A group of wonderful GW Law students (some pictured) tweaked that in an awareness- and fund-raiser, called Justache, to make it about the Equal Justice Foundation, which funds stipends for law students working in the public interest. Begun last year, Justache invites participants to register in early November clean-shaven. For the rest of the month, men have to let the upper-lip grow and keep the rest of their face relatively clean. Women participate using [...]]]> The global movement to promote men’s health issues, Movember, led GW Law students to adapt it to raise money to support public interest law service. The idea behind the Movember movement is that men grow moustaches in November to raise money and awareness for men’s health issues, especially prostate and testicular cancer.

A group of wonderful GW Law students (some pictured) tweaked that in an awareness- and fund-raiser, called Justache, to make it about the Equal Justice Foundation, which funds stipends for law students working in the public interest. Begun last year, Justache invites participants to register in early November clean-shaven. For the rest of the month, men have to let the upper-lip grow and keep the rest of their face relatively clean. Women participate using fake mustaches, glued, drawn or otherwise.

Participants must raise pledges of at least $15 weekly during the month. The participant raising the most money wins first prize in the competition. Last year, most contributions came from friends passing along a dollar or two, but there were a couple big donations. With about ten competitors in 2008, Justache raised about $3,000. The fund-raiser winner was Katie Taylor, winning a $150 prize. The honor of best mustache went to Jeremy Abbott. 

This year, more funds are expected. There are 35 participants signed up, including 4 women and 3 professors, with pledges raised and photographs appearing here (and rules are here).  There is also a gala dinner this year, tomorrow night, where a couple dozen guests, mostly GW Law students, are paying $75 each to attend.

I was the lucky recipient of an invitation and look forward to a delightful evening with this group. (I wasn’t asked to pay the entrée fee but how can I resist contributing at least that for this wonderful cause?)  Rumor is other guests may include Members of American Mustache Institute and selected Members of Congress sympathetic to the cause.

The only other school GW Law’s Justache promoters are aware of that’s done anything similar is Georgetown, although it seems to have been abandoned.   An old post on mustaches from the WSJ Law Blog has a defunct link to their competition. Also, as GW Law student Dan Martin put it to me, “they apparently did it in the spring, rather than the sacred month of Movember.”

Kudos to all GW Law students behind this, with special thanks to Dan Martin (on the right in the photo here) and Greg Crespo (in the center) for the leadership and Dan for the information and dinner invite!

The current financial crisis, plus the Enron calamity earlier this decade, made clear the vitality of having accounting standards, for securitization and similar financial transactions, that make a company’s debt obligations transparent to investors. The Financial Accounting Standards Board has done just that by issuing two new accounting standards governing such deals. As always, FASB did so after extensive study, deliberation, solicitation [...]]]> On Monday, I criticized political interference with US accounting standard setting and this morning I referenced innovative securitization deals that contributed to the credit crisis. Now I read that Rep. Scott Garrett (R-NJ) yesterday offered an amendment to the House financial reform bill to require the accounting standard setter to prepare a written study on the effects of its new accounting standards for securitizations!

The current financial crisis, plus the Enron calamity earlier this decade, made clear the vitality of having accounting standards, for securitization and similar financial transactions, that make a company’s debt obligations transparent to investors. The Financial Accounting Standards Board has done just that by issuing two new accounting standards governing such deals. As always, FASB did so after extensive study, deliberation, solicitation and evaluation of comment letters from anyone interested in providing them.

Garrett’s proposed amendment would now impose a legal obligation on FASB to do a more particular study, in cooperation with various federal regulatory agencies, on the effects of the new standards on companies who do securitization deals. This is objectionable for at least the following reasons: (1) it is inherently objectionable political intermeddling into the independent accounting standard setting process; (2) it is the result of lobbying campaigns by banks and others in the business of securitization; and (3) it caters to those lobbying interests rather than focusing on those for whom accounting standards are written: investors.

Rep. Garrett says he’s worried that making securitizations more transparent to investors would make it more difficult for banks and other financial institutions to do them. That would, in turn, mean reduced availability of consumer credit. It is as if the Representative has not read a single newspaper in the last two years. After all, it does not appear that the biggest problems in the country the past decade were consumers borrowing too little or banks doing too few opaque financing deals.

Beginning in the late 1980s, when I was in practice, I and other lawyers participated in incubating the market for financial derivatives and securitization transactions. In the beginning, these deals were nowhere near as exciting as the same period’s newly-exciting mergers and acquisitions and finance practices. We would prepare one-off interest rate swap form contracts on a small scale. We would package credit card accounts receivable into pools for sale [...]]]> Causes of the worldwide credit crisis include, perhaps dominantly, the proliferation of innovative financial contracts, purportedly devices that would reduce financial risk but that instead backfired to concentrate and intensify it on a galactic scale. What role did corporate law culture play in this part of the cause? Was it too exciting? Should it be duller?

Beginning in the late 1980s, when I was in practice, I and other lawyers participated in incubating the market for financial derivatives and securitization transactions. In the beginning, these deals were nowhere near as exciting as the same period’s newly-exciting mergers and acquisitions and finance practices. We would prepare one-off interest rate swap form contracts on a small scale. We would package credit card accounts receivable into pools for sale to investors. But this practice area became increasingly exciting through the 1990s and 2000s as derivatives and securitization deals proliferated and came to form whole departments in law firms, rivaling mergers and acquisitions groups in glamour and revenue.

In the early 1990s, when I entered corporate law teaching, there was much exciting academic work being done, the culmination of what Yale corporate law scholar Roberta Romano heralded as a “revolution” in corporate law scholarship which, in the 1960s and 1970s, at least, had been dull. In that earlier period, the focus, in practice and the academy, was merely on positive, doctrinal law, mostly statutes, and on the old-fashioned duties managers owed to shareholders, often meaning practicing lawyers telling creative clients “no” when innovative ideas would violate longstanding duties.

Beginning in the 1980s, the focus in both turned to innovative deals, especially highly-leveraged hostile takeovers and what courts should do about them. Scholarship studied market behavior, looking empirically at deal effects on stock prices, how quickly and accurately information was absorbed into stock prices, how to measure investment risk and value. Important strands of this scholarship, and resulting law, urged facilitating these debt-financed deals.

In practice and scholarship, intensifying through the 1980s and into the 1990s, transactional and financial innovation was the rage. Corporate lawyers turned innovative, cutting edge, exciting, doing deals, developing new contractual devices for financial products—including those I worked on. Corporate law scholars took up finance theory with alacrity, doing exciting research showing how this innovation worked, with many producers and devotees of this work arguing how law should give it maximal space to flourish (though there were dissenters from this dominant view, including me).

As recently as 2005, Professor Romano, a leading scholar in this dominant style, urged doing more of it, more innovative financial engineering in practice and more finance oriented and exciting research in the academy. Professor Romano urged law schools to develop programs in law and finance to assist promoting this excitement, in practice and research, reporting how her school created a degree program in law and finance to seal the exciting links between law and finance and between cutting-edge law practice and legal scholarship.

Earlier this year, on a corporate law panel at the annual meeting of the Association of American Law Schools, though, Professor Romano said the program had attracted little interest among students. As Matt Bodie reports, panel discussion included talk of how the exciting finance models had failed and yet how problematic it is to design corporate law absent reliable empirical information. Professor Bodie wisely wondered whether these facts and lamentations spelled the end of the “revolution” in corporate law—a “post-post-revolution” period.

That makes me wonder, is it an inherent virtue for corporate law practice and scholarship to be exciting, or is being dull okay? Would the world be better off if more participants in corporate life were as dull as corporate lawyers used to be? Is it okay to tell clients “no, you can’t do that,” or, as I recall one stodgy old Cravath lawyer tell a client back in the late 1980s, “you can do that, but be prepared to go to jail”?

One of these is the product released late summer by the “anything-for-a-buck” John Wiley & Sons, to the discredit of its “author,” famed Wall Street denizen and critic, Henry Kaufman (The Road to Financial Reformation: Warnings, Consequences and Reform, 2009, 240 pp.).

I like Kaufman, nicknamed “Dr. Doom,” having read many of his writings. But this contains virtually no  current analysis of the present [...]]]> About 1 in 5 people I know expert in financial policy has written, is writing, or wants to write a book about the prevailing crisis. Every editor at commercial publishers I know is salivating to get such books under contract and sold to a voracious public. The result is and will be many books that should be not be written, published or read.

One of these is the product released late summer by the “anything-for-a-buck” John Wiley & Sons, to the discredit of its “author,” famed Wall Street denizen and critic, Henry Kaufman (The Road to Financial Reformation: Warnings, Consequences and Reform, 2009, 240 pp.).

I like Kaufman, nicknamed “Dr. Doom,” having read many of his writings. But this contains virtually no  current analysis of the present situation, instead repackaging old pieces in the veneer of current commentary.

A guess is editors at Wiley reached out to many potentially successful “authors” and that Kaufman, among them, said he could not write a fresh comprehensive account but would let them republish old stuff, stitched together in a new guise. Pity that many are spending $30 for 240 pages of text (double-spaced) that contains essentially nothing new—but many old pieces that enable the current packaging to say “I told you so.”   Wiley editors may think that a selling point, but I don’t (nor did The Economist’s reviewer).

The volume’s only important idea is this: business schools are culprits in the crisis for their excessive devotion, for forty years, to research and teaching of models of modern finance theory, and subordination or exclusion of research and teaching in economic and financial history. I endorse the rebuke, which I also repeatedly say includes the elevation of elegant finance by subordination of sturdy old-fashioned principles of accounting.

Following is a summary of this digest, which I discourage anyone to buy. Shoppers more astute than I may detect the absence of value from three squibs Wiley managed to include on the outside jacket: (a) journalist  Amity Shlaes says “buy it for Figure 12-1 alone;”* (b) former Senator Bill Bradley says Kaufman has “consistently and correctly warned us of the dangers;” and (c) former Fed Chair Paul Volcker notes the volume is “drawing in part on earlier writings” (an understatement and revealing to the discerning).

Part I’s Chapters, called Perspectives, read as old news, circa 1988, with Chapter 1 exuding angst about securities price volatility, globalization, portfolio insurance(!), and securitization; Chapter 2 underscoring the “value of history” in finance, routinely neglected by each new generation’s Wall Street denizens; and Chapter 3 reminding everyone that Adam Smith endorsed not only economic freedom and government reticence, but also warned of excessive financial concentration.

Part II, Chapters 4 through 7 expressly acknowledge their vintage: reprinting speeches or writings made in 1987, 1986, 1989 and 1981, respectively. These are portrayed under the heading, Neglected Early Warnings. These lament regulatory lag compared to financial innovation, excessive debt, and intensifying financial concentration.

Part III, The Bigness Dilemma, reviews old Mr. Kaufman works on concentration (Chapter 8); offers a trot (Chapter 9) on how every famous economist, except extremist on the left Karl Marx and extremist on the right Milton Friedman, prescribed government oversight of financial institutions; presents (in Chapter 10) a speech vintage circa 1987, revealingly entitled “Do We Still Need Glass-Steagall?”, endorsing that statute repealed a decade ago now; and culminating in a likewise long-rejected cautionary tale called “Banking and Commerce Should Not Merge” (Chapter 11).

Part IV, Financial Crises, has two Chapters: 12, called Postwar Financial Crises: 1966-2001, obviously written at least 8 years ago, culminating with the tech bubble burst, without even referencing Enron; and followed by what appear to be 14 pages of new writing, Chapter 13, called “The Great Financial Crisis of 2007-2009,” which is the first time, beginning at page 153 of 240 textual pages, that the author gives a current evaluation of the present situation.

It may be the intended heart of the book, wherein the author demonstrates how everything he has been warning and writing about for 30 years, digested in the previous 152 pages, was on the money. When drafting this review, I struggled to include a sentence here beginning with the phrase, “The Chapter’s interesting new insight is . . .” but found nothing to fill in that predicate. “I told you so” is not a reason to compile old writings into a new book.

Part V, Chapters 14-17, show the same motif of republishing old thoughts and writings, these appearing to date to about 1999. Chapter 14 repeats earlier chapters, reprinting yet earlier works, about the hazards of securitization and derivatives, and repeating old and earlier here-reprinted prescriptions for developments, like meeting globalization by creating a Board of Overseers of Major Institutions and Markets (here on p. 175 and earlier on p. 126). Chapter 15 is a vintage piece called “The Perils of Monetary Gradualism,” discussing problems using analysis that could have (and may have) been written two decades ago. Chapter 16 repeats the lecture on the value of history in finance from Chapter 2 (and many of Kaufman’s writings, those both reprinted here and not reprinted here). Chapter 17 registers a standard and oft-made objection to the lack of financial transparency in our system, starting with the Federal Reserve.

The final two Chapters, apparently written recently, add little value to a book priced at $30, offering 6 pages on interest rates (Chapter 18) that could have been a blog post and, in Chapter 19, a more essayistic and moderately interesting meditation on what the crisis implies for economics: less debt, an increased savings rate, less focus on finance theory’s risk models, increased financial concentration but that must be reversed, how the dollar will yet remain the global reserve currency, and how important reforming financial regulation is—primarily focused on reforming the Federal Reserve.

In short, everything in this book has been said before—not only by Mr. Kaufman, but by many others. I don’t fault Mr. Kaufman as much as I fault the editors at Wiley for what I consider an irresponsible publishing snare. It does suggest the editors at Wiley could have made a good living peddling sub-prime mortgage loans (a subject the volume does not analyze at all).

_____

*  The jacket squib’s reference to “Figure 12-1″ must be a mistake.  There is no Figure 12-1.  There is an Exhibit 12.1 but this is a quotidian list of important financial crises since 1945.  The reference probably was intended to Exhibit 8.3 or 8.4, showing massive concentration in US banks and massive leverage of those banks, respectively.  Chalk this up to sloppy work at Wiley, more interested in selling books  commercially than publishing them with integrity.

An old joke says every financial crisis needs an accounting culprit to blame. The current crisis may be attributable instead to the dominance of modern finance theory and subordination of traditional accounting principles. Two generations of finance theorists—in business and law schools—developed elaborate models to measure and manage risk in a theoretical world of efficient markets where accounting is not relevant.

Yet two strange twists have arisen—one showing the intellectual limits of the finance story and the other the dark art of making accounting into a political issue. Both concern debate over how to measure financial assets on a balance sheet—the so-called fair value debate.

First, for decades, proponents of modern finance theory urged standard setters to direct asset measurements using fair value rather than applying traditional [...]]]>

An old joke says every financial crisis needs an accounting culprit to blame. The current crisis may be attributable instead to the dominance of modern finance theory and subordination of traditional accounting principles. Two generations of finance theorists—in business and law schools—developed elaborate models to measure and manage risk in a theoretical world of efficient markets where accounting is not relevant.

Yet two strange twists have arisen—one showing the intellectual limits of the finance story and the other the dark art of making accounting into a political issue. Both concern debate over how to measure financial assets on a balance sheet—the so-called fair value debate.

First, for decades, proponents of modern finance theory urged standard setters to direct asset measurements using fair value rather than applying traditional accounting conventions. The prescription was based on assertions that emphasized the reliability of efficient markets to reveal relevant values. Proponents said traditional accounting conventions, using acquisition cost adjusted over time, were comparatively impoverished.

Amid the crisis, those same people shift their stance, now saying fair value measures in stressful markets are either misleading or put downward pressure on values that could render owners of impaired assets, especially banks, insolvent. On its face, this is an admission about the limits of markets to reveal reliable asset values, that modern finance theory is impoverished.

Second, without opining on the merits of measuring assets at fair value or using historical cost accounting conventions, this issue, once again, is turning accounting standard setting into a political expression rather than a professional one. Politicians in Congress, under heavy bank lobbying, pressured the US standard setter [the Financial Accounting Standards Board] to adopt bank-friendly approaches to asset measurement.   Now, Congressional bills  (here, for example, and noted here) contemplate empowering politicians and/or a new federal agency to oversee US accounting standard setting, equipping them with veto rights over any accounting standards the political power consensus disfavors.

Such politicization of accounting, a recurrent threat in the United States that generally is recurrently defeated, is dangerous, as Bill Bratton has explored. Injecting politics into accounting standard setting would not only turn our accounting system into a version of the politically-pockmarked and incomprehensible US tax code, it would diminish the hard-won emphasis on investors as the primary constituent for which accounting standards are adopted.

Examples of hard-won investor focus, and successful resistance to campaigns to make accounting a political product in the US, include (a) accounting for oil companies during the energy crisis of the 1970s, (b) accounting for mergers in the takeover wave of the 1980s, (c) accounting for pensions and employee benefits in the late 1980s after these proliferated and (d) accounting for stock options in the late 1990s and early 2000s after these mushroomed.

In all those contexts, lobbyists got politicians to pressure the independent accounting standard to steer it off its intended course. In each case, however, eventually the standard setter won, retained its position and achieved adoption of accounting standards focused on the needs of investors, rather than parochial interests of managers.

In the current context, the legislative talk is going much further, to create political watch-dog power to oversee the independent standard setter, even giving the federal agency power to veto any standard it does not like. This is a dangerous proposal that should be rejected out of hand.

There is no accounting culprit in the current crisis, a crisis more a product of modern finance theories. Politicians ought to focus on those theories that failed rather than exploit a period of chaos and confusion to alter practices that have succeeded.

Above all, modern finance theories seduce belief that markets, not accounting, matter. Yet the intense and costly political lobbying about what accounting should be also shows that real-world participants know that finance theory’s intellectual elegance masks important drivers of capital allocation.

See the accompanying photograph of a fallen condo in China, taken by Bill Hopen, featured in a story by Mish Shedlock.   Hopen sees in the story and photograph a tragic metaphor for a coming economic crash in Chinese real estate, which he worries  is likely, a year or two behind the similar convulsions the West began two years ago.  If so, prospects for global [...]]]> A Civil Engineering Quiz: Suppose you build a 12-story condominium using pilings designed to tolerate a degree of surface imbalance on its north and south side of about 2,000 tons.   Then suppose you dig an underground garage on the building’s south side to 20 feet and pile the dirt on its north side to about 30 feet, yielding a surface imbalance of about 3,000 tons.   What would happen?

See the accompanying photograph of a fallen condo in China, taken by Bill Hopen, featured in a story by Mish Shedlock.   Hopen sees in the story and photograph a tragic metaphor for a coming economic crash in Chinese real estate, which he worries  is likely, a year or two behind the similar convulsions the West began two years ago.  If so, prospects for global economic recovery are dimmer than many suppose.   Mish and Bill offer more photos and explain the concerns more fully at the foregoing two links.  Worth a look.   

Current Events Quiz: Will the effort that goes into determining the cause of the photographed building crash  be proportional to that expended determining the cause of the economic crash imperiling the West, and predicted soon to imperil China?   Is it difficult to understand why it is easier to see such excessive imbalances in physical than economic settings?

Scholars and practitioners of corporate law got to know Sam as a distinctive figure in the shareholder rights movement of the 1980s. Blending his training as a lawyer with his acumen as a businessman, Sam stood out among his peers in that movement by acquiring companies he intended to manage better than incumbent managers, rather than picking them apart to bust up or flip them for a quick buck. In doing so, he accumulated a considerable fortune.

Scholars and friends of Cardozo Law School knew Sam as a philanthropist and benefactor. He co-founded and co-endowed, with his wife Ronnie, [...]]]> Sam Heyman, lawyer, businessman and philanthropist, died this weekend at the age of 70 after complications arose following open heart surgery at Mt. Sinai Hospital in New York.

Scholars and practitioners of corporate law got to know Sam as a distinctive figure in the shareholder rights movement of the 1980s. Blending his training as a lawyer with his acumen as a businessman, Sam stood out among his peers in that movement by acquiring companies he intended to manage better than incumbent managers, rather than picking them apart to bust up or flip them for a quick buck. In doing so, he accumulated a considerable fortune.

Scholars and friends of Cardozo Law School knew Sam as a philanthropist and benefactor. He co-founded and co-endowed, with his wife Ronnie, The Samuel and Ronnie Heyman Center on Corporate Governance, which I had the pleasure of directing for most of the 1990s. The Heyman Center was Sam and Ronnie’s way of helping to educate law students interested in corporate law and providing a forum to generate ideas on the subject.

The Heyman’s multi-million dollar gift enabled us at Cardozo to award scholarships to students, support students in public interest work, study comparative corporate law at Oxford, fund special advanced courses at Cardozo, bring learned visiting scholars to Cardozo, and hosting of scores roundtables, speaker series, conferences and many multi-day symposia.

The Heymans never influenced any of our activities, but were always ready to support them in any way we asked them to. Among my favorite Heyman Center events, and an example of the Heyman’s willingness to contribute both money and ideas, was Sam’s own lecture in our 1999 speaker series called “Non-Practicing Lawyers.” Sam shared with our students his insights on the value his law degree gave him in thinking about risk, ethics and opportunities as applied to the business context.

Another of my favorite Heyman Center events was our 1997 symposium entitled Warren Buffett: Lessons for Corporate America, in which Sam and Ronnie participated, and for which they hosted a delightful dinner party at their home. This was one of many Heyman Center events for which Sam and Ronnie opened their home up to me and the Cardozo community.

Sam was a generous philanthropist, thoughtful and reflective business leader, best friend of Cardozo Law School and abiding supporter of mine and friend to me, plus from all accounts and my indirect observations, a wonderful husband and father.

We all will miss him.

Photo Credit: Norman Goldberg (Sam giving lecture at Cardozo, 1999).

NYT obituary here.

Along with dozens of others apparently caught up in the ongoing insider trading scandal at Galleon, today, an associate at the prestigious firm, Ropes & Gray, is alleged to have violated securities laws by using confidential information obtained from clients to profit in securities trades. [...]]]> In my corporations classes, I urge my students planning a career in corporate and securities law to resist the ubiquitous opportunities and occasional temptations to trade on the basis of material non-public information. I offer in terrorum encouragement by emphasizing that all trades are tracked and that enforcement authorities periodically review them for unusual patterns. Those are traced back to professional advisors, including law firms, having been involved in related deals. It is not difficult for authorities to catch these violations.

Along with dozens of others apparently caught up in the ongoing insider trading scandal at Galleon, today, an associate at the prestigious firm, Ropes & Gray, is alleged to have violated securities laws by using confidential information obtained from clients to profit in securities trades. Lawyers, as fiduciaries, who obtain material information through client representation, violate their fiduciary obligations and hence federal securities laws when they trade on it.  See United States v. O’Hagan, 541 U.S. 642 (1997).

Over at the Wall Street Journal blog, Ashby Jones is asking how common insider trading is among lawyers. This is obviously a difficult empirical question. I can add, however, that (a) in the four years that I practiced law at Cravath, Swaine & Moore, one of my fellow-associates engaged in this activity (with his brother) and authorities prosecuted him (in 1995) for it and (b) during the two years before that when I was a paralegal at Skadden, Arps, one of the associates for whom I worked did so (with his sister) and he was likewise caught (in 1990). 

In addition, the famous case embracing the so-called misappropriation theory of insider trading, United States v. O’Hagan, 541 U.S. 642 (1997), involved a lawyer—a partner at Dorsey & Whitney, representing Grand Met in its acquisition of Pillsbury, who generated nearly $4 million in unlawful trading gains from the knowledge.

I repeat to my students, past and present, and all lawyers: do not do this!

As an author of books on Buffett’s investment philosophy, including a compilation of his letters I prepared for a law review symposium at Cardozo Law School in 1997, I’m quoted in tomorrow’s USA Today story covering the deal (written by Adam Shell).

Adam’s story correctly reflects my take on the deal as squarely meeting Buffett’s traditional criteria: a business within Buffett’s “circle of competence” (i.e., that is easy for him to understand), run by people he “likes, trusts and admires,” and at a price reflecting good value for money.

More [...]]]> Economic prognosis positive is the signal to hear today from Warren Buffett and Berkshire Hathaway’s agreement to buy 100% of the stock of the railroad, Burlington Northern Santa Fe, consolidating the company’s 22% ownership stake in a $34 billion acquisition.

As an author of books on Buffett’s investment philosophy, including a compilation of his letters I prepared for a law review symposium at Cardozo Law School in 1997, I’m quoted in tomorrow’s USA Today story covering the deal (written by Adam Shell).

Adam’s story correctly reflects my take on the deal as squarely meeting Buffett’s traditional criteria: a business within Buffett’s “circle of competence” (i.e., that is easy for him to understand), run by people he “likes, trusts and admires,” and at a price reflecting good value for money.

More broadly, the story reflects how this acquisition is a very public statement that Buffett is “bullish on America,” the long-time slogan of erstwhile investment bank Merrill Lynch (now a part of Bank of America).

There’s one way the deal and Berkshire’s disclosure is unusual: Buffett says this acquisition is a big “bet” on Burlington, its management, and the US economy. Buffett does not usually talk about investing using the word “bet” or other gambling terms, eschewing them in favor of emphasizing cool, calculated, rational evaluation of business and its environment.

Another notable feature about this investment, Berkshire’s largest acquisition ever, is how Burlington is particularly strong, among railroads, in transporting goods from West coast ports into America’s heartland. Forecasting high returns doing that suggests a prediction that, as the US economy recovers, the country will remain heavily reliant on imports, certainly of goods and probably of energy, especially from China and East Asia.

Maybe there is a gamble here, on both a US recovery and the post-recovery shape of trade, manufacturing and consumption. And there is always risk in investment. But this one fits enough within traditional Berkshire investments that it suggests being bullish again may be a safe bet.   [Disclosure: I own Berkshire Hathaway stock, and have for many years.]

 Photo Credit: Norman Goldberg (Buffett teaching my Corporations class at Cardozo Law School, 1998)

Seven years ago, when Sarbanes-Oxley was enacted, many people declared it “sweeping legislation.”  The vast majority of observers and participants said it was the most significant set of reforms since the Great Depression.   Proponents thought this an affirmative good and opponents, like Larry Ribstein and Roberta Romano, found it repugnant.

I was among the minority who explained how this notion of “sweeping” was rhetorical over-statement–and how the rhetoric combined with the modest changes could actually work, which they did.   Certainly compared to what is coming, Sar-Box will be the yawn I [...]]]> As previously hinted at here, revolutionary changes are forthcoming in financial regulation.  These will be far more significant than any that have been made, including compared to those in 1933 and 1934 after the 1929 stock market crash and ensuing Great Depression. 

Seven years ago, when Sarbanes-Oxley was enacted, many people declared it “sweeping legislation.”  The vast majority of observers and participants said it was the most significant set of reforms since the Great Depression.   Proponents thought this an affirmative good and opponents, like Larry Ribstein and Roberta Romano, found it repugnant.

I was among the minority who explained how this notion of “sweeping” was rhetorical over-statement–and how the rhetoric combined with the modest changes could actually work, which they did.   Certainly compared to what is coming, Sar-Box will be the yawn I suggested it was, though Congress continues to debate, in the current negotiation, how far parts of it should go, including whether to extend its internal control requirements to smaller enterprises.  

Amid the current hurly-burly, also as previously noted, we at GW are hosting a conference,  next Friday, to sort through some of this.  A program is here, along with details on how to register.   One highlight among many: our keynote speaker is SEC Commisioner Luis Aguilar, though spots for his lunch time talk may be scarce.

These bills are elaborate, complex and defy tidy characterization.  All are likely to change, some significantly, as the legislative process grinds along. The Senate Banking Committee is unlikely to produce anything equivalent until well into November.

In general, however, together the House FSC’s work would make for sweeping change.  The bills would:

(1) create three new federal agencies: a Federal Oversight Council, a Consumer Financial Protection Agency and an Office of Federal Insurance;

(2) considerably expand powers of the Securities Exchange Commission, including by [...]]]> The Staff of the House Financial Services Committee is extremely busy and doing a very good job of keeping its role in the legislative process transparent. A reasonable run down of current activity in financial regulation reform appears here. (You can even sign up to get email alerts.) 

These bills are elaborate, complex and defy tidy characterization.  All are likely to change, some significantly, as the legislative process grinds along. The Senate Banking Committee is unlikely to produce anything equivalent until well into November.

In general, however, together the House FSC’s work would make for sweeping change.  The bills would:

(1) create three new federal agencies: a Federal Oversight Council, a Consumer Financial Protection Agency and an Office of Federal Insurance;

(2) considerably expand powers of the Securities Exchange Commission, including by subjecting rating agencies to considerable regulation and oversight by the SEC plus eliminate an exemption to the Investment Company Act of 1940 for private financial advisors.; and

(3) expand the mandate and powers of the Commodity Futures Trading Commission concerning regulation of derivative securities.

These pending Committee steps, of course, are in addition to bills the House passed earlier this year, including the summer’s Corporate and Financial Institution Compensation Fairness Act of 2009, embracing shareholder say on executive compensation to a certain extent.

At this link, you can access pending bills totaling just about 1,000 pages.   Following is an additional breakdown:

NEW AGENCIES

Financial Stability Improvement Act of 2009 (draft 10/27) (253 pages) (would create a Financial Services Oversight Council with extensive authorities and duties)

Consumer Financial Protection Agency Act of 2009 (draft 9/25) (291 pages) (would create elaborate new independent federal agency, the CFPA, with broad regulatory powers, many taken away from the Federal Reserve) [summary here]

Federal Insurance Office Act of 2009 (draft 10/16) (15 pages) (would create federal office within the Treasury Department, the FIO, to monitor insurance industry) [summary here]

EXPANDED SEC POWERS

Investor Protection Act of 2009 (draft of 10/16) (153 pages) (would expand powers of the Securities and Exchange Commission in substantial ways) [summary here]

Enhanced Accountability and Transparency in Credit Rating Agencies Act of 2009 (draft 10/16) (37 pages) (would considerably expand SEC oversight of rating agencies and prescribe important aspects of their governance structures and policies and procedures) [ summary here]

Private Fund Investment Advisers Registration Act of 2009 (draft 10/16) (11 pages) (would eliminate private adviser exemption from Investment Company Act of 1940)

EXPANDED CFTC MANDATE AND REGULATIONS

OTC Derivatives Markets Act of 2009 (draft 10/2) (187 pages) (would expand authority of Commodity Futures Trading Commission over certain kinds of financial swap deals and prescribes specific clearing regulations and other regulation)[summary here]

UPSHOT

With this kind of legislative energy, you can be sure another crisis like the one gripping us will never happen again!  (But you can also be sure others will.)

It did so, however, in an opinion void of any analysis of the lower court opinions. As to the lost profits claim, in particular, the Court of Appeals merely said it agreed with the lower courts that the assertion was “speculative.” It did not explain why and did not confront or correct [...]]]> As I predicted last month, the New York Court of Appeals last week reversed an Appellate Division decision denying any damages to buyers of real property from sellers who admitted breach of contract to purchase and sell real property. The Appellate Division had denied sought damages measured by lost profits, the contract-market differential and reliance expenses. The Court of Appeals agreed as to lost profits and contract-market differential but reversed as to reliance expenses.

It did so, however, in an opinion void of any analysis of the lower court opinions. As to the lost profits claim, in particular, the Court of Appeals merely said it agreed with the lower courts that the assertion was “speculative.” It did not explain why and did not confront or correct patently erroneous statements in those opinions that the buyers could not recover because they were pursuing a new business enterprise.  More responsibly, though still without analysis, the Court rejected the contract-market claim, by referencing evidence showing that the property value at breach did not exceed the contract price.

Most important, on the reliance branch, the Court of Appeals reversed the lower court rulings that simply failed to see that reliance damages are a standard alternative to expectancy damages (whether lost profits or the contract-market differential), especially when the latter cannot be determined with reasonable certainty.  The Court cited Section 349 of the Restatement (Second) of Contracts, and numerous New York Court of Appeals cases, including the classic Freund v. Washington Square Press, all of which allow recovery of reliance losses incurred in preparing to perform a contract, so long as these are foreseeable and ascertainable.

But what of those incorrect lower court statements about lost profits?  Should the Court not have addressed them?   Affirming by saying it agreed that the lost profits claim was ”speculative” does not exactly reject erroneous statements in the lower court opinion, such as that new businesses face a different burden or hurdle in recovering lost profits.    Reversal as to reliance damages does not disturb them.   While I concur with the Court on all its results in all three damages holdings, does it promote judicial economy to leave clearly erroneous lower court statements about a recurring issue in contract law uncorrected?

Friday Nov. 6, 2009, GW Law, 2000 H Street, NW, DC

Breakfast (8:30 a.m. – 9:15 a.m.)

Welcome (9:15 a.m. – 9:30 a.m.)

Edward Labaton, President, ILEP

Frederick M. Lawrence, Dean, GW Law School

Panel I: The Legislative Agenda (9:30 a.m. – 11:15 a.m.)

Moderator: Jeffrey Manns, Professor, GW Law School

Panelists: Edmund L. Andrews, Economics Correspondent, New York Times

Ricardo R. Delfin, Special Counsel, Securities and Exchange Commission

Dean V. Shahinian, Senior Counsel, Senate [...]]]> As financial regulation reform reaches its apogee, we at GWU are delighted to host a roundtable on Friday Nov. 6 at the Law School (2000 H Street, NW, Washington, DC).   An outline of the Program, co-sponsored by the Institute for Law and Economic Policy, follows, along with how to register.  Note that participation of some panelists is subject to the legislative calendar.

Friday Nov. 6, 2009, GW Law, 2000 H Street, NW, DC

Breakfast (8:30 a.m. – 9:15 a.m.)

Welcome (9:15 a.m. – 9:30 a.m.)

Edward Labaton, President, ILEP

Frederick M. Lawrence, Dean, GW Law School

Panel I: The Legislative Agenda (9:30 a.m. – 11:15 a.m.)

Moderator: Jeffrey Manns, Professor, GW Law School

Panelists: Edmund L. Andrews, Economics Correspondent, New York Times

Ricardo R. Delfin, Special Counsel, Securities and Exchange Commission

Dean V. Shahinian, Senior Counsel, Senate Banking Committee

David A. Smith, Chief Economist, House Financial Services Committee

Dan S. Sokolov, Senior Attorney, Department of the Treasury

Arthur E. Wilmarth, Jr., Professor, GW Law School

Panel II: Federal Enforcement (11:15 a.m. – 12:30 p.m.)

Moderator: Theresa A. Gabaldon, Professor, GW Law School

Panelists: James D. Cox, Professor, Duke University Law School

Rob Cox, New York Bureau Chief, Breakingviews

Lorin Reisner, Deputy Director, Enforcement, Securities and Exchange Commission

James Robertson, Judge, U.S. District Court (D.C.) and/or Stanley Sporkin

Lunch (12:45 p.m. – 2:00 p.m.)

Keynote Speaker:  Louis Aguilar, Commissioner, SEC

Panel III: State & Private Enforcement (2:00 p.m. – 3:30 p.m.)

Moderator: Lawrence A. Cunningham, Professor, GW Law School

Panelists: Lisa M. Fairfax, Professor, GW Law School

Steven D. Irwin, Commissioner, Pennsylvania Securities Commission

Donald C. Langevoort, Professor, Georgetown University Law Center

David Markowitz, Office of the Attorney General, State of New York

Lawrence A. Sucharow, Partner, Labaton Sucharow LLP

TO REGISTER, CONTACT

Laura Stein, Insitute for Law & Economic Policy, laurasteinesq@yahoo.com

Attendance at the luncheon/keynote is limited according to the order in which registration is received.

Should law journals do more? Are any doing so? Aside from promotions such as we at Concurring Opinions offer to a necessarily limited number of journals on this blog, listing recent issues, and some symposia pitches, law reviews don’t market themselves. Florida Law Review is poised to change this, and I support the leadership.

Contracts with some publishers, especially trade, university or hybrid presses, often contain industry-standard publisher promises to market using reasonable [...]]]> How are academic works promoted by publishers, trade or university presses, academic book publishers and law journals? In general, trade presses do a broad funded pitch, university presses do some but more narrowly, academic book publishers make a strong push to a targeted audience and law journals do . . . pretty much nothing.

Should law journals do more? Are any doing so? Aside from promotions such as we at Concurring Opinions offer to a necessarily limited number of journals on this blog, listing recent issues, and some symposia pitches, law reviews don’t market themselves. Florida Law Review is poised to change this, and I support the leadership.

Contracts with some publishers, especially trade, university or hybrid presses, often contain industry-standard publisher promises to market using reasonable or best efforts. Most such houses do so. In my experience, McGraw-Hill and John Wiley & Sons take these clauses seriously and do a good job performing them, not only with paid advertisements, but with results in the form of visible book reviews, author tours and presentations, and, ultimately, sales.

Other contracts, especially with academic book publishers, like West or Lexis, are silent on publisher marketing, but those presses commit resources to the effort anyway. I am impressed with both these publishers of my books. They get word out to teachers about my books, supplements, new editions, and supporting materials like classroom slides, problems-solutions, and teachers’ manuals and updates. The results are large numbers of adoptions and resulting sales, plus more people giving me valuable input into how to improve the work in subsequent editions.

Law review publishing contracts, at least the 40+ I’ve signed, never talk about journal promotional efforts, and I’ve rarely seen a law journal undertake much of any. Journals are obviously trying to expand their presence with various on-line variants of their production, a form of promotion, though mostly responding to new ways of disseminating knowledge. Aside from lack of time, theory may say this is fine because academics will research to discover the great published knowledge and resulting citations will reflect what is valuable—no marketing needed.

Theory and traditional practice aside, Florida Law Review, which will publish a piece of mine in 2010, has created a promotional program.  Florida Law Review has a Communications Editor, and related staff. Their job is to reach out to members of the legal community having particular interest in pieces they publish. The Review’s Communications Department works in partnership with authors to develop marketing plans to publicize works to the media, prominent professors, and accomplished practitioners.

This inspired approach to the dissemination of academic knowledge manifests in other creative results, like this recently featured at the Faculty Lounge, a Florida Law Review piece accompanied by interactive media. I’m impressed. In fact, this effort was a factor to me when I chose to accept Florida Law Review’s publication offer over other offers.

In previous years, I served as Faculty Advisor to my school’s law review. If I were doing that today, I’d urge editors to look at the Florida model as a leader. But perhaps that is happening elsewhere and I don’t know about it.

Readers of this post could benefit from comments saying what is doing at other reviews and, of course, what is appealing and anything detracting about what seems to me a desirable, innovative, law review practice.

The piece, reportedly stimulated by something Justice Sotomayor said about the role of gender in judging, spends the previous 30 pages: (1) reviewing literature about possible differences in attitudes and experience judges may have, [...]]]> On the last page (31) of a new empirical article by law professors concerning the role of gender among judges, the following conclusion appears: “we find that women do just as well as the men [sic] in terms of basic judging measures.”  I am not surprised and wonder: (1) what portion of the population, among laypersons or lawyers and certainly legal academics, would really be surprised by this; (2) whether we need an empirical study before drawing such a conclusion; and (3) whether any empirical study, this one included, can realistically provide evidence for (or against) such a conclusion.

The piece, reportedly stimulated by something Justice Sotomayor said about the role of gender in judging, spends the previous 30 pages: (1) reviewing literature about possible differences in attitudes and experience judges may have, according to gender; (2) summarizing data on state high court judges, 1998-2000 (and adding a smaller bit of data on federal judges), concerning numbers of opinions they write, how often they are cited by other courts, and how often they filed panel opinions disagreeing with panel judges of their own political party; (3) summarizing data about such matters as where judges went to law school and marital status; (4) reporting elaborate regression analyses of these data; and (5) testing various hypotheses, using these factors and resulting relations among the data, to tell us whether men or women are better judges (measured by things like opinions produced and citation frequency).

To be fair, the paper’s four authors acknowledge, in the end, limitations of the empirical methodology they use, emphasizing weaknesses in the inputs, and the meaning of resulting outputs.  In addition, the paper manifests requisite hallmarks of good academic work: a literature review, statistically testable hypotheses, reports of the statistical analysis plus qualifications and modesty about the entire undertaking.   

Furthermore, of course, in principle, the quest is valiant, for confirming hunch and intuition with statistical data is a vital exercise and tradition in academic research. And this paper may provide more support for its assertions than I could offer for claims I may make, like, in contract law: (1) Ellen Ash Peters was a more thorough and convincing judge than Learned Hand; (2) Judith Kaye was at least as persuasive and clear as Oliver Wendell Holmes; and (3) Benjamin Cardozo was superior to all of them on all counts. 

Even so, this paper puzzled and troubled me like few others ever have.    It led me to wonder whether all the work that went into preparing it, and my hour reading it, was worthwhile, and whether we have learned anything from it.

NB: The paper, oddly entitled Judging Women, by Stephen Choi (NYU Law), Mitu Gulati (Duke Law), Mirya Holman (Duke Law/UNC Econ/Pol), Eric Posner (Chicago Law), can be found here.

Facts like these appear at the heart of longstanding, though little known, allegations against Dick Clark, host of the wildly popular arbiter of successful commercial music decades ago, American Bandstand. Though Clark faced Congressional hearings over such allegations back in the 1960s, they never went anywhere and legal [...]]]> Suppose the host of a show like American Idol insisted that, in exchange for putting participants on air and gaining publicity, participants had to sign agreements transferring copyright and all future royalties from songs they perform on the show to the host. Suppose further that these participants signed such contracts, and ensuing royalty streams generated millions of dollars for the host, nothing to the performer. Would these agreements be enforceable? Under what legal theories could they be challenged?

Facts like these appear at the heart of longstanding, though little known, allegations against Dick Clark, host of the wildly popular arbiter of successful commercial music decades ago, American Bandstand. Though Clark faced Congressional hearings over such allegations back in the 1960s, they never went anywhere and legal claims do not appear to have been pursued. This quiescent state of affairs may reignite amid the new documentary on the subject, Wages of Spin, which suggests that artist and producer reticence to pursue legal claims is due to lack of knowledge or capacity or to how the power Clark wields in the industry has made many potential witnesses and other adversaries reluctant to challenge him.

The film, made by Shawn Swords (who, in the interest of full disclosure, is a friend of mine and high school classmate), is not so much an expose of Clark’s moral compass as an exploration of the tactics he used to run the show. As a documentary, it adopts an objective tone and viewpoint, though undoubtedly does not provide the adversarial forum to explore or test all assertions and counter-assertions that adjudication of disputes provides.

Accordingly limited, the skeletal facts may permit considering, in broad outlines, issues from the common law of contracts concerning the enforceability of such agreements. I mention four below: lack of consideration, unconscionability, illegal bargain and duress. Comments are open to add to this list—or subtract from or qualify it. (Of course, any inquiry like this skirts potentially applicable statutes of limitations, which raise additional issues concerning tolling, discovery, diligence and others that would require considerably more facts to evaluate.)

Consideration.  First, artist-producers could argue that the transfer of their rights lacked consideration. The evidence may show the transfer was not made for sufficient consideration but, at best, for the promise and delivery of time on the air and play time for the records. Under traditional theories of contract formation, however, this claim would be difficult to sustain. Courts routinely say they will not inquire into the adequacy of consideration, so long as some quid pro quo exists. It is probably enough to observe that the deals involved the exchange of royalty assignments for airplay or air time.

Unconscionability.  Second, the artist-producers could allege that, despite the presence of such consideration, the relation between the copyright royalty value and the air time was so lopsided that no reasonable person would have proposed and no rational person would have assented to it. This attempts to invoke the doctrine of unconscionability, a rarely used exception to the usual judicial deference to party determinations of the content of bargains. Although worth considering, this claim may be difficult to sustain given how the value of royalties may well have been dependent upon, and a function of, the airplay or air-time given in exchange.

Illegal Bargain.  Third, the artist-producers could assert that the arrangement amounted to an illegal bargain, one a court should not enforce. This claim could invoke the standard talk of the period that characterized as “payola” the exchange of pay for airtime. It was condemned as an unsavory practice, equivalent to a bribe, though it is not obvious that there were actual laws prohibiting it. Though many courts take the notion of illegal bargain literally, so that refusing enforcement must be based on an exchange that is in substance illegal, some courts invoke a broader sense of public policy in electing to refuse enforcement. Entertaining such a ground to refuse enforcement involves an extensive balancing of the interests in light of related public policy.

Duress.  Fourth, the artist-producers may assert that the agreements were not the product of the exercise of free will but were products of duress that Clark or his associates induced. In general, contracts formed as a result of duress may be set aside, but proving duress requires showing that the opposing side exerted an unlawful threat, improper or coercive influence or techniques to induce assent. This is likewise not a commonly invoked ground for setting aside a contract, and depends heavily on particular facts at the time of contracting. Viewers of the documentary may detect evidentiary leads and predicate assertions to provide a firmer basis for evaluating the probability that this theory to challenge enforceability of the contracts would succeed.

Remedies.  Ultimately, if artist/producers could identify infirmities in the contract formation process, whether lack of consideration, unconscionability, illegal bargain, duress, or otherwise, to what remedy would they be entitled? Since the claim is to set aside the contracts, the remedy is not a contractual remedy but a form of restitution for unjust enrichment. This considers the value of the benefit conferred by the aggrieved party on the benefited party.

In principle, this would mean all royalties under the copyrights would be accounted for and returned—plus reassignment of putative contract rights, including associated copyrights and related royalties. Given the scope of claims implicated—some 143 songs, many of them monster hits—hundreds of millions of dollars would be at stake.

This season, there are several noteworthy forums, including at Pitt and Seton Hall Law Schools and, just two weeks ago, an Institute for Law and Economic Policy conference in which I participated, featuring Joseph Stiglitz (Columbia), Kenneth Feinberg (US special compensation master), Lucien Bebchuk (Harvard), Charles Elson (Delaware), Jill Fisch (Penn), Harvey Goldschmid (Columba), Frank Partnoy (San Diego), and [...]]]> Policy formulation benefits from academic knowledge, often showcased at timely conferences, and there have been plenty of contributions this year and last concerning financial regulation reform amid the economic crisis. Late last fall, I posted a list of conferences pending then, including GW Law’s Panic of 2008 Conference, which will result in a book to be edited by my GW Law colleagues, Larry Mitchell and Art Wilmarth.

This season, there are several noteworthy forums, including at Pitt and Seton Hall Law Schools and, just two weeks ago, an Institute for Law and Economic Policy conference in which I participated, featuring Joseph Stiglitz (Columbia), Kenneth Feinberg (US special compensation master), Lucien Bebchuk (Harvard), Charles Elson (Delaware), Jill Fisch (Penn), Harvey Goldschmid (Columba), Frank Partnoy (San Diego), and a dozen others.

At GW Law, we will host a follow-up to our Panic of 2008 conference on Friday November 6, co-sponsored by ILEP, featuring academic contributions from Jim Cox (Duke), Don Langevoort (Georgetown) and Art Wilmarth (GW), plus participants from Treasury and the SEC and Senate and House Committees having jurisdiction and from the media (including Ed Andrews, New York Times). Discussion will concentrate on the emerging legislative agenda, along with enforcement (federal, state and private).

A notable interactive on-line interchange will by hosted by Steven Davidoff (University of Connecticut), using his platform as editor of the New York Times on-line deal forum. The description suggests a provocative discussion showing skepticism about standard interpretations of the crisis and pending prescriptions for reform. Notable participants include David Zaring (Penn/Wharton, co-author of an article with me on the subject, forthcoming in GW Law Review), Joseph Grundfest (Stanford), David Skeel (Penn) and Lynn Stout (UCLA).

As the Administration and Congress write legislation, ideas and input from events like these, seeming to be on the sidelines, can be important and useful. Tune in.

Debate manifested in numerous class action lawsuits, state attorney general investigations under state consumer protection laws, federal legislators circulating bills to curtail the fees, and July 2008 Federal Communications Commission hearings and suggestions for compromise. Much of this energy has dissipated, perhaps partly because some companies have modified some of their contracts, including by adjusting [...]]]> What happened to debate about cell phone subscriber contracts containing early termination fees? Companies and subscribers sign multi-year term contracts, exchanging service for monthly and other fees. Contracts provide that customers terminating early breach and owe damages, usually a flat fee of between $150-225. Companies claim these fees partly compensate them for costs like subsidizing handsets to customers, but customers assert these fees coerce them to continue in an unwanted relationship.

Debate manifested in numerous class action lawsuits, state attorney general investigations under state consumer protection laws, federal legislators circulating bills to curtail the fees, and July 2008 Federal Communications Commission hearings and suggestions for compromise. Much of this energy has dissipated, perhaps partly because some companies have modified some of their contracts, including by adjusting the fee according to when in the term a customer terminates. But not all companies have adjusted and not all contracts have been changed.

Lawsuits continue to wind their way through courts, involving issues ranging from subscriber assertions of unjust enrichment to violation of consumer protection laws. A particularly interesting issue concerns whether the clauses are enforceable under the general common law of contracts. One of the few cases to have resulted in a judicial opinion on the merits grappled extensively with this issue, which turns out to be more complex than one may suppose. Ayyad v. Sprint Spectrum (Cal. Super., Alameda County 2008.)

The court, in a class action, found the clauses unenforceable, though not because they charged subscribers too much, but mainly because the company’s losses from breach by early termination were greater (plus, more generally, the fees did not reflect a compensatory impulse, shown further by how they did not vary with the time of subscriber breach).

This result may be surprising for two reasons. First, as a matter of traditional contract law, concern focuses more on stipulated damages that overcompensate and thus penalize breach rather than those that under-compensate. Second, as a matter of fact, is it likely that company losses from subscriber breach exceed $150-225 per subscriber, on average or on particular contracts?

Legal remedies for breach of contract are designed to compensate aggrieved parties for loss. Within this compensation principle, doctrine shows greater aversion to over-compensation, as by denying losses for emotional distress or punitive damages, rather than under-compensation, reflected in limitations on the compensation principle barring recovery for losses avoidable, unforeseeable or not provable with reasonable certainty.

Law allows parties to express their own remedies by contract, stating sums to be paid by a breaching party to the other upon designated breaches. But law jealously reserves power to police stipulated remedy amounts for reasonableness. Standard tests of enforceability insist that actual damages be difficult to prove with reasonable certainty and that the stipulated sum is reasonable in relation to forecast or actual damages.

Doctrinal talk distinguishes between enforceable clauses by calling them liquidated damages and unenforceable clauses by calling them penalties, nomenclature reflecting contract law’s historically greater aversion to over-compensating than under-compensating aggrieved parties, concentrating the penalty inquiry on how much the breaching party must pay on breach.

But what about stipulated damages clauses that are too small to compensate an aggrieved party’s losses, not a penalty on the breacher but a functional penalty on the aggrieved party? Such cases are less frequent and traditional doctrine, such as the Restatement (Second) of Contracts, does not talk about them.

Its Section 356(1) announces: “A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.” Professor Farnsworth, in his treatise, wrote: “Since it is the in terrorem effect that is objectionable, the proscription applies only if the stipulated sum is on the high, rather than the low, side of conventional damages . . . .”

The few cases calling stipulated damages clauses invalid when too low, rather than too high, often involve other considerations. For example making a real estate buyer’s damages 10% of the purchase price when seller sold the property for a gain 3.5 times that was held invalid. Wilt v. Waterfield (Missouri 1954). Perhaps this was because it was too low, but also because it was invariant to the gravity of the breach, raising doubt about whether it was intended to compensate.

Likewise, though rare, burglar alarm subscribers have recovered actual damages from alarm companies who negligently breach contracts, rather than a much lower stipulated sum. Samson Sales, Inc. v. Honeywell (Ohio 1984). Though traditional contract law can be applied, even calling the low sum a penalty, the negligence feature may warrant departure or relaxation of standard contract law tools.

More recently, and more generally, revised Article II of the UCC is amended to speak not only of damages too high, as before, but also damages too low, something new.

Add to this list the Sprint cell phone case. Though damages were difficult to prove with reasonable certainty, meeting prong one of the traditional test, the sum was not reasonable in relation to forecast or actual damages, lacking suggestion of a compensatory objective.

Aside from being invariant to the gravity of breach (the same flat fee applied without regard to how much time remained on a contract when a subscriber terminated), the main objection was how the sums were too low in relation to the company’s probable forecast or actual losses.

Determining a cell service provider’s actual losses from early subscriber termination is difficult and the estimates of party experts in the litigation differed radically. There is general agreement that the best compensatory measure is the company’s lost profits from subscriber breach.  All also agree that generally means estimating the company’s lost revenue less costs it avoided as a result of the breach.

Lost revenues can be comparatively easier to estimate, based on factors like contract price, minutes charged, usage and so on. The cost side generates intense dispute about classifying costs as fixed or variable, a perennial challenge in calculating contract damages. Fixed costs cannot be avoided after breach, and are included in compensatory damages, but variable costs can be avoided, so are excluded from compensatory damages.

Unsurprisingly, the subscribers’ expert witness offered to show that nearly all costs varied, and got per customer lost profits down to below $10. If believed, the stipulated sums over-compensated, amounted to a penalty, were unenforceable, and breaching subscribers would owe at most about $10 for any breach.

But the company convinced the court that most costs were fixed, not variable, showing lost profits per customer averaged some $525, vastly more than the stipulated damages, ranging from $150-225 per customer. On this basis, the clause was invalid, and customers owed the company damages far greater than the stipulated amount.

Among costs not avoidable as a result of breach, were subsidies companies gave to new customers, like handsets at prices less than cost and free or discounted months of service. As a policy matter, the companies also say this business model, using term contracts, subsidies and termination fees, was essential to the proliferation of cell phones and service to huge numbers of people, in all economic backgrounds, and resulting value of a massive network of users. Benefits radiate throughout the economy, domestically and internationally.

Absent these tools, including the early termination fees, companies say they would have to use a different business model, one that would raise prices, reduce affordability of phones and services, contract the size of the cell phone network, and retard all associated economic gains arising from the current model.

This may also explain why debate seems to have dissipated—though many subscribers still fume at these terms. And the dueling expert arguments about costs avoided are just the first reaching adjudication. They leave a nagging sense that the disparity suggests we are much farther away from the truth than this single judgment suggests.

To what damages is the Buyer entitled? According to an intermediate appellate court in New York, which affirmed that Seller breached in bad faith, Buyer is entitled to neither expectancy damages (lost profits) nor reliance damages (as a matter of summary judgment).

Is this likely to be upheld by the New York Court of Appeals, which heard oral argument in the case last week? For the following reasons, I doubt it, but either way [...]]]> Suppose a partnership of two individual real estate developers agrees to buy raw land from a local government authority to develop a retail factory outlet in a special trading zone of upstate New York across the St. Lawrence River from Canada.   A trial court found that the Seller breached this contract “in bad faith.”  

To what damages is the Buyer entitled? According to an intermediate appellate court in New York, which affirmed that Seller breached in bad faith, Buyer is entitled to neither expectancy damages (lost profits) nor reliance damages (as a matter of summary judgment).

Is this likely to be upheld by the New York Court of Appeals, which heard oral argument in the case last week? For the following reasons, I doubt it, but either way look forward to the Court’s opinion.

The lower court denied lost profits by saying they would be too speculative to prove with reasonable certainty. The court acknowledged that Buyer had entered into numerous leases with retailers ready to do business at the factory outlet, but several lessees had since cancelled them. Nor did Buyer show it could have obtained requisite financing to attract and secure tenants for those or other retail spaces (or, perhaps, though the court does not say this, to develop the site).

The court cited a famous New York case, Kenford Co. v County of Erie (1986), announcing that “a start-up commercial enterprise faces a stricter standard when seeking damages for lost profits [because] ‘there does not exist a reasonable basis of experience upon which to estimate lost profits with the requisite degree of reasonable certainty’” (emphasis added).

For at least four reasons, as a matter of the general common law of contracts and of New York law, this statement may be wrong and certainly warrants review. True, courts hesitate to award lost profits damages to “new businesses.” But it is doubtful that there is a blanket rule barring doing so absolutely (as there may have been in a few jurisdictions a long time ago). See MindGames (federal court predicting applicable state supreme court would overrule an antique precedent barring lost profits to any new business).

Second, it may be a mistake to say new businesses face a “stricter standard.” The standard is the same, not only for new businesses and established businesses, but for lost profits and other damages, and for all aggrieved parties seeking contract damages: they all must prove asserted damages with reasonable certainty. 

The problem a new business faces is absence of probative records of past performance that an existing business has to estimate lost profits. It is not a different standard, but a difference in the capacity to generate requisite evidence. It is also possible to sustain the claim on the basis of comparable businesses run by others. See Fera Village Pizza.

Third, New York’s Kenford case, which the court relies on, involved lost profits asserted under a contract to build a domed stadium. The New York Court of Appeals noted longstanding judicial aversion to awarding lost profits in contexts, such as sporting events, that depend on “the whim of the general public and the fickle nature of popular support for professional athletic endeavors.” The landmark case of Chicago Coliseum v. Dempsey famously makes the same point. It may be far easier to prove lost profits under a sales contract for land to be used as a retail factory outlet than for a sports stadium or event.

Fourth, it is not obvious from the opinion why the various procured lessees cancelled their leases, and explanations could include the highly-publicized failure of the government agency to transfer the land in this case. That tenants cancelled tends to support, not undermine, the basis for a lost profits measure.  Further, although the court rejects Buyer’s claim in part because it did not provide evidence that it would have been able to finance the acquisition of additional tenants, it does not elaborate on what financing this would require or how it affected overall development prospects.  These issues of fact make it seem particularly incorrect to grant summary judgment.

In addition to rejecting Buyer’s lost profits claim on potentially weak grounds, the court also denied its alternative claim to reliance damages. Buyer sought to recover costs it incurred in preparing to develop the retail factory outlet center. While the opinion does not detail the elements, one may imagine that they involve costs like advertising and negotiating leases.

The court denied such damages on the ground that nothing in the Buyer-Seller contract(s) said anything about Buyer doing these things. The contracts contemplated the Buyer appearing at the closing, paying for the land and accepting title.  All these costs it incurred at its own expense, the court says.

This decision may also be incorrect for several reasons and certainly warrants review. First, it is common in cases where an aggrieved party is unable to prove lost profits (or other expectancy) with reasonable certainty, to be permitted to recover reliance damages instead. Indeed, that is a feature of the landmark case of Chicago Coliseum v. Dempsey mentioned earlier.

There is a fighting issue about whether reliance damages can be recovered for costs incurred before the contract was made, but that does not seem to be an issue this court addressed or resolved. Additional difficulties arise in determining which outlays were made in reliance on the contract (those that vary with its performance) and which were not.  But, again, the court does not explore these matters.  The court may have been thinking of the restitution cases, where preparations to perform that do not confer benefits on the other party are not recoverable in quantum meruit.  Curtis v. Smith.  But this does not mean they are not recoverable as reliance damages.

In short, the opinion being reviewed resembles a legal fossil of an earlier age. It suggests reviving something of an absolute ban on lost profits for new businesses, long ago abandoned; fails to see the standard modern alternative of reliance damages when lost profits cannot be proven with reasonable certainty; and seems to erect standard limitations on the restitution recovery as (misplaced) limitations on the reliance recovery.

Not on the list, and not mentioned today, or much discussed in the cacophonous litany, are the credit scoring systems lenders use to make first and sometimes final cuts on loan decisions. The credit scores lenders used before the crisis are still used today. But they do [...]]]> The Financial Crisis Inquiry Commission, created by the Fraud Enforcement and Recovery Act (May 20, 2009), held its first public meeting today, launching its mandate to examine causes of the financial crisis. The statute enumerates 22 possible culprits, all now usual suspects, like executive compensation, bad regulatory oversight, financial derivatives, complex securitization schemes and the like. Also on the list is the general notion of bad lending practices at banks, which two Commissioners today likewise noted in general terms.

Not on the list, and not mentioned today, or much discussed in the cacophonous litany, are the credit scoring systems lenders use to make first and sometimes final cuts on loan decisions. The credit scores lenders used before the crisis are still used today. But they do not measure credit-worthiness, or probability of loan repayment, as much as they measure whether applicants are good customers of banks, compared to those less reliant on banks. They value debt, and over-leverage is a recurring culprit in all financial crises.

To illustrate, take a pop quiz. Suppose the following two people apply for a mortgage loan on a home in suburban Maryland (say for $500,000). (1) Which is more credit worthy? (2) Which is more likely to be approved? (3) Would the answers differ if the decision were made today, after the financial crisis, or two years ago, before that?

Applicant A is a tenured Professor of Medicine at Johns Hopkins University, with a mid-6 figure base salary, doubled by significant practice income, revenue on patents she shares with the University, and rental income from resort properties she inherited from an aunt years ago that are owned free and clear of any liens or loans. The Doctor has no outstanding debt, a net worth in the low seven figures and has bought and sold two previous homes, paying off related mortgages before their maturity date.

Applicant B is a local real estate developer, with a low-6 figure income, ¼ of which is in contingent bonus compensation, and no other source of income. His net worth consists mainly of a modest retirement account, stock options and grants from his employer, and some cash in the bank, about enough to make the down-payment contemplated by the mortgage loan application. He has several lines of credit outstanding, all with meaningful balances, that he has increased regularly for years, though always paying monthly minimum balances when due.

(1) A, the Doctor, is by far the more creditworthy of the two.

(2) B, the real estate developer, will have a much higher credit score.

(3) No, under the so-called Desktop Underwriting software that lenders use, before crisis and now (hawked as enabling these decisions to be “made in less than 15 minutes”), B gets a far higher credit score than A. B passes lender underwriting cut-offs; A does not.

Why? Credit scores increase when people have large amounts of debt and decrease when they do not have large amounts of debt. Credit scores are unaffected by factors like employment security, equity net worth, or income. True, after credit score screening, banks may apply an additional test to borrowers with good credit scores, to assure requisite ratios of income to debt payment obligations. But the credit scores bias even that evaluation and still overlook significant factors. They essentially foreclose the possibility of making loans highly likely to be repaid.

In short, credit scores do not reflect people’s probability of repaying loans (whether they are creditworthy) but whether someone is a good customer of the banking system. Contributing to the crisis, banks made mortgage loans to millions of people with wonderful credit scores who lacked creditworthiness. They avoided lending to people with bad credit scores and strong credit quality. The practice continues. The Commission should put credit scoring on its list of possible causes of the financial crisis.