Archive for the ‘Corporate Law’ Category

Wachtell Lipton’s Errors on Shareholder-Paid Director Bonuses

posted by Lawrence Cunningham

Amid debate over shareholders offering contingent payments to directors, Wachtell Lipton recommends an option that may be tempting for incumbent boards: unilaterally adopting a bylaw banning the arrangements.  Boards should be wary of this advice.

True, Wachtell’s position concurs with my view that such payments are lawful, contrary to the position urged by my esteemed fellow corporate law Prof., Stephen Bainbridge.  But that’s where Wachtell and I part company, first because Wachtell’s proposal is myopically universal and second because it errs on a basic legal point about board and shareholder power.

In my view, not only are the arrangements lawful, but shareholder bodies ought to have the choice to embrace or reject them.  My guess is that they are desirable for some corporations in some settings and not so for others.  Therefore, the use or rejection of these ought to be determined, as with much else in corporate life and law, in context by business people participating in particular governance situations. Read the rest of this post »

  May 11, 2013 at 1:10 pm   Posted in: Corporate Law, Current Events   Print This Post   5 Comments

The Reality of Short Termism Per Mark Roe

posted by Lawrence Cunningham

Short-termism in stock markets preoccupies many policy makers and analysts of late but Mark Roe wonders about the validity of some of the conventional talk.   He has posted a series of three short articles on the topic excerpted from a larger project, all worth a look: (1) about whether the cause of any new corporate short-termism may not be stock markets but the speed of change in business pressures;  (2) Are Stock Markets Really Becoming More Short-Term?, and (3) Apple’s Cash Flow Problem, using that case to question the assumption of short-termism.   Business Lawyer will publish the longer version of the inquiry this summer in Mark’s piece, Corporate Short-termism — In the Boardroom and in the Courtroom.  All worth reading.

  May 6, 2013 at 9:44 am   Posted in: Corporate Law, Current Events   Print This Post   No Comments

Prof. Bainbridge on Hess: Critics Still Not There Yet

posted by Lawrence Cunningham

Prof. Steve Bainbridge replied to my post about shareholders paying bonuses to director nominees elected in contested elections, highlighted by the pending proxy battle at Hess.  Steve clarifies his objection to Elliott Associates, the activist shareholder hedge fund, promising to pay its director nominees bonuses if Hess’s stock price outperforms a group of industry peers over the next 3 years:

When I described these transactions as involving a conflict of interest, what I had in mind was the general conflict of interest ban contained in Restatement (Second) of Agency sec 388:  ”Unless otherwise agreed, an agent who makes a profit in connection with transactions conducted by him on behalf of the principal is under a duty to give such profit to the principal.”  Surely the hedge fund payments here qualify as, for example, the sort of gratuties picked up by comment b to sec 388:

“An agent can properly retain gratuities received on account of the principal’s business if, because of custom or otherwise, an agreement to this effect is found. Except in such a case, the receipt and retention of a gratuity by an agent from a party with interests adverse to those of the principal is evidence that the agent is committing a breach of duty to the principal by not acting in his interests.  Illustration 4.   A, the purchasing agent for the P railroad, purchases honestly and for a fair price fifty trucks from T, who is going out of business. In gratitude for A’s favorable action and without ulterior motive or agreement, T makes A a gift of a car. A holds the automobile as a constructive trustee for P, although A is not otherwise liable to P.”

How is the hedge fund’s gratitude for good service by the Hess director any different than T gift to A?  To be sure, directors are not agent of the corporation, but “The relationship between a corporation and its directors is similar to that of agency, and directors possess the same rights and are subject to the same duties as other agents.” . . . Thus, I believe, even if the hedge fund nominee/tippees are scrupulously honest in not sharing confidential information with the funds, put the interests of all shareholders ahead of those of just the hedge funds, and so on, there would still be a serious conflict of interest here.

I can offer 4 replies to Steve’s fine legal points, which I’ll first summarize and then elaborate:

1.  While Steve acknowledges that agency law doesn’t apply, he stresses similarities between agency and corporate law when justifying reference to the American Law Institute’s Restatement (Second) of Agency, but then omits the differences that warrant treating directors differently than agents.

2. Even accepting arguendo Steve’s proposal to rely on the Restatement (Second) of Agency,  he chose to present Illustration 4 as governing the Elliott-Hess arrangement, but the next one, Illustration 5 (excerpted below), is more on point and comes out the other way because the agent and principal are free to agree otherwise.

3.  Even if agency law applied, the Restatement (Second) of Agency, initially adopted in 1958, was superseded in 2006 by the Restatement (Third) of Agency, whose provisions support the Elliott-Hess arrangements.

4.  But agency law doesn’t apply.  The ALI’s applicable standard from corporate law is stated in its Principles of Corporate Governance, expressly referenced in the Restatement (Third) of Agency.  This standard puts the burden on those challenging such arrangements to prove defects such as unfairness or secretiveness, which opponents have not done.  Read the rest of this post »

  May 4, 2013 at 5:44 pm   Posted in: Agency Law, Corporate Law, Current Events   Print This Post   4 Comments

Debating “The Shareholder Value Myth”

posted by Kelli Alces

Many thanks to Larry and the Concurring Opinions folks for inviting me to blog this month. This is my first time blogging and I’m glad to finally try it out.

On Wednesday, I attended an event promoting Lynn Stout’s book The Shareholder Value Myth, sponsored by the Federalist Society and the American Enterprise Institute. The event was structured as a debate of Stout’s thesis with Jonathan Macey (who wrote this review of the book) taking the opposing position. In her book, Stout argued that the widely accepted norm that corporations are owned by shareholders and exist to maximize shareholder wealth is a destructive myth. Instead, Stout claimed, corporations own themselves and in running corporations, managers can and should pursue any lawful purpose.

It is a real credit to Lynn that there was such a lively, thought-provoking debate about the topic. That corporate managers have an obligation to work on behalf of shareholders to maximize shareholder wealth may be the most basic tenet of corporate law and policy. Options theory aside, many think of shareholders as the “owners” of the corporation and even those who question whether shareholders technically own the corporation do not doubt that the corporation should be operated in such a way as to maximize shareholder value. This unwritten “norm” has dominated corporate law, policy, scholarship, and, indeed, management for a long time (for precisely how long, Stout and Macey disagreed).  It is extremely impressive that Stout has been able to provoke a debate about the viability of this fundamental norm.

Wednesday’s debate was the second time I’d seen Stout present at a Federalist Society event. Both times, she began her presentation by arguing that hers was the truly conservative position. It seems an unlikely claim that surprises the audience given what her conclusions are, but I think it highlights what Stout does so well – she reaches her audience with their priors in mind in order to really draw them into her ideas where they might be tempted to dismiss her arguments out of hand. Her presentation was not about good corporate behavior or environmentalism, themes she touched upon in the book, but rather about how debunking the shareholder value myth would allow corporate law to favor state law over federal regulation, to prefer common law rules to statutory regulation, to enhance private ordering, and to honor the lessons of history.

Read the rest of this post »

  May 3, 2013 at 3:48 pm   Posted in: Corporate Finance, Corporate Law, Uncategorized   Print This Post   17 Comments

Director Bonuses for Performance, Prawf Debate and the Bigger Picture for Hess

posted by Lawrence Cunningham

A hot debate rages among corporate law professors amid one of the largest proxy battles in a decade: Hess Corp., the $20 billion oil giant, is the focus of a contest between its longstanding incumbent management and the activist shareholder Elliott Associates.   Ahead of Hess’s annual meeting on May 16, where 1/3 of the seats on Hess’s staggered board are up, antagonists offer dueling business visions.  They battle bitterly over such fundamentals as sectors to pursue, degrees of integration to have and cash dividend policy.

The professorial debate, more civil, is about a novel pay plan Elliott proposes for its director nominees, which Hess’s incumbents condemn and Elliott defends as suited to shareholders. On one side, all quoted in Elliott’s investor materials circulated April 16, are me, Larry Hammermesh (Widener), Todd Henderson (Chicago), Yair Listoken (Yale) and Randall Thomas (Vanderbilt); on the other  Steve Bainbridge (UCLA), Jack Coffee (Columbia) and Usha Rodriques (Georgia), all of whom have blogged since the matter was first reported by Steven Davidoff (Ohio State) in the New York Times April 2 (for which he connected with me for comment).

As in all such cases, Elliott proposes to pay nominees a flat fee of $50,000 each for their troubles and to indemnify them for legal liability.  The novelty is that Elliott will provide incentive compensation to the group: if any Elliott nominee is elected as a result of this year’s  contest, all nominees receive a bonus at the end of three years if Hess’s stock performs better than a group of industry peers. Elliott, not Hess, pays all bonuses.

Hess incumbents portray the bonuses as objectionable (and Steve, Jack and Usha agree). Incumbents say they give nominees incentives to maximize short-term shareholder value rather than serve as long-term stewards.   They say the pay somehow makes the directors beholden only to Elliott, preventing the exercise of business judgment for the benefit of the corporation and its shareholders as a whole.

I have taken a different view, set out in Elliott’s materials last month (p. 148):  The bonuses seem surgically tailored to tie the payoff to Hess’s stock price performance compared to competitors. That is intended to align the interests of those directors with those of the company’s shareholders.  Elliott makes the promise at the outset and then has no role to play afterwards, other than to pay up if milestones are met.  No one is beholden to Elliott and the independence of those directors is not compromised.  There is no incentive to liquidate the company or concentrate on the short term but every incentive to manage to outperform peer company stock price performance over three years.

Read the rest of this post »

  May 1, 2013 at 7:41 pm  Tags: Corporate Law  Posted in: Corporate Law, Current Events   Print This Post   No Comments

The Supreme Court’s Theory of Corporate Political Activity

posted by Jay Kesten

In an earlier post, I outlined an argument that – despite having attracted a fair amount of criticism – the Supreme Court’s vision of corporate political activity may have substantial normative merit from a corporate governance perspective.  In this post, I’ll describe that vision in two related parts.  First, whose expressive rights are being vindicated when corporations engage in political activity?  And second, what internal governance structures should regulate how and when corporations speak?

The first question raises a tricky issue at the intersection of constitutional law and corporate theory.  Corporations are legal fictions, albeit exceedingly useful ones.  They are not self-aware, they have no conscience, and they cannot act or speak except through human beings. Yet, the law has long treated corporations as legal “persons” for most purposes, including eligibility for many (though not all) constitutional protections. This treatment poses a metaphysical question: just what sort of “person” is a corporation?  To answer this question, the Supreme Court has historically relied on several theories of the corporation: the grant (or concession) theory, the aggregation theory, and the real entity theory.  Briefly, the grant theory views the corporation as purely a creature of the state, having only the rights and protections provided by statute, and thus broadly vulnerable to government regulation. The aggregation theory looks past the corporate form to the individual members or shareholders exercising their freedom of associating for some legitimate business, and concludes that corporations must thus have whatever powers and privileges necessary to vindicate the rights of those underlying constituents. The real entity theory posits that corporations exist independently of their constituents or the statutes authorizing them, and are thus a distinct entity entitled to all (or at least most) of the rights of natural persons. The Supreme Court’s corporate jurisprudence has, infamously, cycled repeatedly and inconsistently through each of these theories, often employing multiple theories in the same case.

In contrast to this general indecisiveness, though, the Court’s corporate political speech cases fairly clearly adopt a version of the aggregate view.  I treat the language from the cases in more detail in this paper, but the core idea – which flows from the early cases concerning corporations’ right to lobby, through Bellotti and more recently Citizens United - is that First Amendment speech rights inure to human beings.  Thus, when corporations speak they do so on behalf of the human constituents acting collectively through the corporate form.  As Justice Scalia explains in his Citizens United concurrence: “[t]he authorized spokesman of a corporation is a human being, who speaks on behalf of the human beings who have formed that association.”

As to the second question, the Court gives a firm but vague response: shareholders, acting through the procedures of corporate democracy, decide whether and how their corporations should engage in public debate.  Yet, it’s not exactly clear what the Court means by “corporate democracy.”  As a matter of corporate law, that concept is not self-defining; the proper allocation of decision-making power between managers and shareholders is one of the central, unresolved debates in modern corporate law.  One can, however, glean three key principles from the Court’s decisions.  First, the decision-making process is necessarily majoritarian. Some shareholders may dissent from the decision, but their remedy (if any) lays elsewhere.  Second, the process must actually vindicate shareholders’ concerns.  The Court concluded that shareholders need no legal protections external to corporate law because any ”abuse[s]” – referring to managerial decisions that do not accord with the majority’s desires – can be “corrected by shareholders” through this process.  Finally, the Court seems to contemplate something broader than merely the representative democracy of electing the board.  As Justice Powell notes in Bellotti, shareholders should be able to privately order their preferences as to corporate political activity by “insist[ing] on protective provisions” in the corporation’s constitutional documents, which would bind managerial authority ex ante.

Some claim that the combination of these criteria simply illustrates the Court’s misunderstanding of modern corporate law.  Shareholder control rights within public firms are largely illusory.  Even a majority of shareholders cannot insist on corporate action outside of certain limited circumstances, and the directorial election process usually leaves much to be desired in terms of disciplining management.

I argue, though, that there is a ready-made governance structure that conforms with this framework: allow shareholders to enact intra-corporate bylaws regulating corporate political activity, which (in most jurisdictions) they can do unilaterally by majority vote.  In the next post, I’ll explain the mechanics of this approach, describe potential limitations arising from current jurisprudence concerning the scope of the shareholder bylaw power, and discuss pragmatic benefits to this form of private ordering.

  April 28, 2013 at 5:13 pm   Posted in: Constitutional Law, Corporate Law, Legal Theory   Print This Post   5 Comments

Call for Papers: National Business Law Scholars Conference

posted by Lawrence Cunningham

I am delighted to pass along the following notice from the organizers of the National Business Law Scholars Conference.  I’m also honored to report that they have asked me to deliver the keynote at this year’s conference, and I look forward to doing so.  

Deadline Extended to May 31

We have received an enthusiastic response to the Call for Papers for the National Business Law Scholars Conference, scheduled for June 12-13, at The Ohio State University School of Law.  We will have additional openings for anyone who would like to make a presentation but has not yet responded.  Thus, we have extended the deadline to MAY 31st.  See the Call for Papers, re-posted below with the extended deadline date, for details on how to submit:

National Business Law Scholars Conference: Call-for-Papers

The National Business Law Scholars Conference (NBLSC)  will be held on Wednesday, June 12th and Thursday, June 13th at The Ohio State University Michael E. Moritz College of Law in Columbus, Ohio.  This is the fourth annual meeting of the NBLSC, a conference which annually draws together dozens of legal scholars from across the United States and around the world.  We welcome all on-topic submissions and will attempt to provide the opportunity for everyone to actively participate.  Junior scholars and those considering entering the legal academy are especially encouraged to participate.

To submit a presentation, email Professor Eric C. Chaffee at echaffee1@udayton.edu with an abstract or paper by MAY 31, 2013.  Please title the email “NBLSC Submission – {Name}”.  If you would like to attend, but not present, email Professor Chaffee with an email entitled “NBLSC Attendance”.  Please specify in your email whether you are willing to serve as a commentator or moderator.  A conference schedule will be circulated in late May.

Conference Organizers:

Barbara Black (University of Cincinnati)
Eric C. Chaffee (University of Dayton)
Steven M. Davidoff (The Ohio State University)

  April 17, 2013 at 9:56 am   Posted in: Accounting, Administrative Announcements, Conferences, Corporate Finance, Corporate Law, Securities, Securities Regulation   Print This Post   No Comments

Publicity and Illegality in Organizations

posted by Lawrence Cunningham

“Corporations do not commit crimes, people do,” would be a good thing for everyone to remember but those who like to vilify the corporation too readily forget.  A valuable new research paper canvasses much of the literature about wrongdoing by people in corporations. Rosa Abrantes-Metz and Danny Sokol focus on cartels that violate antitrust laws, shifting the lens from the firm level to those within a corporation and offering a broader review of screens useful to combat illegality.  It’s a great contribution to and synthesis of the literature.  

I will draw on its lessons as I revise the current edition of my accounting textbook written for use in law schools, as well as to reflect on the corporate governance aspects of this problem, addressed in several important passages of my collection of Warren Buffett’s letters to constituents of Berkshire Hathaway.

Buffett’s writings address the tone at the top and promoting a culture of compliance. As CEO, he sends a biannual letter to his managers emphasizing that the most important job of every one of Berkshire Hathaway’s 300,000 employees is preserving Berkshire’s reputation.  For 25 years, that memo has included some version of this sentence:  ”We can afford to lose money, even a lot of money, but we can’t afford to lose reputation, even a shred of reputation.”

Another point he repeats will be of special interest to lawyers among our readership.  He says it is not enough to comply with the law or letter of law. Berkshire must apply a stricter test, called the New York Times test: we would be happy to have all our activities written up on the front page of a national newspaper in an article written by an unfriendly reporter.  It is a much more poignant test than whether you comply with a particular antitrust law or accounting principle.

I call the toughest battle to fight concerning compliance the disease of the crowd. A common defense of sketchy behavior is that everyone else is doing it.  In that letter, Buffett explains that such a  response is usually an excuse rather than a reason. If so, the action probably should be avoided.  To implement such a policy, Buffett offers  senior managers a hotline to him directly if they detect even a whiff of dubious behavior. Those managers pass that message down the ranks and establish parallel hotlines from their troops to them.

Above all, once wrongdoing is detected, swift and public action is required. The worst thing managers can do when they discover illegalities by their employees is try to hide it.  In America, people are very forgiving of substantive errors or even wrongs. They are relentlessly unforgiving of attempts at evasion, duplicity, or hiding things.  (“It’s the cover up, stupid.”) Although Jonathan Macey has recently released an interesting book lamenting the decline of reputation as the constraint portrayed in economic models, it remains a powerful force.  Read the rest of this post »

  April 12, 2013 at 10:39 am   Posted in: Accounting, Corporate Law   Print This Post   No Comments

Board Composition—Old Wine in New(er) Bottles

posted by Charles Whitehead

It’s a pleasure to join Concurring Opinions this month. The internet can be a little touch-and-go in China—I was in central China last week, with only limited access—but I hope to contribute some thoughts as the “Beijing correspondent” over the next few weeks.

For those who have not yet been to Beijing, let me commend it to you. Beyond the tourist attractions (and there are many), there is much going on in China as the country begins to lower the cost of central government, enhance domestic consump¬tion (and inward investment), and promote a deeper capital market. Every day brings something new.

Perhaps as surprising is the ubiquity of U.S. corporate governance—in particular, the director-monitor model—as a standard against which domestic alternatives are measured, notwithstanding some fundamental differences in corporate structure and financial markets.

As some may be aware, my co-authors and I recently addressed the role of directors beyond monitoring in a working paper, entitled Lawyers and Fools: Lawyer-Directors in Public Corporations (available here; forthcoming, The Georgetown Law Journal). Read the rest of this post »

  April 8, 2013 at 9:23 am   Posted in: Corporate Law   Print This Post   No Comments

Delaware Chancery Court’s Role Understated Accidentally

posted by Lawrence Cunningham

The State of Delaware, often seen to compete to attract the chartering of businesses, makes a strange pitch for its Chancery Court, one that seems intended to brag suitably but which accidentally is watered down to the trivial:

The Delaware Court of Chancery is widely recognized as the nation’s preeminent forum for the determination of disputes involving the internal affairs of the thousands upon thousands of Delaware corporations and other business entities through which a vast amount of the world’s commercial affairs is conducted.

The statement (my emphasis added) meant to say that the Chancery Court is among the best business law courts in the country, probably true.  Instead it says that the court is the best at a narrow specialty: the internal affairs of business entities chartered in Delaware (which, it then notes, are important in global commerce).

The next sentence tries to make up for the modesty, but it both comes too late and overstates with its use of the words “unique” and “unmatched”:

Its unique competence in and exposure to issues of business law are unmatched.

Government officials charged with promoting Delaware’s business sophistication need a rewrite.

  March 30, 2013 at 8:32 pm   Posted in: Corporate Law   Print This Post   No Comments

Defending Citizens United?

posted by Jay Kesten

My thanks to Danielle and her co-bloggers for inviting me to share some of my thoughts.  This is my first foray into blogging, and I’m thrilled to join you for awhile.  I’d like to start by discussing a current project, which examines the internal governance of corporate political activity.  Comments, suggestions and critiques are most welcome.

Corporate political activity has long been an exceptionally contentious matter of public policy.  It also raises a hard and important question of corporate law:  assuming corporations can and will engage in political activity, who decides when they will speak and what they will say?  In several cases, the Supreme Court has provided a relatively clear, albeit under-developed, answer:  ”[u]ltimately, shareholders may decide, through the procedures of corporate democracy, whether their corporation should engage in debate on public issues.”  (First Nat’l Bank of Boston v. Bellotti, cited with approval in Citizens United v. FEC).

This corporate law aspect of the decision has attracted substantial criticism alongside widespread calls for major reforms to corporate and securities laws.  Some argue that the Supreme Court misunderstands the reality of modern corporate law, insofar as shareholders have little practical ability to constrain managerial conduct.  Others question why political decisions should be made by either shareholders or managers, rather than some broader group of corporate stakeholders.  A third group claims that political activity is just another corporate decision protected by the business judgment rule.  Thus, empowering shareholders in this regard would improperly encroach on the board’s plenary decision-making authority.

Yet, despite these concerns, there may be pragmatic and normative merit to the Supreme Court’s approach.  In a current paper – “Democratizing Corporate Political Activity” – I present a case for shareholder regulation of corporate political activity through their power to enact bylaws.  I’ll describe the argument in more detail in subsequent posts, but, briefly, I present three normative justifications for this governance structure.  First, it may mitigate the unusual and potentially substantial agency costs arising from manager-directed corporate political activity.  Second, it may increase social welfare by: (i) reducing deadweight losses and transaction costs associated with rent-seeking; and (ii) making corporations less vulnerable to political extortion.  Third, if corporate speech can shape our society’s distributional rules, corporate law should not interpose an additional representative filter in the democratic process.  That is, we should not assume that investors – merely by purchasing stock in a public company, often through an intermediary such as a mutual fund – grant managers the unilateral authority to engage in political activity on their behalf.

With that said, I should be clear upfront that there are important challenges and objections to each of these arguments.  I will describe the main concerns as I proceed.

The next post will lay out the Supreme Court’s vision of corporate political activity, and explain why the shareholder bylaw power best fits the Court’s description of shareholder democracy in this context.

  March 30, 2013 at 7:57 pm   Posted in: Corporate Law, Legal Theory, Political Economy, Politics   Print This Post   2 Comments

Why Other People’s Money is The Best Hollywood Film About Business

posted by Lawrence Cunningham

Go down the list of Hollywood films about business and you will find one biting portrayal of capitalism after the next. As the late Larry Ribstein documented and explained, all of the following movies and most other artistic renderings have this biased flaw: Erin Brockovich, A Civil Action, The Constant Gardner, Blood Diamond, Michael Clayton, Pretty Woman, Wall Street (or take older examples such as Dinner at Eight or The Hudsucker Proxy or those once listed by Forbes as epitomizing this genre, such as Citizen Kane, The Godfather, It’s A Wonderful Life, Glengarry Glen Ross).  

That’s why I find Other People’s Money (1991) refreshing, and probably the best Hollywood film about business (contrary to dominant, contending, opinion).  The movie is among the few nuanced artistic portrayals of corporate life. The play, and the movie it became, presents two sides of the story when conflicts arise between economic imperatives and socially pleasant outcomes. That’s why I often assign the film as part of my course in Corporations (hello students!).

OPM pits against each other two men seeking to control the destiny of an ailing New England family company in the dying industry of manufacturing wire and cable: a greedy and creepy takeover artist called Larry “the Liquidator” Garfield (in the film played by Danny DeVito) and the patrician lord of the target company named Jorgenson (Gregory Peck, making for perfect casing of both roles). 

Garfield opens with a monologue celebrating money, along with dogs and doughnuts, and denigrating love and basic human kindness. In his first encounter with Jorgenson, Garfield announces that the New England company is worth “more dead than alive.”

Jorgenson sniffs at such short-termism, stressing moral aspects of business life, and refuses either to pay Garfield to go away or borrow money to navigate through the difficult times. Garfield counters with assertions about free enterprise, Darwinian markets and the imperatives of business change.

The drama pursues this contrast between “doing right” and “doing well” through a proxy fight for corporate control. It climaxes with an exchange of speeches at a special meeting of shareholders.  Read the rest of this post »

  March 25, 2013 at 3:10 pm   Posted in: Corporate Law, Culture   Print This Post   3 Comments

Auditing’s Snafu: Foreign Secrecy and Impaired Audits

posted by Lawrence Cunningham

Many US companies maintain substantial global operations, with increasing volumes of business done in China; many foreign companies are listed on US securities exchanges.  This cross-border expansion makes the reliability of financial reports created in foreign locales increasingly important.  Yet, in tandem with this cross-border expansion, there have been increasing assertions abroad, including in China, that local secrecy laws restrict access to the work papers of auditors, frustrating the ability of US federal authorities to enforce US securities laws designed to promote financial reporting integrity.

The snafu was joined this week in a case where the SEC is seeking access to audit work papers of a Deloitte affiliate in Shagnhai but the firm refuses.  The firm’s lawyers cite Morrison v. National Australia Bank, the 2010 SCOTUS ruling that, absent explicit language, federal statutes are seen as intended to apply within the US, not be extraterritorial.  It said that the federal securities laws lacked such explication.   

Furthermore, for Deloitte to comply with the SEC’s requests, the lawyers said, would risk committing a serious crime under Chinese law, one punishable by imprisonment. Deloitte’s lawyers say that the combination of Morrison and Chinese secrecy laws puts the records beyond the SEC’s reach.

Lawyers for the SEC object that these points cannot possibly be seen to limit the SEC’s administrative subpoena power under which it has demanded the Deloitte documents. But, during oral argument, the SEC’s lawyers did not acquit themselves well, according to one report, as they could not readily cite the precise legal authority supporting their position. 

Deloitte says there isn’t one and that the appropriate procedure to handle such cross-border securities matters is by diplomacy not enforcement. In this view, the SEC is wrong to proceed against Deloitte in court but must dispatch appropriate US officials to broker a resolution with Chinese regulatory counterparts.

The stakes are high for both sides in the case, of course, and for investors and students of auditing. After all,  audits endow financial statements with credibility. Shareholders are willing to pay for audits in exchange for that credence value.  But if an auditor’s work papers are top secret, inaccessible even to a regulatory overseer, how much of an audit’s credence value is lost? Is it still rational for shareholders to condone paying the auditor’s fee?

When the credibility of financial statements are in doubt, investors should shun their issuer and sell the stock.  A critical mass of shareholders of companies affected by this snafu might do well to follow that old-fashioned Wall Street Rule. If they did, then, along with such companies, the need to resort to either a diplomatic or enforcement solution would disappear. Read the rest of this post »

  March 15, 2013 at 4:22 pm   Posted in: Accounting, Administrative Law, Corporate Law, Securities Regulation   Print This Post   No Comments

The Essays of Warren Buffett: Third Edition

posted by Lawrence Cunningham

It’s a pleasure to report that this weekend marks the release of the third edition of The Essays of Warren Buffett: Lessons for Corporate America.  Originally published as the centerpiece of a symposium sponsored by Cardozo Law Review in 1997 at which Warren Buffett debated 20-some law professors (listed after the jump) on every important issue facing corporate America, this book is a thematic arrangement of Buffett’s annual letters to the shareholders of Berkshire Hathaway from 1977 to the present.

As I explain in my Introduction,  the central theme uniting Buffett’s essays is that the principles of fundamental business analysis, first formulated by his teachers Ben Graham and David Dodd, should guide investment practice. Linked to that theme are management principles that define the proper role of corporate managers as the stewards of invested capital, and the proper role of shareholders as the suppliers and owners of capital. Radiating from these main themes are practical and sensible lessons on the entire range of important business issues, from accounting to mergers to valuation.

The book has particular significance for devotees of behavioral economics who are skeptical of strong claims about market efficiency, as the book provides both the philosophical architecture of value investing and the intellectual defense of that practice, which distinguishes sharply between price and value.
Read the rest of this post »

  March 14, 2013 at 6:00 am   Posted in: Accounting, Book Reviews, Corporate Finance, Corporate Law   Print This Post   No Comments

Word Clouds of Buffett’s Letters

posted by Lawrence Cunningham

Here are word clouds I created to visualize words Warren Buffett used most frequently in two of his famous letters to Berkshire Hathaway shareholders, the first based on his newest letter (2012, released Friday) and the second based on his oldest (1977).

The word “billion” has (inevitably) replaced the word “million;” Charlie (Munger) has assumed a preeminent position; acquisitions matter greatly now but not then; insurance float matters more in 2012 while insurance underwriting mattered more in 1977; BNSF and GEICO are big today, along with newspapers, not the textile company or trading stamp business as was true back then.  Quite a few other changes should be obvious as well.  Among the similarities: the centrality of earnings to discussions of corporate performance (particularly as compared to cash flow or dividends).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Read the rest of this post »

  March 3, 2013 at 3:19 pm   Posted in: Corporate Finance, Corporate Law, Current Events   Print This Post   No Comments

Volume 60, Issue 3 (February 2013)

posted by UCLA Law Review

Volume 60, Issue 3 (February 2013)

Articles

Urban Bias, Rural Sexual Minorities, and the Courts	Luke A. Boso	562
Private Equity and Executive Compensation	Robert J. Jackson, Jr.	638
The New Investor	Tom C.W. Lin	678

Comments

The Fate of the Collateral Source Rule After Healthcare Reform	Ann S. Levin	736
A New Strategy for Neutralizing the Gay Panic Defense at Trial: Lessons From the Lawrence King Case	David Alan Perkiss	778

  February 27, 2013 at 10:25 pm   Posted in: Corporate Finance, Corporate Law, Criminal Law, Health Law, Law Rev (UCLA), LGBT, Race   Print This Post   No Comments

The Dell and Apple Cash Problems

posted by Lawrence Cunningham

As Apple’s board and shareholders fight over what to do with the oceans of cash the company has accumulated, it’s usful to compare another tech company in the news, Dell, which also boasted substantial accumulated cash.  Drawing the connection is David Einhorn, the Apple shareholder trying to pressure Apple’s board into issuing new preferred stock with a perpetual cash dividend as a way to distribute vast portions of its cash.  

Einhorn was a large shareholder in Dell through last year when he tried to persuade that company’s board to revise its policy on cash retention versus dividends.  According to Einhorn, he grew frustrated with Dell’s stubbornness and eventually gave up by following the old-fashioned Wall Street Rule: selling the stock and thus exiting his position.  

As Einhorn tells it, that disagreement, along with similar disappointment of other large shareholders, contributed over the ensuing year to the downward pressure on Dell’s stock price.  The result is a price so low that, lo-and-behold, the time came for company founder and 16% stockholder Michael Dell to propose to acquire the company in a leveraged buy out that will, in effect, now use hoarded cash to support the deal.  Einhorn is clearly upset with this turn of events.  

The Dell part of Einhorn’s Apple story is a pretty clear threat to Apple’s board: he will try to influence Apple’s cash/dividend policy for a while, hoping to win; if he does not succeed within short order, however, he can follow the Wall Street Rule and sell the stock.  

It’s a high-stakes threat. Apple’s board may prefer to get rid of Einhorn, a thorn in their side, which they can apparently count on whether they change Apple’s cash policy or not.  

  February 25, 2013 at 9:05 am   Posted in: Corporate Law   Print This Post   No Comments

Einhorn v. Apple: Round One Technical for Einhorn

posted by Lawrence Cunningham

In corporate law, there are two broad strategies shareholders can adopt to challenge board action: a substantive claim that decisions breach fundamental fiduciary duties and a technical claim that decisions violate the machinery of corporate statutes, regulations, charters, bylaws or contracts. Shareholders often find that they lack strong substantive grounds and therefore pursue technical ones and vice versa. Such is the story of the shareholder David Einhorn’s campaign against the board of directors of Apple, Inc., a California corporation, round one of which went today to Einhorn on technical grounds.

The substantive fight is about how Apple should allocate substantial accumulated cash, running to some $140 billion. The board wishes to retain it; the shareholder wants it distributed to shareholders. Einhorn envisions using a specific approach to distributing the cash that would involve the issuance of a new class of preferred stock to existing shareholders with a stated cash dividend. Einhorn has no right to direct the board on such a matter and any claim challenging the board’s decision would be decisively dismissed. In fact, I cannot imagine any reputable attorney filing such a suit. Boards, not shareholders, set dividend policy.

So Einhorn’s lawyers turned technical, generating a high-visibility fight over arcane laws governing proxy statements such as Apple had recently circulated ahead of its upcoming annual meeting. One proposal indirectly addresses Einhorn’s idea of having the Apple board create a new class of preferred as a vehicle to make the distribution he seeks.

The proposal is to amend Apple’s charter to eliminate a provision giving the board the unilateral power to issue new classes of preferred stock on such terms as the board chooses. Absent such a clause, any such issuance would require a shareholder vote.

Apple’s board made this proposal for reasons that have nothing to do with Einhorn’s campaign. Such blank check preferred, as the vernacular calls it, has historically been seen as a strong pro-management device, not pro-shareholder, as it gives a board vast unilateral power ordinarily shared with shareholders. In fact, many Apple shareholders, including the large institutional investor and governance advocate, CalPERS, have long sought just such a proposal.

Again, Einhorn does not and cannot challenge the proposal in substance, because it is a perfectly legitimate proposal for a board to make and one that many shareholders have long championed. So Einhorn’s lawyers drilled to even deeper technical law. Federal securities regulations fashioned by the SEC say that when companies put proposals for shareholder votes they cannot bundle numerous different proposals together but must put each up for a vote. (SEC, Proxy Rule 14a-4.)

When Apple published its proxy statement earlier this year, it had decided to treat the amendment of its charter as a single topic, within which a few different proposals were indeed clustered. In addition to repealing the blank check preferred, the proposal requires majority voting for directors (another pro-shareholder reform proposal long-sought at many companies by institutional investors) and establishing a par value for the company’s stock of $0.00001 per share (a highly-technical change).

A federal judge today said Apple is not allowed, under the SEC rule, to bundle those charter amendment proposals into one, handing Einhorn a technical victory. Apple’s CEO calls the case a silly side show. Einhorn is boasting of victory. Who is right?

The technical procedural machinery of corporate governance often works in strange ways to give shareholders avenues of redress that substantive fiduciary duty law cannot handle. Statutes, regulations, charters, bylaws, and contracts set the rules and allocate power in ways that all must respect. Apple’s proposed charter amendment has nothing to do with the wisdom or prudence of what to do with all that $140 billion in cash. But Einhorn and the Apple board do have differing business judgments and both are allowed to use all that machinery to battle for the policy they favor.

In a way, Einhorn and Apple’s CEO are both right. Einhorn won this technical round but the substantive power about the dividend policy remains firmly in the board’s hands.

  February 22, 2013 at 10:00 pm   Posted in: Corporate Law   Print This Post   7 Comments

Dodge v. Wholefoods?

posted by Dave Hoffman

Like many corporate law teachers, I have mixed views about the old chestnut of Dodge v. Ford.  On the one hand, it’s very quotable. On the other, shareholder wealth maximization is a normative goal, not a rule with teeth.  Still you go to war with the data you have.

Now we’ve more data – useful for an exam fact pattern, at least!  An alert student (thanks, C.M) found this choice quote in a recent interview of Wholefoods CEO John Mackey:

“JOHN MACKEY: I think that Whole Foods does have higher purposes. We take them very seriously. We don’t exist primarily to maximize profits.

We’re fulfilling the mission that we set for ourselves of helping people to live healthier lives, to hopefully reverse this obesity crisis we have in America. Whole Foods does feel this sense of responsibility to try to make a difference. And that filters through our team member base to our customers. We really are united around kind of our mission as an organization. That really makes a difference.”

Now, obviously this is a branding statement – which could be interpreted as a way to make money by convincing customers to pay more for fruit than they ought to.  And maybe nothing Mackey says should be taken very seriously. See, e.g., fascism & sockpuppets. Indeed, he’s certainly said CSR-like things like this before.  But it’s still striking to see a CEO say essentially what Henry Ford said (and was punished for saying) in Ford v. Dodge. In the interview, Mackey also was asked about why his perspective is rarely articulated by CEOS.  Check out his answer after the jump.

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  February 15, 2013 at 11:45 am   Posted in: Corporate Law   Print This Post   3 Comments

DPAs and Corporate Governance

posted by Lawrence Cunningham

In this season’s law review submission process, I am circulating an article about deferred prosecution agreements (DPAs) and corporate governance.    DPAs are controversial tools increasingly-used to settle corporate criminal cases, usually without indictment. Targets admit facts, pay fines and promise governance reforms—such as replacing officers, adding directors and prescribing reporting lines.

Some view DPAs as coerced extractions of overzealous prosecutors, while others say they are mere whitewash that let corporate crooks off the hook. The weight of commentary urges prosecutors to get out of this business, to avoid corporate governance entirely, while some wonder why the intrusions are not deeper and more frequent.

I explain why prosecutors should invest in corporate governance and take a measured approach to reforming it. Ignoring governance can be perilous and embracing it can produce more effective reforms.

My diagnosis indicates a lack of both investment and transparency so I make two prescriptions: prosecutors should profile the corporate governance of businesses they target at the outset and publicly articulate rationales for reforms when settling.

The paper first surveys the landscape of contemporary corporate governance, stressing two normative points. First: one-size-does-not fit all. Corporate governance varies enormously from company to company, depending on such factors as ownership structures, management characteristics and employment policies. Second: failure to appreciate that poses serious risks, always to given companies, and sometimes to the economy at large.

That is the proper lesson to draw from the 2002 case of Arthur Andersen, where an indictment destroyed the auditing firm because it was a partnership owned and managed by its members in the veracity business.

Instead, prosecutors took a broader and cruder lesson: that they should always be averse to indicting any large business. The result of that aversion has been the proliferation of DPAs—which, despite controversy and criticism, is not necessarily a bad effect, so long as these lessons are incorporated into their production.

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  February 10, 2013 at 11:44 am   Posted in: Corporate Law, Courts, Criminal Law, Criminal Procedure, Current Events   Print This Post   2 Comments

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