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Distributed Ledgers, Traceable Shares, and the Division of Power in Corporate Law

George S. Geis, Traceable Shares and Corporate Law, 113 Nw. U. L. Rev. __ (forthcoming 2018), available at SSRN.

Theories of corporate governance, and associated normative claims about the optimal balance of power between shareholders and boards of directors, often gloss over—or ignore entirely—”the recessed plumbing of back-end clearing processes.” To be sure, growing empirical literatures inform such debates by illuminating various strategies of exit and voice deployed by important categories of investors, yet the accuracy, efficiency, and integrity of securities trading and voting mechanisms often go unexplored.  In the article Traceable Shares and Corporate Law, George Geis provides a fascinating window onto the complex mechanics of clearing and voting in publicly traded companies—and particularly how “distributed ledgers and blockchain technology” may revolutionize these processes, with potentially profound implications for corporate law and governance.

As Geis recounts, by the 1960s, transfer of physical stock certificates had become unworkable due to substantial growth in trading volume.  The solution to this problem was “unidentified fungible bulk” shareholding.  Shares now typically reside at the Depository Trust & Clearing Corporation (DTCC), with legal title held by a subsidiary called Cede & Company, which appears as the record holder of the stock in corporate stockholder lists.  Accordingly, when the stock is sold from one investor to another, DTCC simply “transfers beneficial ownership electronically from seller to buyer via bookkeeping adjustments”—obviating the need for slow, cumbersome, and expensive transfers of physical stock certificates.

While an elegant solution in the abstract, however, the mechanics remain what Geis aptly terms “a kludge.”  This results largely from the array of intermediaries—notably banks, brokerages, and third-party service providers—involved in the complex process of transmitting trading and voting information up and down the chain between DTCC, at one end, and “beneficial” shareholders, at the other. For example, the process of voting shares in a publicly traded company involves execution of a “global proxy” by Cede, the record holder, permitting votes for shares held at DTCC to be cast by custodian banks and brokerages. These in turn either execute further proxies to beneficial shareholders or (more likely) request voting instructions from them—an approach that firms may, in turn, “outsource…to a third-party provider.”

Given the complexity and the number of parties involved, it is hardly surprising that such processes could impact legal rights that hinge on identification of particular shares with particular investors.  For example, § 11 of the Securities Act of 1933 provides a potent cause of action for investors who acquire shares issued pursuant to a materially misleading registration statement—but courts have tended to interpret this provision to require that the shares in question be directly traceable, with mathematical certainty, to the defective registration statement. This requirement is easily met when IPO shares represent the only publicly traded stock, yet may prove impossible to meet if multiple vintages of stock were available in the secondary market at the time of purchase—due to fungible bulk clearing. Likewise, establishing appraisal rights following a merger under § 262 of the Delaware General Corporation Law (DGCL) requires that the shares in question were not voted in favor of the merger—which could prove problematic if the complex multi-step voting mechanics described above go awry.

Against this backdrop, however, Geis argues that we find ourselves in “an important moment for corporate law…because new technology is approaching a state where clearing and settlement systems may soon support traceable shares.” Building on the detailed yet accessible technical introduction that he provides, Geis observes that “it has become possible to envision how distributed ledger technology might be adopted to permit direct and rapid settlement of stock trades.” This, he suggests, could permit development of “a ‘golden ledger’ of stockholders, reflecting the most current ownership data and substantially reducing (or perhaps even eliminating) the need for the custodial arrangements” described above.

While Geis acknowledges that any effort to develop and implement such a system would face formidable legal and technological hurdles, he concludes that “the odds of a transformation cannot be ignored” and provides a survey of the significant changes we might witness if each share of publicly traded stock could literally be traced to a particular shareholder.  Straightforwardly, the action for materially misleading registration statements under § 11 of the Securities Act would become more widely available in secondary markets, as multiple vintages of stock would no longer preclude direct tracing. Identifying who should be entitled to pursue an appraisal action under DGCL § 262 would likewise become a simpler matter, as the voting record for the shares in question would be more readily determinable. More generally, we might expect “a reduction of unintentional errors,” as multiple checks on accuracy are a hallmark of blockchain technology. At the same time, such a system might curb so-called “empty voting”—that is, voting shares “without economic exposure to the consequences of a decision”—by obviating the practical need to key voting power to a “record date” falling weeks in advance of the actual vote (thereby limiting potential for voting rights to be severed from economic rights by a sale between those dates). By the same token, traceable shares might facilitate new forms of remedies—for example, permitting plaintiffs in securities class actions to “claw back” gains from investors who benefited from corporate misrepresentations (say, by selling their stock at an inflated price).

Perhaps most intriguing of all, however, are the implications for long-standing debates regarding corporate governance theory. Minimally, traceable shares could raise thorny questions “about the circumstances under which an outside shareholder (or other party) should be able to access” newly available “real time data about the identification and ownership stake of all shareholders”—access to which could readily fuel shareholder activism.  At the same time, “a more accurate system for tabulating votes and parsing out other legal rights might cause some scholars to reconsider their positions” on the optimal balance of power between shareholders and boards in publicly traded companies. Where this might lead necessarily remains uncertain, given the nascent state of the technology and the fact that (by hypothesis) we cannot know what such granular data might reveal about the interests and incentives of various categories of investors. Regardless, Geis compellingly argues that traceable shares could impact corporate law and governance in fundamental ways, and the article provides a nuanced and insightful guide to this complex and dynamic landscape.

Cite as: Christopher M. Bruner, Distributed Ledgers, Traceable Shares, and the Division of Power in Corporate Law, JOTWELL (July 11, 2018) (reviewing George S. Geis, Traceable Shares and Corporate Law, 113 Nw. U. L. Rev. __ (forthcoming 2018), available at SSRN), https://corp.jotwell.com/distributed-ledgers-traceable-shares-and-the-division-of-power-in-corporate-law/.

How Much Do You Really Know About Fraud?

How did mail fraud come to be a powerful, all-purpose statutory tool for pursuing financial fraud in the United States? How does financial fraud resemble and differ from other kinds of commercial fraud—false advertising, misrepresenting the qualities of goods or land, or making impossible promises a seller never intends to keep? And is there, as there seems to be, a connection between novelty and innovation—new markets, new products, new frontiers—and fraud?

Ed Balleisen’s new book, Fraud: An American History from Barnum to Madoff, examines fraud, writ large in America from the end of the civil war through the turn of the millennium. As anyone who knows Balleisen’s work would expect, Fraud is exceptionally researched, observant, thoughtful, and rendered in charming prose. Fraud spans the familiar legal silos to provide a sweeping history of different varieties of fraud, and their regulation. This is useful, and the book works because of Balleisen’s disciplined focus on his core questions—how fraud manifests, how regulatory anti-fraud strategies have evolved across time, how and when industry self-regulation has intervened to control it, and how judicial institutions and processes have influenced anti-fraud efforts. The book examines a recurring toggle between interventionist and laissez-faire regulatory approaches; the venerable, if inconsistent and imperfect, tradition of industry self-regulation; and the seemingly perennial link between influence (or lack thereof), and punishment (or lack thereof). It makes a remarkable contribution to our understanding of how fraud and its regulation have evolved thus far, and the conditions out of which our current regulatory models developed.

It turns out that, in telling ways, regulation of fraud maps onto social priorities across time. Through the microcosm of fraudulent conduct and its regulation, Balleisen’s narrative exposes all the richness, promise, contradiction, and imperfection of American society and government. For example, where social status matters—as it did in the tight, homogeneous 19th century business establishment—it will matter to fraud enforcement too. One aggressive businessman with some sketchy conduct in his past will skate through to fame and fortune (see Richard W. Sears of Sears, Roebuck), while another will be ruined (see St. Louis publisher and banker Edward Gardner Lewis).

Balleisen also makes clear the abiding link between moral outrage, and core social characteristics or values. The variable forms that exhortative anti-fraud campaigns take across time tell us something about American society across time. Balleisen describes Better Business Bureau rallies in the early 20th century that were reminiscent of Protestant revival meetings; of urgings to be “a man” and therefore upstanding in the 1950s; and of claims, throughout the 20th century that fraud (or, alternatively, regulatory efforts to curb it) was “anti-American.” Predictably, more than once, such moral statements have shaded into anti-immigrant or anti-Semitic sentiment. Also predictably, though there were populist moments in which farmers or the poor were front-and-center, most anti-fraud campaigns were primarily directed toward protecting the white middle class. And yet, we should not underestimate the broader success of regulation, which inures to everyone’s benefit. I can go to the garden store to buy fertilizer, confident that it contains what it says it does. Blatant frauds like the Volkswagen emissions scandal are the exception now, at least with respect to tangible products.

One social norm is especially central, and it has dominated both opportunities for fraud and anti-fraud regulation. That is capitalism. Fraud makes clear just how thin is the line between “acceptable” capitalist pursuit of profits and “unacceptable” deceit. Particularly in boom times, capitalist enthusiasm soars and regulatory waters seem to recede. Why didn’t merit-based “blue sky” securities laws gain a more permanent foothold, for example, given how energetic the populist moment that engendered them was? Perhaps it all just seemed so burdensome during the Roaring Twenties, when everyone seemed to be getting rich quick. Balleisen also tells a series of intriguing stories about the links between novelty—new markets, new products, new frontiers—and fraud. In innovative contexts, fraud often surrounds a nugget of real promise. Novelty entails uncertainty, which blurs the line between honest, excessive optimism and outright deceit. And yet, novelty also both attracts fraudsters, and makes it harder to recognize and track their misbehavior. (Is it too obvious to mention cryptocurrencies here?)

Law has played both sides of the fostering-innovation-versus-protecting-investors dialectic. Law can be the mechanism through which fraudsters are stopped, information asymmetries are addressed, and potential victims are protected; however, law is also the means through which alleged fraudsters raise procedural complaints, claiming that state action is over-intrusive or that it violates their rights. This is not surprising: that balance is fundamental to what we mean by the Rule of Law. Still, watching those competing imperatives rise and fall across time in the context of fraud illuminates just how dependent legal practice is on its normative environment, and how implicated it is in our sometimes internally inconsistent sentiments about both capitalism and fairness. Industry self-regulation has reflected some of the same tensions: industry sometimes pressed its advantage where it could, arguing for self-regulation rather than state oversight where public sentiment seemed to allow it. And yet industry also got ahead of state regulation and implemented its own meaningful anti-fraud strategies, during times when public sentiment seemed to demand that instead.

In the end, as this history of fraud and its regulation show us, law remains a tool rather than a force unto itself. Law can occasionally change norms, but there are limits. Law-in-action finds its level, contingent on and subordinate to the dense network of norms, power and influence, and historical context in which it is embedded. If this is true, we should end with a question: what does it mean that virtually no one has been criminally prosecuted for the multiple financial frauds we have collectively endured over the last fifteen years, which Balleisen tells us are greater in magnitude and frequency than they have been at any other time in the last century?

Cite as: Cristie Ford, How Much Do You Really Know About Fraud?, JOTWELL (June 14, 2018) (reviewing Ed Balleisen, Fraud: An American History from Barnum to Madoff (2017)), https://corp.jotwell.com/how-much-do-you-really-know-about-fraud/.

Talking Out of Both Sides of Your Mouth

James W. Coleman, How Cheap is Corporate Talk:? Comparing Companies’ Comments on Regulations with Their Securities Disclosures, 40 Harv. Envtl. L. Rev. 47 (2016), abridged in 47 ELR 16081 (August 2017).

It doesn’t take masses of data or high-powered statistics to generate important results. It takes a good question. James Coleman asks one and thoroughly massages it for insight.

Corporations exercise their speech in multiple audiences. Marketing addresses consumers. The Human Resources Department addresses employees. Coleman focuses on corporate speech to the SEC and the EPA about the proposed Renewable Fuel Standard between 2009 and 2013.

The number of corporations whose statements in the rule-making procedure and in their annual reports can be compared are small. In 2009, Professor Coleman studied 33 corporations and only 11 in 2013. The small number is not as significant as the lessons we learn when we compare what is said to these two audiences.

The messages are different. To the SEC, in their Annual Reports (10-K’s ), corporations generally minimize the impact of the proposed rule on their business. To the EPA, some holler that the rule will be unenforceable, cause them ruin and bring harm to the United States. Not a surprising result, but nicely demonstrated.

Royal Dutch Shell provides a good example. It spoke out of both sides of its mouth in 2013. It told the EPA that the Renewable Fuel Standard would “limit the supply of gasoline” and result in “severe economic harm” to its consumers and the public (at 70). In its Annual Report for 2013, Royal Dutch Shell wrote that as a result of “new energy policies in…the USA…[t]he…market for biofuels is growing…[and] We are one of the world’s largest biofuels producers” (71 n. 110).

The mention of the biofuels market is noteworthy. Regulations often will impact corporations differently. Depending on the corporations’ investment in ethanol, corporations differed in their responses to the Renewable Fuel Standard. Those invested in ethanol and biofuels sometimes urged the EPA on. Those who didn’t warned the EPA about the Standard.

The mixed messaging presents a particular problem from a new governance perspective. The new governance, unlike the old command-and-control, relies on corporate cooperation with regulation. Corporations are supposed to contribute their energies and their information constructively, both in their investor reporting and their communications with agencies. In their annual reports, corporations provide information, but more than that, they convey how their energies will be directed so that investors can make predictions about growth. These discussions of their energies should not be mere puffery. The EPA, meanwhile, needed to know whether the rules that it was proposing were feasible for regulated companies. Companies in the industry have more information than does the agency about what realistically can be demanded, but have little incentive to be forthcoming, crying about over-regulation and change for the worse.

Professor Coleman suggests that the predictions in the 10-K’s “can be used to audit corporations’ regulatory submissions “ (at 54), referencing Rule 10b-5 liability. Rule 10b-5 imposes liability for mis-statements in the 10-K, a liability that does not exist when corporations are speaking to regulators during rule-making procedures. (Of course, the PSLRA extended safe harbor protections, but did not eliminate liability for false “predictions,” as Professor Coleman emphasizes.)

I am less sanguine than is Professor Coleman about the current viability of 10b-5 litigation to keep corporations honest when they speak to regulators. But, seeking consistency when corporations speak is desirable as a matter of good governance. Much work on corporate compliance is directed to ensuring that the tone at the top is spread throughout corporate undertakings. At the least, we should, as does Professor Coleman, pay attention when corporations speak out of both sides of their mouth.

Cite as: Robert Rosen, Talking Out of Both Sides of Your Mouth, JOTWELL (May 18, 2018) (reviewing James W. Coleman, How Cheap is Corporate Talk:? Comparing Companies’ Comments on Regulations with Their Securities Disclosures, 40 Harv. Envtl. L. Rev. 47 (2016), abridged in 47 ELR 16081 (August 2017)), https://corp.jotwell.com/talking-out-of-both-sides-of-your-mouth/.

Corporate Political Activism 5.0

Elizabeth Pollman & Jordan M. Barry, Regulatory Entrepreneurship, 90 S. Cal. L. Rev. 383 (2017), available at SSRN.

Regulatory Entrepreneurship by Elizabeth Pollman and Jordan Barry provides a must-read thought provoking descriptive account of how certain companies influence and shape regulation in the modern economy. In short, “regulatory entrepreneurship” describes companies’ attempts to dismantle, weaken, and exploit gray areas in the preexisting regulatory architecture that impede a particular line of business. With clear illustrations the article sheds new light on the tactics employed by some of today’s fastest growing companies such as Uber and Airbnb to surmount regulatory obstacles.

Article’s Findings

The article distinguishes regulatory entrepreneurship (“RE”) from more reactive traditional modes of corporate political activism and lobbying where companies insulate themselves from competition and protect existing profit centers. In the traditional context, the article asserts that changing the law is not necessarily material to a company’s overarching business plan and usually constitutes a relatively small part of their overall operations and focus. By contrast “regulatory entrepreneurship” is more proactive and central to a company’s overarching business strategy and viability.

RE is best thought of as one of multiple forms of political advocacy companies utilize. Generally, companies shape and are shaped by their regulatory environments: they mobilize to alter the regulatory environment or they simply adapt to the preexisting regulatory and political context. RE reflects the former approach. It is distinct from the discussion of “regulatory arbitrage” in the corporate law literature where corporate actors merely adjust taking the “law as given, then try[ing] to take advantage of the law as best they can by making minor alterations to their behavior.” (P. 397.) RE is a process where companies proactively “seek to shape the legal environment to suit their needs instead.” (P. 397.) In practice such distinctions —RE versus regulatory arbitrage— may become blurry. Nevertheless, it is helpful to identify different methods of corporate political advocacy and possibly predict under what circumstances these different methods are likely to be successful and what types of companies are likely to use them. The article helps answer these important questions, and builds upon the literature in this area providing a more textured and contextual narrative.

Certain conditions foster RE: high profit potential; a company’s financial resources; and specific business features such as scalability, connectedness, and mass appeal. Law-related factors also contribute to the success of RE strategies. For example, certain types of regulation are more conducive to RE: regulations characterized by civil fines as opposed to criminal penalties, local and state regulations as opposed to national regulations, and unpopular regulations as opposed to popular ones. Although RE involves companies’ attempts to dismantle or weaken the existing regulatory architecture, actual repeal of regulation is not necessary for success if lax enforcement will suffice. Courts are not the most effective fora for RE; the legislative and executive branches, especially at the local and state level, are the preferred venues for regulatory entrepreneurs to exert influence.

RE is particularly popular among, but not limited to, startups and technology companies such as Uber (taxi regulations) and Airbnb (zoning regulations). Regulatory entrepreneurs tend to be well-financed-platform-oriented-start-ups, prioritizing rapid user growth over immediate profits, made possible by a large well-connected user base and an ecosystem of investors willing to support high risk growth strategies. (Pp. 430-431.) The article further suggests how an aggressive libertarian Silicon Valley start-up culture might contribute to the more aggressive tactics regulatory entrepreneurs use to bring legal change such as: breaking the law (i.e., asking for forgiveness rather than seeking permission from regulators); taking advantage of legal gray areas; mobilizing their users and stakeholders to thwart government action; and rapidly “growing too big to ban.” Pp. 398-406.)

Ultimately, the article predicts that RE will continue to grow along with the influence of regulatory entrepreneurs, due in part to regulatory entrepreneurs’ ability to mobilize large previously unorganized groups toward political action on their behalf. These developments have the potential to impact the balance of power among companies that shape local, state, and national policies in the future.

Article’s Implications
Is regulatory entrepreneurship good or bad?

The authors are noncommittal concerning whether RE results in optimal regulatory outcomes. They acknowledge that the goal of RE is profit, and there is no particular reason to expect companies engaged in RE to act in the public interest. They acknowledge RE’s benefit to the extent that existing laws or regulations may be antiquated, impede innovation, unduly restrict competition, and impose unnecessary costs on entrepreneurs, consumers, and the public. Taking a balanced approach, however, the article recognizes RE’s potential limitations. Regulations targeted by regulatory entrepreneurs, although a bit inefficient, could serve beneficial public welfare purposes that could be undermined and displaced or ignored by a regulatory entrepreneur’s narrow focus. Another important question is whether a regulatory entrepreneur’s top-down mobilization and manufacture of opposition to existing regulations reflects socially desirable outcomes or is simply another chapter in the regulatory capture story where users and consumers are manipulated as part of a broader scheme to influence the regulatory environment.

Another potential downside to RE involves expertise asymmetries between private sector companies and regulators. Regulators may not adequately study or understand the impact of new technological advances leading to suboptimal outcomes and unintended consequences. A standard critique of government bureaucracy is its slow pace responding to technological innovations. Yet delays resulting from prudent due diligence are preferable to hasty uninformed decision-making. RE is not simply a story of regulatory capture at the local, state, and national level, it may also reflect an expertise gap between government and private actors.

Is there a connection between the aggressive tactics employed by regulatory entrepreneurs, company culture, and internal controls?

The article mentions some of the criticisms and earlier scandals surrounding Uber. More recently, a high-profile scandal related to Uber’s handling of workplace sexual harassment contributed to the dismissal of Uber’s founder and CEO Travis Kalanick. Developments such as these raise questions whether companies engaging in RE are more prone to engage is overly aggressive competitive practices, dismiss widely accepted workplace norms, and have weak internal controls.

In conclusion, the article is an informative balanced assessment of a newer method of corporate political activism that will impact the shape of the regulatory environment and the balance of power among today’s companies.

Cite as: Omari Simmons, Corporate Political Activism 5.0, JOTWELL (April 20, 2018) (reviewing Elizabeth Pollman & Jordan M. Barry, Regulatory Entrepreneurship, 90 S. Cal. L. Rev. 383 (2017), available at SSRN), https://corp.jotwell.com/corporate-political-activism-5-0/.

A Dream Deferred?

Mariana Pargendler, How Universal is the Corporate Form? Reflections on the Dwindling of Corporate Attributes in Brazil (2017), available at SSRN.

The proliferation of what might generally be called the convergence literature over the past several decades has brought new insights into the study of corporate governance. In particular, it has allowed scholars to identify and seek to understand diversities in corporate practices, despite what appears to be more or less unity of form.

Mariana Pargendler’s excellent new paper brings exciting insight to the conversation. Acknowledging the apparent universality of the core features of corporate law, she engages in a study of Brazilian law and its evolution over the past several decades to demonstrate that Brazilian courts and legislators have significantly diluted these elements. Significant diminution of the protection of limited liability, legal personality and capital lock-in, share transferability, delegated management, and ownership by investors are leading to a well-functioning but distinctly different concept of business enterprise, while continuing to appear to maintain most of the structural features of the corporate form.1 Whether this transformation eventually will result in new legislation creating a new form of business enterprise is anybody’s guess, and Pargendler sensibly notes the recency of these developments and the inability to predict where they go. Nevertheless, as she notes: “In some respects, Brazilian law is dream come true for progressive corporate law scholars … .” (P. 53.) Her facilitation of that dream is a welcome addition to the literature.

Pargendler emphasizes these phenomena as uniquely Brazilian. But she also claims that “in many, though not all respects, there is at least a theoretical case that Brazil’s watered down corporate regime is the most efficient model – not only for Brazil, but everywhere,” (P. 5) observing that Brazil can be seen as “unknowingly” adopting a number of corporate reforms proposals developed by U.S. scholars.

This core argument derives from her analysis of the efficiency and distributional effects of Brazil’s reforms, as well as the complementarity of the core features of the corporate form. Several arguments she suggests might support her view: (i) the contingency of efficiency on the institutional environment, suggesting elimination of the formal causes of agency problems when the institutional environment is unable to properly address them, (ii) the self-reinforcing nature of decorporatization due to the complementarity of core features of the corporate form, and (iii) the promotion of greater distributional equity through decorporatization.

The paper proceeds through a careful and detailed description of the principal changes in Brazilian corporate law, encompassing the five core areas identified above. Pargendler then provides persuasive analysis of each of the efficiency arguments she proposes, at the same time cautioning that the recent development of these phenomena prohibits strong conclusions at this point. Finally, she explores the applicability of Brazil’s reforms and her arguments to other nations, especially developing countries.

The paper is fascinating. More important, Pargendler has opened up a truly new perspective for thinking about the way we should understand the corporate form and how we should think about its universal applicability. We have long understood that practices within the standard form diverge among nations. Pargendler takes the bold new step of proposing that forms can and, perhaps, should, change (and perhaps converge) as well.

  1. Some of the changes apply primarily to close corporations, “but the trend toward decorporatization in Brazil is not limited to close corporations.” (P. 53.) In addition Pargendler notes, among other arguments that even if the major changes were limited to close corporations, they nevertheless would be important because of the importance of close corporations to the economies of many countries. []
Cite as: Ezra Mitchell, A Dream Deferred?, JOTWELL (March 29, 2018) (reviewing Mariana Pargendler, How Universal is the Corporate Form? Reflections on the Dwindling of Corporate Attributes in Brazil (2017), available at SSRN), https://corp.jotwell.com/a-dream-deferred/.

Saving America’s Future From the Way We Save Now

William A. Birdthistle, Empire of the Fund: The Way We Save Now (2016).

Last spring, I decided to teach a research seminar on the investment fund industry and regulation. Scoping out available literature, I picked up William Birdthistle’s recent book, Empire of the Fund – and, literally within minutes of reading, knew that I had found the perfect anchoring text for the seminar. More than that, I was hooked. Over and over again, the book made me nod my head and raise my eyebrows, in a single moment of recognition and enlightenment. It made me shake my head in anger and wrinkle my forehead in puzzlement. It made me laugh out loud as I turned pages sparkling with humor and brilliance, and it made my heart heavy as I stopped to think about what made it all so funny. I finished the book in one sitting, and it was an experience.

That’s because Professor Birdthistle’s book is not just about the nuts and bolts of mutual funds: it is ultimately about all of us, ordinary Americans trying to save some of our hard-earned money for such scary and inevitable things like old age. Birdthistle is using the familiar structure of a mutual fund as an institutional prism through which to assess the consequences of America’s grand experiment with putting the financial responsibility for retirement squarely on individuals, rather than society as a whole. Since the 1980s, most Americans – or, at least, the lucky ones who can afford to – have been saving for retirement by contributing a portion of their earnings to 401(k) plans, which then channel the bulk of these savings to mutual funds. We, individual savers, ostensibly have the power to choose where to invest our money. In reality, however, these choices are largely meaningless: ultimately, we are all captive investors in the sprawling, incestuous, multi-trillion-dollar mutual fund empire. But, the book asks, do we really understand how, and for whose benefit, this empire operates?

To answer this fundamental question, Birdthistle meticulously explores and exposes deep structural flaws in the existing mutual fund system. His analysis is couched in deliberately, and suggestively, clinical terms. The book starts by laying out the basic anatomy of a mutual fund: its purpose, structure, and economics. It then proceeds to diagnose some of the main “diseases and disorders” plaguing that system: excessive and non-transparent fees, unreliable valuations, conflicts of interests, and outright manipulative behavior on the part of fund managers seeking to maximize their own profits at the expense of fund investors. The picture that emerges is both nuanced and easily comprehensible. Above all, however, it is deeply troubling. And, as the book explains, the continuous invention of new types of funds – including the now ubiquitous money market mutual funds and increasingly popular exchange-traded funds – does not necessarily help to fix the underlying problems in how the fund industry operates.

Birdthistle closes the book by offering a brilliantly simple and potentially effective cure for America’s visibly ailing retirement saving system. He proposes allowing all individuals to invest their savings through the federally-run Thrift Savings Plan (“TSP”), currently available only to federal government employees. As a former federal employee with a (very) small TSP retirement account, I was immediately intrigued by this proposal: isn’t it odd to channel everyone’s retirement savings into this boringly simple, low-risk, and incredibly low-cost investment vehicle? What about the great capitalist ideal of one’s “freedom” to invest in super-fancy, super-diversified, super-risk-sensitive products sold by expensive investment professionals in the private sector? Birdthistle’s answer is disarmingly simple and undeniably correct: individual savers can never enjoy real freedom in a system that is built to favor self-interested fund managers. To regain freedom, individual investors have to alter the structural balance of power: they have to increase their collective bargaining power by pooling their economic strength – and to do so via a publicly-controlled investment vehicle.

Perhaps unsurprisingly, I like this solution for two main reasons. First, it is explicitly structural, rather than narrowly transactional or disclosure-oriented (a low-hanging fruit in many situations). Second, it embraces and emphasizes the critical role of public instrumentalities in making modern finance not only more fair and democratic but also more efficient. As Birdthistle notes in response to predictable criticisms, “The private sector should certainly be able to do something similar to TSP, but it hasn’t.” There is a reason why it hasn’t: private fund managers’ primary incentive is to maximize their own profits, even where it is directly at odds with the overarching public interest in providing a reliable retirement savings system. And it is the same reason why we, the investing public, must step in and take control of our savings.

Whether or not this can or will be done in the near future is anybody’s guess. But maybe there is hope, especially if people on Capitol Hill hurry up and read Professor Birdthistle’s wonderfully insightful and extremely accessibly written book. I certainly hope they do.

Cite as: Saule T. Omarova, Saving America’s Future From the Way We Save Now, JOTWELL (January 26, 2018) (reviewing William A. Birdthistle, Empire of the Fund: The Way We Save Now (2016)), https://corp.jotwell.com/saving-americas-future-way-save-now/.

A New Look at the Theory of the Firm

Tamara Belinfanti & Lynn A. Stout, Contested Visions: The Value of Systems Theory for Corporate LawU. Pa. L. Rev. (forthcoming 2017), available at SSRN.

Tamara Belinfanti and Lynn Stout’s Contested Visions: The Value of Systems Theory for Corporate Law, forthcoming in the University of Pennsylvania Law Review, brings systems theory to the theory of the firm. I picked the paper up expecting a cross-disciplinary reference to the work of Niklas Luhmann and other social theorists. But the reference here is to another branch of the systems inquiry, the cross-referents of which go to engineering, biology, and computer, environmental and management science. Belinfanti and Stout include a succinct and lucid primer of the basic points. They then deploy them against the most important point in the quadripartite case for shareholder value as the purpose of the firm.

A little law and economics background needs to be provided to show the importance of the intervention. Microeconomics does not yield shareholder value maximization as the purpose of the firm as a primary proposition. Indeed, in a frictionless world with complete markets, optimality would mean maximizing the yield to every actor connected to the firm rather than just the yield to the shareholders. Shareholder primacy emerges once frictions and incomplete markets are interpolated. It follows from four more particular assertions: first, an instruction to maximize for multiple constituents would be incoherent; second, the shareholder interest, as the residual interest, points management in the most productive direction; third, the shareholders are vulnerable, relatively speaking, because other firm constituents can protect themselves with contracts; and, fourth, a multiple constituent model would lack yardsticks with which to measure management performance, where the shareholder model can measure performance with standard metrics like the stock price and periodic earnings.

Three of the four legs that thus support the shareholder primacy table are looking shaky. The first justification—governance incoherence—never did a lot of work. To rebut it, all one needs to do is follow the doctrine and direct management’s duties to the enterprise and then take a confirming look across the Atlantic to large German companies with dual boards. The second and third justifications—shareholder incentive alignment and shareholder vulnerability—have lost cogence as shareholder power has waxed in recent years. With short-termist hedge funds now taking the lead as shareholder value shock troops, shareholder incentives are no less problematic than anyone else’s. Nor do shareholders any longer stand out as a vulnerable constituency. Indeed, the remission of other constituents to contractual protection never did resonate very well in world dominated by at will employment contracting.

This leaves shareholder advocates with only a single powerful justification—the point that shareholder-directed metrics like the stock price and periodic earnings provide the only workable yardsticks with which to evaluate management performance. In a multiple-constituency firm without these focal points, it is said, self-serving managers would hide behind vaguely defined constituency interests with negative effects on productivity. There is much to be said for this point.

Belinfanti and Stout push back against it, drawing on systems theory’s account of interconnected processes. No silver bullet metric emerges. Indeed, in the authors’ description, the whole point of systems theory is that things are way too complicated to yield such a metric. What we get instead are multiple indicators, all directed toward the measurement of the system’s health and sustainability. A warning emerges in cumulative picture that results—excess emphasis on shareholder concerns can cause systemic damage.

I did not finish the paper persuaded that systems theory provides a viable basis with which to discipline management in a multiple constituency firm. But I am thinking about it. Meanwhile, this thought-provoking essay is the most constructive intervention on the constituents’ behalf in a long, long time.

Cite as: Bill Bratton, A New Look at the Theory of the Firm, JOTWELL (November 24, 2017) (reviewing Tamara Belinfanti & Lynn A. Stout, Contested Visions: The Value of Systems Theory for Corporate LawU. Pa. L. Rev. (forthcoming 2017), available at SSRN), https://corp.jotwell.com/a-new-look-at-the-theory-of-the-firm/.

Historicizing Corporations and Democracy

Corporations and American Democracy (Naomi R. Lamoreaux & William J. Novak eds., 2017).

Americans’ interest in the impact of corporations on society, always high, reached fever pitch with the Supreme Court decisions in Hobby Lobby and Citizens United, as reflected in the ongoing political and media dialogue about reforms necessary to protect or restore democracy. Believing that the historical assertions informing this debate are largely “claims about the history of corporations in the United States that are at best outdated, if not entirely lacking in historical foundation”, the Tobin Project supported new research on this topic, the results of which are now available in Naomi R. Lamoreaux & William J. Novak, Corporations and American Democracy (2017) (hereinafter “Lamoreaux & Novak”).

Lamoreaux & Novak contains the work of 16 scholars, organized as an introductory essay and ten chapters, which together provide a coherent and enlightening look at the nature of the corporation and corporate law from the founding of America to the present. At the same time, Lamoreaux & Novak also provides a provocative look at the nature of democracy, viewed in the context of the nation’s ongoing struggle over the proper relationship between corporations and government. Whether your interest lies in better understanding the corporation at the turn of the 19th century, in the early stages of the industrial revolution, during the pre-first-World-War reform era, in the early days of the New Deal, or as the corporation later evolved, Lamoreaux & Novak has something for you. For me, the highlight was Chapters 2 and 3, which provide a much needed clarification of the standard account of our understanding of the corporation as it evolved in the nineteenth century.

The standard account, which describes the history of corporations and corporate law as a race to the bottom, goes something like the following. At the onset of the 19th century, business activity was conducted primarily by artisans and craftsmen. Corporations were mostly engaged in quasi-public activities, and charters were granted only via legislative act and only with charter provision designed to ensure that the corporation served a public interest. With the onset of the industrial revolution, the demand for corporate charters by railroaders and manufacturers could not be filled by special chartering, leading to general incorporation laws. In an effort to retain at least some of the public-interestedness of these new creatures—business corporations—the first generation of general incorporation laws contained many public-interest-oriented immutable laws. But, by the coming of the 20th century, states (led by New Jersey) were adopting lenient general incorporation laws which enabled corporations to operate with near total disregard of the public interest.

In Chapter 2, Eric Hilt explores the corporation from 1791 through the first half of the 19th century with a primary focus on New York, which during that period was both the center of American economic life and a corporation law trend setter. What we see is the interconnectedness between politics and the corporation.

At the starting point, 1791, New York politics is dominated by aristocratic landowners and wealthy merchants and only two businesses had been permitted to incorporate, one of them the Bank of New York. A survey of New York City wealth in 1791 reveals that stockholders in these corporations were disproportionately wealthier than the population as a whole, that the stock was also distributed disproportionately amongst different categories of the population, with public officials benefitting the most disproportionately. In other words, at our starting point the evidence suggests that governmental control of corporate chartering fostered corruption, as public officials skimmed off a substantial portion of the economic rents flowing from stock ownership.

In the period from 1791 to 1830, the number of business corporations in the United States steadily increased, reaching 250 by 1800, 1,138 by 1810, and at least 4,492 by 1830, with 23% of these chartered by New York State. While turnpikes, canals and other quasi-public businesses accounted for approximately half of New York’s business corporations, the other half included 70 banks, 73 insurance companies, and 293 firms in the manufacturing and mining sector.

New York also led the way in the move to general incorporation. However, its first statute, enacted in 1811, limited “free” incorporation to manufacturers of textiles, glass, iron, steel or lead, and placed a $100,000 limit on capitalization. The statute seemed clearly a response to New York falling behind neighboring states in the number of small manufacturing enterprises, and can be seen as an effort to spur entrepreneurial activity in New York.

Thus, beginning in 1811 and continuing until mid-century, New York had both a limited form of general incorporation and the continued importance of special chartering. Larger firms and those with greater influence could still use special chartering to obtain more desirable rights and privileges than would be provided by operating with a general incorporation charter.

As we move from 1791 to mid-century, Hilt shows that the nature of public corruption changed.  By 1826, public officials are no longer the most disproportionate beneficiaries of stock ownership. Instead, Hilt persuasively argues, special chartering had become a mechanism by which “to perpetuate and extend the power of a political party and the interest groups associated with it.” Dominant-party legislators used special charter provisions not to protect the public interest, but to grant monopoly protection and other special economic privileges to the favored corporations owned by supporters.

In Chapter 3, Jessica Hennessey and John Wallis take us from the world of 1840 to the 20th century, and provide a very different understanding of the universal move from special chartering to widely available and fairly liberal general incorporation statutes which occurred during this period. Rather than being a phenomenon unique to corporations and a governmental failure to protect the public interest, the move to general incorporation is but a part of a general effort to curb the unique corrupt use of special chartering by dominant political factions.

In the first part of the 19th century, citizens could and did approach the legislature for special laws granting benefits only to them in a wide range of matters. For example, permission for divorce could be obtained by a special legislative act, a path famously used by Andrew Jackson’s wife Rachel to divorce her first husband. In another area of great concern, municipalities were subject to legislative mercy in pleading for charter provisions to allow local governance.

Hennessey and Wallis show that beginning in 1851, state after state began adopting “general law provisions . . . mandating that laws for a wide variety of purposes be ‘general’ laws that applied equally to everyone.” A strong correlation can be shown between a state’s adoption of general law provisions and its adoption of a general incorporation statute. During the same period, states began adopting home rule provisions that provided municipalities with blanket governance rules rather than a patchwork of special charters.

Initially general incorporation statutes and municipal home rule laws contained substantial immutable provisions, but by century’s end had given way to more liberal statutes granting substantial discretion in how a particular corporation or municipality could choose to structure its internal and external affairs. With respect to corporations, this move to more liberal general incorporation statutes has been commonly described as a race to the bottom.

Hennessey and Wallis caution that this standard view is misleading at best. People at the time thought general incorporation statutes, and broader general law provisions, “limited the ability of politicians and legislatures to create special privileges [and thus were designed] to improve how democracy works.” Was the move to less restrictive general incorporation statutes inconsistent with that goal and a function of state legislatures being captured by business interests? We may come to a different answer than has commonly been given if we see this 19th century history as part of an ongoing struggle to create democracy itself. Hennesey and Wallis remind that a near unique aspect of American society is the richness of public and private organizations and the ease with which individual can organize as they choose. As they note, citing China and Russia as leading examples, “[m]ost political systems manipulate organizations, limiting their number and allocating special privileges among them to coordinate and enrich ruling political coalitions.”

The move to more liberal general incorporation statutes occurred as the modern corporation of Berle and Means fame was first stirring. But rather than see this move as the product of legislative self-interest or corruption, might we see it as two steps forward and one step back in the creation of our democracy? The remaining steps taken, and those yet needed, are the subject of the remainder of this fine book.

Cite as: Charles O'Kelley, Historicizing Corporations and Democracy, JOTWELL (September 27, 2017) (reviewing Corporations and American Democracy (Naomi R. Lamoreaux & William J. Novak eds., 2017)), https://corp.jotwell.com/historicizing-corporations-and-democracy/.

The Discreet Charm of Conveyancing on the Blockchain

Jeanne L. Schroeder, Bitcoin and the Uniform Commercial Code, 24 U. Miami Bus. L. Rev. 1 (2016).

When Adam Levitin and I taught The Law of Money seminar a year ago, not one student chose to write about bitcoin. We congratulated ourselves on drawing young people hip enough to ignore the hype emanating from googly-eyed technophiles and smug pundits, and beefed up the readings on silver in 18th century China. The rude awakening came last spring, when bitcoin gobbled up half the class and forced me to wrestle with the problem of legal writing about financial innovation. Jeanne Schroeder’s lovely Bitcoin and the Uniform Commercial Code saved the day. The article reads at first like an old-fashioned doctrinal piece of the sort that have become rare. That would be valuable enough, but the bigger payoff for me was seeing a patient sifting of bitcoin through the UCC illuminate the work of legal institutions at the intersection of finance and technology.

Most students said that they wanted to write about fintech-y stuff because it was new and hot and law firms were all over it. However, defining “it” became a problem, especially for bitcoin. At a high level of generality, bitcoin is a protocol designed to extract, represent, and circulate value using a decentralized system for recording transfers (blockchain).1 Putting transfer verification in the hands of the public at large makes the blockchain hard to manipulate, and makes transfers faster and cheaper.

Depending on your perspective, bitcoin could be a currency, a payment system, a commodity, an economy, a political system, or a flash in the pan. Law papers about bitcoin tend to follow a handful of templates. For example, they might survey the regulatory response (are regulators competing for turf?… stifling innovation? …fueling regulatory arbitrage?), compare institutional designs for a given function (what makes a good parallel currency? …how have payment systems built trust?), or analyze internal governance (is blockchain democratic? … fair? …stable?).

Schroeder eschews a comprehensive take on bitcoin, and zeroes in on the challenge it poses for the UCC’s taxonomic worldview. Her analysis is of serious practical importance, because bitcoin’s classification as collateral under Article 9 of the UCC could make or break its ability to function as a payment medium. The UCC also makes a great lens for thinking about bitcoin because of its self-consciously modern roots and fascination with commercial practice. The result is a scale model for the broader task of managing financial innovation in a fragmented regulatory regime.

The article first lays out why bitcoin cannot be money under the UCC, and why it matters. Along the way, the reader gets to ponder the logic of physical possession and the magic of proceeds under the UCC, including a supremely teachable hypothetical. Schroeder makes a compelling argument that bitcoin’s exclusion is not primarily a matter of outdated definitions limiting money to government payment media (Sec. 1-201(b)(24)), but is part of the fabric of the Code. Money under the UCC is essentially physical cash, which is hard to encumber and easy to move. Cleansed of its past each time it passes from hand to hand, money can zip through the stream of commerce. Physical possession is central to the UCC’s regime for transferring cash, but make zero sense for electronic currencies. As a result, even if the definition were fixed, the functionality would be impaired. Instead of super-negotiable money, bitcoin is most likely be classified as a “general intangibles,” a catch-all category prone to lingering encumbrances, which would make it hard to transfer and useless as a payment medium.2

Wading through the weeds of attachment and perfection (which somehow feels urgent in Schroeder’s telling), the reader might miss a bigger point about financial innovation and the UCC. The Code still stands as one of the most ambitious statutory modernization projects in U.S. history; it swept centuries of legal contrivance off the field with a flourish, and became indispensable to the financialization of the U.S. economy, including derivatives and structured finance. This flamboyantly modern code seems to hold an oddly quaint view of money, securities, and financial assets. Bitcoin looks like a blip in what has already been a decades-long story of friction and adaptation.

Illustrating the point, the second half of the article revisits the history of amending Article 8 of the UCC to create a regime for transferring investment securities not represented by physical certificates. The initiative was meant to reflect market and regulatory responses to the Wall Street paperwork crisis of the late 1960s and early 1970s, which saw brokerage houses buried in an avalanche of paper that they could not process.

All else equal, it makes sense to model a regime for transferring electronic money on the one for transferring securities that lack physical form—except that the reform process for securities was a mess. UCC revisions for “uncertificated securities” had initially stumbled over the clunky way they recorded transfers. Technology has since caught up with the law: blockchain solves the recording problem. But market participants did not wait around for blockchain; they found a workaround using custodial holding in the late 1970s. Federal legislation and more UCC revisions adapted to the new market-institutional reality, elaborating a category of “securities entitlements” (essentially, claims on the intermediaries), which coexists with the ill-fated uncertificated securities. Today’s bitcoin holders could also achieve negotiability using the securities entitlement regime, but they may have to sacrifice some of bitcoin’s decentralization ethos by having to rely on intermediaries.

In the end, blockchain’s capacity to replace “confusing metaphors of tracing rules … with the reality of actual tracing” seems a lot more promising and a lot more scary than bitcoin’s monetary designs. For this reason, and doctrinal dividends notwithstanding, the lasting contribution of Schroeder’s article is probably not in the law of bitcoin. The value is in her careful case study of how a legal system should assimilate potentially disruptive innovation. The UCC is massively invested in its taxonomies, while innovations such as bitcoin often defy existing categories. Schroeder’s article guides its readers through the history and policy behind the Code’s taxonomies, taking its architecture and bitcoin’s political aspirations seriously throughout. The result is a pragmatic and novel meshing of the two.

  1. The Khan Academy has a very helpful set of videos on the basic idea. []
  2. Schroeder offers an amendment, which would assemble elements of super-negotiability under the UCC and adapt them for bitcoin and other cryptocurrencies; however, that is properly a minor part of her argument. []
Cite as: Anna Gelpern, The Discreet Charm of Conveyancing on the Blockchain, JOTWELL (August 16, 2017) (reviewing Jeanne L. Schroeder, Bitcoin and the Uniform Commercial Code, 24 U. Miami Bus. L. Rev. 1 (2016)), https://corp.jotwell.com/the-discreet-charm-of-conveyancing-on-the-blockchain/.

Digital Regulation and Digital Markets

Rory Van Loo, Rise of the Digital Regulator, 66 Duke L. J. 1267 (2017), available at SSRN.

Consumers and corporations today exist in a world of highly intermediated markets. Digital intermediaries aid consumers in their decisions with more and more regularity. They sort the good from the bad, the expensive from the inexpensive, the suitable from the inappropriate. Private and public digital intermediaries collectively act as a soft regulatory force in the marketplace. Private intermediaries like Amazon, AirBnB, Priceline, Carfax, Google, Houzz, and Zillow help consumers make purchasing decisions on goods and services like diapers, automobiles, airline tickets, hotel rooms, summer vacations, car rentals, furniture, apartments, and almost everything under the sun.  Public intermediaries like the Consumer Financial Protection Bureau and the Affordable Care Act via their mortgage calculator and insurance exchanges, respectively, assist consumers make key life decisions about buying a home and purchasing health insurance. All of these innovative tools, made possible by technologically-driven intermediation, are generally designed to lead to better, more informed decisions in the absence of heavy-handed government regulation – but do they? How do we better ensure that such innovative, digital intermediaries work in the best interests of consumers? How should we think about law and regulation in the marketplace given the rise of these digital intermediaries?

In his recent article, Rise of the Digital Regulator, Professor Rory Van Loo explores these and other questions concerning digital intermediaries. These questions will likely be some of the most vexing and consequential ones for corporations, law, and society in the near future as many of the most valuable and disruptive businesses today are in the business of serving as digital intermediaries for consumers. Professor Van Loo’s article has two core motivations: (1) it highlights the under-appreciated shortcomings and challenges posed by digital intermediaries; and (2) it offers early sketches of potential legal reforms to better address the rise of digital intermediaries.

The article highlights many of the failings and frailties of digital intermediation that are often overlooked in the enthusiasm and allure surrounding them. Private intermediaries frequently operate in uncompetitive landscapes because of the huge barriers to entry posed by the access, accumulation, and analysis of the large volumes of data necessary to create workable, appealing interfaces. Furthermore, because of significant start-up and maintenance costs coupled with the lack of competition, private intermediaries sometimes skew their results to promote options that are more profitable to them, and less sensible to the consumer. Travel websites, for instance, do not always highlight the best choices for consumers; rather, they frequently highlight options of paid sponsors without clear disclosures to the consumers. Public intermediaries face similar issues. They frequently operate with little competition and face huge cost constraints in creating the data analytics capabilities needed to produce a workable framework for the public. Moreover, public intermediaries are subject to the political pressures of elected officials, policymakers, and special interests that sometimes run contrary to the best interests of a majority of the public.

To address some of the shortcomings faced by private and public intermediaries, the article provides a few touchstones to consider. In particular, the article contends that regulation of private intermediaries should focus on promoting more disclosures, encouraging smart competition and improving consumer protection. As for public intermediaries, the article contends that regulation should focus on “adequate funding, anticapture mechanisms, performance metrics, and fully exercising information-collection powers.” (P. 1315.) Ultimately, the article calls for a “uniform lawmaking initiative” akin to the Uniform Commercial Code to design rules and guidelines to govern digital intermediaries. Mindful of the institutional and political barriers inherent in that recommendation, the article contends that this may be one of the best, most realistic paths forward.

The rise of digital intermediaries has presented, and will continue to present some of the clearest benefits and most vexing challenges for consumers, corporations, and regulators. As the marketplace becomes more driven by data, algorithms, and artificial intelligence, digital intermediaries will play an ever-important role in helping us hear the whispers of signals amid the cacophony of noise. More and more, the laws and rules affecting corporations are going to be about the laws and rules of digital intermediaries. In the end, the power to intermediate and to filter is essentially the power to choose. It is an awesome power that must be thoughtfully exercised and carefully governed. Whether our analog political and rulemaking processes are up to addressing the challenges posed by digital intermediaries in a timely fashion remains an important, open question. Nevertheless, as we begin to think about how best do so, Professor Van Loo’s article offers an instructive, early map for the road ahead.

Cite as: Tom C.W. Lin, Digital Regulation and Digital Markets, JOTWELL (July 14, 2017) (reviewing Rory Van Loo, Rise of the Digital Regulator, 66 Duke L. J. 1267 (2017), available at SSRN), https://corp.jotwell.com/digital-regulation-and-digital-markets/.