Business Law Prof Blog

How to Fix the "Broken" Financial System: Stop Trying to Fix It

According to Paul Volcker, the "financial system is broken."  Furthermore, with regard to limits on the abilities of regulators, he says: “Relying on judgment all the time makes for a very heavy burden whether you are regulating an individual institution or whether you are regulating the whole market.” 

He's right on that.  If we like markets (and I think we do), then we need to recognize we can't always regulate (or, for that matter, buy) our way out of some of these messes.  I am now firmly of the mind that we should have a five-year moratorium (minimum) on financial regulation.  This goes both ways -- nothing can be repealed and nothing can be added. 

I am of a mixed mind on the new financial regulations, but since they already passed, I say leave them alone and let the market adjust. Similarly, with regard to Sarbanes-Oxley, regardless of whether one likes it, it's part of the current market, and companies have adjusted to it.  So - leave it all alone. Regulators need to work with what they have, and businesses have to work with what is there.

I happen to think that we have a fairly solid system in place, but there are clearly some inherent potential pitfalls built into that system. I just think those pitfalls are primarily because the financial system is a (relatively) open market.  Markets involves people, which means that at every level (as a consumer, a seller, or a regulator) we are still, as Mr. Volcker puts it, "[r]elying on judgment all the time."  And no matter what we do, that's part of the problem.  

Unless, of course, we're living in The Matrix.  Then, who cares?

--Joshua Fershee

Is the Revlon Duty Creeping into the Business Judgment Rule? (No)

When Chancellor Chandler decided eBay v. Newmark (pdf) (aka “the craigslist case”), the case triggered all kinds of discussions, including the implications of poison pills and analogies to Dodge v. Ford. I remain interested in the Dodge v. Ford angle and the role of philanthropic goals of a corporation.

There are some who see the craigslist case as an adoption of the Sen. Al Franken version of a corporation’s obligations to shareholders: “[I]t is literally malfeasance for a corporation not to do everything it legally can to maximize its profits.” Of course, there are others who disagree. The Franken-like argument seems be that Delaware’s Revlon duty (as explained in Time, Inc. - pdf) of requiring the “board to enhance short-term shareholder value” now applies all the time, not just when the board puts the company up for sale. While that makes for good sound bites, and I suppose it is a plausible interpretation, that’s pretty clearly not what Chancellor Chandler meant.

Instead, the Chancellor stated that craigslist’s majority owners “prove[d] that they personally believe craigslist should not be about the business of stockholder wealth maximization, now or in the future.” Thus, he concluded, “The corporate form in which craigslist operates . . . is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment.” As such, corporations clearly can do at least some things that are philanthropic; it’s just that they can’t be “solely” philanthropic – thus the Dodge v. Ford connection.

Okay, but I have a problem with this on two fronts. Regardless of their stated view, craigslist is not a nonprofit, and as I understand it, files and pays taxes like any other (proper, for-profit) corporation. According to a BusinessWeek article, the company has been profitable since 1999. That said, it is also true that the company’s leaders make clear that they are not trying to takeover the world or maximize wealth. I’m not clear that’s a problem any more than it is inherently a problem for a company to decide to grow to fast and fail miserably (I’m looking at you, Krispy Kreme and Boston Market.)

Second, under the Delaware General Corporation Code § 101(b), “[a] corporation may be incorporated or organized under this chapter to conduct or promote any lawful business or purposes . . . .” Certainly there is nothing there that indicates a company must maximize profits or take risks or “monetize” anything. I think Chancellor Chandler concedes as much when he notes that it is at least conceivable that a philanthropic company may be okay when there are no “other stockholders interested in realizing a return on their investment.”

Thus, it seems to me, the next question should be what it means to say there was a stockholder "interested" in realizing a return on their investment. As I noted in an earlier post, eBay knew the kind of company in which they were buying shares (and taking a minority position. craigslist is operating exactly with the same philosophy as they had before eBay bought in to the company. And, in fact, that philosophy is probably why eBay decided to reserve its right to compete.

If that’s the case, why did eBay buy in? I think it’s pretty clear it is not primarily because they had any specific expectation of a return on investment. I think eBay invested as something of a hedge -- they recognized that if craigslist were to monetize itself, it would likely be a huge revenue source and they wanted to ensure eBay was part of that process if (not necessarily when) that were ever to happen. They reserved the right to compete in case eBay figured out a way to monetize a similar product. (And note that it’s not clear they were not getting a return; it’s simply a lower return than some people think that return could be.) As such, it would be improper to allow eBay, simply by virtue of being a shareholder, to require a change in the way in which the craiglist operates.  This is not a bait and switch where craiglist changed the rules of the game (at least with regard to their corporate philosophy) after cashing eBay’s check.

I guess I simply don’t agree with Chancellor Chandler’s assessment that craigslist is operating as a “purely philanthropic” corporation, and I don’t think eBay is being deprived of any expected potential return on investment. Just because craiglist’s majority owners use a lot of pro-philanthropic language, I see a market leader who is seeking to perpetuate that position. At the end of the day, then, craigslist is a “largely” philanthropic entity, and it is exactly the kind of small-but-profitable entity eBay bought a portion of in the first place. And that, to me, is just fine under Delaware law.  At least, it should be.  

Philanthropy as a Business Model: Comparing Ford to craigslist

At The Conglomerate, Gordon Smith notes some comparisons between Dodge v. Ford (pdf here) and eBay v. Newmark (pdf here). I certainly see the comparison (and I think his post here on the case and Christine Hurt’s earlier post here are great).  Still, I think I am a little more critical of the Dodge v. Ford analogy than Professor Smith. Here’s why:

In Dodge v. Ford, Henry Ford stated clearly that he was operating the business as he saw fit and that he was changing toward supporting philanthropic purposes. As the Dodge v. Ford opinion notes:

‘My ambition,’ declared Mr. Ford, ‘is to employ still more men; to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this, we are putting the greatest share of our profits back into the business.”

. . . .

The record, and especially the testimony of Mr. Ford, convinces that he has to some extent the attitude towards shareholders of one who has dispensed and distributed to them large gains and that they should be content to take what he chooses to give. His testimony creates the impression, also, that he thinks the Ford Motor Company has made too much money, has had too large profits, and that, although large profits might be still earned, a sharing of them with the public, by reducing the price of the output of the company, ought to be undertaken. We have no doubt that certain sentiments, philanthropic and altruistic, creditable to Mr. Ford, had large influence in determining the policy to be pursued by the Ford Motor Company-the policy which has been herein referred to.

Contrast this with Chancellor Chandler’s explanation of craiglist:

Nevertheless, craigslist’s unique business strategy continues to be successful, even if it does run counter to the strategies used by the titans of online commerce. Thus far, no competing site has been able to dislodge craigslist from its perch atop the pile of most-used online classifieds sites in the United States. craigslist’s lead position is made more enigmatic by the fact that it maintains its dominant market position with small-scale physical and human capital. Perhaps the most mysterious thing about craigslist’s continued success is the fact that craigslist does not expend any great effort seeking to maximize its profits or to monitor its competition or its market share.[fn6]

In further contrast to Henry Ford’s statements, in footnote 6 Chancellor Chandler provides a quote from craigslist’s CEO “testifying that craigslist’s community service mission ‘is the basis upon which our business success rests. Without that mission, I don’t think this company has the business success it has. It’s an also-ran. I think it’s a footnote.’”

Nonetheless, Chancellor Chandler, as Professor Smith points out, appears to see these cases in a similar light:

The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment. Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders.

Without getting into the appropriateness of the other moves taken by the majority owners of craigslist, I am inclined to think that craiglist’s explanation of their business model should sufficiently distinguish the mission – and business purpose – from that put forth by Henry Ford. That is, I have always been of the mind that Henry Ford could appropriately have defended his actions (or at least had a much stronger case) if he had never talked about doing anything other than building Ford into the strongest possible company for the longest possible term.

I see the problem for Henry Ford to say, in essence, that his shareholders should be happy with what they get and that workers and others are more his important to him than the shareholders. However, it would have been quite another thing for Ford to say, “I, along with my board, run this company the way I always have: with an eye toward long-term growth and stability. That means we reinvest many of our profits and take a cautious approach to dividends because the health of the company comes first. It is our belief that is in the best interest of Ford and of Ford’s shareholders.”

For Ford, there seemed to be something of a change in the business model (and how the business was operated with regard to dividends) once the Dodge Brothers started thinking about competing. All of a sudden, Ford became concerned about community first. For craigslist, at least with regard to the concept of serving the community, the company changed nothing. And, in fact, it seems apparent that craiglist’s view of community is one reason, if not the reason, it still has its “perch atop the pile.”

Thus, while it is true craigslist never needed to accept eBay’s money, eBay also knew exactly how craigslist was operated when they invested. If they wanted to ensure they could change that, it seems to me they should have made sure they bought a majority share.  

Proxy Access: The Added Wrinkle of the North Dakota Corporations Law

Back in 2007, North Dakota passed the North Dakota Publicly Traded Corporations Act (ND Act), which became Chapter 10-35 (Publicly Traded Corporations) of the North Dakota Century Code.  The ND Act provided a shareholder friendly alternative to the state's Business Corporations Act, Chapter 10-19.1 for companies that were so inclined.  (Find the referenced North Dakota laws here.)

Before the state could pass the law, the state constitution needed be amended, and voters approved the necessary changes in 2006 (for more on the history of the ND Act, see pdf here). A North Dakota-based publicly traded corporation is not subject to the ND Act unless it opts-in, essentially by reincorporating in the state. None of the state's public corporations existing before the ND Act was passed have done so.  

One of the main provisions of the ND Act gave proxy access for purposes of nominating candidates for election to the board of directors for a "qualified shareholder" of the publicly held corporation subject to the law. N.D. Cent. Code 10-35-08.  A qualified shareholder is a person or group of persons holding 5% of the company's shares authorized to vote for directors, and each person or member of the group must have held the shares for at least two years. N.D. Cent. Code 10-35-02(8).

As has been well documented, now comes the SEC amendments to Rule 14a-11, which allows such access for persons or groups of persons holding 3% of such shares who have owned those shares for three years. The SEC revisions allow the use of state or foreign law for nominations in addition to those permitted under Rule 14a-11, under 14a-19. Thus, as I read it, companies subject to the ND Act will now have to permit proxy access to two sets of qualified shareholders:  (1) the SEC-mandated 3%/three-year ownership shareholders and (2) the ND Act-mandated 5%/two-year ownership shareholders. 

Is this a big deal? As to ND Act companies, probably not. The only company subject to the ND Act is a public company already controlled by Carl Icahn. Thus, this issue is largely moot.  However, there is an indirect North Dakota connection that could loom larger. 

At least fifteen companies -- including Staples, Exxon Mobil, and Whole Foods -- have considered and defeated shareholder proposals to reincorporate under the ND Act.  Of those companies defeating the proposal, reports indicate that at least seven companies garnered at least 3% of the vote in support of the change.  This probably indicates that there is already a group of shareholders with 3% of the ownership ready to nominate directors.  And because of the ND Act, they should be relatively easy to find.