Category: Corporate Law

5

A Global Financial Regulator?

Barney Frank, who will likely take over the House Financial Services Committee if the Democratics win next week, has this to say to the Financial Times about regulatory cooperation:

‘Doesn’t that sound like fun,’ Mr Frank said . . . ‘Joint action is theoretically [good] but what does that mean? In American baseball, if the runner and the ball arrive at the base at the same time, the tie goes to the fielder. Who breaks a tie if there is a disagreement over policy between the SEC and FSA?’

Asked if a supra-national regulator would be needed, he told the Financial Times: ‘I don’t know. At this point that’s something to look into.’

Those are some scary words for folks who are already worried about the federalization of corporate law. About SOX itself, Frank said:

[T]he idea that Sarbox could be more widely applied abroad was “not going to happen” because it was being watered down in the US.

Business and financial leaders in Europe continue to fret about the possibility that Sarbox could find its way to the UK and elsewhere through the back door, such as if a stock exchange in the US acquired one in the UK.

Asked if Europeans were justified of such concerns, Mr Frank said: “It’s not going any further. Six months from now it will be less of a burden for companies than it is today.” His view reflects a belief in Washington that Sarbox should not be changed through Congress.

Instead, the two regulators responsible for overseeing how it is implemented – the SEC and Public Company Accounting Oversight Board, the accounting watchdog – should clarify how sections of the law should be implemented.

4

CEOs, Just Cause, and $$$$

With the Disney case and now Grasso grabbing headlines, disputes over large payouts to former corporate executives have garnered great attention of late. Last week, another such dispute boiled to the surface, this time in the form of an appeal from an arbitration award in favor of Robert J. O’Connell, the terminated former CEO of MassMutual Financial Group. Sample media accounts can be found here, here, and here.

According to these stories, MassMutual’s allegations of O’Connell’s wrongdoing included, among other things, having affairs with several female employees, making $23 million on questionable “shadow” stock trades, intervening to prevent disciplinary actions against family members who held senior positions, and buying a fancy company-owned condo at a below-market price. The arbitration panel found that MassMutual failed to prove some of these allegations, failed to adhere to procedures for termination set forth in O’Connell’s contract, and otherwise failed to demonstrate just cause as defined in that contract. The panel did find that the firm was entitled to a return of the $23 million. Nevertheless, it awarded O’Connell compensation under the agreement worth between $40 and $50 million. MassMutual is now seeking to overturn the award in a Massachusetts court.

Without more information, we can’t tell whether the arbitrators got it right or wrong, but let’s focus instead on the contract itself. Here is how one report described the substantive portion of the just cause provision:

According to O’Connell’s contract he signed in 1998 when he joined MassMutual, he could be fired for a criminal conviction, theft or embezzlement, as well as for “conduct that constitutes willful gross neglect or willful gross misconduct … resulting in material harm to the company.”

Assuming this description is accurate, the term smacks of board of director abandonment of core principles of corporate governance. While there are many just cause provisions in employment contracts that are not the least bit problematic, this is the CEO we are talking about, this is quite a just cause provision, and the compensation at stake is, well, large.

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27

Sentenced to 24 Years

The news of the day is Jeff Skilling’s 24-year sentence. The outrage level in the blawgosphere is at DEFCON 1.

Ellen Podgor:

But I don’t think we will see sentences like this in the future because people will eventually realize the worthlessness of issuing such draconian sentences in non-violent white collar cases. The bottom line is that these sentences are not likely to deter future criminality, as many who engaged in the conduct just did not see themselves as committing crimes.

Peter Henning:

While Jeffrey Skilling receives 24 years for presiding over the collapse of Enron, former Congressman Randy (Duke) Cunningham sells his office to a string of defense contractors for a bit over $1 million and receives a sentence of 8 years. Soon-to-be former Congressman Bob Ney will likely be sentenced to less than 3 years in prison for selling out his office to lobbyists led by Jack Abramoff. How can there be such a disparity between the sentences for public corruption and the corporate frauds perpetrated by Ebbers and Skilling? The harm from public officials, especially those elected to office, who abuse their positions for personal gain is, in my opinion, nearly as great as that caused by corporate chieftains who preside over collapsing companies.

Larry Ribstein:

Judge Lake may well have correctly applied the law by supposing that Skilling was tied to $80 million in investor losses. But to quote Mr. Bumble, who was told that the law supposed that his wife acted under his direction, “if the law supposes that, the law is a ass—a idiot.”

Christine Hurt:

Judge Lake explained that the sentence was proportionate to the crime because Skilling effectively sentenced “hundreds, if not thousands,” to a “life sentence of poverty.” I think I would quibble with that statement, but I guess that’s for another post.

Note that Skilling gets the pain of a long sentence without even the solace of “one for the record books.” To be known as the holder of the longest white-collar crime sentence, Skilling would have had to receive a sentence of 25 years and a day.

I disagree with much of these laments against the Enron prosecution, for reasons I have already discussed. Twice. To put the sentence itself in perspective, I thought it would be fun to google “sentenced to 24 years” and see what I came up. And the results were, predictably, random. A cop who stole drugs, a Dynergy executive (for accounting fraud, later reduced to six years), a retail level drug dealer, a woman busted (allegedly) for holding merely 2.72 g of cocaine, and the significant other of another large drug dealer, convicted for conspiracy.

The message: federal time is hard time for lots of folks, convicted of many nonviolent offenses, in circumstances where deterrence isn’t (necessarily) a strong argument for punishment. Indeed, I’d bet that most of the time spent in federal prison is for “nonviolent” crime, in that sentence enhancements for possessions of firearms and drugs dominate over bankrobbery.

If we think that violence and responsiveness to punishment are the only way to justify long sentences, why not be outraged about such punishments every day? Moreover, it seems to me that Skilling isn’t being punished for going to a jury (while others took the plea discount). He’s being punished because the jury disbelieved his testimony.

6

Legal Scholarship and the Nixon Effect

nixon.jpgLegal thinking often seems to be cyclical. Constitutional law scholarship provides (to my ignorant outsiders perspective) a clear example of this. In the 1960s and 1970s the law reviews were filled with articles exalting the role of the courts as guardians of liberty and searching for various jurisprudential philosophers’ stones that would allow the courts to bestow items from the liberal wish list upon the nation e.g. constitutionally mandated rights to welfare payments, etc. The country, however, had the bad manners to proceed along its own political path without reference to the concerns of the legal academy and five GOP presidents to two Democratic presidents later, the federal judiciary is filled with conservatives. Academic panegyrics to judicial modesty and minimalism according sprout like mushrooms. There is, of course, the temptation to see such a cycle in crassly political terms, and perhaps have the bad manners to suggest that left-of-center constitutional law professors are simply modifying their jurisprudential theories in the face of right-of-center election results.

Private law scholarship is also prone to its own intellectual cycles. In the 1970s, Grant Gilmore was confidently predicting the Death of Contract and Farnsworth and his associates were putting the finishing touches on the second Restatement, which confidently set out to deliver us from the horrid formalism of Williston’s work. The gentle establishment liberal sanity of the Legal Process movement seemed to reign supreme, troubled only by the pesky legal economists, whose influence Morton Horton Horwitz assured us peaked in about 1980. Fast forward twenty-five years, and one can read defenses in the Yale Law Journal of formalistic contract interpretation that Williston never imagined of in his headiest pre-Realist dreams. Of course here too, there are crassly political explanations. Flinty-hearted Chicago-school economists are no doubt more attracted to private law subjects like contracts or corporations rather than the intricacies of substantive due process. Furthermore, more than one aspiring conservative legal academic has been advised to go into business law by Federalist Society elders on the grounds that it constitutes a kind of safe preserve for right wingers. Finally, the results at the elections have given ambitious projects for say consumer protection the same surreal feel as articles arguing that the courts should announce a constitutional right to welfare payments. It ain’t going to happen, so why bother?

For all of the fun involved in spinning out political stories to account for the cycles of legal thought, however, there is a simpler academic imperative at work. There is a sense in which young scholars have no choice but to slay their elders. Writing an article saying “amen” to the reigning theoretical consensus is probably not the route to tenure and academic fame. Hence, the discredited ideas of one generation are going to inevitably find their champions in the next generation for the simple reason that no scholar wants to write articles saying “Me too.”

Think of it as the Nixon effect. When he left office the intellectual consensus on Nixon was overwhelmingly negative. Not surprisingly, Nixon’s reputation has risen with time for the simple reason that no one is interested in a new book suggesting that Nixon is a crook, but a book suggesting that Nixon wasn’t so bad after all will get some attention. Not to worry. In the fullness of time, a consensus in favor of a more positive view of Nixon will develop, and some young Turk historian will make his reputation by pointing out that at the end of the day Nixon was a lying, paranoid, un-indicted co-conspirator.

1

Corporate Internal Affairs and the Constitution

Many thanks to Dan and the others at Co-Op for inviting me to visit for a few weeks.

Along with most everyone else, I have been waiting for months to see which cases the Supreme Court would review. One I have been watching is Moores v. Friese, No. 05-1590, a matter that has intrigued others, including Christine Hurt and Larry Ribstein.

Well, today the new term begins and . . . petition denied. Fair enough, but there is still a story here.

The case is a suit by a litigation trustee of Peregrine Systems, a Delaware corporation based in California, against various insiders under a California insider trading statute that allows the issuer to sue insiders and potentially recover treble damages. A central issue is whether the California provision applies because, under the “internal affairs doctrine,” the law of the state of incorporation normally governs internal conflicts among a corporation’s shareholders, directors, and officers. The California Court of Appeals, 36 Cal. Rptr. 3d 558 (Ct. App. 2005), reinstated these claims after concluding that this provision does not address internal affairs because it is more akin to blue sky (securities market) regulation. The California Supreme Court denied review.

The contours of the internal affairs doctrine under California law is fascinating stuff, but this is no reason for the U.S. Supreme Court to get involved. That is, of course, unless (1) this insider trading provision necessarily falls within the doctrine, and (2) California’s adherence to it is constitutionally mandated under the dormant commerce clause or due process clause. The cert petition presented this theory, and it was endorsed in an amici curiae brief filed by the U.S. Chamber of Commerce and others.

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0

The “Academic Business Judgment Rule”

Larry Ribstein is ruminating on recent flack he’s taken for his posts [here and here] on Ken Lay’s accountability. I think (or hope) that he is referring to posts like mine when he says:

I’m dubious about the use of criminal law for the sort of non-Vesco crimes Lay was convicted of, and think that a life sentence for such crimes belongs in the “foolish” category. But this sort of thinking is protected by what one might call the academic business judgment rule, and it’s not the pathology I’m discussing here.

He also suggests that some anti-capitalist sentiment is “ingrained.” Overall, Larry’s post is well worth a read. I very much endorse the idea that the aspect of academic freedom most worth defending is the freedom to be apparently wrong!

3

18th Century Venture Capitalists

dismal.jpgAs I posted earlier, of late I have been reading Virginia history. I have one title to suggest: Charles Royster, The Fabulous History of the Dismal Swamp Company. It is an tremendously detailed history of one of the great 18th century land speculations, the attempt to drain and sell the Great Dismal Swamp on the Virginia-North Carolina border. George Washington was one of the movers and shakers in the company, but other characters in the story include names like George Wythe, Richard Henry Lee, Patrick Henry, and a host of other luminaries from the American Revolution, as well as lesser known names like Christopher Gist, a Virginia merchant who helped to found Lloyd’s maritime insurance business.

Royster is a good writer and — for me at least — the narrative works nicely. The research represented by the book is awe-inspiring and the result is an enormous wealth of detail about everything from family politics (everyone who was anyone is colonial Virginia was related to everyone else) to imperial politics. At the center of the story, however, is what amounts to a venture capital deal.

To me one of the most fascinating parts of the story is the role that the events of the American Revolution play in it. The Dismal Swamp Company was founded as the Seven Years War (aka the French and Indian War) was coming to an end and its story twists through the years leading up to independence. Furthermore, given the vast scale of the project it inevitably became entangled in colonial and ultimately metropolitan politics. Hence, the events of the Revolution play out in the story, but in a new angle. They are not at center stage. Rather, the Stamp Act and Patrick Henry’s fiery speeches in the House of Burgesses are secondary characters who come on and off stage only as they impact the unfolding drama of the deal.

If one sees history in legal terms, the plots are often structured around public law stories in general and constitutional ones in particular. Royster’s book is, in a sense, the private law story of the American Revolution. He is not a legal historian, but the law is hardly a bit player in his story. The drama, however, centers less around constitutional arguments about rights and representation than around bills of exchange, maritime insurance contracts, mortgages, debts, collection actions, wrangles over title to land, corporate governance, and the like, all of which propel the characters in the story via various complicated paths to ruin or fortune.

Definitely worth reading.

8

Wild KPMG Fees Decision

Barely one day old, and Gonzalez-Lopez is already making waves in corporate law. To see the connection, however, you’ll have to bear with me for a bit of brush-clearing.

Judge Lewis A. Kaplan (S.D.N.Y.) today ruled on certain individual defendants’ motions to dismiss an indictment arising from the KPMG tax shelter investigation. (Large pdf here.) According to the defendants, their due process rights were violated when the U.S. Attorney pressured their former employer (KPMG) not to advance and reimburse legal fees incurred as individuals defendants. Judge Kaplan found a due process violation, scolded the government, and suggested a new lawsuit against KPMG to recover those legal fees, in which today’s decision would have collateral effect and make the proceedings summary. In short: the decision seems to constitutionalize the right to receive indemnification from your employer.

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4

The Disney Opinion and “Not in Good Faith”

As I noted earlier today, I thought, upon first read, that the Delaware Supreme Court’s Disney opinion from yesterday dealt a fatal blow to my “not in good faith” director liability argument. For those who missed it the first dozen times, I maintain that a complaining shareholder who is suing her directors, alleging that the directors failed to act in good faith, does not *have* to go so far as to prove “bad faith” acts by her directors, but, rather, she can point to the absence of good faith acts on which to pin liability. The phrase “not in good faith,” I maintain, does not mean (only) “bad faith.” Under my “not in good faith” theory of liability, directors who basically abdicate their duty or bury their heads – which are acts arguably short of bad faith acts – have violated their fiduciary obligation to act “in good faith.” And I thought that when I read the Disney opinion yesterday that the Delaware Supreme Court was boxing me in by maintaining narrowly that “not in good faith” only meant “bad faith.” Not so, it seems.

I had forgotten, when I first read yesterday’s opinion, that sometimes Delaware opinions take a second or third read before one can glean their full import. Such was the case with Disney. While I *thought* that the Disney opinion supported the position that my broad “not in good faith” category had no place in Delaware fiduciary jurisprudence, I was very wrong. More clearly, despite frequently invoking the phrase “bad faith” in the actual holding of the case, the Delaware Supreme Court in Disney did not say that a plaintiff shareholder who was trying to establish that a director acted without good faith in violation of her fiduciary obligations must prove “bad faith.” Quite the opposite: when the court discusses (in what I would call “dicta”) three categories of troublesome director behavior, the third category discussed appears to be almost exactly the same as the Nowicki Not-In-Good-Faith category! And that third category is (a) a category distinct from the court’s “bad faith” category (see below) and (b) a category that deals with liability-meriting behavior!

Allow me to explain in more detail:

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0

The Nowicki “Not In Good Faith” Manifesto LIVES ON!

I first read and posted about the Disney opinion last night. At that time, I all but agreed with Gordon Smith that the Delaware Supreme Court had shut down my “not in good faith” argument. (For those of you who somehow missed the first several recitations of my theory, my view is that the phrase “not in good faith” (as it pertains to the business judgment rule presumption and DGCL 102(b)(7)) means something DIFFERENT than “bad faith.” My view is that acts “not in good faith” INCLUDE bad faith acts, but there is also a narrower additional category reached by “not in good faith.” Essentially, Caremark-esque cases would fit into the “not in good faith” category.)

What I had forgotten, however, was that Delaware jurists are crafty. (I discussed this recently on the wonderful Truthonthemarket blog.) So, while it SEEMED to Gordon that the Nowicki “Not in Good Faith” theory could not live on, and I agreed with his pronouncement because I was weak with illness and I only had the strength to read the 89 page opinion *one* time instead of the requisite three, I now find, on my third read of the Disney opinion, that my “not in good faith” theory, much like a cockroach, has largely survived the Disney fall-out.

More on this later.