.  None of them were bitching when AIG was climbing up the mountain!

September 27, 2008 in Hot Topics | Permalink | Comments (4) | TrackBack (2)

Friday, September 26, 2008

Credit Addicts and Their Enablers

Posted by Jeff Lipshaw

There's an old joke (I guess it's a joke) about a person searching for a lost wallet at night under a street light.  "But you lost it over there," says a bystander, pointing down the street.  "Yes, but there's no light there," responds the searcher. 

I'm not sure I can improve on Christine Hurt's analysis of the situation:  this crisis is not about evil, or class warfare, or fraud.  It's about bubbles.  Bubbles are about systemic misapprehension of risk.  Bubbles are about the perception that something in the market always goes up, or at least, everybody else thinks it's going up, and if we are going to compete with them, we better do what they're doing.  When the bubble burst, and it's really hard to understand how it all happened, and worse, when we still don't understand the impact of the bursting, it is certainly a lot easier to resort to tried and true bromides and political stereotypes (the bright spot under the street lamp) than to accept the more likely truth:  we are all either addicts or enablers and co-dependents to the addicts.

Imagine a family.  Dad, Mom, and the kids.  Dad and Mom own a house.  They believe the value of the house is the one true immutable in the world - it will always go up.  Dad and Mom go out and borrow against the equity in their house to supplement the family's life style.  And what a binge it is!  Vacations to Hawaii.  Private schools.  Each kid gets a car.  But the family now has a lot more fixed debt, and it has to be paid back sometime.  The kids don't think about it, and Mom and Dad aren't worried; they know the value of the house will support it, and they seem to be alright making the payments.

But now there's a small glitch.  Dad loses his job.  Or the interest rate cranks up a notch.  Now Dad and Mom are having a hard time making the payments.  The drastic way out would be to sell the house, tap the equity and pay off the lifestyle loan, but it turns out the value of the house has gone down.  Uh oh.  Somehow the piper has to be paid.  Who's going to pay it?  Dad, Mom and the kids.  Dad and Mom say to the kids:  sorry but we have to move to a small apartment, sell the cars, take you out of private school, and put you in public school, because we just aren't worth what we used to be.  The kids say:  "how can that happen?  Life was good.  Mom and Dad, you were greedy scum (if not fraudulent creeps)."  Mom says to Dad:  "I told you something wasn't right!"  Dad says to Mom:  "you never should have bought those clothes."  Mom said to Dad:  "what made you think we could afford a golf club membership?"  And the kids blame both of them, even though their lives in the short-term were probably better as a result of the binge.

Now take my story and write it large.  We can see the analog of the kids' position in my following paraphrase of a bitter post over at the Wall Street Journal's website on the bail-out term sheet.  An angry taxpayer notes that you contributed to the binge if, in the last eight years, (1) you worked in a position that allowed you to influence or alter the way people purchase real estate; (2) you purchased a house without a down payment or an understanding of your debt obligation; (3) you purchased a home with an interest only, Alt-A, sub prime, piggyback or other type of nonstandard mortgage to shoehorn your way into a house you could never afford without the benefit of financial magic; (4) you participated in cash out refinancing to pay for your kids education, improve your house, take a vacation or anything else that will not bring you a probable return for your spending borrowed money; (5) you worked within the real estate industry or any other business being financed by unduly cheap money. 

This rant (not unwarranted, by the way) gets at the addicts but I'm not sure it identifies the enablers.  In my analogy, the kids got to share, albeit indirectly, of the pleasures of the binge.  Put another way, the creation of wealth in the financial markets is no longer "us" and "them."  I don't have at my fingertips the amount of the NYSE and NASDAQ capitalization that is owned by institutions, but it's huge.  When I say institutions, I mean mutual funds (Fidelity, T. Rowe Price, Vanguard), insurance companies, union pension funds, state employee pension funds (like CalPERS), university endowments, private foundations, 401(k) plans, 403(b)(7) plans.  These institutions work for us, rich people and not so rich people, by making investment choices, which in turn are a matter of assessing risk.  If CalPERS took no risk with the pension funds held for all the California public employees, and bought nothing but T-bills, it would have a flock of exceedingly upset retirees.  The question is how much did CalPERS and the institutions like it (a) benefit from the bubble, and (b) enable the bubble by buying up the leveraged debt securities or the equity securities of the companies investing in the leveraged debt?  Empiricists, do me a favor.  Please track how much of the stock of AIG, Fannie Mae, Freddie Mac, and Sallie Mae was held over the last seven years by pension funds, and in particular, union pension funds.**  (Note to file:  CalPERS was one of the big investors in Enron.  And full disclosure:  as I recall my investment advisor bought Enron for me at about $80, but, as I recall, had the good sense to sell at $22.)  This isn't to blame them:  it's to say maybe we have met the enemy and they are us. 

My point here is that a lot of people who are professionals in the quantification and monetization of risk got it wrong.  They managed to get it wrong all at the same time because there is a "herd" aspect to this:  if you don't show the short term returns others are getting, capital (for who owns the capital, see above, because it's all of us) will flee to other managers.  I suspect the bell curve of venality is about what it is for any other group in society - most of them were probably about as evil as Mom and Dad.  (This is the subject for another time:  are corporate boards any more venal than synagogue boards, or non-profit boards, or law faculties, or the Congress?  Put another way, what if your battles happen not to be for money, but instead the currency is power, or influence, or fame, or position, or re-election?  But I digress.)

So now we're having a big family council, trying to decide who bears the brunt of this seven-year long family binge.  Like the above-quoted ranter, the kids say "we benefited from this, but we didn't cause it, why should we have to pay for the excess?  Dad should have to quit the golf club, and Mom should have to get rid of her car."  One of the kids wants to cap Dad's allowance.  One of them has asked the FBI to look into whether there was fraud.  Mom and Dad say:  "look, kids, we're really sorry we messed up, but we are still the best thing you've got to get this right."

And here we are.

** UPDATE:  I did a little quick investigation of my own.  If you look at AIG's proxy statement, Fidelity's funds owned 5.7% of the company as of Feb. 14, 2008, making it the second largest shareholder after C.V. Starr, which is Hank Greenberg's firm.  Meaning that all of us who had 401(k) or 403(b)(7) or other retirement or investment accounts with Fidelity got the benefit, not so indirectly, of AIG's market value, spurred on in part by its participation in the credit markets.  Similarly, as of June 30, 2008, the California Public Employees Retirement System (one of the largest pension funds in the country, holding $54 billion in assets as of that date) held securities in the following companies valued at the time as shown:  JPMorganChase, $395 million; Bank of America, $355 million, AIG, $229 million; Goldman Sachs, $228 million; Morgan Stanley, $133 million; KB Homes, $6.7 million. 

You can say that "we the taxpayers" are bearing the brunt of the diminution in asset value, but to some extent (and I think to a large extent), we are merely shifting the burden from a left pocket to a right pocket.  That tells us two things:  (a) it's still very unclear whether a bail-out helps or hurts in the end, but the markets seem to think it helps, and (b) It's a fair request that money not stick too much to those involved (transaction costs and agency costs), but, at the end of the day, all of us want competent people at the helm of all of those companies whose returns fund our retirements.

September 26, 2008 in Hot Topics | Permalink | Comments (3) | TrackBack (0)

Saturday, September 20, 2008

Complexity and Disclosure Regulation

Posted by Jeff Lipshaw

The only upside for me, I suppose, of the financial turmoil this week is that I'm teaching securities regulation so there is something exciting and topical to discuss.  Reading Joe Nocera in the New York Times this morning and thinking about a timely piece of scholarship just posted on SSRN, it occurs to me there is some insight into the regulation issue here, even though I have no clue how to translate it into something that works as a practical matter. 

The introductory portion of securities regulation (at least in the Choi and Pritchard casebook) deals with the appropriate form of regulation in markets where information is highly asymmetric, and the feedback loops are relatively long.  (The counter-example is buying and selling salt water taffy that tastes like cod liver oil - you may not have known it would be disgusting when you bought it, but it doesn't take long to figure out that something is amiss.)  What we discuss at the outset is the difference between merit regulation and disclosure regulation; in short, the 1933 Act, by and large, does not regulate the substance and merit of the securities offering, but rests on the assumption that markets will work more efficiently if material information about the issuer is disclosed.

I have long been skeptical of rational and cognitive solutions for what seem to me to be irrational and non-cognitive problems.  This was my criticism of a lawyerly proposal in which venture capitalists would be required to disclose risks to entrepreneurs - since they don't even see risk in the same way, how is this going to work?  Nor am I convinced that the strong or even the weak efficient capital market hypothesis holds (in terms of all or some information being efficiently worked into share prices).  It also why I'm skeptical of Elizabeth Warren's proposal for a Financial Product Safety Commission on consumer credit (at least as one that has only disclosure powers, and not merit powers).  But there's little doubt in my mind that at some level of widely understood kinds of information, the disclosure system works pretty well.  That is, if you look at the way analysts cover companies in industrial or service industries, it doesn't take too much extraordinary brainpower to replicate the financial models and do a pretty good job of anticipating who is going to succeed and who is going to fail.  That's not to say that the ordinary retail investor understands, but the institutional buyers do, and that's what drives the market.

On Wednesday, a student asked, "so what will the regulatory solution be?"  (Or something like that.)  I hadn't thought it through at the time, but I was pretty sure we didn't want merit regulation (e.g., the current ban on short-sales), but I wasn't sure how disclosure regulation was going to help.  Of course, disclosure regulation morphs into merit regulation when it becomes apparent from the disclosure that nobody should be investing in this scam!

What if you have companies issuing securities not in pretty well understood industrial or service businesses, but in businesses that require the equivalent of understanding quantum string theory or decoding the human genome?  Yes, that's great, there's disclosure, but either nobody understands it, or so few people do that truly robust and efficient markets in the securities never arises.  Here, as quoted by Joe Nocera, is Henry Paulson, on the mortgage-backed securities that facilitated irresponsible borrowing and lending:  "The inability to determine their worth has fostered uncertainty about mortgage assets and even about the financial condition of the institutions that own them."  In short, even the experts have insufficient information.

Steven Schwarcz (Duke) has posted a number of timely and insightful pieces on this, including a Utah Law Review article on the failure of disclosure regulation in the subprime crisis. Most recently, however, he suggests in Complexity as a Catalyst of Market Failure:  A Law and Engineering Inquiry that there is really a double-barreled effect here:  the securities themselves are too complex to understand, and the system itself under which the securities are traded, or the contracts are signed is complex and fragile in an engineering sense. 

I suggested to Steve that the thesis seems intuitively correct.  Most deal lawyers know that the more complex the deal, the more difficult to get it to close.  Moreover, I have experience in putting together several highly complex joint ventures between large and sophisticated multi-national companies.  When you cannot reduce the structure of the business to something even the executives can understand, they will figure out something they do understand, and work to that goal, whether or not it was the one originally intended.  For example, assume that for tax and public reporting purposes (i.e., what you consolidate and what you don't), you structure a joint venture reciprocally so that the European parent owns two-thirds of the equity of the joint venture entities in Europe and the U.S. parent owns two-thirds of the equity of the joint venture entities in North America.  But the real opportunities are in Asia.  Do the participants in the venture focus on the most efficient plan to exploit the Asian market for the overall benefit of the venture?  Or do they look at the 33% spread between gaining the business in one JV entity over the other, and compete with themselves rather than for the ultimate success of the business?  (I'm not making this up.)

My point is that even relatively simple business structures can promote unintended consequences because people either don't understand the dynamics, ignore them, or talk themselves into believing that they are manageable.  Multiply this by an entire industry of credit instruments, and you have a market full of unintended consequences in which millions of people trade, presumably relying on efficient capital markets to protect them, when in fact there can't be an efficient capital market because too few people actually understand what's going on.

I have no idea how to draw the line I've just suggested.  I have shelves full of closing books with relatively complex leveraged buyout financing or conduit municipal bond financing that most people don't understand, but which do not pose much of a threat to the financial system as we know it.  The deal struck between AIG and the Fed doesn't seem all that complex to me, but that hasn't stopped much of the relatively sophisticated world from thinking that the Fed now owns 80% of AIG.  I don't understand the complexities of wheeling electrical power, or how the telecommunication system allows me to be posting this note, or even how the guts of my computer do what they do.  And I'm no worse off.  It strikes me, however, that the problem is that those "masters of the universe" punching the computer keyboard of the financial system think they understand what's going on inside, and they don't.

September 20, 2008 in Hot Topics | Permalink | Comments (2) | TrackBack (0)

Thursday, September 18, 2008

More on Debt-Equity, Transparency, Line-Drawing, and the Forest and the Trees

Posted by Jeff Lipshaw

I posted the gist of this as a comment over at Conglomerate, but I want to add a point about what seems to me to be a common over-reaction.  One theme seems to be that perhaps the Fed is playing fast and loose with interpretations of its own authority.  Perhaps.  It doesn't seem that way to me, but there's no precedent here.  It seems to me, however, an over-reaction to confuse close reading of text with attempts to finagle, fool, deceive.  There's a line to be drawn, and that's the point here.

To recap:  did the Fed have the authority to take "equity warrants" as a way of getting additional security for or return on its loan?  [I still don't know what the trigger is on the warrants, and don't know if they expire merely because the debt is repaid, as some commenters have suggested.  In my description of credit facilities in the prior post, the warrants would not expire merely because the debt was repaid.  If they do expire upon repayment, they are still not "collateral," but a device that serves as an economically equivalent substitute, because to post collateral you have to have rights in it (e.g. own it!), and AIG doesn't have rights in (i.e. own!) its own stock.]  Debt versus equity is a line that has existed in the law forever, as are well-accepted forms of financing, like sale-leasebacks, in which the economic substance is very, very similar to ownership plus loan. Reporting and transparency is another issue, but I don't think that's the critical one here. Another example is the law under Articles 9 and 2A of the UCC that attempt to distinguish a true lease from the mere granting of a security interest.

The inherent issue in any system that classifies by way of language is the (I apologize, but here it goes) linguistic "family resemblance" problem (see Wittgenstein). That is, debt and equity resemble each other in some ways, and one can, without any malevolence, work the edges. That's not to excuse attempts to make things opaque or stupidity, but it's what lawyers have always done. It's why good counselors tell their clients who are working the trees to make sure they step back and look at the forest.

One of the things I come back in many of my classes is the linguistic conundrum of definitions. Again, use the Howey test in securities law - is it really the definition we are applying ("a person invests his money....") or are we using a paradigm of stock versus not-stock and analogizing things in the middle? See John Searle's introduction to Speech Acts on this point - to criticize a definition or a distinction means that you have some a priori idea of what the difference is by which you can criticize the definition!

September 18, 2008 in Hot Topics | Permalink | Comments (2) | TrackBack (0)

The AIG Deal and Debt Versus Equity

Posted by Jeff Lipshaw

My claim to fame is ego not hubris (there's a subtle difference), so I'm not going to sit here in the middle of the upheaval and claim to know that it is the end of free markets as we knew them or that the invisible hand will get everything settled just fine.  It was, however, kind of neat to go off-topic in two business law classes yesterday and, as Usha Rodrigues observes, be cool (a rare event in my life!).  I'm also not panicking.  The one thing I told both classes was to look with some skepticism at anybody on Today, Good Morning America, The Situation Room, or Larry King Live who assesses the situation without a preface to the effect that this is all very, very complex and not really capable of being reduced to a sound bite.  People are, as far as I can tell, getting it wrong.  On the other hand, I tried to find the actual AIG-Fed deal documents yesterday, and could not, so I too am speculating.

I've been e-mailing back and forth with David Zaring, however, about his post analyzing the Fed's authority to do this deal in this form.  The loose interpretation of the events is that the Fed "bought" AIG, or "took control" of AIG.  If you frame the issue that way, it does indeed seem difficult to fit this within Section 13(3) of the Federal Reserve Act:

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System . . . may authorize any Federal reserve bank . . . to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank. . . .  All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.

I moved from litigation to transactional work in the late '80s, and made my bones doing leveraged "vulture capital" deals.  Our clients would swoop in and buy up troubled companies (mostly automotive suppliers).  The financing consisted of "credit facilities" (the closing books are sitting on my shelves here) we used to negotiate with GE Capital and Westinghouse Capital in those halcyon days of being able to own companies with very little of your own skin in the game (i.e. lots of leverage!).  The credit facility would consist of a term loan and preferred stock to buy the company, a revolving credit line for working capital, and warrants as the "equity kicker."

We need to zero in on these warrants, because as I read the press reports (not having seen the documents), the so-called "80% ownership" the Fed got was in the form of "equity participation warrants." This isn't collateral in the sense of an asset owned by AIG and capable of being foreclosed on if there is a default on the loan.  (In contrast, what IS collateral is, for example, the shares in National Union Fire Insurance, which writes a huge chunk of the D&O coverage in the U.S. and I believe is nicely profitable.)  Warrants are options to buy the stock - a contract right to own in the future, not present ownership.

The reason that lenders like GE Capital took warrants is that they didn't want to own equity (other than the preferred stock).  What they wanted to do was exercise the warrants when the leveraged company got sold or went public (known in the parlance as "flipping" the company).   The warrants served the purpose of making the potential return on the credit facility commensurate with the risk.  What I'm suggesting, if in fact I'm correct about the structure, is that warrants as part of a loan package were ephemeral ownership at best. 

Since nobody is going to "flip" AIG, it's less clear to me how the warrants produce value.  Let's assume that AIG survives and even thrives.  At some point, the government exercises the warrants and there is a humungous public offering of now extremely valuable AIG stock, and the Fed gets a return commensurate with having loaned $85 billion.  Or the government sells the warrants and never owns any of AIG even for a fleeting moment.

The rest of the "control" of AIG occurs, I'm assuming, in the positive and negative covenants of the loan agreement. I had the good fortune of teaching the classic partnership case of Martin v. Peyton yesterday, in which the issue is whether the lenders are partners of the borrowers when part of the pay-back involves a profit-sharing plan, and the lenders have significant "control" rights (such as veto power on transactions, etc.)  The holding of the case is that, notwithstanding all of the conditions, this is still fundamentally debt and not equity - that is, the lenders are not co-owners of the borrower.  David thinks that the Fed's directive to change out the AIG CEO is evidence of "control;" it just doesn't strike me that way.  It's the classic case of good lawyers being able to write affirmative covenants as negative covenants - we aren't telling you who to hire, we're just holding a veto over who you do hire, and we veto the incumbent.

So while the transaction may be unprecedented, the Fed doesn't own, and almost certainly never will own AIG.  And, by the way, there is precedent for the government swooping in and owning a private enterprise.  Way back when I was in law school at Stanford, Victor Palmieri offered a course (I didn't take it) called Crisis Management, the subject of which was the failure of the Penn Central railroad, and the creation of Conrail.  Now it's true Congress authorized the creation of Conrail, and it was a private corporation all of whose stock was owned by the United States.  But if the government really wants to own AIG (I seriously doubt it!), there's time.  As I recall, when Citicorp agreed to acquire Travelers Insurance, which included Salomon Smith Barney, there was this little impediment called Glass-Steagall that had to get amended or repealed before the deal could close.

The bottom line:  in complex financing, you reach a very fine line between debt and equity.  Nobody can claim to have it absolutely right.  But in my world, the equity kicker just sounds like part of the credit package, not "ownership."  Accordingly, it didn't seem such a stretch to think it fell within "such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe."

September 18, 2008 in Hot Topics | Permalink | Comments (2) | TrackBack (0)

Wednesday, September 17, 2008

Wisdom about Wisdom

Posted by Jeff Lipshaw

I was hoping a moderate conservative would say this, and David Brooks of the New York Times did.  It's what was flashing through my mind as I imagined Secretary Paulson and Chairman Bernanke yesterday explaining a credit swap first to President Bush.  I then flashed forward to the same conversation with President Palin.  Here's an excerpt:

In the current Weekly Standard, Steven Hayward argues that the nation’s founders wanted uncertified citizens to hold the highest offices in the land. They did not believe in a separate class of professional executives. They wanted rough and rooted people like Palin.

I would have more sympathy for this view if I hadn’t just lived through the last eight years. For if the Bush administration was anything, it was the anti-establishment attitude put into executive practice.

And the problem with this attitude is that, especially in his first term, it made Bush inept at governance. It turns out that governance, the creation and execution of policy, is hard. It requires acquired skills. Most of all, it requires prudence.

What is prudence? It is the ability to grasp the unique pattern of a specific situation. It is the ability to absorb the vast flow of information and still discern the essential current of events — the things that go together and the things that will never go together. It is the ability to engage in complex deliberations and feel which arguments have the most weight.

How is prudence acquired? Through experience.

* * *

Sarah Palin has many virtues. If you wanted someone to destroy a corrupt establishment, she’d be your woman. But the constructive act of governance is another matter. She has not been engaged in national issues, does not have a repertoire of historic patterns and, like President Bush, she seems to compensate for her lack of experience with brashness and excessive decisiveness.

September 17, 2008 in Hot Topics | Permalink | Comments (3) | TrackBack (0)