Business Law Prof Blog

BLPB: Links 11/30/13

• If you are looking for some books to help you better understand our economic history, try: Timothy Shenk on “The Long Shadow of Mont Pèlerin” – reviewing Angus Burgin’s The Great Persuasion (“[U]ncovering a history where the supposed founders of the American chapter of neoliberalism at the University of Chicago reprimand Hayek’s The Road to Serfdom for overdoing its indictment of the state while Keynes reports himself “in a deeply moved agreement” with the very same text.”).

• I thought I knew what it felt like to be scatterbrained and distracted, then I started spending time on Twitter.  Let’s just say my belief that meditation is an integral part of work-life balance was reinvigorated.  Relatedly, try: (1) bidushi on “The corporate world’s flirtation with meditation” and (2) “Free Video – ‘3-minute breathing space’ Guided Meditation” from the Oxford Mindfulness Centre.

• For the blogroll: Jennifer Taub’s "perpetual crisis" blog (“a blog on banking, corporate governance, and financial market reform”).

• Finally, you might be interested in Michael Pettis on “When Are Markets ‘Rational’?" (“To me, much of the argument about whether or not markets are efficient misses the point. There are conditions, it seems, under which markets seem to do a great job of managing risk, keeping the cost of capital reasonable, and allocating capital to its most productive use, and there are times when clearly this does not happen. The interesting question, in that case, becomes what are the conditions under which the former seems to occur.”).

“be first, be smarter, or cheat”

In the movie Margin Call, which “[f]ollows the key people at an investment bank, over a 24-hour period, during the early stages of the financial crisis,” one of the main characters says: “There are three ways to make a living in this business: be first, be smarter, or cheat.”  Given that only a few folks will be first or smarter, it may not be surprising that a “new report finds 53% of financial services executives say that adhering to ethical standards inhibits career progression at their firm.”  In a piece over at The Guardian, Chris Arnade, a former Wall Street trader describes why.  What follows is an excerpt from that piece, but you should go read the whole thing here.

After a few years on Wall Street it was clear to me: you could make money by gaming anyone and everything. The more clever you were, the more ingenious your ability to exploit a flaw in a law or regulation, the more lauded and celebrated you became. Nobody seemed to be getting called out. No move was too audacious. It was like driving past the speed limit at 79 MPH, and watching others pass by at 100, or 110, and never seeing anyone pulled over. Wall Street did nod and wave politely to regulators’ attempts to slow things down. Every employee had to complete a yearly compliance training, where he was updated on things like money laundering, collusion, insider trading, and selling our customers only financial products that were suitable to them. By the early 2000s that compliance training had descended into a once-a-year farce, designed to literally just check a box….

As Wall Street grew, fueled by that unchecked culture of risk taking, traders got more and more audacious, and corruption became more and more diffused through the system. By 2006 you could open up almost any major business, look at its inside workings, and find some wrongdoing. After the crash of 2008, regulators finally did exactly that. What has resulted is a wave of scandals with odd names; LIBOR fixing, FX collusion, ISDA Fix. To outsiders they sound like complex acronyms that occupy the darkest corners of Wall Street, easily dismissed as anomalies. They are not. LIBOR, FX, ISDA Fix are at the very center of finance ….

[So,] where is the real responsibility? … [T]he people who really should be held accountable have not. They are the bosses, the managers and CEOs of the businesses. They set the standard, they shaped the culture…. The managers knew what was going on. Ask anyone who works at a bank and they will tell you that. The excuse we have long accepted is ignorance: that these leaders couldn't have known what was happening. That doesn't suffice. If they didn't know, it's an even larger sin.

The Superrich and the SEC

On Saturday evening I leave for Geneva to attend the United Nations Forum on Business and Human Rights with 1,000 of my closest friends including NGOs, Fortune 250 Companies, government entities, academics and other stakeholders.  I plan to blog from the conference next week.  I am excited about the substance but have been dreading the expense because the last time I was in Switzerland everything from the cab fare to the fondue was obscenely expensive, and I remember thinking that everyone in the country must make a very good living. Apparently, according to the New York Times, the Swiss, whom I thought were superrich, "scorn the Superrich," and last March a two-thirds majority voted to ban bonuses, golden handshakes and to require firms to consult with their shareholders on executive compensation. Nonetheless, last week, 65% of voters rejected a measure to limit executive pay to 12 times the lowest paid employee at their company. According to press reports many Swiss supported the measure in principle but did not agree with the government imposing caps on pay.

Meanwhile stateside, next week the SEC closes its comment period on its own pay ratio proposal under Section 953(b) of the Dodd-Frank Act. Among other things, the SEC rule requires companies to disclose: the median of the annual total compensation of all its employees except the CEO; the annual total compensation of its CEO; and the ratio of the two amounts. It does not specify a methodology for calculation but does require the calculation to include all employees (including full-time, part-time, temporary, seasonal and non-U.S. employees), those employed by the company or any of its subsidiaries, and those employed as of the last day of the company’s prior fiscal year.  A number of bloggers have criticized the rule (see here for example), business groups generally oppose it, and the agency has been flooded with tens of thousands of comment letters already.

The SEC must take some action because Congress has dictated a mandate through Dodd-Frank.  It can’t just listen to the will of the people (many of whom support the rule) like the Swiss government did.  It will be interesting to see what the agency does. After all two of the commissioners voted against the rule, and one has publicly spoken out against it.  But the SEC does have some discretion. The question is how will it exercise that discretion and will the agency once again face litigation as it has with other Dodd-Frank measures where business groups have challenged its actions (proxy access, resource extraction and conflict minerals, for example). More important, will it achieve the right results? Will investors armed with more information change their nonbinding say-on-pay votes or switch out directors who overpay underperforming or unscrupulous executives? If not, then will this be another well-intentioned rule that does nothing to stop the next financial crisis?

  

MIDAS-- Market Data by the SEC

For those of you interested in empirical research now or in the future, keep in mind the new MIDAS (Market Information Data Analytics System) data sets available from the SEC.

Every day MIDAS collects about 1 billion records from the proprietary feeds of each of the 13 national equity exchanges time-stamped to the microsecond. MIDAS allows us to readily perform analyses of thousands of stocks and over periods of six months or even a year, involving 100 billion records at a time.

MIDAS collects posted orders and quotes, modifications/cancellations, and trade executions on national exchanges, as well as off-exchange trade executions. 

The methodology for MIDAS is available here.

Happy Thanksgiving BLPB readers!  

-Anne Tucker

The Nuclear Option: What if the U.S. Senate was a Corporation?

The news media and blogs have been filled with discussions of the “nuclear option” adopted by U.S. Senate Democrats last week. No, Senate Democrats are not threatening the Republicans with weapons of mass destruction (well, not all the Senate Democrats). It’s just a new way to end a filibuster. A simple majority vote is now sufficient to stop filibusters of executive and some judicial nominations.

I’m sure your first thought about the nuclear option had nothing to do with politics or judicial appointments. Your first thought was undoubtedly the same as mine: what would happen if the Senate were a closely-held corporation? (What? That wasn’t your first thought? I guess I’m too much of a business law geek.)

Duties of Controlling Shareholders; Oppression

As I’m sure you know, many jurisdictions impose a stronger fiduciary duty on those in control of a closely held corporation. See, e.g., Donahue v. Rodd Electrotype Co. of New England, Inc., 328 N.E.2d 505 (Mass. 1975). Actions that disadvantage the minority are subject to careful review. In addition, many corporate statutes allow courts to dissolve the corporation if those in control of the corporation have acted oppressively. See, e.g., Revised Model Business Corporation Act section 14.30(a)(2)(ii).

The Democratic rule change could violate its fiduciary duty to the minority Republican Senators and constitute oppression. The Republican Senators would argue that the rule change unfairly deprives them of most of their power over corporate affairs, upsetting the reasonable expectations they had when they entered the Senate.

That claim would be difficult for the Democrats to refute. The filibuster rule is a longstanding one and the express purpose of the change was to take away power from the minority. But that’s not the end of the matter. The Democrats could still win if they could show a legitimate business purpose for the action and no less drastic means of accomplishing that purpose. See, e.g., Wilkes v. Springside Nursing Home, 353 N.E.2d 657 (Mass. 1976).

The Democrats will argue that they had a legitimate “corporate” purpose: ensuring that our nation’s courts have sufficient judges. Moreover, they would say, they tried other, less drastic means to end the stalemate, with little success.

As with many of these majority-minority disputes, the resolution of these arguments by the court would depend on what the judge had for breakfast.

Dissolution for Deadlock

Of course, if the Senate were a closely held corporation, the Democratic senators might not have needed to resort to the nuclear option. Instead, they could have taken advantage of provisions like section 14.30(a)(i) of the Revised Model Business Corporation Act, which allows a court to dissolve the corporation if

the directors are deadlocked in the management of the corporate affairs, the shareholders are unable to break the deadlock, and irreparable injury to the corporation is threatened or being suffered, or the business and affairs of the corporation can no longer be conducted to the advantage of the shareholders generally, because of the deadlock.

Because of the filibuster rule, the directors (the Senators) were deadlocked and the shareholders (the voters) have been unable to break that deadlock for quite a while now. But is that deadlock causing irreparable injury to the country? Judges aren’t being appointed but there are, after all, other judges. The nation’s courts haven’t ground to a halt. And many people would argue that the business and affairs of the Senate have never been conducted to the advantage of the shareholders generally; if so, it’s hard to say that’s “because of the deadlock.”

I have a better idea: let’s imagine the Senate as a general partnership. Then, we can hold them all personally liable for their actions.

Conference on Financial Misconduct

The CFA Institute, the Journal of Corporate Finance, and the Schulich School of Business are sponsoring a Conference on Financial Misconduct, April 3-4, 2014, in Toronto, Canada.  Deadline for submissions is December 15, 2013.  You can go here for all the information.  What follows is the stated rationale, along with suggested research questions.

RATIONALE:

Financial market misconduct erodes investors trust, and in turn influences stock market liquidity and performance, and exacerbates volatility.  Financial market misconduct includes but is not limited to fraud.  Despite the widespread media attention on market misconduct, the causes and consequences of market misconduct are often misunderstood and under researched around the world. The evolving structure of markets gives rise to new work on topic

This international conference will provide a timely debate on financial market misconduct. The conference also encourages, but does not require, submission to the Journal of Corporate Finance. Papers submitted to the Journal of Corporate Finance would go through the normal review process.

RESEARCH QUESTIONS:

Some research questions that contributors to the conference might address are:

• Is market misconduct more common in different countries or across different exchanges?  If so, what types (earnings management, insider trading, market manipulation, dissemination of false and misleading information, other)?
• What are the causes of international differences in expected or detected misconduct?
• What are the consequences of market misconduct, and do they differ across countries or exchanges?
• Can regulation be designed to improve ethical standards and corporate governance?
• Does high frequency trading mitigate or exacerbate market misconduct?
• Does crowdfunding facilitate potential financial market misconduct, and how might such potential misconduct be mitigated through regulation?
• Do intermediaries such as lawyers, auditors, and investment bankers mitigate or exacerbate financial market misconduct?
• Is financial market misconduct exacerbated or mitigated under different types of ownership, such as government, institutional, or family ownership?
• How is market misconduct related to activist investors such as venture capital, private equity, and hedge fund investors?
• How is fraud risk and ethics priced in markets?
• How does the risk of market misconduct affect corporate valuation?
• To what extent has the failure of regulation and reporting standards exacerbated the incidence of market misconduct and the recent financial crisis?
• What encourages the adoption of ethical standards in public firms versus private firms?
• Related research questions on both publicly traded and privately held institutions are welcome.

Did Ayn Rand Channel the Secret Law of Attraction?

I was reading the introduction to the 35^th anniversary edition of Atlas Shrugged the other day, and a number of quotes taken from Ayn Rand’s related journal entries struck me (bold highlights are mine):

• I must show in what concrete, specific way the world is moved by the creators.  Exactly how do the second-handers live on the creators. Both in spiritual matters—and (most particularly) in concrete, physical events. (Concentrate on the concrete, physical events—but don’t forget to keep in mind at all times how the physical proceeds from the spiritual.)

• [I]t is proper for a creator to be optimistic, in the deepest, most basic sense, since the creator believes in a benevolent universe and functions on that premise. But it is an error to extend that optimism to other specific men. First, it’s not necessary, the creator’s life and the nature of the universe do not require it, his life does not depend on others. Second, man is a being with free will; therefore, each man is potentially good or evil, and it’s up to him and only to him (through his reasoning mind) to decide which he wants to be. The decision will affect only him; it is not (and cannot and should not be) the primary concern of any other human being.

• [A] creator can accomplish anything he wishes—if he functions according to the nature of man, the universe and his own proper morality, that is, if he does not place his wish primarily within others and does not attempt or desire anything that is of a collective nature, anything that concerns others primarily or requires primarily the exercise of the will of others.

To the extent one can sum up the foregoing as asserting that some type of essentially limitless creative power exists within humans, which is exercised via thought or reason, and need not – in fact should not – concern itself with the success or suffering of others, this sounds an awful lot like some of the rhetoric associated with “The Secret” or “The Law of Attraction.”  For those not familiar with the law of attraction, here is an excerpt from a review of “The Secret” that might help (for a version of the law of attraction presented by a disembodied spirit, as channeled by Esther & Jerry Hicks, go here – you might also want to check out Frank Pasquale’s post on the false advertising implications of The Secret here):

Supporters will hail this New Age self-help book on the law of attraction as a groundbreaking and life-changing work, finding validation in its thesis that one's positive thoughts are powerful magnets that attract wealth, health, happiness... and did we mention wealth? Detractors will be appalled by this as well as when the book argues that fleeting negative thoughts are powerful enough to create terminal illness, poverty and even widespread disasters.

I am certainly not the first person to have considered the possible connection between Ayn Rand’s philosophy and the law of attraction.  For other examples, go here (“Homage to Atlas Shrugged & Ayn Rand” page on “Powerful Intentions,” which describes itself as “a unique Law of Attraction Online Community”) or here (“50 Prosperity Classics,” citing Ayn Rand, The Secret, and Esther & Jerry Hicks).  The Atlas Society itself suggests (in a post entitled, "False Beliefs and Practical Guidance"): “If practical advice from ‘law of attraction’ preachers helps you keep focused on your goals, then use it.”

Anyway, I have not spent a lot of time researching this question (readers that have made it this far are likely now thinking either, “good” or “you’ve already spent way too much time on this”), but I would be curious to hear from anyone who knows of some better sources that either associate Ayn Rand with, or distinguish her from, the law of attraction.

Turchin on the Consequences of “Elite Overproduction”

Peter Turchin recently posted an interesting piece on Bloomberg entitled, “Blame Rich, Overeducated Elites as Our Society Frays.”  Here is an excerpt:

The “great divergence” between the fortunes of the top 1 percent and the other 99 percent is much discussed, yet its implications for long-term political disorder are underappreciated…. Increasing inequality leads not only to the growth of top fortunes; it also results in greater numbers of wealth-holders…. There are many more millionaires, multimillionaires and billionaires today compared with 30 years ago, as a proportion of the population…. Rich Americans tend to be more politically active than the rest of the population. They support candidates who share their views and values; they sometimes run for office themselves. Yet the supply of political offices has stayed flat …. In technical terms, such a situation is known as “elite overproduction.” … [Another example:] Economic Modeling Specialists Intl. recently estimated that twice as many law graduates pass the bar exam as there are job openings for them…. Past waves of political instability, such as the civil wars of the late Roman Republic, the French Wars of Religion and the American Civil War, had many interlinking causes and circumstances unique to their age. But a common thread in the eras we studied was elite overproduction. The other two important elements were stagnating and declining living standards of the general population and increasing indebtedness of the state…. Elite overproduction generally leads to more intra-elite competition that gradually undermines the spirit of cooperation, which is followed by ideological polarization and fragmentation of the political class. This happens because the more contenders there are, the more of them end up on the losing side. A large class of disgruntled elite-wannabes, often well-educated and highly capable, has been denied access to elite positions…. History shows a real indeterminacy about the routes societies follow out of [such] instability waves. Some end with social revolutions, in which the rich and powerful are overthrown…. In other cases, recurrent civil wars result in a permanent fragmentation of the state and society…. In some cases, however, societies come through relatively unscathed, by adopting a series of judicious reforms, initiated by elites who understand that we are all in this boat together. This is precisely what happened in the U.S. in the early 20th century. Several legislative initiatives, which created the framework for cooperative relations among labor, employers and the government, were introduced during the Progressive Era and cemented in the New Deal. By introducing the Great Compression, these policies benefited society as a whole.

Why Delaware?

When teaching on entity formation, my students often ask why so many companies choose Delaware.  Numerous academics have attempted to answer that question, and now the Official Website of the First State [Delaware] lists reasons why it thinks businesses choose Delaware.

The listed reasons are:

1. The statute
2. The courts
3. The case law
4. The legal tradition
5. The Delaware Secretary of State

No new claims here, but interesting to see how the state sees (or promotes) its advantages. 

The webpage also includes a blog, entitled "Delaware Corporate and Legal Services Blog," which only has a few posts so far, but may be worth tracking. 

H/T: Francis Pileggi

Is the failure to prosecute executives “morally suspect” and are internal compliance programs mere “window dressing”? The view from a federal judge.

Federal district court judge Jed Rakoff is no stranger to controversy.  He has admonished the SEC for failing to obtain admissions in two settlements and other judges have since followed suit (see here for example). This likely played some part in SEC Chair Mary Jo White’s decision in June to start seeking admissions during settlements.  White announced a few days ago that her lawyers are ready for more trials, and that in her view, trials facilitate public accountability.

Judge Rakoff has now set his sights on the Department of Justice, and his recent speech entitled “Why Have No High Level Executives Been Prosecuted in Connection with the Financial Crisis,” has made headlines around the world.  I heavily excerpt the speech below, but I recommend that you read it in full.  In his remarks, he sharply criticizes the DOJ for failing to prosecute individuals, a topic I discussed last week here. He also offers his own theories to rebut what the DOJ’s explanations. His remarks remind us that the 5-year statute of limitations on many crimes will run shortly and therefore many people may never face prosecution.

Judge Rakoff first acknowledged in his speech that prosecutors had other priorities including focusing on post-9/11 and insider trading cases.  He then minces no words in spreading the blame around. Some of his most biting censure is below:

 “…what I am suggesting is that the Government was deeply involved, from beginning to end, in helping create the conditions that could lead to such fraud, and that this would give a prudent prosecutor pause in deciding whether to indict a C.E.O. who might, with some justice, claim that he was only doing what he fairly believed the Government wanted him to do… [i]n recent decades, however, prosecutors have been increasingly attracted to prosecuting companies, often even without indicting a single individual. This shift has often been rationalized as part of an attempt to transform “corporate cultures,” so as to prevent future such crimes; and, as a result, it has taken the form of “deferred prosecution agreements” or even “non-prosecution agreements,” in which the company, under threat of criminal prosecution, agrees to take various prophylactic measures to prevent future wrongdoing. But in practice, I suggest, it has led to some lax and dubious behavior on the part of prosecutors, with deleterious results… [The prosecutor is] happy because [he] believe[s] that [he has] helped prevent future crimes; the company is happy because it has avoided a devastating indictment; and perhaps the happiest of all are the executives, or former executives, who actually committed the underlying misconduct, for they are left untouched… I suggest that the future deterrent value of successfully prosecuting individuals far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window-dressing. Just going after the company is also both technically and morally suspect.”

I am sure that general counsels, ethics officers and board members don’t think that their compliance programs are cosmetic, check-the-box initiatives, but they should take heed of Judge Rakoff’s words. Clearly the SEC has made a significant policy shift and perhaps the DOJ will as well.  In the meantime, companies and their counsel should prepare for the new paradigm in which settlements may require more than shareholder dollars.

Indemnification Obligations for Director Defendants in Derivative Suits

I was recently asked to evaluate a corporation’s obligation to indemnify a director named in a derivative suit initiated by the corporation alleging that the director usurped corporate opportunities. The MBCA establishes a standard framework for optional and mandatory indemnification of directors and officers, sets the appropriate boundary of indemnification obligations (i.e,. no reimbursement of derivative suit settlements or intentional misconduct), establishes the procedures for indemnification and advancement of expenses, and provides mechanisms for directors to enforce their indemnification rights through court orders.  The standard procedures for indemnification require the corporation to authorize the indemnification and make a determination that the conduct at issue qualifies for indemnification.

MBCA § 8.55 Determination and Authorization of Indemnification

(a) A corporation may not indemnify a director ….[until after] a determination has been made that indemnification is permissible ..[and].. director has met the relevant standard of conduct ….

(b) The determination shall be made:

(1)…. a majority vote of all the qualified directors…., or by a majority of the members of a committee;

(2) by special legal counsel ….or

(3) by the shareholders, but shares owned by or voted under the control of a director who at the time is not a qualified director may not be voted on the determination.

(c) Authorization of indemnification shall be made in the same manner as the determination that indemnification is permissible…..

 The determination is tricky for advanced expenses because the determination is made before the adjudication and with limited facts.  Yet, as the comments to the MBCA reflect, access to advance funds is often necessary to provide directors/officers with full protection because few individuals have personal resources to finance potentially complex and protracted litigation.  Some states, like Georgia OCGA § 14-2-856 and Delaware § 145, broaden the indemnification provisions established in the MBCA by providing procedures for shareholder agreements to expand the scope of corporate indemnification obligations and avoid the “determination” of complying conduct required under the MBCA.  A writing mandating an advance of expenses creates a vested right that cannot be unilaterally terminated. More importantly, statutes that recognize a vested right to advanced expenses avoids the requirement of a determination regarding the advance, which will often constitute a self-dealing transaction (director named in suit and seeking advance, also votes on determination of conduct qualification for indemnification) and therefore requires the entire fairness evaluation.

The expanded indemnification statutes raise all sorts of interesting questions about the scope of indemnification (the Georgia statute for example is intended to expand the scope to possibly include derivative suit settlements and fines), the process required for the mandatory advances (i.e., whether a shareholder vote approving the obligation can later be attacked because a defendant, who is now conflicted, voted shares in favor of the obligation), and whether these provisions violate public policy.  If you know of cases addressing these issues or litigating these expanded indemnification statutes in other jurisdictions, please respond in the comments.

Anne Tucker 

Defining Social Enterprise

Given my interest in social enterprise, many friends and colleagues e-mailed me Professor Steven Davidoff’s recent article in the New York Times DealBook about Make a Stand,  a company founded by then eight-year old Vivienne Harr that sells “all-natural, certified organic, U.S. grown/Fair-Trade, GMO-free” lemonade and donates 5% of gross revenue to organizations focused on ending child slavery. 

As Professor Davidoff mentions, Make a Stand is organized as a social purpose corporation in Washington state.  Social purpose corporations are one of the many “social enterprise” legal forms that have arisen in the U.S. over the past five years, along with benefit corporations, benefit LLCs, flexible purpose corporations, L3Cs, public benefit corporations, and sustainable business corporations. 

While these new legal forms have been grouped under the term “social enterprise,” the term “social enterprise” is not well defined in the literature. 

The Social Enterprise Alliance (the “SEA”) defines “social enterprise” through a tripartite test:

1. Directly addresses social need;
2. Commercial activity [not donations] drives revenue; and
3. Common good is the primary purpose.

The recent "social enterprise" statutes, however, do not expressly require products or services of social enterprises to directly address social need in the way described by the SEA.   Most of the social enterprise statutes are also unclear on whether shareholder or other stakeholder interests take priority.  The benefit corporation statutes do require a “general public benefit purpose” but simply list shareholder interests alongside other stakeholder interests that the directors must consider in every decision (and shareholders are the only listed stakeholders that the statutes give standing to sue derivatively ).

Professor Christine Hurt (Illinois Law) describes one of the differences between corporate social responsibility (“CSR”) and social entrepreneurship (often used interchangeably with “social enterprise”) as: 

CSR focuses on companies that make widgets, but who do so in an enlightened way; Social entrepreneurship envisions companies that make a completely different kind of widget. . . .most of the companies who are heralded for "good CSR" make products for rich people or at least premium products that are a splurge for the average person: Ben & Jerry's ice cream; Burt's Bees; Toms shoes. In making these products, which are more expensive than their competitors, they brand themselves as "giving back" or being enlightened to employees, communities or the environment. These companies don't seem to be losing money by "doing well and doing good," though their profit margins arguably might be lower than otherwise.

 

Social entrepreneurs start for-profit companies in a sphere usually inhabited only by not-for-profits and try to do something that can't be done by NGOs because of capital scarcity or knowhow scarcity. Social E's make a different kind of widget that isn't needed by rich people, but by the needy: affordable clean water, light sources, hygiene products, sanitation, etc.

However, most of the companies that have chosen the social enterprise legal forms, including Make a Stand, look more like companies engaging in CSR than social enterprises as defined by Professor Hurt.  Make a Stand's lemonade may be made in an "enlightened way" and a percentage of revenue is given away, but the lemonade itself appear to be made for sale to relatively wealthy consumers. 

Some legal scholars have given “social enterprise” a much broader definition, a definition that looks much more like Professor Hurt’s description of CSR – essentially, companies that use commercial activity to drive revenue with at least one significant social or "common good" purpose. 

Part of the confusion stems from people using the term “social enterprise” to describe at least three different types of enterprises, which I have listed below.  Some companies will, of course, fall in more than one category. 

Generous Enterprise.  What (and how much) the company gives away.  Examples include Make a Stand’s 5% of revenue giving pledge, Patagonia’s 1% of revenue for the planet commitment, and TOMs Shoes’ and Warby Parker’s buy one, give one model.     

Responsible Enterprise.  How (and under what conditions) the product is made.  Examples include companies committed to fair trade, organic, recycled materials, LEED certified buildings, good corporate governance practices, fair treatment of employees, and the like.  Some companies that spring to mind as attempting to be "responsible" are Ben & Jerry’s, Method, Plum Organics, and Seventh Generation.  On the smaller side, someone I went to high school is a co-founder of a company that falls into this category; Recover Brands makes clothing from recycled plastic bottles and recycled cotton.

Justice Enterprise.  Who makes and who purchases the product.  These companies exist to provide employment to disenfranchised and/or create products for purchase by disenfranchised.  Greyston Bakery, Spring Back Recycling (a company that began as a project by the Belmont University Enactus team), Thistle Farms, and others, exist, in large part, to hire, train, and support the disenfranchised (especially those transitioning from homelessness and prison).  Companies like Grameen Danone Foods, Cure2Children, and Power Africa develop products or services targeted at underserved communities with the goal of improving their lives; each of these three organizations is providing and developing, as Professor Hurt put it, “a different kind of widget that isn't needed by rich people, but by the needy.”  Steven Buhrman at Wannado Local inspired the naming of this category.  As mentioned to me by Professor Hurt, this category could be broken into two.  I agree.  Perhaps, "reintegration enterprises" for the first, and  "social innovation enterprises" for the second.

Social enterprises could also be divided by whether they make and distribute profits.  Originally, the term social enterprise was used primarily in the non-profit context and primarily in articles originating in business schools.  Law professors, however, have generally and increasingly used the term in the for-profit context.

Academics, managers, investors, consumers, customers, and governments are all using the term “social enterprise,” but more precise terminology may be helpful.  Clarity is important when governments offer incentives to “social enterprises” and investors decide to invest in “social enterprises” so that both groups identify the type of social return they are seeking.  Also, clarity within the three groups is needed.  How much giving is sufficient?  What are the standards for responsible operation?  What types of products and services are appropriate for a justice enterprise?  Right now there are more questions than answers in the social enterprise space, but there are an increasing number of people working on answers, including those at B Lab, academics and practitioners (including those who blog at SocEntLaw.com), and the Sustainability Accounting Standards Board (“SASB”).

Cross-posted at SocEntLaw.

The Emerging National Electricity Market: Regulators Take Note

Last week, I had the pleasure of being part of the Second Annual Searle Center Conference on Federalism and Energy in the United States.  (I had the good fortune to be part of the first one, too.)  The conference covered a wide range of energy issues from electricity transmission siting to hydraulic fracturing to natural gas markets.  One paper/presentation struck me as particularly interesting for markets generally (I am told an update version will be available soon at the same site: “The Evolution of the Market for Wholesale Power” by Daniel F. Spulber, Kellogg School of Management, Elinor Hobbs Distinguished Professor of International Business and Professor of Management Strategy & R. Andrew Butters, Kellogg School of Management, Northwestern University.

Here is the conclusion: 

A national market for wholesale electric power in the US has emerged following industry restructuring in 2000. Tests for correlation and Granger Causality between trading hubs support the presence of a national market. Going beyond pairwise analysis, we introduce an array of multivariate techniques capable of addressing the national market hypothesis, including the common trend test. Although there is strong evidence of integration between the series, the analysis suggests a division between the eastern and western parts of the market. We also find border connects of 300 miles between the three interconnects.

The absence of transmission between the interconnects and significant border effects suggests that the national market is not yet fully integrated, even within the one-month horizon. Construction of transmission facilities between the interconnects would complete the development of the US wholesale market for electric power. Our analysis suggests that transmission facilities connecting the three regions would result in substantial gains from trade.

This conclusion – that “[a] national market for wholesale electric power in the US has emerged following industry restructuring in 2000 – could have a profound effect for how we view (and FERC views) wholesale electricity markets.  The study notably does not control for or otherwise address the price of renewable energy credits (RECs), which are required for compliance with renewable portfolio standards in a majority of states. This may not change the conclusion, but it would be interesting to see how if the RECs have any influence on the market operations.

In addition, it’s possible that more than just the 2000 market restructuring is at play here.  Since that time, electricity generation from natural gas has grown dramatically, and there is every reason to believe that will continue.  According to the Energy Information Administration, “Nearly 237 GW of natural gas-fired generation capacity was added between 2000 and 2010, representing 81% of total generation capacity additions over that period.”  If natural gas really is a major driver in facilitating this market, it would mean that that recent shale gas boom is even broader reaching than some may have expected. 

There’s more work to be done here to be certain a national market for electricity really is emerging and if more can be done to facilitate that market. If true, such a market could bode well for the consumers, especially those in higher cost regions.  It could also be an indicator that the regulatory structure of the market, even if not ideal, it working efficiently.  If so (as I am inclined to believe), it suggests that the Congress and FERC should leave the market-related regulations alone, and focus efforts on things that will further develop the market, such as the study’s finding “that transmission facilities connecting the three regions would result in substantial gains from trade.”

There's No Partial Credit in Law Practice

A student who completed one of my computer-assisted legal exercises pointed out that one of his answers was partially correct, and asked me why he didn’t receive partial credit. The short answer is a technical one--the software doesn’t allow for partial credit on questions. But the student’s inquiry made me think about the deeper issue of giving credit for partially correct answers.

All of the law professors I know give partial credit for exam essay answers that contain errors or reach erroneous conclusions. In the context of a single end-of-semester exam, where there’s significant time pressure and no opportunity for students to redo their answers, that philosophy probably makes sense. But does it teach our students the wrong lesson?

One doesn’t get credit for partially correct answers in law practice. Answers are either right or wrong. If the lawyer tells the client yes and the correct answer is no, it doesn’t matter that most of the lawyer’s analysis was correct. Overlooking a crucial fact or missing an important step in the analysis is not excusable in practice. The client is unlikely to congratulate the lawyer for being 80% correct.

Of course, lawyers get lucky. The lawyer’s answer may be right even though the analysis is completely wrong. A poorly drafted clause in a contract may never be triggered. But lawyers don’t survive for long on luck. Eventually, poor or incomplete analysis will bite the lawyer.

A partially correct answer is bad lawyering. It may make sense to give credit for a partially correct answer on law exams, but we should make it clear to our students that partially correct isn’t acceptable in real life.

Bhattacharya Provides a Literature Review of Insider Trading Controversies

A quick review of the top 10 Papers for Corporate, Securities & Finance Law eJournals on SSRN for the period of September 18, 2013 to November 17, 2013 (here), led me to Utpal Bhattacharya’s paper “Insider Trading Controversies: A Literature Review.”  Here is the abstract:

Using the artifice of a hypothetical trial, this paper presents the case for and against insider trading. Both sides in the trial produce as evidence the salient points made in more than 100 years of literature on insider trading. The early days of the trial focus on the issues raised in the law literature like fiduciary responsibility, the misappropriation theory and the fairness and integrity of markets, but the trial soon focuses on issues like Pareto-optimality, efficient contracting, market efficiency, and predictability raised in the financial economics literature. Open issues are brought up. A jury finally hands out its verdict.

Eric Chaffee Re-Launches Securities Law Prof Blog

Congratulations to Eric Chaffee, former BLPB contributing editor & friend of the blog, for taking over the Securities Law Prof Blog reins from Barbara Black.  Barbara has left some big shoes for Eric to fill, having single-handedly built the Securities Law Prof Blog into one of the staple blogs for business law folks, but if anyone is up to the task it's Eric.  Make sure you add the Securities Law Prof Blog to your personal blogroll.

“Rehabilitating Concession Theory” (Third Updated Draft w/ Minor Changes)

I have posted an updated draft of my latest paper Rehabilitating Concession Theory, which is forthcoming in the Oklahoma Law Review, on SSRN.  I have made only minor changes to the the prior draft, but I thought I’d post the abstract and link to the paper here in case any blog readers haven’t seen the paper before and might be interested in the content.

In Citizens United v. FEC, a 5-4 majority of the Supreme Court ruled that, “the Government cannot restrict political speech based on the speaker's corporate identity.” The decision remains controversial, with many arguing that the Court effectively overturned over 100 years of precedent. I have previously argued that this decision turned on competing conceptions of the corporation, with the majority adopting a contractarian view while the dissent advanced a state concession view. However, the majority was silent on the issue of corporate theory, and the dissent went so far as to expressly disavow any role for corporate theory at all. At least as far as the dissent is concerned, this avoidance of corporate theory may have been motivated at least in part by the fact that concession theory has been marginalized to the point where anyone advancing it as a serious theory risks mockery at the hands of some of the most esteemed experts in corporate law. For example, one highly-regarded commentator criticized the dissent by saying: “It has been over half-a-century since corporate legal theory, of any political or economic stripe, took the concession theory seriously.” In this Essay I consider whether this marginalization of concession theory is justified. I conclude that the reports of concession theory’s demise have been greatly exaggerated, and that there remains a serious role for the theory in discussions concerning the place of corporations in society. This is important because without a vibrant concession theory we are primarily left with aggregate theory and real entity theory, two theories of the corporation that both defer to private ordering over government regulation.

Crime and Punishment: Prosecuting Executives and Forcing Companies to Admit Guilt

 

“Man grows used to everything, the scoundrel!” 
― Fyodor Dostoyevsky, Crime and Punishment

This week two articles caught my eye.  The New York Times’ Room for Debate feature presented conflicting views on the need to “prosecute executives for Wall Street crime.” My former colleague at UMKC Law School, Bill Black, has been a vocal critic of the Obama administration’s failure to prosecute executives for their actions during the most recent financial crisis, and recommended bolstering regulators to build cases that they can win. Professor Ellen Podgor argued that the laws have overcriminalized behavior in a business context, and that the “line between criminal activities and acceptable business judgments can be fuzzy.” She cited the thousands of criminal statutes and regulations and compared them to what she deems to be overbroad statutes such as RICO, mail and wire fraud, and penalties for making false statements. She worried about the potential for prosecutors to abuse their powers when individuals may not understand when they are breaking the law.

Charles Ferguson, director of the film “Inside Job,” likened the activity of some major financial executives to that of mobsters and argued that they have actually done more damage to the economy. He questioned why the government hadn’t used RICO to pursue more criminal cases.  Former prosecutor and now private lawyer Allen Goelman pointed out rather bluntly that prosecutors aren’t cozy with Wall Street—they just won’t bring a case when the evidence won’t allow them to win. He also reminded us that greed and stupidity, which he claimed was the cause of the “overwhelming majority of the risky and irresponsible behavior by Wall Street,” are not crimes.  Professor Lawrence Friedman wrote that  the law “announces the community’s conceptions of right and wrong,” and if we now treat corporations like people under Citizens United then we should likewise make the executives who run them the objects of the community’s condemnation of wrongdoing.

Finally, Senator Elizabeth Warren concluded that if corporations know that they can break the law, pay a large settlement, and not admit any guilt or have any individual prosecuted, they won’t have any incentive to follow the law. She also argued for public disclosure of these settlements including whether there were tax deductions or releases of liability.

This brings me to the second interesting article. Former SEC enforcement chief and now Kirkland & Ellis partner Robert Khuzami recently said, “I didn’t think there was much doubt in most cases that a defendant engaged in wrongdoing when you had a 20-page complaint, you had them writing a big check, you may well have prosecuted an individual in the wrongdoing.” While not endorsing or rejecting current SEC Chair Mary Jo White’s position to require certain companies to admit wrongdoing in settlements, he raised a concern about whether this change in policy would place undue strain on the agency’s limited resources by forcing more cases to go to trial.  He also raised a valid point about the legitimate fear that firms should have in that admitting guilt could expose them to lawsuits, criminal prosecution, and potential business losses.  Chair White did not set out specific guidelines for the new protocol, but so far this year 22 companies have benefitted from the no admit/no deny policy and have paid $14 million in sanctions. But we don’t know how many executives from these companies lost their jobs. On the other hand, would these same companies have settled if they had to admit liability or would they have demanded their day in court?

Should the desire to preserve agency resources trump the need to protect the investing public—the stated purpose of the SEC? If neither the company nor the executive faces true accountability, what will be the incentive to change? In a post-Citizens United world, will Congressmen strengthen the laws or bolster the power and resources of the regulators to go after the corporations that help fund their campaigns? Have we, as Dostoyevsky asserted, become “used” to the current state of affairs where drug dealers and murderers go to jail, but there aren’t enough resources to pursue financial miscreants?

What will make companies and executives “do the right thing”? Dostoyevksy also wrote “intelligence alone is not nearly enough when it comes to acting wisely,” and he was right. Perhaps the fear of the punishment for clearly enumerated and understood crimes, and the fear of the admission of wrongdoing with the attendant collateral damage that causes will lead to a change in individual and corporate behavior.  I agree with Professor Podgor that there is clearly room for prosecutorial abuse of power and that the myriad of laws can lead to a no-mans land for the unwary executive forced to increase margins and earnings per share (while possibly getting a healthy bonus).  While I have argued in the past for an affirmative defense for certain kinds of corporate crimial liability, I also agree with Professor Black and Senator Warren.  At some point, people and the corporations (made up of people) need more than “intelligence” to act “wisely.” They need the punishment to fit the crime.

 

 

 

 

 

Teaching Law in a Business School v. Law School

Last week, I attended and presented at my first legal studies in business school conference, the Southeastern Academy of Legal Studies in Business ("SEALSB") annual conference.  On this recent trip, I was able to meet a number of other professors who hold positions similar to mine at other business schools.  Most of the professors were from the southeast, but we also had professors from California, Michigan, Minnesota, and New York.

One of the new pieces of information I learned was that, while I was correct in my previous post stating that there is no “meat market” equivalent for legal studies in business school positions, the Academy of Legal Studies in Business (“ALSB”) does send out job postings, on occasion, to its members.  Also, more than one professor in attendance claimed to have obtained his/her current position by attending the ALSB annual meeting and networking.

In this post, I will discuss some of the differences I see between my current job as a professor teaching law in a business school and my previous job as a law professor in a law school.  I draw on my own experiences and conversations I have had with many professors across the country, at both types of schools.  That said, this is just anecdotal evidence, and I imagine experiences differ. 

Scholarship. 

• Business school deans and colleagues usually require education on legal scholarship and law journals. Business schools are used to traditional peer reviewed journals (generally double blind) that are listed on Cabell’s.  That said, most business schools I know of, are accepting (at least some) law reviews as acceptable placements from their tenure track legal studies professors 

• Business schools also tend to encourage, or at least not penalize, co-authored work, whereas it seems many law schools apply a significant discount to co-authored articles. 

• Legal studies professors in business schools may have to struggle to obtain WestLaw access and legal research support.  Everyone I talked to at SEALSB had obtained access, though it seemed to require a bit more effort than at a law school. 

Teaching.

• In law schools, very roughly speaking, the average teaching load seems to be 2/1 at research schools and 2/2 at the teaching schools.  In business schools, the normal teaching load seems to be either 2/1 or 2/2 at the research schools (with 2/2 appearing to be the norm), and 3/3 (or in some limited cases 3/4 or 4/4) at teaching business schools. Teaching loads seem to be a bit lighter at law schools, though this may be changing at some law schools given the financial challenges many are facing.   

• Business school professors tend to give many more assessments than law school professors.  In law schools the norm still seems to be one major assessment per semester, though plenty of professors do more.  Most of the legal studies professors in business schools claimed to give at least three major assessments a semester, and sometimes as many as six or seven. 

• The business school professors I spoke to tended to have smaller classes (20-50), at least smaller than the large section law classes (70-150).  That said, some of the professors from large state universities reported undergraduate classes as large (or sometimes much larger) than the average large section law school class.

• Many legal studies professors I have met teach both undergraduate and graduate business law courses, though some only teach undergraduate.  Obviously, law professors only teach graduate students.  That said, the average MBA student likely has more work experience than the average law student. 

Service. 

• As far as I can tell, service requirements seem similar at law and business schools.

Compensation. 

• Compensation of law professors and legal studies in business school professors seems relatively close, at least if the business school has an MBA program, in addition to its undergraduate program.  The compensation seems a bit less uniform across business schools than across law schools, with a few business professors who would be outliers, on the low end, of current law school compensation. 

These are all obviously generalizations, and I am sure there are many exceptions, but I thought the rough sketch of the differences might be useful for those who are trying to choose between teaching law at a business school or at a law school. 

Mom & Pop Investors

We live in a world where most working individuals have some retirement savings invested in the stock market.  The stock market funds, in part, college educations, and serve as the primary wealth accumulator for post-baby boom generations.  My parents—an elementary school teacher and a furniture salesman—lived in Midwestern frugality and invested their savings from the mid-80’s until 2006 when they pulled out of the market.  They retired early, comfortably (so I believe), and largely because of consistent gains in the stock market over a 30 year period.  The question is whether this story is repeatable as a viable outcome for working investors now. 

The Wall Street Journal ran a story on Monday “Stocks Regain Appeal” documenting the number of dollars flowing into markets from retail investors as well as the anecdotal confidence of investors.  The WSJ reports that:

“U.S. stock mutual funds have attracted more cash this year than they have in any year since 2004, according to fund-tracker Lipper. Investors have sent $76 billion into U.S. stock funds in 2013. From 2006 through 2012, they withdrew $451 billion.” 

This seems indisputably good right?  Maybe.  The real question for me is why is more money flowing into the markets and confidence high?  Is this behavior driven by information, emotion, or herd mentality?  Robert Shiller, recent Nobel Prize winner and author of Irrational Exuberance, wrote in March in a column for the NYT that investors were confident, but who knows why.  Shiller’s conclusions were based on data from the cyclically adjusted price-earnings ratio, CAPE, of 23 suggesting that the market was priced high, which is interesting when compared with his data that 74% of individual investors did not think that the market was overpriced.  Shiller strengthened his cautionary stance on the market last month when the CAPE held at 23.7, and Shiller warned that stocks were the “most expensive relative to earnings in more than five years.”

This is business law blog, not a market blog, yet the role of the market interests me greatly.  As corporate law scholars, we teach students and write about the legal limits, obligations and assumptions that establish the market and dictate how individuals and institutions interact with the market and corresponding corporate-level controls.  In 2007 the market collapsed (self-corrected if we want to use the economists’ terms) and what was the result?  Dodd-Frank and a series of legislation aimed at policing the market.  If we are interested in the laws that govern the market, surely some attention must be paid to how and why the market works the way that it does.

 -Anne Tucker