Category: Corporate Law


Delaware Chancery Court’s Role Understated Accidentally

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.


Defending Citizens United?

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.


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

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 dominantcontending, 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.

Jorgenson acknowledges the financial losses currently facing the company, stressing that they are due to the rise of fiber optics that impaired demand for wire and cable.  But he makes the pitch for tradition, loyalty, and sticking with the company and its employees through tough economic patches.   Admitting that the company’s niche business may have become anachronistic, he argues that it will be able to re-purpose itself and prosper over the long term, if only everyone would be patient.

Jorgenson lambasts Garfield as a mere money-man who gets rich by using other people’s money yet “creates nothing, builds nothing, runs nothing.” He gets a standing ovation when thundering against

 murder in the name of maximizing shareholder value, substituting dollar bills where a conscience should be. . . . A company is more than money. Here we build, we care about people.

Garfield follows by saying “Amen,” and calling Jorgenson’s plea to save the company a mere prayer, one that fails to appreciate earthly economic reality, essentially referencing Schumpeter’s famous principle of “creative destruction.” Fiber optics rendered wire and cable obsolete and the best thing to do is recognize that fact, sell off the company’s remaining assets, and move on. He explains:

This company is dead. I didn’t kill it; it was dead when I got here This business is dead, let’s have the decency to sign the death certificate and invest in the future. Who cares [about the employees]? They didn’t care about you. . . . Employee wages went up way more than stock. Who cares? Me. I’m your only friend. I’m making you money; that’s the only reason you became shareholders. You want to make money, invest somewhere else, create new jobs. . . At my funeral you’ll leave with a smile on your face and a few bucks in your pocket – that’s a funeral worth having.

Who wins?  [Spoiler Alert: Answer Coming.]

The shareholders vote with Garfield, siding with a capitalist over Jorgenson’s impassioned plea for broader concerns. That is somewhat unusual in Hollywood films about business, where the capitalist’s argument rarely carries the day.

Here the referendum accepts that what may be the downside of capitalism, short-term effect on employees and communities, can be outweighed by its salutary long-term effects of moving forward on a clean slate towards ultimately brighter futures all the way around. It turns Jorgenson’s view of the long-term around on itself.

On the other hand, the Hollywood film version of the art adds a scene that did not appear in the stage version: Garfield falls in love with Jorgenson’s daughter and the two hatch a plan to sell the dying firm to its employees who will then repurpose it along the lines Jorgenson envisioned. A happy ending is snatched from the jaws of creative destruction after all.  As Larry Ribstein wrote in his assessment of this twist, which thus ultimately does not stray too far from Hollywood’s favored pathways: “Capitalism is acceptable only if it has a heart.”



Auditing’s Snafu: Foreign Secrecy and Impaired Audits

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 More


The Essays of Warren Buffett: Third Edition

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.
UPDATE:  Read More


Word Clouds of Buffett’s Letters

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).


Buffett 2012 Letter Word Cloud



Buffett 1977 Letter Word Cloud














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Volume 60, Issue 3 (February 2013)

Volume 60, Issue 3 (February 2013)


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


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

The Dell and Apple Cash Problems

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.  


Einhorn v. Apple: Round One Technical for Einhorn

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.


Dodge v. Wholefoods?

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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