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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/.

Plus ça Change

Camden Hutchison, Progressive Era Conception of the Corporation and the Failure of the Federal Chartering MovementColum. Bus. L. Rev (forthcoming, 2017), available at SSRN.

Good history, including good legal history, sheds light on our own times. Well-written history, peopled with recognizable figures and marked by a strong narrative arc, also makes for good reading. In a new article, Camden Hutchison brings a precise historical eye and an engaging storytelling style to the understudied area of corporate legal history. His topic is Progressive Era corporate law reform, and particularly the question of why the United States failed to develop a federal corporate law regime in that period (and, of course, since).

Hutchison investigates how it could be that “in an era marked by ambitious efforts to reform the national economy, the [federal] chartering movement would distinguish itself, both in the breadth of its political appeal and the decisiveness of its failure”. His conclusions are illuminating and relevant. Once again, in the current era of populist discontent and economic inequality, we find ourselves confronting fundamental questions about the corporate form, the relationship between private wealth and the public interest, and about what a “progressive” corporate law regime might actually seek to accomplish.

Hutchison’s rich, thoroughly researched article is one product of a doctoral degree in history combined with several years of corporate practice with a global law firm. He draws on extensive primary sources to tell the story of US corporate law from state corporate chartermongering in New Jersey in the latter 1800s, through failed federalization efforts during the Roosevelt and Taft Administrations, and beyond. Federal chartering was a national political issue in the Progressive Era. Following the dramatic growth of industrial corporations during the “great merger movement” of 1895-1904 and through to the Federal Trade Commission’s establishment in 1914, the federal corporate chartering and antitrust movements were politically interconnected. Hutchison is a careful historian who does not overclaim about his story’s contemporary relevance, but his account nevertheless raises some provocative possibilities.

For example, Progressive Era reformers understood corporate law in a broader, more political economy-informed sense than the field tends to permit today. Corporations were not just neutral legal vehicles for achieving corporate aims or, more pointedly, for maximizing shareholder wealth. Rather, Progressive Era policymakers saw corporations as “quasi-public instruments of the state, whose legal privileges were contingent upon provision of a public benefit”. Note that we are still decades before Karl Polanyi published The Great Transformation (1944). Polanyi’s notion – it is a critique – of the market economy as a sphere of competitive capitalist human activity free of public or moral claims does not seem to inhibit Progressives’ enthusiasm for reform. These many decades later, after living through some remarkable extremes in thinking about what efficient markets can be expected to achieve on their own, we could do worse than to revisit these Progressive Era assumptions. In insisting that corporations assume public obligations in exchange for the benefits of incorporation, some Progressive Era reformers share a starting point with scholars such as Anna Gelpern and Erik Gerding, and Bob Hockett and Saule Omarova, who scrutinize the deep structures of finance and financial regulation in the service of a more contemporary progressive politics.

This is not to say that Progressive Era reformers had a particularly well developed or accurate understanding of how corporations and their constituent parts operated. We are pre-Berle and Means’ The Modern Corporation and Private Property (1932) here too. Progressive Era reformers tended not to distinguish between investors and managers, ownership and control; it was “corporations” versus the “public”. Many of the reformers’ ostensibly public-oriented priorities, like concerns over “watered” stock or corporate disclosure, would be understood as investor protection mechanisms today. Then, they were understood as weapons against inflated dividends and monopolistic pricing. Some Progressives’ thinking was fuzzy, if not downright mistaken, about how certain initiatives aimed at the public interest (e.g., automatic bankruptcy proceedings for overcapitalized corporations) would adversely affect not only corporate interests but shareholders’ and other stakeholders’ too. But considering the public interest as distinct from some “corporate” corporate one reminds us of the conceptual vice in which Berle and Means have held corporate law theory. Especially given the ways in which financial and legal innovations have shattered the atoms of the corporation, and the share, we may even wonder whether the separation of ownership from control is still the most salient or interesting divide around which corporate law should orient itself. Perhaps, understanding why Progressives framed the conversation in terms of public interest and concentrated economic power has the potential to inject fresh life into corporate law theory generally.

For scholars of policy change, the failure of federal chartering also offers a cautionary tale. Logistical details and labels were not fatal – when a movement has momentum, people in favour of “federal chartering” can also get behind “federal licensing”, and vice versa. But superficial consensus can mask deep ideological disagreement. Corporatist and anti-corporate forces were aligned around the high level objective of federal chartering, but for divergent reasons. Anti-corporate advocates like William Jennings Bryan saw federal chartering as a means of supplanting overly permissive state acts. Corporatist progressives were a somewhat varied bunch (and not always “progressive” as we might use the term), but included some who saw federal corporate licensing as a bulwark against federal antitrust enforcement! Once it came to hammering out the details, then, the scope for agreement turned out to be exceedingly – indeed, impossibly – narrow. The failure of the Hepburn Bill in 1909, which foundered on small businesses’ opposition to exempting labor unions and agricultural collectives from the Sherman Act, is one of several fascinating narratives in Hutchison’s article. And yet, as he observes, there is more than one way to skin a cat. Corporate federalization may have failed, but for better and for worse at least some of its less controversial objectives, including mandatory corporate disclosure, were eventually achieved through other federal legislative regimes.

Social and intellectual memory can be in scarce supply in times of upheaval and uncertainty. In this article, Camden Hutchison makes a welcome contribution in helping us see the trajectory and priorities of corporate law thinking across a broader historical time frame.

Cite as: Cristie Ford, Plus ça Change, JOTWELL (June 14, 2017) (reviewing Camden Hutchison, Progressive Era Conception of the Corporation and the Failure of the Federal Chartering MovementColum. Bus. L. Rev (forthcoming, 2017), available at SSRN), https://corp.jotwell.com/plus-a-change/.

The Baby and the Bath

Joel Friedlander, Vindicating the Duty of Loyalty: Using Data Points of Successful Stockholder Litigation as a Tool for Reform, Bus. Lawyer (forthcoming 2017), available at SSRN.

At least since Karl Llewellyn crossed back over the Mississippi on his return from Montana,1 legal scholars have understood the value of lived experience as necessary to demonstrate the significance of legal theory. One could even note the rise of empiricism over the last several decades as a further development of this kind of insight. Yet laboratory empiricism can teach only so much. Important as it is, taken alone it can miss the trees that populate the forest.

Joel Edan Friedlander’s new paper is important precisely because it comes up to us from a place that numbers and theory alone cannot reveal. A highly experienced member of the Delaware plaintiffs’ bar, Friedlander writes in response to recent developments that threaten further to limit the already highly limited institution of shareholder litigation.

Despite their rather unsavory origins,2 restrictions on shareholder litigation help to keep in check the possibility of corporate extortion by plaintiffs whose only real interest in vindicating shareholders’ rights is a quick settlement and high legal fees. Yet it is also the case that such suits serve the important function of enforcing against corporate directors those fiduciary duties that have been left still standing. While the litigation process can be abused, so can the corporate process, and no better legal institution for the insured integrity of the latter has yet been designed.

Although Friedlander’s own personal interest in continued shareholder access to the courts is obvious, this paper is nicely balanced with real-world facts and modest claims. Empirical studies have demonstrated the worthlessness of much shareholder litigation, except of course to plaintiffs’ lawyers. But as Friedlander notes from the start, those studies fail to understand that many such cases are settled without judicial opinion, thus escaping the notice of scholars. He sets out to use eight highly successful cases in which he has participated in order to analyze which potential reforms will achieve their goal of weeding out meretricious litigation without destroying significant value-adding lawsuits.

Four basic reforms are at issue: early settlement of disclosure claims; laws permitting fee-shifting bylaws; laws restricting expedited discovery; and the application of the business judgment rule to controlling shareholders upon compliance with certain procedural niceties.

As to early disclosure settlements that would preclude deeper investigation that could (and sometimes does) reveal the existence of significant loyalty claims, Friedlander approves of recent Delaware developments restricting early dismissal and suggests that courts also could rely more heavily on questions of adequacy of shareholder representation to ensure that plaintiffs’ counsel is interested in more than simply hit and run.

He explores the problems inherent in fee-shifting arrangements, analyzing several cases to demonstrate the almost preclusive effect they would have on meritorious litigation at a premature stage. While I was not especially surprised by the size of defendants’ legal fees, it did strike me as both interesting and impressive to see how relatively inexpensively plaintiffs’ firms (or at least Friedlander’s firm) can litigate. In any event, the asymmetry in fees would operate to preclude much meritorious litigation, just as security for expense statutes did with respect to derivative suits.

Somewhat related is the importance of expedited discovery. Giving due credit to the merits of restricting expedited discovery in and of itself, he assesses this reform in light of diminished fiduciary protections in cases where an informed and disinterested shareholder majority approves the deal. Left with substantive fiduciary protection and an obligation to produce only board minutes, proxy statements, and other corporate documents, defendants can pretty much prevent plaintiffs from getting past the door. Friedlander stresses the importance of emails and other forms of internal communication that would be revealed in discovery as essential to establishing a meritorious cause of action. Finally, he discusses the expansion of the business judgment rule to controlling shareholders as yet a further justification for demanding more balance in procedural litigation rules.

Friedlander’s work is important. It is important to scholars as a cautionary tale about paying as much mind to what you don’t know as to what you do know. More importantly, it highlights significant dimensions of shareholder litigation that argue in favor of cautious reforms that would sustain the possibility of significant shareholder recovery in appropriate places. With any sort of meaningful fiduciary duty increasingly melting away like Greenland’s glaciers, it may be all we have left.

  1. Karl N. Llewellyn & E. Adamson Hoebel, The Cheyenne Way (1941). []
  2. Lawrence E. Mitchell, Gentlemen’s Agreement: The Anti-Semitic Origins of Restrictions on Stockholder Litigation, 36 Queen’s L. J. 71 (2010). []
Cite as: Ezra Mitchell, The Baby and the Bath, JOTWELL (May 18, 2017) (reviewing Joel Friedlander, Vindicating the Duty of Loyalty: Using Data Points of Successful Stockholder Litigation as a Tool for Reform, Bus. Lawyer (forthcoming 2017), available at SSRN), https://corp.jotwell.com/the-baby-and-the-bath/.