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.
posted by Stanford Law Review
The Stanford Law Review Online has just published an Essay by Daniel Crane entitled Has the Obama Justice Department Reinvigorated Antitrust Enforcement?. Professor Crane assesses antitrust enforcement in the Obama and Bush administrations using several empirical measures:
The Justice Department’s recently filed antitrust case against Apple and several major book publishers over e-book pricing, which comes on the heels of the Justice Department’s successful challenge to the proposed merger of AT&T and T-Mobile, has contributed to the perception that the Obama Administration is reinvigorating antitrust enforcement from its recent stupor. As a candidate for President, then-Senator Obama criticized the Bush Administration as having the “weakest record of antitrust enforcement of any administration in the last half century” and vowed to step up enforcement. Early in the Obama Administration, Justice Department officials furthered this perception by withdrawing the Bush Administration’s report on monopolization offenses and suggesting that the fault for the financial crisis might lie at the feet of lax antitrust enforcement. Even before the AT&T and Apple cases, media reports frequently suggested that antitrust enforcement is significantly tougher under President Obama.
For better or worse, the Administration’s enforcement record does not bear out this impression. With only a few exceptions, current enforcement looks much like enforcement under the Bush Administration. Antitrust enforcement in the modern era is a technical and technocratic enterprise. Although there will be tweaks at the margin from administration to administration, the core of antitrust enforcement has been practiced in a relatively nonideological and nonpartisan way over the last several decades.
Two points stressed earlier should be stressed again: (1) statistical measures of antitrust enforcement are an incomplete way of understanding the overall level of enforcement; and (2) to say that the Obama Administration’s record of enforcement is not materially different than the Bush Administration’s is not to chide Obama for weak enforcement. Rather, it is to debunk the claims that antitrust enforcement is strongly dependent on politics.
This examination of the “reinvigoration” claim should not be understood as acceptance that tougher antitrust enforcement is always better. Certainly, there have been occasions when an administration would be wise to ease off the gas pedal. At present, however, there is a high degree of continuity from one administration to the next.
Read the full article, Has the Obama Justice Department Reinvigorated Antitrust Enforcement? by Daniel Crane, at the Stanford Law Review Online.
July 18, 2012 at 10:15 am Tags: Antitrust, Corporate Law, law enforcement, Obama administration Posted in: Antitrust, Empirical Analysis of Law, Law Rev (Stanford), Politics Print This Post One Comment
posted by Michelle Harner
Have you noticed the number of empty storefronts around? (For a list of recent store closings, see here.) Business failure unfortunately is part of an economic recession, but it also follows changes in consumer patterns and market demands. Although studies debate the advantages of online versus brick and mortar stores (see here, here and here), consumers are increasingly more comfortable shopping online. Increased security and user-friendly return policies (not to mention all of those free shipping deals) appear to be fostering that trend.
Online or virtual stores also have a very different business model and cost structure (see, e.g., here). A small workforce in one location can service all of a company’s online customers. Compare that model with the brick and mortar model where a company operating in more than one location needs, at a minimum, to own or lease property in each location, pay maintenance and taxes for each facility, retain employees at each facility and comply with the law of each jurisdiction. (For interesting comparisons, see here, here and here.) Accordingly, brick and mortar stores are relying to some extent on certain intangibles—e.g., consumers wanting to touch and see what they are buying, wanting personal service, etc.—to offset these additional costs.
So is it the economy, the changing market or (as is likely) some combination of factors causing companies like Blockbuster, Borders and Harry and David’s to struggle? (For my prior post related to Borders’ financial challenges, see here.) And if it is the latter, will traditional brick and mortar retail stores make a strong comeback when the economy recovers? I am not so sure. I think we may see more retail bankruptcies end like Circuit City’s case—i.e., Circuit City’s core business continues, as does the use of its name, but only in an online form (and under new ownership; see here). Although I appreciate the efficiencies of this model for both the company and the consumer, I do not think it is necessarily the best trend for us as communities and neighbors. As the commercial says, having a face-to-face conversation with a salesperson about your product questions: “priceless.”
posted by Michelle Harner
Being a huge sports fan and a corporate law geek, I have truly enjoyed the attention garnered by the Green Bay Packers’ ownership structure in the build up to the Super Bowl (see, e.g., here). The success of the Packers’ non-profit, fan-owner structure raises several interesting questions (see here). That structure also is a refreshing departure from the commercialization of the sports industry generally.
Nevertheless, the Packers’ appearance in Super Bowl XLV also highlights opportunity for innovation and small business profit in the sports context. Indeed, the infamous cheesehead hats were created by a Wisconsin sports fan on his way to a Brewers’ game (see here). Talk about innovation—he apparently ripped the foam from his couch and painted it orange. Before he knew it, he owned and operated a small foam-manufacturing company that caters to Wisconsin sports fans’ every need.
Interestingly, the cheesehead hat entrepreneur is not alone. There is an entire cottage industry of sports entrepreneurs who seek to profit from the loyalty of sports fans everywhere (see, e.g., here and here). And these are not just the high-profile athletes turned entrepreneurs. These are ordinary people with unique or innovative ideas. Take those sports entrepreneurs who are operating online sports stock exchanges (see, e.g., here). I suspect that Aaron Rodgers’ stock price is at an all-time high at the moment.
posted by Michelle Harner
Activist investors have been very busy in recent months, both in the U.S. (see here, here and here) and elsewhere. Among other things, Bill Ackman, through Pershing Square Capital Management, obtained seats on the board of J.C. Penney and was named Chairman of Howard Hughes Corp.—the spinoff of General Growth Properties. Ackman invested in both the equity and debt of General Growth Properties shortly before its chapter 11 bankruptcy filing and, by many accounts, hit a home run on this particular investment. The governance structure of the resulting company, Howard Hughes Corp. (which is reportedly named for the former filmmaker/entrepreneur), also is very interesting. According to Ackman, “it’s a company you can buy stock in. You can throw out the board. The board is elected annually. You can call a shareholder meeting with 15 percent of the vote…so, you know, you can get me back.” So is this a sign of things to come?
Many predict a very active proxy season for activist shareholders and the companies they target. (For an explanation of this trend, see here.) Commentators also suggest the activist agenda likely will include “proliferation of majority voting for directors from the larger public companies to mid-size and smaller companies (which we believe will see the largest number of proposals), separation of the offices of Chairman of the Board and CEO, 10 percent or lower thresholds for shareholders to call special meetings and enabling shareholders to act by majority written consent.” This agenda includes governance features that are similar to those ascribed to Howard Hughes Corp., but Ackman was able to achieve that structure without a proxy fight. Ackman, like a growing number of activists, turned to the chapter 11 bankruptcy process to win control and implement a specific governance agenda. (For an explanation of this loan-to-own strategy, see here.)
Activist distressed debt investors recently acquired ownership and control of companies like Lear Corp., Philadelphia Newspapers, Reader’s Digest, Six Flags and Tropicana Casino & Resorts through chapter 11. Certainly, not all activist distressed debt investors are focused on governance changes, and the value added by their activism is subject to debate. And interestingly, much of their activism goes unnoticed, unlike their shareholder counterparts. So will these debtholder activists follow Howard Hughes Corp.’s lead and implement investor-friendly governance policies? Will these policies truly enhance enterprise value? These important questions—related to both shareholder and debtholder activism—will only be answered with time and performance results, but create many issues for corporate boards and governance scholars to consider in the interim.
posted by Michelle Harner
As I was preparing to fly home from a conference yesterday, I was watching msnbc’s Your Business, which was profiling a small business that uses comedy to create a positive corporate culture. The company, Peppercom (a public relations firm), employs a comedy coach to work with its employees not so much to help employees tell good jokes but to build confidence and communication skills. Although this approach may not work for every business, Peppercom apparently has landed several large accounts based on its approach to business and the personality of the firm and its employees. (For an example of using comedy to discuss corporate ethics with employees, see here.)
I have to admit that I initially thought the msnbc segment was entertaining but not really applicable to the larger business community. I then boarded my Southwest Airlines’ flight and, along with the other passengers, was serenaded by one of the flight attendants who actually got most of the people on the flight to join her in the chorus of “Rolling Down the Runway” (adapted from John Fogerty’s “Proud Mary”). This experience made me reflect further on the importance of corporate culture to the overall productivity of a firm (see here and here) and the tools available to cultivate that culture.
I have previously written about corporate culture and “tone at the top” in the context of enterprise risk management (see here and here), but certainly the benefits of a positive corporate culture do not end there. Employing a workforce that enjoys coming to work, is comfortable communicating throughout the firm and portrays that positive image to the outside world potentially holds real value. (For interesting discussions of corporate culture at AIG and Lehman Brothers prior to the crisis, see here, here, here and here.) I think the challenge in this broader context, as in the enterprise risk management context, is finding the right people to foster that culture. Policymakers can impose incentives and perhaps even a process designed to promote a positive, ethical and risk aware culture at any given company, but those regulations only go so far. The people leading the company must be committed to the endeavor and the implementation of that culture—checking the box or adopting an ethical code or employee handbook is not enough.
This notion of good corporate governance being tied to the individuals serving on boards of directors and management teams was one of the issues explored during the conference I was attending. That conference, hosted by the Adolf A. Berle, Jr. Center on Corporations, Law and Society at the Seattle University School of Law, was a wonderful collection of corporate scholars from various disciplines discussing the issues we continue to face in corporate governance generally and how Adolf Berle’s work informs that discussion. I am not sure we uncovered any definitive answers, but I certainly am encouraged by the discourse and energized to continue the pursuit.
posted by Michelle Harner
The PR departments of the Big 3 automakers are working overtime. With the public opening of the North American International Auto Show just days away, Ford, General Motors and Chrysler released financial results showing a significant increase in sales in 2010 and promising outlooks for 2011. And the flurry of news coverage certainly has a different feel than the doom and gloom of the coverage just two years ago (see, e.g., here).
Why the difference? Is the economic recovery helping the Big 3? Is chapter 11 bankruptcy the reason for the apparent rebirth of General Motors and Chrysler? If so, what explains Ford’s current success (for some interesting perspectives on this, see here and here)?
Many commentators have analyzed the General Motors and Chrysler bankruptcy cases, and they thoughtfully dissect what was novel, not so novel and somewhat troubling about those cases (see, e.g., here, here and here). It is difficult to assess exactly what role chapter 11 played in General Motors’ and Chrysler’s recoveries, other than to state the obvious that both companies used the process to reduce overhead and balance sheet liabilities significantly. That certainly can provide new life to a company; the question then becomes what the company does with the opportunity.
posted by Michelle Harner
In my opening post, I referenced the slow pace of change and how it can be exceedingly painful for individual consumers. I want to follow up on that concept in the business context, where slow change—or the failure to change at all—can be fatal.
Consider, for example, Borders, which recently announced that it was suspending payments to vendors and trying to refinance its debt obligations (see here and here). Borders, like its competitor Barnes & Noble, is struggling to compete with big box retailers that offer steep discounts on traditional books and the growing popularity of e-Books (see here, here and here). Also like many retailers, Borders was hit hard by the economic recession (see here).
Some may say that Borders is a victim of the recession and creative destruction. And that may, in part, be accurate. (For interesting perspectives on the utility of recessions and creative destruction, see here and here.) But anyone who follows the retail industry or is an avid reader had some sense that this was coming (see here, here and here). So why didn’t Borders’ management? Or rather, why didn’t they react more quickly to the changing market and economy?
posted by Jonathan Lipson
I don’t watch much TV. So, I am hardly the person to make strong claims about its quality or trends. That said, I find it fascinating that three of the best shows of the past few years—Battlestar Galactica, Madmen, and Glee—share a really odd structural feature: They have all taken ridiculously bad ideas from cringe-able eras and turned them around completely, made them not only fresh, but evocative, disturbing, intriguing.
They are, in short, evidence of the virtues of extreme recycling.
Just imagine the pitch meeting for Galactica: We’ll take what has to have been one of the dumbest pop-culture packing peanuts ever and make it stronger, faster, better: How about an allegory about civil liberties and faith after 9/11 using Cylons and vats of goo?
Or what about Madmen: Let’s explore the most virulent cancers on our culture with lovingly pornographic attention to detail, to demonstrate the complex symbiosis among banality, beauty, evil and exculpation. Madmen is the money shot of commodity fetishism, proving once again the truth of Chomsky’s admonition that if you want to learn what’s wrong with capitalism, don’t read The Nation, read the Wall Street Journal.
And Glee? Well, all I can say is: Don’t Stop Believing.
Which may lead you to this question: No one really takes the “and everything else” part of CoOps’s desktop mantra seriously, so what the frak does this have to do with law? Read the rest of this post »
November 2, 2010 at 10:25 am Tags: Bankruptcy, battlestar galactica, Corporate Finance, Corporate Law, dodd-frank, glee, good faith, lender liability, madmen, shadow bankruptcy Posted in: Bankruptcy, Contract Law & Beyond, Corporate Finance, Just for Fun, Movies & Television Print This Post One Comment
posted by Judd Sneirson
Sustainability, according to the Brundtland Report, entails “meeting the needs of the present without compromising the ability of future generations to meet their own needs.” Businesses can act sustainably by treading lightly on the planet, and by developing products, services, and technologies that contribute to larger societal efforts to live more sustainably. The business literature describes this as focusing on the “triple bottom line”: how the company is doing financially, how the company is doing environmentally, and how the company is doing socially. Thus, sustainable businesses are managed with an eye toward profit, people, and the planet.
If corporate law permits but does not require firms to act sustainably, how can we encourage corporations to be more sustainable? Corporate law reform is one possibility, although I am skeptical whether either Congress or the Delaware legislature would force sustainability on corporations. Tax incentives are more likely, and the forthcoming Senate climate change legislation may well include carbon taxes or a cap and trade system that would increase corporate attention to the environment. The recent SEC guidance on climate change reporting likewise encourages, but does not force, corporations to act more sustainably, and while many companies currently voluntarily engage in triple bottom line reporting, I doubt the SEC would go there any time soon.
The market, for its part, seems to encourage sustainable business practices; energy and resource efficiency are two areas typically ripe for cutting costs, and consumers will often pay more for sustainable goods and services. One interesting trend along these lines is private certification labels that highlight, for consumers mostly, firms’ sustainability commitments. The B Corporation certification and mark is one popular example of this: a firm qualifies according to the organization’s sustainability survey, inserts sustainability language in its corporate charter, and pays a modest fee in exchange for use of the B Corporation mark. (LEED building certifications and the Forest Stewardship Council offer similar examples, and I’ve developed a public law version for state legislatures to consider.) We shall see whether this trend continues to catch on and what other innovations develop to encourage sustainable business.
posted by Judd Sneirson
At the beginning of the month I posted that corporate social responsibility tends to pay off or at least break even and said that I would blog about the issue further during my stint here this month. Well, I have since been delinquent in my blogging (how do you regulars do it?) but will try to make up for it today, now that my corporations exam is written and the one student who comes to my office hours has already stopped by.
The big, recurring debate in corporate social responsibility is between those who think that corporate decisionmakers must aim to maximize shareholder returns and those who think that corporate decisionmakers should act in the best interests of the entire firm—its shareholders, to be sure, but also its other, non-shareholder constituencies. When shareholder and non-shareholder interests diverge, the issue comes to a head. Where does corporate law stand? Read the rest of this post »
posted by Judd Sneirson
Thanks for inviting me to guest blog for the month, and thanks Danielle for the kind introduction. I have written some about corporate social responsibility, which according to a Financial Times conference last week “is now an inextricable part of doing business.” Here’s a brief excerpt from the New York Times write-up:
“We believe that CSR is entering its second stage of evolution, whereby it is being integrated into corporate strategy and is becoming part of good corporate governance,” wrote Jayne Van Hoen, the global director for conferences and events at the Financial Times, in the program for the event.
The menu of speakers—a medley of sustainability and investor relations directors from companies like Ford, Dell and ExxonMobil; corporate environmental consultants; and socially conscious fund managers—formed the basis, Ms. Van Hoen said, “of a single program at companies that believe a strategy of ‘doing good’ will not only be its own reward, it will also enhance shareholder value.”
The quote makes two interesting points. The first is that corporate social responsibility is an indicator of good corporate governance. Cynthia Williams has made this point before, writing that firms that manage environmental and social issues intelligently probably manage other issues intelligently, too. Financial economist Michael Jensen’s enlightened stakeholder theory also supports this view; his theory holds that firms can best enhance their long-term value by taking into account the interests of all of the firm’s constituencies—its shareholders, to be sure, but also its consumers, employees, creditors, suppliers, and the public.
The second interesting point is the suggestion is that “doing good” turns a profit. Empirical studies tend to confirm this result (although they don’t speak to causation), as does the prevalence of green efforts by mainstream American corporations and venture capital money pouring into green startups. In these everybody-wins situations, there is no conflict between the shareholder primacy folks and CSR types like me. Where CSR comes at the expense of shareholder profits, however, these corporate law camps are at odds with one another. I hope to blog about that issue more as the month progresses.
posted by Michelle Harner
Something about Tiger Woods’ press conference last Friday was very familiar. I felt as though I had heard those words before. “I knew my actions were wrong. . . . But I convinced myself that normal rules didn’t apply. I felt I was entitled.” (See here for this quote and an interesting comparison of the Woods and Toyota situations.) I then heard an interview yesterday with author and psychologist Ellen Weber Libby, who is promoting her new book, The Favorite Child (video description of book here). After listening to Libby’s interview, I realized that the hubris evident in Woods’ statement is similar to that we often hear in the comments, or see in the conduct, of corporate managers. Consider Ken Lay’s statement regarding the Enron scandal: “I take full responsibility for what happened at Enron. But saying that, I know in my mind that I did nothing criminal.” (See also description of allegations in complaint against Bank of America here.)
Libby explains the “favorite child” scenario as one where a child makes her parents feel good and in exchange the child receives special privileges. Libby herself used Tiger Woods as an example in the interview and uses her brother-in-law, Scooter Libby, as an example in the book. Although treating a child as a favorite can promote positive characteristics, such as self-confidence, it also can impair a child’s ability to recognize the consequences of her actions, according to Libby. I cannot help but notice similarities between these natural family tendencies and those we observe in the corporate “family” context. (Notably, the overconfidence and failure to appreciate consequences sometimes apparent in the corporate context might be a combination of the two; a corporate manager raised as a favorite child in her natural family and then further enabled by her corporate family. Indeed, personality traits such as narcissism are identified by some commentators as indicative of an overconfidence bias in corporate managers. See here and here for discussion of overconfidence in the current and past economic downturns.)
The analogy is not perfect, but I think it fosters valuable analysis. Corporate boards may overlook or be more lenient with respect to scrutinizing the conduct of corporate managers when times are good and the managers’ performance is making the board feel good about the company. The same arguably can be said about oversight from shareholders, regulators and the markets. But this leniency obviously is troublesome when exceptional corporate performance is based on inappropriate risk-taking or illegal conduct. So the challenge then becomes how to motivate appropriate oversight and encourage a healthy dose of skepticism into corporate governance. I touched on this issue in a prior post, and I come back to it here because I think it is an extremely challenging task. Creating a legal rule is not difficult, but designing a rule to change human behavior in an effective manner and without unwanted side effects is. And then you have to consider how best to implement that rule—e.g., legislation, best practices, etc. This difficulty may explain our long history of corporate scandals (for just a portion of this history, see here and here), but it should not discourage us from continuing to try.
posted by Michelle Harner
I was honored last week to attend the Fourth Annual Law & Entrepreneurship Retreat, hosted by Gordon Smith at the BYU Law School. It was a wonderful collection of legal scholars who focus aspects of their teaching and scholarship on legal issues affecting entrepreneurs and innovation. Several of the papers and much of the general discussion considered innovation, particularly whether we can or should attempt to regulate innovation and related risks. The economic crisis provided the general context for this discussion; should we restrict or monitor innovation in the financial industry and, if so, how can we perform those tasks effectively?
I was struck by several things during the conference, including the universal and recurring nature of the innovation conundrum. I realized as we were debating solutions to abuses of credit derivatives that the proposed subject of regulation was novel, but the problem was not. We struggled with governing “the marriage of steam power and iron rail” in the late 1800s (see sample of related text here); it is a habitual problem in the biotech, energy, intellectual property and other fields (see here, here and here); and the problem is not confined to the United States (see here).
The recurring Hobson’s choice lies in the nature of innovation itself—to innovate is to create something new or different. As one commentator observes, “Genuine novelty knows no rules. We cannot reduce to routine what we do not know. Yet of course we cannot resist trying.” (See here at 1.) And innovation is often a very good thing (see here). So the challenge is to mitigate the negative side effects of innovation without stifling it altogether. (For a discussion of the regulation choices and challenges in the financial product context, see here, here and here.) Certainly easier said than done.
posted by Michelle Harner
As I mentioned in a previous post, Bank of America and some of its current and former executives, including its former CEO Ken Lewis, are facing tough times. The executives were named as defendants in a scathing complaint filed last week by New York Attorney General, Andrew Cuomo, relating to Bank of America’s 2008 acquisition of Merrill Lynch. And yesterday, Judge Rakoff suggested that he might not approve Bank of America’s latest $150 million deal with the SEC to settle allegations of fraud and misconduct in connection with the Merrill Lynch acquisition. Judge Rakoff expressed his views that the settlement was too small, lacked focus on the individual executives and did provide sufficient oversight of Bank of America’s proposed corporate governance changes.
In contrast to these trying times for Bank of America and its executives, one former Bank of America/Merrill Lynch executive is getting a second chance. John Thain, the former CEO of Merrill Lynch who orchestrated the Bank of America deal and then redecorated his office for a reported $1.2 million, was named as the new CEO of small business lender, CIT. Admittedly, CIT could use a talented turnaround artist at its helm; having just emerged from bankruptcy, CIT has a long way to go. And the markets seem to think Thain is the guy. Time will tell whether Thain can achieve for CIT what he did for NYSE and Merrill Lynch. In the interim, Thain’s new opportunity must add insult to injury on the heels of Bank of America’s and its executives’ latest legal challenges, which stem in part from bonuses that Thain approved for Merrill Lynch employees immediately before the Bank of America acquisition.
posted by Michelle Harner
The recent announcements that the SEC reached a new $150 million settlement with Bank of America (see here) and that the New York Attorney General commenced civil litigation against certain current and former Bank of America executives (see here) are an interesting study in corporate versus individual accountability for corporate misconduct. The SEC did not pursue any actions against the individual executives at Bank of America (see here); rather, the SEC’s action and resulting settlement focus on the corporate entity. The Attorney General’s action, on the other hand, focuses on alleged individual misconduct.
The different approaches may be due in part to different legal standards of liability. In general, the SEC must establish intentional misconduct on the part of individuals in this context (see also here); the applicable New York law does not include this type of scienter requirement. (A cynic also might say that the difference relates to public opinion and Andrew Cuomo’s potential campaign for the governor’s office.) Nevertheless, the New York Attorney General’s approach appears to address more directly the concerns expressed by Judge Rakoff when he rejected the SEC’s original $33 million settlement with Bank of America (see also here).
The different approaches also raise an important question regarding whether corporate or individual liability is a more appropriate or effective remedy and deterrent for corporate misconduct. How far do we want to extend the legal fiction of the corporation? How in either situation do we avoid the corporation and its shareholders paying for individual misconduct that harms the corporation and its shareholders (e.g., indemnification)? How do we distinguish between good faith, honest mistakes and reckless, cavalier misconduct? And how do we level appropriate sanctions against individual wrongdoers without deterring other qualified individuals from serving on corporate boards?
These are difficult questions that courts, legislatures and commentators try to balance and address. I am not convinced that we have reached an appropriate equilibrium, and perhaps we never will. But I think we could benefit from acknowledging that corporate misconduct is caused by individuals and that some individual accountability is necessary to deter future misconduct. Notably, that remedy does not need to be a monetary penalty. In fact, public reprimands and temporary and permanent bars could be even more effective because those remedies impact reputation and arguably make it more difficult for the individual to commit similar wrongs in the future. (For a discussion of bars and the SEC’s and courts’ use of them, see here and here.) They also may ameliorate the concern that holding an individual liable for the amount of losses typically associated with corporate misconduct is too punitive. (For other means to address this concern, see here.) As we continue to reflect on and try to learn from the economic crisis of the past few years, I hope we consider alternatives to link more directly corporate misconduct and corporate accountability.
posted by Michelle Harner
For the past few years, many businesses have struggled to meet payroll and keep the doors open. But such challenges are not bad news for everyone. At least one group of investors (a/k/a distressed debt investors) has found a way to capitalize on the financial troubles of businesses. In fact, recent reports (see here and here) suggest significant above-market returns for hedge funds that utilize a distressed debt investment strategy (e.g., Avenue Capital Group, Third Avenue Funds, Third Point Funds).
A distressed debt investor basically buys the debt of a troubled company and then flips the debt for a quick profit or seeks returns through a longer investment horizon. Investors that fall in the latter category may simply wait for the debt to be refinanced or cashed out, or they may seek to utilize the leverage associated with the debt instrument upon a default or potential default by the company. In fact, “activist” distressed debt investors may use their distressed debt holdings to influence management decisions (think of Carl Icahn’s letter to CIT bondholders) or gain control of the company through a debt-for-equity exchange or credit bid at an asset sale (think of Carl Icahn’s recent acquisition of Tropicana Entertainment and bid for Trump Entertainment).
The existence of an activist investor in a company’s debt holdings can swiftly change the dynamics of the company’s restructuring negotiations. These investors typically want to achieve their objective at the lowest cost (thereby maximizing their upside), which often conflicts with the objectives of other stakeholders. Conflict can lead to delay, expense, litigation and even liquidation. Many companies, such as Adelphia, Aleris, Foamex, Fairpoint, Lyondell and Tropicana Entertainment, have experienced this type of conflict firsthand.
That being said, hedge funds and private equity firms that typically invest in distressed debt may be a good (or the only) source of funding for troubled companies. And their investment objective (maximizing their upside) is understandable given their obligations to their own fund investors and, let’s be honest, the typical fund fee structure. So the question then becomes who is or should be protecting the interests of other stakeholders to mitigate conflict and obtain a fair deal for the company? Is management, particularly in a distressed situation, up to the task? Even if it is, management typically does not learn about the presence of a distressed debt investor in the company’s capital structure until it is too late. Notably, this issue is beyond the scope of the proposed Hedge Fund Transparency Act of 2009 and the Financial Regulatory Reform: A New Foundation proposal submitted by the Group of 30. Moreover, proposed revisions to Bankruptcy Rule 2019 (requiring some disclosure of holdings) may help some companies and other stakeholders in the bankruptcy context, but again the information may come too late and only for bankrupt companies. And whether you focus on disclosure, representation or accountability in considering the creditor control issue, you certainly need to target more players than just hedge funds and private equity firms.
posted by Michelle Harner
We started our spring semester today at Maryland, and I am teaching one of my favorite courses, Legal Profession. Having faced ethical dilemmas in practice (and unfortunately seen very talented lawyers disciplined, disbarred and jailed), I believe that this course is extremely valuable. I suspect, however, that most of our students disagree with me, which is why they typically wait until the last semester of law school to take this required course. In fact, the very first time I taught Legal Profession, I asked my class of 75 3Ls to raise their hands if they would “elect” to take Legal Profession if it was not required for graduation. Only one student raised her hand; I promptly commented that she was perhaps the smartest woman in the room. Since that first year, more students have raised their hands, but I attribute at least part of that increase to a note in prior students’ outlines to “raise hand when Prof. Harner asks . . . .”
Why the resistance to learning, understanding and appreciating the ethical rules governing lawyers’ conduct? Some students have the ill-conceived notion that the study of ethics is boring. (I actually happen to think the topic, particularly the hard questions in the grey areas, is really interesting, controversial and timely; ever watch an episode of Boston Legal?) But for many students, at least based on my conversations, their lack of enthusiasm for the course stems from the simple belief that they are moral individuals who would never act unethically. It is the old “it will never happen to me” mentality.
Unfortunately, I think individuals, including lawyers and business executives, fall prey to this mentality far too frequently. (For an interesting discussion of similar psychological traps, see here and here.) For example, a lawyer may be a moral individual but the pressure of the practice—client demands, senior partner demands, billables, family obligations, etc.—and even good old human greed can blur the line between right and wrong. Likewise, not all executives who get caught up in corporate scandals or pursue excessive risk are bad people; rather, these individuals often get trapped by the same pressures as lawyers. And the consequences can be devastating for the individual and those around her.
I do not know how we correct this mentality or if we can change this aspect of human nature. For my part, I try sensitize my students to the issue and help them decide what kind of person and lawyer they want to be before they enter the profession. I think the use of peer reporting and whistleblower provisions may help curb some of these human tendencies (in the lawyer context, consider Model Rules of Professional Conduct 8.3 and 1.13), but we need to stay focused on the human side of the problem as we continue to draft and amend rules and regulations to govern lawyers, business executives and others. (This side of the corporate risk management problem was thoughtfully raised in a comment to one of my prior posts. See here.) It is a difficult issue, but one worth tackling.