Business Law Prof Blog

Corporate Scholarship Highlights: Felix Chang's Banks & Clearinghouse Regulations

Felix Chang, at the University Of Cincinnati College Of Law, recently posted a draft of his excellent paper, The Systemic Risk Paradox: Banks and Clearinghouses Under Regulation.  The paper will be published in the Columbia Business Law Review (congrats Felix!) in the fall.  I first read Felix’s paper in conjunction with the George Washington University C-Leaf Junior Scholar workshop earlier this spring. After the workshop, I asked him to let me know when a draft was ready to share with BLPB readers, and here is the Abstract:

Consolidation in the financial industry threatens competition and increases systemic risk. Recently, banks have seen both high-profile mergers and spectacular failures, prompting a flurry of regulatory responses. Yet consolidation has not been as closely scrutinized for clearinghouses, which facilitate trading in securities and derivatives products. These nonbank intermediaries can be thought of as middlemen who collect deposits to ensure that each buyer and seller has the wherewithal to uphold its end of the deal. Clearinghouses mitigate the credit risks that buyers and sellers would face if they dealt directly with each other. 

Yet here lies the dilemma: large clearinghouses reduce credit risk, but they heighten systemic risk since the collapse of one such entity threatens the entire financial system. While the systemic risks posed by large banks have been tackled by regulators, the systemic risks of these nonbank intermediaries have received less attention. In fact, clearinghouses have been cloaked with a regulatory mantle which encourages unchecked growth. 

This Article examines the paradoxical treatment of regulators toward the systemic risks of clearinghouses and banks. It explores two fundamental questions: Why does the paradox exist, and who benefits from it? Borrowing from antitrust, this Article offers a framework for ensuring that the entities which control a large clearinghouse (the big banks) do not abuse its market dominance.

-Anne Tucker

Breaking Bad and the Law

My wife claims that I wasted quite a bit of time watching the Breaking Bad TV series on Netflix over the past few months, but given this recent call for papers, I may claim I was just doing professional development.

The editorial board New Mexico Law Review does not list any business law topics in their areas of particular interest, but I can think of a few.  Accounting fraud and money laundering feature prominently.  The IRS is involved in some episodes.  Magrigal (a global conglomerate), Los Pollos Hermanos (a restaurant chain), and A1A car wash (which becomes a family-owned business) are three businesses that take center stage.  There is a sale of a company (the car wash) in one episode and possible fiduciary duty issues throughout.  I may even see a benefit corporation angle to explore...

This is a fun idea for a special law review issue. 

Racism, Capitalism, and the NBA

Unless you have been under a rock, you’ve probably heard about the racially offensive (and morally repugnent) comments apparently made by Donald Sterling, owner of the NBA’s Los Angeles Clippers, made about African-Americans, including Magic Johnson.  Just moments ago, the league announced how it would respond.

NBA Commissioner Adam Silver announced that an NBA investigation has concluded that Sterling was the voice reflecting hateful speech, views that are “deeply offensive and harmful.”  (Note that the investigation was done by the Wachtell Lipton firm.)   

Commissioner Silver apologized for Sterling’s comments and vowed action. The result: Effective immediately, Sterling is banned for life from games, practices, facilities, and player personnel decisions, and he is barred from executive meetings.  In addition, the maximum fine of $2.5 million is levied, which will for to charities selected jointly by the NBA and the player’s association.  Silver said he will do everything in his power to help force a sale of the team. 

Silver said, “We stand together in condemning Mr. Sterling’s views. They have no place in the NBA.” Sterling said that a three-fourths vote of owners could force Donald Sterling to sell. He did not know how it would proceed, but Silver said he would encourage owners to force Sterling to sell, and the process will begin immediately. 

Last week, I posted about the need for open debate in the context of Mozilla CEO Brendan Eich’s resignation, and the ability for people to have cordial discussions about different views, even if one thinks the other’s views are wrong.  In that post, I explained my view that rushing to fire people for expressing different political views might be in the power of a company, but that calling for someone’s ouster because they have different views is not productive. 

I still believe that, but I also think the NBA has acted appropriately here, and I hope the owners follow through to oust Sterling. As I explained in my post about Mozilla: 

Certainly, one can imagine a scenario where a CEO’s prior political or organizational giving would create problems for the organization.  For example, an environmental organization may not be comfortable with a CEO who had given money to a group fighting climate legislation. But, in that circumstance, the hiring body, and likely the CEO, would, or at least should, have known that support for climate change initiatives would be expected as part of the job.  Top employees often become the face of the organization, and that comes with job, but if a particular political view is deemed necessary for the job, it would help if the CEO knew it during the interview process. 

Unlike Eich’s situation, Sterling’s apparent statements indicate a level of animus that required a strong response. I am also certain that the NBA would have considered Sterling’s views on race to be a huge problem for the league and the team, at least if displayed publicly.  Despite a long list of Sterling’s past statements, there is little doubt Sterling knew that such statements, at least made publicly, would be damaging.  It's unfortunate that Sterling would decide that it’s the public part of the view that are the concern (and not the views themselves), but that’s a different issue.

Organizations like the NBA work in their own best interest, and the role of the NBA is to promote and perpetuate the NBA and its teams.  In taking (and hopefully sustaining) action against Sterling, they are doing that.  They also happen to be, in my view, responding morally and ethically, as well. (I’ll note that there are legitimate questions about whether the NBA should have acted a long time ago, but for the moment, I’ll stick with “better late than never.”)  If the NBA does not ultimately, and relatively quickly, eliminate Sterling from an ownership role, though the entire league will suffer. Frankly, if the league and its owners don’t follow through, they should suffer. 

The NBA is, in many ways, a snapshot of capitalism.  In the market, where consumers have full information, the market works. Now that Sterling’s views are out in public, I suspect all of the NBA owners understand just what that means.  I rather hope so. 

Three Interesting Books

I have three really interesting recent books sitting on my reading pile. (Much of my reading is now on a Kindle, so I guess “reading pile” is no longer appropriate.)

Unfortunately, I am unlikely to make a dent in that “pile” for a bit. Exams and a couple of article deadlines are going to keep me busy in the near future. But, just in case some of you have a little more spare time than me, I wanted to bring these important books to your attention.

Erik F. Gerding, Law Bubbles, and Financial Regulation (Routledge 2014).

Gerding is a law professor at the University of Colorado. He examines the history and causes of market bubbles, with special attention to the crisis of 2007-2008, and attempts to fight bubbles. It’s a fairly expensive book so, with apologies to Erik, I suggest you try to find it in your library if you can. If they don’t have it, do what I did and ask your library to order it. An introductory chapter is available here.

Omri Ben-Shahar and Carl E. Schneider, More Than You Wanted to Know: The Failure of Mandated Disclosure (Princeton University Press 2014).

Ben-Shahar is a law professor at the University of Chicago and Schneider is a law professor at the University of Michigan. Their focus is on the many mandated disclosures people encounter in their daily lives—for example, the dozens of pages we all must sign when we get a mortgage. They argue that mandated disclosure seldom works.

William Easterly, The Tyranny of Experts: Economists, Dictators, and the Forgotten Rights of the Poor (Basic Books 2014).

This is the only book of the three that doesn’t fit into the main channel of business law. Easterly, an economist at N.Y.U., discusses anti-poverty programs and their effect on the third world. He argues that the technical solutions proposed by experts haven’t worked and that the real key to development is bottom-up: giving poor people economic freedom.

Lawrence Mitchell on Halliburton v. Erica P. John Fund and the Other Law Professors

[The following post comes to us from Lawrence E. Mitchell, Joseph C. Hostetler - Baker & Hostetler Professor of Law at Case Western Reserve University School of Law.  All formatting errors should be attributed to me, Stefan Padfield.]

The March 5, 2014 oral argument in Halliburton Co. v. Erica P. John Fund, Inc.¹ made clear that one of the issues being considered by the Supreme Court is whether to supplant the "market efficiency" analysis currently required at the class certification stage in securities fraud class action cases with a "price impact" analysis instead. Our purpose is not to debate the relative merits of that potential change. Rather, it is to identify a critical point that seemed to get lost in the argument: neither the Justices nor the advocates addressed what a price impact analysis would look like in the context of the most common securities fraud scenario—the making of false statements designed to mask bad news. While some of the briefing before the Court touches on the issue, the authors of a working paper cited by proponents of both sides have supplemented their views with a recent blog post that, while brief, discusses potential approaches to measuring the "price impact" of such fraudulent statements more comprehensively than anything the parties or their amici filed with the Court. The author-bloggers are law professors, but they are not the same law professors whose amicus brief dominated the questioning at the oral argument itself.

"The Law Professors' Brief"

Given the large number of amicus briefs filed in Halliburton—ten for petitioners, twelve for respondent, and one ostensibly in support of neither party—a disproportionally large portion of the oral argument was focused on the brief Professors Adam C. Pritchard of the University of Michigan Law School and M. Todd Henderson of the University of Chicago Law School filed in support of petitioner Halliburton. Their operating premise is that the "efficient capital markets hypothesis is not necessary to the use of the fraud on the market theory—whenever the market incorporates fraudulent information into the price, a 'fraud on the market' has occurred, whether the market is efficient or not."² They argue in favor of eliminating one of the current requirements that securities fraud class action plaintiffs must establish to invoke the fraud-on-the-market presumption at the class certification stage, namely the requirement that "the market" in which the security at issue trades be shown to be "efficient." Instead, in determining reliance, they support using event studies to examine whether an alleged misrepresentation caused a movement in the price of the stock.

Justice Kennedy posed specific questions about the "position" or "theory" of "the law professors" to counsel for both sides, Justice Scalia asked about the effect of the professors' "Basic writ small" approach on the provisions of the Private Securities Litigation Reform Act, and Justice Kagan sought from the Solicitor General's Office the government's view "if the law professors' position were adopted."³ More broadly, four of the Justices (Roberts, Kennedy, Breyer, and Alito) asked questions specifically containing the terms "event study" or "event studies."⁴

The Halliburton Oral Argument Did Not Contemplate The Typical Securities Fraud Case

The vast majority of securities fraud cases do not involve alleged false statements of positive news that might be expected to increase the value of the stock price. Rather, in a typical securities fraud class action, the false statement is one that conceals a development adversely affecting the issuing corporation. Under those circumstances, there is little or no "impact" on the stock at the time the false statement is made; the false statement minimizes or prevents the decline that would otherwise have occurred had investors been given the opportunity to fully consider the negative development and reassess the value of their investments. A measurable "impact" on the stock price in such circumstances would not be seen until a "corrective disclosure" occurs, which could be substantially after the fraudulent statement is made.

However, to the extent the Justices dabbled in hypotheticals from the bench, they contemplated false statements that were accompanied by stock price increases. Justice Alito appeared to suggest that a stock price increase at the time of the misrepresentation is a necessary prerequisite for fraud, although the question could equally be taken as addressing an "inefficient" market where there is a time lag until new information was absorbed. He asked: 

to say that false representation affects the market price is quite different from saying that it affects the market price almost immediately, and it's hard to see how the Basic theory can be sustained unless it does affect the market price almost immediately in what Basic described as an efficient market. Isn't that true? Why should someone who purchased the stock on the day, shortly you know, an hour or two after the disclosure, be entitled to recovery if in that particular market there is some lag time in incorporating the new information?⁵ 

The Other Law Professors

The amicus brief of Professors Pritchard and Henderson makes passing reference in a footnote to the fact that the impact of a misrepresentation may occur when corrective information is disseminated to the market.⁶ Two other law professors, Lucian Bebchuk and Allen Ferrell of Harvard Law School, also touch on the issue in a 2013 working paper, and although their paper was cited by petitioner and in one of respondent's amicus briefs, the citations were in support of other propositions.⁷ In a post-argument blog entry, Professors Bebchuk and Ferrell expand on their working paper, noting that "[w]hile event studies at the time of misrepresentation are an important tool, it is crucial to emphasize that the tools available for implementing a fraudulent distortion approach are not limited to event studies at the time of misrepresentation. A fraudulent distortion approach should not be generally implemented by conducting an event study at the time of misrepresentation."⁸ As further explained in their blog post:

there are reasons to expect that event studies at the time of misrepresentation would fail to identify a fraudulent distortion in some cases in which it exists. This would be the case when the misstatement was a so-called confirmatory lie—that is, a misstatement made so as to meet market expectations. In such a case, failure to document a price reaction to it would not be expected even assuming the misstatement had a fraudulent impact. In such a fact situation, the confirmatory lie might prevent a stock price drop that would have occurred had the truth been told.⁹ 

Professors Bebchuk and Ferrell go on to discuss "event studies at the time of corrective disclosure" and "[a]nother potential analytical tool, with a long tradition in the finance and accounting literature [called] forward-casting."¹⁰ They conclude that "the determination of fraudulent distortion would not always be best done by conducting an event study at the time of the misrepresentation."¹¹

*    *    *    *

Should the Supreme Court opt to change the rules of the road by adopting a "price impact" approach, the only rule that would make sense is one that recognizes that the impact can occur not only when a false statement is made, but alternatively (and indeed more often) when the truth is revealed. A rule in which the false statement must cause a measurable "impact" on the price of a company's stock at the time the statement is made would not legitimately incorporate the "price impact" approach as a workable test. 

[1] No. 13-317 (S. Ct.).

[2] Brief of Law Professors as Amici Curiae in Support of Petitioners at 2 Halliburton Co. v. Erica P. John Fund, Inc., (No. 13-317), 2014 WL 60721 at  *2.  

[3] See Oral Argument at 17:10-18; 29:15-17; 34:11-13; 41:11-13, 48:2-11 Halliburton Co. v. Erica P. John Fund, Inc. (No. 13-317), available at http://www.supremecourt.gov/oral_arguments/argument_transcripts.aspx.

[4] See id. at 17:10-18, 18:7-12; 20:3-9, 21:3-6; 22:8-9, 24:8-14; 29:15-17; 34:11-13; 45:1-4; 52:22 -53:4.

[5] Id. at 32:1-11 (emphasis added).  See also, id. at 21:19-25 (hypothetical by Justice Breyer in which “everybody . . . bought on the New York Stock Exchange and our theory of this case is that the stock exchange did absorb the information and the price went up and then went down.”) (emphasis added).

[6] See Brief of Law Professors as Amici Curiae in Support of Petitioners at 26 n.9 Halliburton Co. v. Erica P. John Fund, Inc., (No. 13-317), 2014 WL 60721 at  *26.

[7] Lucian A. Bebchuk & Allen Ferrell, Rethinking Basic, Discussion Paper No. 764, Harvard Olin Ctr. for Law, Bus. & Econ. (Dec. 2013), revised April, 2014, available at, http://www.law.harvard.edu/programs/olin_center/papers/764_Bebchuk.php (cited in Brief of Petitioners at 39, Brief of Securities Law Scholars as Amici Curiae in Support of Respondent at 11, 13.

[8] Lucian Bebchuk and Allen Ferrell, Remarks on the Halliburton Oral Argument (2): Implementing a Fraudulent Distortion Approach, The Harvard Law School Forum on Corporate Governance and Financial Regulation (March 12, 2014, 9:10 AM),  (Emphasis added).  https://blogs.law.harvard.edu/corpgov/2014/03/12/remarks-on-the-halliburton-oral-argument-2-implementing-a-fraudulent-distortion-approach/.

[9] Id.

[10] Id.

[11] Id.

FINRA Board of Governors Upholds FINRA Rules Prohibiting Class Action Waivers in Customer Contracts

FINRA and NASD rules have long provided that customers must arbitrate individual disputes with their brokers, but that class claims can be brought in court (and are not subject to arbitration).

In 2011, after the Supreme Court’s decision in AT&T Mobility v. Concepcion, the brokerage company Charles Schwab amended all of its customer agreements to require that the customer waive the right to bring class claims and agree to resolve all disputes in individual arbitration.

FINRA brought an enforcement action against Charles Schwab for violation of its rules, and in 2013, a hearing panel concluded that the FINRA rules were unenforceable because they conflicted with the Federal Arbitration Act.

On Thursday, that decision was overruled by the FINRA Board of Governors.  FINRA concluded that its rules, promulgated in conjunction with, and under the oversight of, the SEC, represent valid exercises of regulatory authority that override the FAA.

 Obviously, this conclusion raises a lot of interesting legal questions about the authority of the SEC to abrogate the FAA, and conflicts between the Exchange Act and the FAA (Barbara Black and Jill I. Gross have written extensively on this issue).

But the part that immediately interests me is FINRA’s conclusion that even though it is – in its view – merely a private actor, it is subject to restrictions imposed by the FAA. 

The FAA requires that contracts for arbitration be deemed as valid/enforceable as any other contract.  As a result, the FAA has been interpreted to preempt any state law – statutory or common – that purports to invalidate arbitration agreements or render them unenforceable, and the Supreme Court has – at least in recent years – steadfastly refused to find that federal statutory rights are implicitly ill-suited for arbitration.

But if FINRA is a private actor – a point to which I’ll return in a moment – it is difficult to see how the FAA comes into play.  The FAA does not inhibit private actors from reaching whatever contracts they desire – including, in FINRA’s case, contracts with its member organizations to prohibit them from imposing certain contractual conditions on its customers.  If FINRA is a purely private actor, it has no power to make any customer contract imposed in violation of its membership rules any less enforceable or valid than any other contract – all it has is the power to exclude brokerages from its membership and impose fines for violation of its membership rules.  One thing has nothing to do with the other.  Otherwise, arbitration clauses would be more than any other contract clauses – they’d be superclauses, areas of law over which parties are not permitted to bargain.  Nothing in the FAA suggests that it was intended to impede private parties’ bargains – to arbitrate or not – and there is no precedent suggesting that the FAA prohibits private actors from arranging their affairs as they wish.  Cf. Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967) (“the purpose of [the FAA] was to make arbitration agreements as enforceable as other contracts, but not more so”).   

The only reason that the FAA is implicated in this dispute, in my view, is because FINRA is not a purely private actor – as an SRO, it exercises “quasi-governmental powers.” DL Capital Group, LLC v. Nasdaq Stock Mkt., Inc., 409 F.3d 93 (2d Cir. 2005).  For example, it enjoys from governmental immunity from lawsuits, and – as the Schwab decision itself highlights – its rules have the status of regulations.  In this very case, a district court held that it did not have “jurisdiction” to entertain Charles Schwab’s objections to the FINRA complaint until Charles Schwab “exhausted” its remedies with FINRA, see Charles Schwab & Co v. Fin. Indus. Regulatory Auth., 861 F. Supp. 2d 1063 (N.D. Cal. 2012) – not exactly the kind of power private parties can exercise.  It is precisely because FINRA exercises governmental and regulatory authority that it is capable of running afoul of the FAA.

The Schwab decision, it seems to me, represents a curious case of FINRA trying to have it both ways – to insist that it is merely a private entity whose membership agreements are purely matters of contracts, but also to insist that the rules that govern those entities have the force of government authority behind them.

PA Courts, Hydraulic Fracturing, and the Energy-Business Law Nexus

Regular readers know of my view that energy and energy law are closely related to business and business law.  Further to that point: Last week, a group of 20 organizations, including those representing the interests of business, oil, coal, aggregate, farm, and power sent an open letter to Pennsylvania state legislators stating their concerns about the state supreme court's decision in Robinson Township v. Commonwealth of Pennsylvania.  That decision overturned Act 13, which largely eliminated local government's ability to prevent oil and gas operations in their jurisdictions through zoning.  The letter explains:

The opinion undermines the traditional and long-recognized authority of the Legislature to balance environmental and economic interests on a statewide basis, leading to the spectra of multiple levels of government and a myriad of agencies second guessing each other in deciding whether to approve particular developments and how to manage natural resources. This expansive, broad and vaguely case-by-case application of the Environmental Rights Amendment threatens to reestablish the very uncertainty and ambiguity that Act 13 and many other statutes were originally intended to address through adoption of a holistic, comprehensive regulatory program that carefully balances the Commonwealth twin interests in economic progress and environmental stewardship. 

The plurality opinion opens the door to a myriad of litigation, at all levels of government, attempting to thwart virtually any type of industrial, agricultural, commercial or residential facility and development. The affects of this ruling will be felt by employers in all industries and will certainly adversely impact efforts to promote job creation throughout the state.

I agree with these organizations on a number of issues here.  First, I think they are right the state legislature had the power to pass Act 13,  or at least something similar. I also agree that the plurality opinion unnecessarily invites litigation in a variety of contexts that could negatively impact both business and the environment.  On the other hand, I think that the legislature took an unnecessarily heavy-handed approach to the legislation when a more modest version of the act could have been similarly effective. 

As I have explained previously, though there are very real risks related to hydraulic fracturing for oil and gas, much of the public, many politicians, and (in this case) judges are too easily distracted by risks that seem like they could be associated with the process, but aren't. When judges assume facts, bad law (and bad policies) are very likely to follow. Building on that assessment, I have posted my article, Facts, Fiction, and Perception in Hydraulic Fracturing: Illuminating Act 13 and Robinson Township v. Commonwealth of Pennsylvania on here on SSRN.  Please click below to continue reading.

Continue reading

Social Enterprise Law Bibliography

As the amount written on social enterprise law increases, I thought it might be useful to create a list of journal articles.  That list is now posted on SSRN here. 

The list is limited to law review articles and purposefully excludes student authored articles, except for one LLM thesis.  (I may be persuaded to include some of the better student notes in the future).  I stayed away from general CSR articles and focused on articles regarding the new social enterprise legal forms.  I stuck mainly to legal academics, but included some of the major practitioner authors.

The list is undoubtedly incomplete, and I welcome suggestions for additions. 

Should the SEC have a conflict about the conflict minerals rule after the DC Circuit decision?

Last week the DC Circuit Court of Appeals generally upheld the Dodd-Frank conflict minerals rule but found that the law violated the First Amendment to the extent that it requires companies to report to the SEC and state on their websites that their products are not “DRC Conflict Free.” The case was remanded back to the district court on this issue.

As regular readers of the blog know I signed on to an amicus brief opposing the law as written  because of the potential for a boycott on the ground and the impact on the people of Congo, and not necessarily because it’s expensive for business (although I appreciate that argument as a former supply chain professional). I also don’t think it is having a measurable impact on the violence. In fact, because I work with an NGO that works with rape survivors and trains midwives and medical personnel in the eastern Democratic Republic of Congo, I get travel advisories from the State Department. Coinicidentally, I received one today as I was typing this post warning that “armed groups, bandits, and elements of the Congolese military [emphasis mine] remain security concerns in the eastern DRC….[they] are known to pillage, steal vehicles, kidnap, rape, kill and carry out military or paramilitary operations in which civilians are indiscriminately targeted… Travelers are frequently detained and questioned by poorly disciplined security forces [I was detained by the UN] at numerous official and unofficial roadblocks and border crossings…Requests for bribes [which I experienced] is extremely common and security forces have occasionally injured or killed people who refused to pay.”

None of this surprises me. I commend the efforts of companies to clean up their supply chains and to cut off income sources to rebel groups who control some of the mines or brutally  insert themselves into the mineral trade. But what the State Department advisory makes clear (and what many people already know) is that the problem that the Dodd-Frank law is trying to solve is not something that can be cured through a “name and shame” corporate governance disclosure, especially one that may no longer have the “shame” factor of having companies brand themselves “not DRC Conflict Free.”

Earlier this week, Senator Ed Markey and eleven other members of Congress sent a letter urging SEC Chair Mary Jo White to avoid any delay in implementing the rule. The letter states in part “…the law we passed was simple. Congress said that any company registered in the United States which uses any of a small list of key minerals from the DRC or its neighbors has to disclose in its SEC filing the use of those minerals and what is being done, if anything, to mitigate sourcing from those perpetuating DRC's violence. Such transparency allows consumers and investors to know which companies source materials more responsibly in DRC and serves as a catalyst for industry to finally create clean supply chains out of Congo.”

The "law" may have been “simple,” but the implementation is not for a large number of companies. That’s probably why the EU has proposed a voluntary self-certification scheme focused on importers rather than manufacturers and sellers like Dodd-Frank.  That’s probably why a large number of companies are not ready to comply, according to a recent PwC survey of 700 companies. 

Chair White, who has made no secret of what she thinks of the SEC’s role in solving human rights crises, still has to reissue Dodd-Frank 1504, the resource extraction rule that was struck down after a court challenge. According to a Davis Polk report, as of April 1, 2014, a total of 280 Dodd-Frank rulemaking requirement deadlines have passed. Of these 280 passed deadlines, 45.7% have been missed and 54.3% have been met with finalized rules. The SEC has a lot of financial rule making to complete and should consider how to prioritize and retool the conflicts minerals rule using the agency's discretion and going beyond the fixes that may be required by future rulings on the First Amendment issue.

I will continue to monitor the future of this law. I am now on my way to a conference for businesspeople, lawyers, academics and students at UConn entitled New Challenges in Risk Management and Compliance. I will discuss regulatory issues related to global human rights and enterprise risk management on a panel with the human rights initiative leader for General Electric and the General Counsel for the Shift Project, who worked with John Ruggie on the UN Guiding Principles on Business and Human Rights. I am excited to meet and learn from them both. The Guiding Principles and earlier iterations of Ruggie’s work greatly influenced both the US and EU conflict mwinerals laws.

Next week I will report back on some of the outcomes from the conference.

Nothing Like Good Results to Make Your CFO Resign

CNN this afternoon ran the following Breaking News headline: "Facebook reports earnings and sales that exceed forecasts. CFO to step down June 1."

I hate to think what the CFO would have done if they had failed to meet expectations.

Racial Identities of Corporations

In March, the Fourth Circuit held in Carnell Construction Corp. v. Danville Redevelopment & Housing Authority, that racial identity can be imputed to a corporation for purposes of standing under Title VI, citing to case precedent from the several circuits allowing 1981 claims to be raised by corporations. 

“[W]e observe that several other federal appellate courts have considered this question, and have declined to bar on prudential grounds race discrimination claims brought by minority-owned corporations that meet constitutional standing requirements.” 

The Fourth Circuit had to deal with the following language in Arlington Heights, 429 U.S. 252, 263 (1977): “As a corporation, MHDC has no racial identity and cannot be the direct target of the petitioners' alleged discrimination. In the ordinary case, a party is denied standing to assert the rights of third persons.” In Arlington Heights, the Supreme Court however did not need to “decide whether the circumstances of this case would justify departure from that prudential limitation and permit MHDC to assert the constitutional rights of its prospective minority tenants. For we have at least one individual plaintiff who has demonstrated standing to assert these rights as his own.” (citations omitted).  The dicta in Arlington Heights was not a barrier to imputing a racial identity to the corporation in the Fourth Circuit case.

In a clear statement, the Fourth Circuit concluded that:

“We agree with the Ninth Circuit that a minority-owned corporation may establish an “imputed racial identity” for purposes of demonstrating standing to bring a claim of race discrimination under federal law. We hold that a corporation that is minority-owned and has been properly certified as such under applicable law can be the direct object of discriminatory action and establish standing to bring an action based on such discrimination.”

Chief Justice Roberts was concerned about the connection of racial identities for corporations and corporate free exercise of religion as raised in the Hobby Lobby and related cases.   Note that fellow BLPB blogger Josh Fershee wrote about the racial identity of a corporation on BLPB here arguing why religious discrimination claims by corporations should be allowed and how the analysis would work.  Professor Bainbridge weighed in on the issue as well.

Here is my best response as to why holding that corporations can have a racial identity is not necessarily fatal to the claim that corporations cannot have a religious identity for purposes of free exercise under the 1^st Amendment, and why religious discrimination cases for corporations may also be more difficult than racial discrimination cases.  

Line drawing.  In the Carnell case as well as in others, the corporations at issue had been certified as a minority/women owned business at the state level, which is treated as a form of pre-requisite for such standing to assert a racial discrimination claim.  There is no similar bright line test or religious entity process for a for-profit corporations.  Indeed the very process of such a certification may implicate other 1^st Amendment protections for freedom of speech and association.

Third Parties & Equity. Second, imputing the racial identity to the corporation for purposes of a Title VI claim of racial discrimination upholds the minimum anti-discrimination standard against third parties.  So in the race cases, the identity of the owners is imputed to the corporation to prevent third parties from evading a legal standard.  In the corporate free exercise of religion context, the owners are requesting that their individual religious beliefs be imputed to the corporation to allow it to evade compliance with a law.  Anti-discrimination laws are applied generally and don’t allow a person to discriminate whether it is with an individual or through a corporation rather than exempting a corporation from a neutrally-applied, generally applicable law. 

This last points get to the debate, in part, about the relevance of reverse veil piercing (RVP) on which Professor Stephen Bainbridge has advocated as a framework to resolve the mandate issue in Hobby Lobby. The corporate veil is rejected in both CVP and RVP when equity requires and that is usually dependent upon a third party interest that is best protected by rejecting the legal fiction of a separate corporate form.  In the anti-discrimination/racial identity there is an equitable argument that the third party cannot discriminate against the corporation simply because it is owned by minorities.  What is the equitable argument in Hobby Lobby?  The fairness rationale is weakened here, especially in light of the interests of the 13.5K employees receiving health care coverage as a form of compensation for their work for the company.  Instead RVP, it must rest, if at all, on the public policy justification advanced by Professor Bainbridge.   But again, the public policy argument cuts both for and against RVP.  There is a public policy argument in protecting/promoting religious freedom as there is in facilitating access to health care, including forms of health care that Congress has determined to be necessary for women (and families) under the ACA.

 -Anne Tucker

Bainbridge on the Insider Trading Liability of Remote Tippees

Steve Bainbridge has an excellent post on the insider trading liability of secondary tippees: where, for example, an insider provides nonpublic information to Tippee #1, and Tippee #1 gives that information to Tippee #2.

He argues that Tippee # 2 should be liable under the Dirks case only if Tippee #2 knew or should have known that the insider provided the information for a personal gain. He's clearly right under Dirks. Dirks says that a tippee is liable only if he knew or should have known that the insider tipped the information in breach of a fiduciary duty, and Dirks says, that for this purpose, a breach of fiduciary duty requires some sort of personal gain. But, as Professor Bainbridge points out, the lower courts have not consistently got this right.

How the Same-Sex Marriage Debate Can Lead to Better Businesses

Over at realclearpolitics.com, a number of leading thinkers, including some leading business law folks such as Richard Epstein and Jonathan Adler, among others, have signed a public statement: Freedom to Marry, Freedom to Dissent: Why We Must Have Both.  Following is a portion of the statement:

The last few years have brought an astonishing moral and political transformation in the American debate over same-sex marriage and gay equality. This has been a triumph not only for LGBT Americans but for the American idea. But the breakthrough has brought with it rapidly rising expectations among some supporters of gay marriage that the debate should now be over. As one advocate recently put it, “It would be enough for me if those people who are so ignorant or intransigent as to still be anti-gay in 2014 would simply shut up.”

 

The signatories of this statement are grateful to our friends and allies for their enthusiasm. But we are concerned that recent events, including the resignation of the CEO of Mozilla under pressure because of an anti-same-sex- marriage donation he made in 2008, signal an eagerness by some supporters of same-sex marriage to punish rather than to criticize or to persuade those who disagree. We reject that deeply illiberal impulse, which is both wrong in principle and poor as politics.

For those who don’t know, former Mozilla CEO Brendan Eich resigned following the public outcry when it was revealed that he had donated $1,000 to support Proposition 8, a 2008 California ballot initiative and constitutional amendment designed to ban same-sex marriage in the state.

To be clear on my stance: I strongly support same-sex marriage, and I fundamentally disagree with Prop 8.   Still, punishing people, as opposed to criticizing people, for contrary and even wrong-headed political views is neither productive nor proper. (Nonetheless, there are multiple examples of people who felt Eich needed to resign. See, e.g.,  here, here, and here.) 

Admittedly, if it’s clear that the head of any organization, whether it is a profit or nonprofit entity, doesn’t further the goals of the organization, then there is a bad fit. Furthermore, this isn’t about Mr. Eich’s free speech rights in that there is no government actor here. This was a private response to a private person’s actions. Mozilla has the power to act to replace Mr. Eich, and members of the public have a right to call for his ouster.  It just doesn’t make it inherently right or wise.

Certainly, one can imagine a scenario where a CEO’s prior political or organizational giving would create problems for the organization.  For example, an environmental organization may not be comfortable with a CEO who had given money to a group fighting climate legislation. But, in that circumstance, the hiring body, and likely the CEO, would, or at least should, have known that support for climate change initiatives would be expected as part of the job.  Top employees often become the face of the organization, and that comes with job, but if a particular political view is deemed necessary for the job, it would help if the CEO knew it during the interview process.  

Even if Mozilla was responsible for the mistake (in hiring someone with political views that were not accepted to many employees and customers), as an entity, the company was not improper to respond in what it deemed to be in the best interest as the organization.  Just as important, though, is the community response to Mozilla as an entity.  The free market allows us all to choose with whom we wish to do business.  But when we make such decisions, we need to be careful about who we are punishing and why.

People have a right to be upset and to protest Mr. Eich’s views.  I think Prop 8 was dead wrong, and I don’t like that anyone supported it.  Still, I don't think calling for Mr. Eich or anyone else to lose their job is proper simply because I disagree with their views.   I would feel differently if there were evidence that Mr. Eich discriminated against gay employees. There just doesn't seem to be any support for that proposition.

We need to be careful to avoid a world where every portion of what we do becomes politicized and polarized.  Although there are core values each of us holds, we should also recognize that not everyone shares all of our core values, all of the time.  Nor can they.  My wife and I agree on a lot of things, and it is a big reason why we’re together.  Still, some of my best learning has been when we don’t agree. Sometimes I change my mind, and other times I don’t, but even then I have learned more about my views and why I hold them. 

I don’t want to live in a world where politicians and news outlets and companies operate in lockstep to a specific set of ideals.  There are too many examples of that already to make me comfortable.  I don’t want to choose only from a Republican burger joint or a Democratic sub shop. We need more.  We need a populist pizza place, and a libertarian ice cream shop, and everything in between.  In my view, the litmus test should be whether people do a good job at doing their job, and whether they treat others well (employees and customers), regardless of their ideological differences.  

Open public discourse is a right under our Constitution, but it is not socially required. When respectful and thoughtful, open discourse helps all of us be better citizens and better people. If we commit ourselves as individuals to respecting others and listening, even when (and especially when) we disagree, good things will follow.  It is one thing to dismiss views with which we disagree; it is another to dismiss, out of hand, the people who hold such views.  For all the complaints about the evils of business, I have a suspicion that if we expected more of ourselves, businesses would follow our lead.

State Crowdfunding Exemptions and Federal Law

The SEC has proposed, but not yet adopted, an exemption that would allow securities to be sold to the general public through crowdfunding. But a number of states have beat the SEC to the punch, adopting exemptions allowing securities to be sold in crowdfunding offerings within those states. See here for a list of the state exemptions.

Those state exemptions do not (and cannot) provide an exemption from federal law. Even if a state exemption is available, the issuer of the securities must still register with the SEC unless a federal exemption is available. The obvious exemption is the intrastate offering exemption in section 3(a)(11) of the Securities Act, and its safe harbor, Rule 147.

The intrastate offering exemption imposes a number of restrictions on the issuer and the issuer's use of the offering proceeds. But there's a potential problem with crowdfunded intrastate offerings even if the issuer complies with all of those other restrictions.

Both section 3(a)(11) and Rule 147 require that the securities be offered and sold only to residents of that one state. It’s not enough to limit sales to residents. An offer to nonresidents would violate the intrastate offering exemption, even if those nonresidents were successfully filtered out before any sales were made.

So how can securities sold on an Internet web site open to the general public not be offered to non-residents? Given the global nature of the Internet, aren’t offers to non-residents inevitable?Luckily, the SEC staff has stepped in and provided advice that will allow intrastate offerings on public Internet sites.

Here is a recent staff interpretation:

Question 141.04

Question: An issuer plans to use a third-party Internet portal to promote an offering to residents of a single state in accordance with a state statute or regulation intended to enable securities crowdfunding within that state. Assuming the issuer met the other conditions of Rule 147, could it rely on Rule 147 for an exemption from Securities Act registration for the offering, or would use of an Internet portal necessarily entail making offers to persons outside the relevant state or territory?

Answer: Use of the Internet would not be incompatible with a claim of exemption under Rule 147 if the portal implements adequate measures so that offers of securities are made only to persons resident in the relevant state or territory. In the context of an offering conducted in accordance with state crowdfunding requirements, such measures would include, at a minimum, disclaimers and restrictive legends making it clear that the offering is limited to residents of the relevant state under applicable law, and limiting access to information about specific investment opportunities to persons who confirm they are residents of the relevant state (for example, by providing a representation as to residence or in-state residence information, such as a zip code or residence address). Of course, any issuer seeking to rely on Rule 147 for the offering also would have to meet all the other conditions of Rule 147.

Thus, as long as the web site makes it clear that offers are being made only to residents of the relevant state and potential purchasers are screened for residence before they see the details of the particular offering, the intrastate offering exemption would still be available.

However, the staff went on to warn about the use of social media or the issuer’s own web site:

Question 141.05

Question: Can an issuer use its own website or social media presence to offer securities in a manner consistent with Rule 147?

Answer: Issuers generally use their websites and social media presence to advertise their market presence in a broad, indiscriminate manner. Although whether a particular communication is an "offer" of securities will depend on all of the facts and circumstances, using such established Internet presence to convey information about specific investment opportunities would likely involve offers to residents outside the particular state in which the issuer did business.

Social media and an issuer’s general web site would reach non-residents and violate the intrastate offering exemption. However, there’s nothing in section 3(a)(11) or Rule 147 that requires an intermediary to be used for the offering, so I don’t think issuers would be excluded from direct, unmediated offerings—as long as they complied with the requirements of Question 141.04—using a separate web page with appropriate disclaimers and only allowing residents to see the actual offering. However, staff interpretations and no-action letters often attempt to impose restrictions that have little relationship to the statutory or regulatory requirements, so perhaps the staff did mean to exclude unmediated offerings.

ICYMI: Tweets from the past week (140420)

Are poison pills appropriate in the age of shareholder activism? http://t.co/r40UEHaqvp by @StevenDavidoff

— Epicurean Dealmaker (@EpicureanDeal) April 18, 2014

"Law & Economics Prof Blog" http://t.co/cB1A56VseC

— Stefan Padfield (@ProfPadfield) April 19, 2014

An oldie but a goodie: J.W. Verret on the "Top Ten Books in Corporate Governance" http://t.co/DKtYxhvFTQ

— Stefan Padfield (@ProfPadfield) April 17, 2014

"despite the ... importance of shareholder voting, none of the existing corporate law theories coherently justify it" http://t.co/no4frvaw12

— Stefan Padfield (@ProfPadfield) April 16, 2014

"business interests have substantial ... impacts on U.S. government policy, while average citizens ... have little" http://t.co/5jgUTC7ZJK

— Stefan Padfield (@ProfPadfield) April 16, 2014

Don't read too much into the conflict rules decision in NAM v. SEC http://t.co/EgRmKveXWE

— Stephen Bainbridge (@ProfBainbridge) April 14, 2014

Do the securities laws matter?

Today I'm plugging my colleague Elisabeth de Fontenay's new article, despite the existential threat it poses to my specialty. 

InDo the Securities Laws Matter?, de Fontenay compares the market for syndicated loans, which are not treated as securities, to the market for bonds, which are.  She finds that the market for syndicated loans is as deep and as liquid as the market for bonds, suggesting that the mandatory disclosure regime that governs bonds, but not loans, is unnecessary.

As she puts it in her abstract:

One of the enduring principles of federal securities regulation is the
mantra that bonds are securities, while commercial loans are not. Yet the
corporate bond and loan markets in the U.S. are rapidly converging,
putting significant pressure on the disparity in their regulatory treatment.
As securities, corporate bonds are subject to onerous public disclosure
obligations and liability regimes, which corporate loans avoid entirely. This
longstanding regulatory distinction between loans and bonds is based on
the traditional conception of a commercial loan as a long-term relationship
between the borrowing company and a single bank, in contrast to bonds,
which may be issued to widely dispersed retail investors and are traded in a
liquid market. Today, however, not only are loans funded by dispersed, nonbank
creditors, but the pricing, terms, participants, and liquidity in the two
markets are rapidly converging. Logically, securities regulators should
respond to this functional convergence by treating loans and bonds as one
and the same. While the regulatory disparity persists, however, it provides a
rare natural experiment testing the effectiveness of the securities laws. That
the loan market has achieved comparable depth and liquidity to the bond
market, even in the absence of mandatory disclosure and robust antifraud
provisions, suggests that the securities laws are not doing the work for
which they were intended.

It's a really fascinating paper.

 

Student Business Plan Competitions

Earlier this semester, Belmont undergraduate students competed for a total of $8,000 in a business plan competition.  The first place team, What’s Hubbin’, won $5,000.  Law firm Baker Donelson was one of the sponsors. 

Each competition team was required to provide: (1) an executive summary, (2) a description of the business (including mission and vision), (3) plans for marketing, operating, finances, and growth, and (4) financial statements (historical, if applicable, and projected).  The finalists presented in front of a team of judges, which included local attorneys, investors, and entrepreneurs.  The event also attracted a strong audience of faculty members (myself included), staff, and students. 

Given the evolving legal industry, and the increasing focus on Law & Technology and Law & Entrepreneurship, I could see business plan competitions like this one being a success at law schools (perhaps in coordination with their sister business schools).

One of the three What’s Hubbin’ team members is Makenzie Stokel.  She is also one of my undergraduate business law students.  I asked her if she would mind answering a few, short questions about the competition and about her team's business, which is one of the competition’s businesses that is already up and running.  My questions and her answers are below.

HM: Will you please briefly describe your business, What’s Hubbin’, for our readers?

MS: What's Hubbin’ is a website that promotes music here in Nashville.  We highlight local artists and promote events going on around town.  Our site allows users to "hub" (RSVP) events and artists and have an organized profile of their music preferences.  We also allow users to filter events based on their preferences to ensure that everyone finds something that they will want to do.  We host events around Nashville and will be hosting a day-long festival at the end of this month.  Our goal is to have everything music related all in one place so users don't have trouble finding events or discovering new music. You can find us online at www.whatshubbin.com and on Twitter at @WhatsHubbin

HM: How has participating in the competition helped your business?

MS: Participating in the business plan competition has helped promote our business a great deal.  We have had multiple blogs write about us, and were even named Belmont's hottest start-up by Southern Alpha.  It has really helped us get our name out there with the Belmont community and provided some validation of our business.  

HM:  How has participating in the competition enriched your college experience, especially your experiences in your classes?

MS: I am so glad that the What's Hubbin' team was able to participate in this competition.  The competition definitely helped us with our public speaking skills, which is necessary to have in classes and after college. It also forced us to think quickly when answering the judges’ questions.  When preparing for the questions that we thought they might ask, we had to determine who was best at the different aspects of our business. The competition, and the start-up process part in general, has been more relevant to some classes than others.  Business Law and Foundations of Entrepreneurship are two examples of relevant classes.  Also, as a result of being involved in What’s Hubbin’, I have seen ways to apply what I am learning in classes outside of school. 

HM: Congratulations and best of luck.

MS: Thank you!

Corporate Scholarship Highlights: A Corporate Right to Privacy

Elizabeth Pollman at the Loyola Law School Los Angeles, recently posted her paper, A Corporate Right to Privacy, on SSRN (forthcoming in the Minnesota Law Review 2014).  This paper timely weighs in on the corporate personhood debate by addressing one aspect of that question:  privacy.

 Abstract: The debate over the scope of constitutional protections for corporations has exploded with commentary on recent or pending Supreme Court cases, but scholars have left unexplored some of the hardest questions for the future, and the ones that offer the greatest potential for better understanding the nature of corporate rights. This Article analyzes one of those questions — whether corporations have, or should have, a constitutional right to privacy. First, the Article examines the contours of the question in Supreme Court jurisprudence and provides the first scholarly treatment of the growing body of conflicting law in the lower courts on this unresolved issue. Second, the Article examines approaches to determining the scope of corporate constitutional rights and argues that corporate privacy rights should be evaluated not by reference to the corporate form itself or a notion of corporate personhood, but rather by reference to the privacy interests of the various people involved in the corporation and their relationship to the corporation. Further, because corporations exist along an associational spectrum — from large, publicly traded corporations constituted purely for business purposes to smaller organizations with social, political, or religious purposes — the existence of a corporate privacy right will and should vary.

Banks, Legal Costs, and ADR

Back in August, Bloomberg reported that the legal costs for the six largest U.S. banks since 2008 totaled over $100 billion. (Yes, billion with a "B.")  Bloomberg included settlement amounts in that huge number, as well as fees to lawyers.

The financial and emotional costs of litigation, not to mention the tremendous amount of time required, amazes me.  Litigation has its place, but the vast majority of disputes eventually settle and many times all parties would have been better off settling earlier using some form of alternative dispute resolution (ADR). 

A former colleague recently pointed me to the University of Missouri School of Law's listserv for ADR educators. 

I know many of our readers only teach business law courses, but adding negotiations to my teaching package has made me see the various intersections between negotiations and business law.  This semester, I set aside some time in my business law classes to discuss a bit of the negotiations literature, and the students seemed to appreciate it.  I just signed up for the listserv, so I cannot speak to its quality yet, but I do think more business law professors should consider exploring the world of ADR.

AALS Call for Papers--Incorporating Numbers in Business Law Classes

 Bringing Numbers into Basic and Advanced Business Associations Courses: How and Why to Teach Accounting, Finance, and Tax

2015 AALS Annual Meeting--Agency, Patnerships, LLCs & Unincorporated Assoc. Section

Washington, DC

            Business planners and transactional lawyers know just how much the “number-crunching” disciplines overlap with business law.   Even when the law does not require unincorporated business associations and closely held corporations to adopt generally accepted accounting principles, lawyers frequently deal with tax implications in choice of entity, the allocation of ownership interests, and the myriad other planning and dispute resolution circumstances in which accounting comes into play.  In practice, unincorporated business association law (as contrasted with corporate law) has tended to be the domain of lawyers with tax and accounting orientation.  Yet many law professors still struggle with the reality that their students (and sometimes the professors themselves) are not “numerate” enough to make these important connections.  While recognizing the importance of numeracy, the basic course cannot in itself be devoted wholly to primers in accounting, tax, and finance.

             The Executive Committee will devote the 2015 annual Section meeting in Washington to the critically important, but much-neglected, topic of effectively incorporating accounting, tax, and finance into courses in the law of business associations.  In addition to featuring several invited speakers, we seek speakers (and papers) to address this subject.  Within the broad topic, we seek papers dealing with any aspect of incorporating accounting, tax, and finance into the pedagogy of basic or advanced business law courses.

             Any full-time faculty member of an AALS member school who has written an unpublished paper, is working on a paper, or who is interested in writing a paper in this area is invited to submit a 1 or 2-page proposal by May 1, 2014.  The Executive Committee will review all submissions and select two papers by May 15, 2014.  A very polished draft must be submitted by November 1, 2014.  The Executive Committee is exploring publication possibilities, but no commitment on that has been made.  All submissions and inquiries should be directed to Jeff Lipshaw, Chair ([email protected])