Nov 25, 2015 Bill Bratton
Developments in corporate law center on two topics these days—shareholder voting and merger litigation. One of the more surprising of the many twists and turns in the latter area is the appearance of appraisal arbitrage. The arbitrage characterization applies because the petitioner under section 262 of the Delaware corporate code takes advantage of the section’s standing rule to buy the transferor’s stock after the record date for the vote on the merger, based on a financial analysis that signals a good chance to prove a valuation in excess of the merger price. A number of special-purpose hedge funds have cropped up as players—Merion Capital, now a frequent appraisal plaintiff, raised $1 billion for a fund dedicated to appraisal claims in 2013. The volume of petitions has spiked up.
Volume has increased substantially despite the fact that appraisal is supposed to be brutally unfriendly to plaintiffs, partly because class actions are prohibited and partly because the plaintiff bears the burden to prove every dollar of damages through a ground up valuation of the company. The surge casts a negative light on the permissive the standing rule, which, in contrast to the blocks erected in representative litigation, facilitates buy-ins. The surge in filings also bids reconsideration of the open-ended approach to valuation techniques followed in the Delaware courts. Finally, it calls into question the fed funds plus 5% interest rate applied to appraisal recoveries under section 262. It is alleged that at a time when interest rates have fallen to little more than zero, a petitioner with a substantial stake can turn a profit on a return of the merger price alone, given an assured 5% yield during the litigation period. Critics are pressuring Delaware to amend the statute to turn back the plaintiffs.
In Appraisal Arbitrage and the Future of Public Company M&A, Myers and Korsmo turn back the critics.
This is a model law review article. It succinctly lays out the framework, and then reports on what has been going on lately, reporting an empirical study of Delaware appraisal litigation over the past ten years. The authors produce a series of crisp, telling descriptive statistics. (There is also a regression but it does not really add anything.) They persuade the reader that the appraisal surge, while certainly dependent on the loose standing rule as a door-opener, is not a function of hold up tactics and does not depend on the 5% interest add-on. The petitioners are selective and target low-premium mergers. Appraisal rights thus are being deployed in accordance with their purpose. Indeed, the authors suggest that Delaware expand section 262 to make appraisal available whatever the form of merger consideration.
This is one of those rare cases where there arises a strong inference that an article influenced the development of the law. Everyone in Delaware with whom I have raised the appraisal arbitrage question makes reference to Myers and Korsmo. The Council of the Corporation Law Section of the Delaware Bar Association cited the article when it took the matter up earlier this year. Significantly, the Council left the standing door open and proposed only a tweak of the statute, suggesting (1) a de minimis dismissal opening for petitions including 1% or less of the shares outstanding or involving a merger consideration of $1 million or less, and (2) an interest cutoff option in the company keyed to a payment of all or part of the merger consideration. As it happened, the legislature left the Committee’s suggestions on the table.
Delaware’s adjustment for appraisal arbitrage instead shows up in the caselaw. Vice-Chancellor Sam Glasscock recently has been using the merger price to trump the petitioner’s showing, reasoning that a well-conducted sale process lends confidence in the dollar result. See, e.g., Huff Fund Investment Partnership v. CKx, Inc., 2013 WL 5878807 (Del. Ch.), affirmed 2015 WL 631586 (Del.). Process concerns have been known to spill over into appraisal cases before, but never to this extent. Even so, the process move makes sense in the present context. Myers and Korsmo pick up on it, mooting a section 262 safe harbor constructed on Revlon principles. This is an intriguing suggestion, but then safe harbors are not the style in Delaware corporate jurisprudence.
Cite as: Bill Bratton,
Appraisal Arbitrage, JOTWELL
(November 25, 2015) (reviewing Minor Myers & Charles R. Korsmo,
Appraisal Arbitrage and the Future of Public Company M&A,
Wash. U. L. Rev. (forthcoming 2015),
available at SSRN),
https://corp.jotwell.com/appraisal-arbitrage/.
Oct 28, 2015 Anna Gelpern
I feel only a bit sheepish for snatching Melissa Jacoby‘s Federalism Form and Function in the Detroit Bankruptcy (Yale J. on Reg. forthcoming) from all the other sections that could claim it, notably Constitutional Law and Courts Law. Although it is the richest law review article I have read in a while—sweeter for being the first in a cycle—I worry that it might fall through the interdisciplinary cracks. Debt rarely takes center stage in constitutional theater these days, ditto bankruptcy procedure in procedure. Even by bankruptcy standards, the project might seem exotic—a deep dive into audio recordings and other primary sources from Chapter 9 (municipal) bankruptcy hearings. Whatever your discipline, you would be mad to miss it. The subject is the biggest-ever public debt restructuring under a statutory scheme. The article is packed with doctrinal, theoretical, and methodological insights. The treatment is sophisticated and empathetic. The policy salience is obvious, as Detroit taps the markets, Chicago totters, Puerto Rico defaults, and the United Nations and the Pope endorse bankruptcy for states.
Chapter 9 of the U.S. Bankruptcy Code is one of the few statutory regimes in the world for public debt restructuring. Its effort to balance federalism and democratic deference against the need to put an over-indebted (likely mismanaged) political unit on a sound financial footing has inspired imitation and criticism. Chapter 9 combines a high barrier to filing with extraordinary deference to the debtor’s policy decisions once it files. There is no bankruptcy estate, no equity, and no liquidation. In theory, states retain sovereignty over municipalities, while federal bankruptcy courts must keep their noses out of municipal affairs. Some commentators have argued that such reticence fuels debtor moral hazard; others have used it to highlight the limitations of Chapter 9 as a framework for bigger, more complex political units.
Until recently, the debate was mostly academic because real political units never restructured under Chapter 9; most of the filing activity involved special tax districts and the like. Detroit’s bankruptcy, coming on the heels of Vallejo and Stockton, CA, Central Falls, RI, and Jefferson County, AL, among others, is arguably a game changer. Having shed over $7 billion of debt in 17 months, Detroit comes closest to testing the proposition that statutory bankruptcy could deliver durable debt relief without compromising people power.
Federalism Form and Function gets at the heart of the question in a novel way. Taking a cue from complex litigation, Jacoby sifts through months of courtroom recordings in real time to draw a framework for managerial intervention by the bankruptcy judge. Those who know the procedure scholarship would not be surprised to discover that courts can exercise tremendous power over the debtor municipality and its creditors through seemingly mundane channels, such as fixing the calendar, appointing mediators and experts, monitoring costs, and conditioning motion rulings. Yet this insight upends the bankruptcy consensus about how Chapter 9 actually works, and poses uncomfortable questions for those who would extend the model to states and countries on the assumption that statutory bankruptcy and third-party adjudication are easily compatible with debtor democracy.
Judge Steven Rhodes used process leverage to force a stream of information out of city officials, then used the information to force the officials to reckon with tort claims, pensions, water services, and other big challenges in a systematic fashion. The all-star team of outsiders assembled under the judge’s direction did exactly what outsiders are meant to do. Unburdened by local political and financial ties, often out of public view, they made practically irreversible decisions with an eye to long-term viability. The outsiders seemed to be people of good will and reasonable priorities: restoring city services, preserving irreplaceable cultural assets, protecting the vulnerable. The end was impressive—a record-fast restructuring, oodles of new money for the city, a renewed sense of possibility—but was it impressive enough to justify the means?
The author comes across as unsettled about the implications of judicial power she documents in Detroit. I was unsettled by my own reaction—I came away from the article in awe of the “Detroit Blueprint.” Intense collaboration among circuit, district and bankruptcy judges, state and local officials left little room for deviation in Detroit. It is as if every part of the process were meticulously rigged to permit a particular range of expressions and outcomes. Thinking outside the box is encouraged; wandering into the woods is unthinkable. No Syriza-Schauble clash-of-democracies circus here. Detroit stayed on the path; now the future looks bright and the all-star team moves on.
Where I live, it is not hard to imagine a city becoming a political football for outsiders whose good will and good judgment are suspect. For all the problems one might have with the Detroit outcome, the Detroit Blueprint could be used in much scarier ways. Federalism Form and Function and its sequels are well-placed to illuminate the possibilities and design the safeguards. No time to waste.
Cite as: Anna Gelpern,
Debt, Detroit, Democracy, JOTWELL
(October 28, 2015) (reviewing Melissa B. Jacoby,
Federalism Form and Function in the Detroit Bankruptcy, 33
Yale J. on Reg. (forthcoming 2016)),
https://corp.jotwell.com/debt-detroit-democracy/.
Sep 21, 2015 Cristie Ford
Chris Brummer,
Disruptive Innovation and Securities Regulation, 84
Fordham L. Rev. -- (forthcoming, 2015), available at
SSRN.
In the early 2000s, I spent some time as a fly on the wall of the floor of the New York Stock Exchange. I talked to specialists—those whose job it was to personally manage trading and make a market for particular high volume stocks—including one who had just earned a coveted specialist’s “seat” (price: $3 million). Once upon a time, a seat was practically a license to make money. As market-makers, specialists bought low and sold high on their own accounts. The NYSE specialists I spoke to talked about decimalization, new at the time—the fact that securities were now quoted in pennies instead of in eighths or sixteenths of a dollar. They agreed that it had cut into their profitability. They were already using an electronic system to pair off small customer orders, and they agreed that it actually handled more order volume than they did. None of them seemed to have given much thought to electronic trading, alternative trading platforms, or the derivatives market. Certainly none of them seemed to think these were existential issues that would undermine their 130-year-old business model.
Securities markets are utterly transformed today. Specialists, as they were then, are gone. Electronic trading networks reign, as does algorithmic trading. The NYSE handles less than 20% of US stock trades (it was 80% just a decade ago). Chris Brummer’s new article, Disruptive Innovation and Securities Regulation, is a gorgeous account of how this happened, how law intersected with innovation, and what the implications might be.
We know already that derivatives and financial engineering have profoundly challenged the assumptions underlying corporate law: think of Bernie Black and Henry Hu’s work on empty voting, Ron Gilson’s and Chuck Whitehead’s work on risk-slicing beyond the corporate share, or Tamar Frankel’s ruminations on how profoundly new technology affects Adolf Berle’s classic analysis of the separation between ownership and control. Bill Bratton and Adam Levitin have pointed out how innovations like the synthetic CDO involving a special purpose entity have redrawn the conceptual boundaries of a firm, and done through contract what formerly would have been done through equity ownership. For a broader audience, Michael Lewis’s influential book Flash Boys gave many a sense of the complex ecosystem in which high frequency traders operate (along with a sense of outrage about the disadvantage at which retail investors and even their pension and mutual funds are put in those ecosystems).
Chris Brummer’s important contribution here is at least four-fold: first, he illuminates the historical dance, from the New Deal era onward, between securities regulation and financial sector innovation. The history he provides is engaging and precise, and he consolidates in one place information about how particular regulatory moves, like the SEC’s Rule 144A (in 1994) or Regulation NMS (in 2007), unexpectedly rearranged markets and altered the business models of the very intermediaries—exchanges, broker-dealers and the like—they were intending to regulate. Among other unexpected relationships, he points out how greater clarity around the standards for private placements produced greater innovation around private placements. The relationship between clarity or standardization, and innovation, is an important one that does not always make it into conversations about finance or the financial crisis.
Second, Brummer identifies the ways in which new technology (particularly automated financial services and private capital markets, including dark pools and crowd-funding) has disrupted regulatory practice. For example, the SEC promulgated Regulation NMS in order to deal with the market fragmentation problem that electronic trading networks had created. It promulgated Rule 144A to help investors gain access to young, innovative, capital-intensive firms. The combined result, though, was to spur high frequency trading and to move trading off public markets, to the detriment of price discovery and fair treatment for retail investors (not to mention the specialists I once spoke to).
The other thing that comes out is how vast and tricky remains the challenge of consumer protection in this space. Consumer protection regulators like the SEC, and the law-based nature of their expertise, did not come out well during the financial crisis. In the wake of the crisis, policy-making momentum and credibility has shifted toward prudential regulation, and more technical financial expertise. Among the contributions in Brummer’s article is a reminder that someone needs to be thinking hard about consumer protection, and priorities such as creating an equal playing field for “real economy” and retail players, in the midst of all this disruptive innovation.
Brummer’s most significant contribution, though, is to pursue a conversation about how we might respond to the challenges that innovation presents for regulation. Back in 2009, Mitu Gulati and Bob Scott asked why law firms don’t have R&D departments. This is a good question (and they provide a fascinating answer) but the question goes beyond just firms. The reality is that law is not terribly good at tracking, let alone engaging in, innovation. This is true even for securities regulation, the area of law perhaps most directly concerned with allocating capital to its best (which often means its most innovative) uses. Brummer’s article has done us a real service by setting out a thorough, insightful description of how far reality has strayed from the static, institution-oriented market structure that New Deal-era regulation assumes. His helpful proposals are to expand the regulatory perimeter, to consider the benefits and limits of objectives-based regulation, and to consider “adaptive financial regulation.” We could perhaps even go further, to consider the ways in which financial regulation needs to be reframed to allow us to think about innovation as a first order regulatory challenge. How might our perspective change, if we started from the point to which Brummer brings us: from a sense of the historical dance between regulation and innovation, and a recognition of the ways in which regulation itself must anticipate and respond to the disruptive and undermining effects of private sector innovation?
Aug 10, 2015 D. Gordon Smith
Verity Winship,
Shareholder Litigation by Contract, __ B.U. L. Rev. (forthcoming, 2015, available at
SSRN.
The debate over litigation bylaws has been percolating in Delaware for several years, but it shifted into high gear last year, when the Delaware Supreme Court held unexpectedly that a fee-shifting bylaw was “facially valid.” ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 558 (Del. 2014). This decision prompted discussion of a corporate litigation crisis, which seems to have abated with action this summer by the Delaware General Assembly, passing legislation prohibiting fee-shifting bylaws and charter provisions for Delaware stock corporations. This legislation also addresses forum selection clauses, authorizing bylaws, or charter provisions designating Delaware as the exclusive forum for claims relating to “internal affairs” and prohibiting provisions designating courts outside of Delaware as the exclusive forum for such claims. Although the immediate threat of crisis has been abated, important issues remain regarding bylaw- and charter-provision-regulating corporate litigation. In Shareholder Litigation by Contract Verity Winship offers a useful framework for thinking about these issues.
Winship begins with a sensible premise: “procedural law should not be used to waive mandatory provisions of substantive law.” (P. 6.) Of course, she recognizes that the number of mandatory provisions in state corporate law is few, but she includes among those provisions “the core duty of loyalty claim within the umbrella of state-law fiduciary suits.” (P. 45.) This is a controversial claim, but one that seems to be shared by the Delaware General Assembly, as the implicit motivation for prohibiting fee-shifting is the desire to preserve fiduciary duty litigation.
It is probably worth noting that the legislation prohibiting fee-shifting was not drafted by members of the Delaware General Assembly, but rather by the Council of the Corporation Law Section of the Delaware State Bar Association, an organization comprising top Delaware corporate lawyers, who have a strong pecuniary interest in a vibrant litigation environment. That said, anyone who believes that fiduciary duty litigation is an important part of the corporate governance system should also endorse Winship’s aspiration to “prevent procedural provisions from being used to kill shareholder litigation altogether” and to “also avoid throwing the baby out with the bathwater.” (P. 6.)
Winship’s approach depends on a contracting framework, which also is not uncontroversial, even though the ATP used this framework in approving the fee-shifting bylaw in that case. The Court in that case reasoned:
Delaware follows the American Rule, under which parties to litigation generally must pay their own attorneys’ fees and costs. But it is settled that contracting parties may agree to modify the American Rule and obligate the losing party to pay the prevailing party’s fees. Because corporate bylaws are “contracts among a corporation’s shareholders,” a fee-shifting provision contained in a nonstock corporation’s validly-enacted bylaw would fall within the contractual exception to the American Rule. Therefore, a fee-shifting bylaw would not be prohibited under Delaware common law. (Pp. 9-10.)
In Private Ordering with Shareholder Bylaws, my co-authors and I suggested that shareholders in public corporations perform not only the conventional functions of selling, voting, and suing, but they also engage in contracting through bylaw amendments. One limitation on our proposal is embedded in the term “shareholder bylaws.” The fee-shifting bylaw in ATP was a “director bylaw,” which seems unlike “contracts among a corporation’s shareholders.” We criticized the Delaware Supreme Court’s opinion in CA, Inc. v. AFSCME Employees Pension Plan, 953 A.2d 227, 238 (Del. 2008) for placing too much bylaw power in the corporate directors, and ATP suffers from this same shortcoming.
Critics of our contracting view note that bylaws are not really contracts, but are simply interpreted by the Delaware courts according to contract interpretation principles. You can see Kurt Heyman, a distinguished Delaware practitioner, making this argument in a recent panel discussion at Fordham Law School. This, of course, is merely a formal objection, which we assume that everyone who endorses the contracting framework recognizes. (Winship dedicates an entire section of her article to examining various caveats to treating bylaws and charters as contracts.) The issue is deciding the extent to which shareholders ought to be allowed to engage in private ordering. Or, in Winship’s words, “Should there be any limit to the procedural provisions to which the parties can contract?” (P. 6.)
Winship’s short answer is “yes.“ Bylaws should be limited by mandatory provisions in the statute, including the newly adopted fee-shifting prohibition. But if the underlying aspiration is to allow individual firms to act as “laboratories of corporate governance,” the number of mandatory provisions must remain rather small. Thus, bylaw provisions altering discovery rules, requiring the posting of a bond, implementing contemporaneous ownership requirements, identifying additional prerequisites to filing derivative lawsuits, and myriad other issues are candidates for private ordering under a robust contracting system.
This article is a full-throated defense of private ordering in corporate governance. It is well written, thoroughly researched, doctrinally sophisticated, and conceptually challenging. And, if it is not clear by now, I add that it is well worth reading.
Jul 7, 2015 Tom C.W. Lin
Securities fraud presents one of the more vexing challenges for financial regulators and policymakers. Each new financial crises and catastrophic fraud frequently begets new tools to fight securities fraud. In a thoughtful recent article, Better Bounty Hunting: How the SEC’s New Whistleblower Program Changes the Securities Fraud Class Action Debate, Professor Amanda Rose examines the SEC’s new whistleblower program as a tool for securities fraud detection, and explores its potential impact on the old fraud detecting tool of class action lawsuits. The motivating argument of the article is that the SEC’s new Whistleblower Bounty Program (WBP) created by Dodd-Frank can serve as a superior alternative to the traditional fraud-on-the-market (FOTM) class action lawsuits as a tool for securities fraud detection and deterrence.
Professor Rose articulates this argument in a logical, measured fashion. She begins by providing background information on the origins of FOTM class actions and the WBP, which is designed to pay large sums to eligible individuals who provide valuable, original information about frauds that result in $1 million or more of penalties. Building on that background, Professor Rose then contends that the WBP could reduce the relative benefits associated with FOTM lawsuits while increasing their relative costs thereby making them a less desirable tool to combat securities fraud. With cautious optimism, she believes that the generous bounty of the WBP and the steep costs often associated class action lawsuits could ultimately lead tipsters who are aware of securities fraud to pursue redress through the whistleblower route rather than the class action route. However, to the extent that the WBP does not function as a feasible replacement for FOTM suits, Professor Rose introduces the innovative idea of adding a qui tam provision in the current whistleblower program as a modest improvement over FOTM suits.
The success and impact of the WBP remains to be seen as the program is still in its infancy. According to the SEC’s 2014 WBP report to Congress, a total of only fourteen awards have been granted since the creation of the program. That said, the SEC has received thousands of tips annually since its inception, and those tips have been increasing year to year. The long term, sustainable success of the program will depend largely on the willingness of individuals with high-quality information about securities fraud to use the program, and the program’s vigilant administration by the SEC. While a more definitive verdict on the WBP remains forthcoming, Professor Rose has provided a promising, underappreciated preview of the program’s full potential.
Ultimately, perfect fraud detection and deterrence in the securities marketplace is a noble but elusive goal. Securities fraud is a persistent, diverse problem that requires a diverse toolkit to solve in a better way. Traditional tools like class action lawsuits are not always the best tools for tackling the diverse variations of securities fraud in the marketplace. In the end, traditional tools like class action lawsuits will have to be complemented, refined, and possibly supplanted by new and better tools such as smart whistleblower-based solutions, as Professor Rose has skillfully articulated in her article, in order to better detect and deter securities fraud in the marketplace.
May 11, 2015 Caroline Bradley
- Yesha Yadav, Insider Trading in Derivatives Markets, 103 Georgetown L.J. 381 (2015)
- Yesha Yadav, Structural Insider Trading, Vanderbilt Law and Economics Research Paper No. 15-8 (March 27, 2015), available at SSRN.
The question of distinguishing between the informational advantages insiders and outsiders may and may not legitimately exploit in trading in the financial markets is perennial: is securities regulation about achieving a level playing field for investors or about imposing sanctions for certain fiduciary and fiduciary-like breaches of duty which go beyond traditional remedies for such breaches. The Second Circuit’s decision in US v Newman emphasizes the fiduciary duty component of liability: at least in a criminal case involving tipping by insiders “the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.”
In these papers Yesha Yadav focuses on two specific problem areas in insider trading regulation, relating to trading in credit default swaps (CDS) by lenders and “structural” trading using a combination of preferential access to information and locational advantages. Both examples present arguments for a rethinking of how insider trading regulation should address the realities of modern, complex, financial markets.
The contexts of the two papers differ. With respect to Insider Trading in Derivatives Markets, Professor Yadav is addressing a context in which regulators have decided to extend insider trading prohibitions to derivative markets. In Structural Insider Trading, on the other hand, Professor Yadav identifies “cracks in regulation” (p. 4).
Congress extended the prohibition of insider trading to transactions in swaps and futures in the Dodd-Frank Act in 2010 and the CFTC implemented the prohibition in rules issued in 2011. By 2010 concerns about the risk of insider trading in credit derivatives was not exclusively a US domestic concern: the Joint Forum of transnational standard setters for financial regulation had identified this as an issue in 2008. But Professor Yadav persuasively argues that trading on insider information in CDSs may improve the informational efficiency of the securities markets, benefiting shareholders. Lenders with access to inside information about their borrowers have incentives to transfer the credit risk associated with their lending, and their ability to hedge risk encourages lending, which benefits shareholders “at least in the near term.”(p. 416) The story is not all positive, however, as lender activity with respect to CDSs may harm shareholders, and shareholders have limited capacity to monitor lenders (p. 417). Lenders may transact in ways that over-emphasize bad news (p. 419).
Professor Yadav suggests that lenders and borrowers might be able to contract around insider trading liability to fix the doctrinal problem. However, she notes that this fix might not work because corporate debtors suffer from a weak bargaining position and monitoring a lender’s compliance with the terms of a contract would be challenging. As usual in the insider trading context disclosure could play a role, although a borrower would have limited options to respond to a lender’s disclosed proposed CDS trades (p. 428). Insider CDS trading raises more general questions about the fit between established doctrine and the realities of the markets: the “tension between law and reality…dismantles long-held assumptions in theory.”
Structural Insider Trading similarly focuses on realities of the financial markets to challenge established assumptions about insider trading law. High speed algorithmic trading strategies combined with geographic proximity to trading venues provides an informational edge (p5) (of course, this development, together with the complex harmonization-differentiation picture of financial regulation also challenges some of the thinking about the decreasing relevance of geography to finance). The informational edge creates a tension between “speed in trading and the policy goal of ensuring broad and equal access to information.”(p 5) Professor Yadav argues:
structural insider trading inverts the traditional policy priority underpinning the prohibition against insider trading. Under Rule 10b-5, liability is justified as a way to protect insiders despite negative effects on market efficiency. By contrast, structural insider trading privileges market efficiency over investor protection, in giving structural insiders the ability to trade on soon-to-be public information despite costs to investors-at-large.
These are two papers which demonstrate very clearly and usefully a need to rethink one area of financial regulation for a complex, evolving, market reality.
Cite as: Caroline Bradley,
Rethinking Insider Trading Regulation, JOTWELL (May 11, 2015) (reviewing Yesha Yadav,
Insider Trading in Derivatives Markets, 103
Georgetown L.J. 381 (2015) and Yesha Yadav,
Structural Insider Trading, Vanderbilt Law and Economics Research Paper No. 15-8 (March 27, 2015)),
https://corp.jotwell.com/rethinking-insider-trading-regulation/.
Apr 13, 2015 Robert Rosen
How many different law review articles cite work by Kahneman and Tversky, progenitors of law and behavioral economics? At least two thousand, two hundred and seventy-three (2,273). And this does not include articles like Professor Baer’s which do not cite Kahneman and Tversky, but cite law review articles which do. Law and behavioral economics is a law professor industry. And, why not? It doesn’t require math and who doesn’t like Brain Games?
How many different law review articles cite work by Oliver Williamson, progenitor of the new institutional economics? At least one thousand, two hundred and fifty-four (1,254). Although smaller, this also reflects an industry which incorporates ideas of agency cost or of just opportunism, which Baer says is, “according to Oliver Wiliamson’s famous definition, a form of self-interest seeking with guile” (P. 99.)
What is the overlap between these 3,527 articles? That is, how many articles cite both Kahneman and Tversky and Williamson? At most 82 (2.3%). Of course, one might also ask what percentage of the smaller number of Williamson-citing papers cite Kahneman and Tversky, yielding a larger but still small number (6.5%). By and large, these appear to be two different lines of scholarship; two different industries.
Miriam H. Baer argues that both lines need to be considered concurrently. Why? The methods and structures of organizational compliance need to deter both deviance originating in individual departures from rationality (the law and behavioral economics line) and individuals whose rationality departs from that of the organization as an entity (the new institutional economics line). To complicate matters, in ways Professor Baer doesn’t highlight, such deterrence also sometimes cut against each other. Call it “the lure of the taboo.” Creating a culture that enshrines non-opportunistic values creates psychological pressures to evade. Sociologists talk about the normality of deviance, but you can just think of the attractiveness of shrimp to those raised in an Orthodox Jewish culture. (And let’s agree to not discuss other taboos).
Professor Baer chooses to focus on one bias, the immediacy bias (exceedingly valuing present over future rewards), which yields a short-term perspective, and temporally inconsistent actions. This bias may result in spur-of-the-moment fraud, unlike the well-planned deceptions of opportunistic individuals.
Compliance measures aimed at preventing spur-of-the moment frauds will either accelerate sanctions or delay the desired gratification. Professor Baer insightfully points out how red-tape has the positive effect of deflecting spur-of-the-moment fraud by delaying or burdening the desired gratification (P. 110.)
Professor Baer continues in this article her earlier important contribution in distinguishing between a “policing approach” to compliance and an “architectural” one (see, Miriam H. Bear, Governing Corporate Compliance, 50 B. C. L. Rev. 949 (2009). She nicely has employees involved in designing architectural constraints to their opportunism by engaging them in identifying areas of operational and compliance risk.
She very nicely describes the limits of the policing approach, which so dominates our culture, not only corporate compliance. And, she urges an integrated effort combining both approaches.
Legal scholarship, in my opinion, too often is determined by theory. Like lemmings, the legal academy follow a theory craze, hence the thousand of articles in behavioral economics and in institutionalism. Articles are written which trace out the implications of a theory for situation after situation.
Situations, however, are not determined by theory. Theory is imbricated in situations. Multiple theories need to be applied to understand, let alone control, situations. A theory might be highly illuminative (as are Williamson’s and Kahneman & Tversky’s), but that which is illuminated by a single theory will likely not suffice to guide pragmatic action. What makes Professor Baer’s article a treat is her recognition of this fact.
Mar 13, 2015 David Millon
Turkuler Isiksel,
The Rights of Man and the Rights of the Man-Made: Corporations and Human Rights (January 7, 2015), available at
SSRN.
The Citizens United and Hobby Lobby decisions have drawn heavy fire from critics of the Supreme Court’s ascription of constitutional and statutory rights to corporations. According to Professor Turkuler Isiksel, a political scientist at Columbia, things may be even worse than those critics appreciate. In the paper referenced above, Isiksel illuminates and offers a trenchant critique of disturbing developments in the transnational arena that may be unknown to specialists in U.S. corporate law. Multinational corporations are claiming that, as legal persons, they are entitled to the rights of human persons under international human rights law.
These assertions seek to shield corporations from domestic regulations imposed by host countries in which they do business. Isiksel’s primary focus is the international investment regime, consisting of a large web of bilateral investment treaties and regional free trade agreements. These are designed to promote foreign investment by guaranteeing protection from expropriation and excessively costly regulations for corporations that have invested in countries that are parties to these agreements. When disputes arise between a corporation and the host state, they are typically resolved through arbitration. Arbitral tribunals are supposed to apply the terms of the particular investment agreement but “they increasingly also make use of human rights law to assess state behavior toward foreign investors.” (P. 38.) Isiksel notes that “[i]nternational human rights law is congenial to firms looking to challenge state measures because it offers a framework for contesting the treatment of private actors by states.” (P. 40.)
Arbitral tribunals have yet to declare that corporations as rights-bearing legal persons actually possess human rights. Nevertheless, these tribunals often look to international human rights law as a source for basic rights to property, due process, and access to justice, as well as principles like proportionality and least restrictive means to assess state imposed burdens. At a time when it is difficult to hold multinational corporations responsible under international law for human rights violations, there is irony in the ability of these firms to protect their own economic interests by couching their complaints against state regulation in the rhetoric of human rights. As Isiksel points out, the “moral stature” of human rights discourse is “appealing to firms looking to challenge state measures that prejudice their profit margins while claiming the moral (and legal) high ground.” (P. 40.)
Human rights claims asserted by corporations come at the expense of the political autonomy of host countries, including their power to enact regulations aimed at protecting their citizens from harm. For example, in one case a Spanish firm operated a landfill in Mexico that handled toxic substances. The facility was located a short distance from an urban center. It became the target of a local citizens’ campaign that eventually resulted in termination of the necessary operating license pursuant to a law already on the books that had previously gone unenforced. An arbitral tribunal sided with the corporation, finding that the public authorities’ response was disproportionate in relation to the asserted public health concerns and was contrary to the legitimate expectations of the corporation that the law would not be enforced against it.
While the notion of a corporation as a legal person possessing the same rights as natural persons might seem absurd, at least a first blush, Isiksel is not content with that intuition. Rather, she takes a close look at the three theories of corporate personhood that have dominated U.S. legal discourse about the nature of the corporation. These are the artificial entity, natural entity, and aggregate theories, all familiar to corporate law scholars in this country. She shows convincingly that none of these theories provides a sufficient basis for claims that a corporate person should be thought of as essentially the same as a human person or at least the moral equivalent of one. For example, she is surely right in stating that the idea of the corporation as an aggregation of humans does not imply that the corporation itself is a human being in its own right; while the constituent humans obviously enjoy human rights and those rights might be implicated by state actions taken against the corporation, it does not follow that the corporation itself somehow enjoys human rights. Beyond her effective analysis of the standard theories found in the legal literature, Isiksel does not offer an in-depth exploration of philosophically grounded ontological or metaphysical claims about what corporations are as potential grounds for human rights claims. Given the stakes, we might expect such arguments to be advanced, but whether they will gain traction remains to be seen. For now, though, Isiksel seems correct to reject the idea that sophisticated theories of corporate agency—of which there are thoughtful and persuasive instances—would also support claims of corporate humanity.
Isiksel is concerned that that the opportunistic use of human rights discourse by corporations threatens to devalue its moral stature. At the end of the day, investment arbitration cases are based on disappointed expectations of financial gain. “Claiming the mantle of human rights is therefore not only a way for firms to offload the risks of doing business to the shoulders of host states, but it also implies a non-existent human right to immunity from investment risk.” (P. 60.) Needless to say, these concerns are altogether different from basic rights to be free from torture, enslavement, arbitrary detention, religious persecution, and other kinds of suffering that can only be experienced by human beings. Might expansion of the human rights tent end up problematizing the idea that people enjoy certain freedoms simply by virtue of our shared humanity?
Isiksel ends with a provocative point that I, by no means an expert on human rights law, found quite interesting. She sees the appropriation of human rights discourse by corporations for use against the states in which they operate as based on a notion of human rights as “fundamentally supranational and anti-statist . . . located above states, making their impact on domestic politics as foreign impositions.” (P. 98.) Contrasting with this model is one that links human rights norms to local normative controversies, where norms are “developed, enriched, and transformed through domestic struggles aimed at reforming domestic public institutions, which in turn reverberate across societies and shape international instruments.” (P. 100.) According to this view, human rights norms emanate from local communities, elevating political discourse and providing standards by which states may be held accountable to their citizens. Seen in this light, efforts by multinational corporations to use human rights norms as levers against domestic regulations aimed at protecting a population’s well-being threaten the ability of local communities to elaborate and enforce human rights norms.
The deployment of human rights discourse by multinational corporations—like the claims for constitutional and statutory rights under U.S. law—are made possible by the idea of the corporation as a legal person in its own right, existing in the eyes of the law separately from the human beings who constitute it. One might attempt to ground objections to these kinds of rights claims on rejection of the idea of corporate personality, but Isiksel does not do this and she is right not to try. The corporate personality idea is too deeply entrenched in western law and legal theory to be susceptible to that strategy and, in any event, the corporation’s separate legal identity serves a socially useful function with respect to capital formation. The challenge therefore is to present strong arguments against particular assertions of rights, whether they are said to arise from international human rights law or domestic constitutions and statutes. In this paper, Isiksel succeeds admirably in exposing the weaknesses of human rights claims in an area of great importance that may not yet be well known to U.S. scholars of corporate law.
Feb 10, 2015 Ezra Mitchell
Etiquette guides suggest that one has a year from the wedding to send a gift. I just read Larry Cunningham’s elegant article published precisely a year ago. So I’m on time to comment.
This piece addresses the explosion in the federal government’s use of deferred prosecution agreements (DPAs) in combatting corporate crime, a phenomenon that has increasingly become the subject of debate, at least in part because of the extraordinary fines that typically constitute a part of these deals. The corporate (or, as Larry corrects the record, partnership) death of Arthur Andersen, and enforcement in the pharmaceuticals industry (where conviction can lead to exclusion from federal health care programs to the detriment of patients) have made prosecutors sensitive to the collateral damage they can cause by indicting and trying (or obtaining guilty pleas from) corporations suspected of misconduct. Much of the literature focuses on the potential abuses inherent in the use of DPAs, which have a fitful history of prescribed guidelines and standards, and which present significant potential for prosecutorial abuse due to the one-sided nature of the bargain. (Among the abuses have been mandated—sorry, bargained-for—waivers on behalf of employees of work product and attorney-client privileges.) Further concern has been their secrecy, precluding interested corporations from tailoring compliance to address prosecutor’s concerns. While commentators see the utility of these agreements in avoiding litigation costs and achieving some measure of deterrence (in addition to avoiding collateral damage), much of the analysis has been negative.
Larry has taken a practical and sensible approach to the problem. DPAs can be useful, he tells us, but only if prosecutors approach the negotiation and structuring of an agreement as a governance problem. Ever since the 1996 Delaware Caremark decision, Delaware law at least formally has required that its corporations structure governance in a manner that discourages unlawful conduct and that makes it detectable when it occurs. Sarbanes-Oxley supplemented this approach with its own regulations. And who better to understand the governance of any particular corporation than its own board and executives? Yet, as Larry shows us, principally through his examination of the travails of AIG during the middle of the first decade of this century, prosecutors can be less than thoughtful about the appropriate, compliance-ensuring governance regime for any particular corporation. He rather convincingly demonstrates that AIG’s role in the financial crisis may well have been a direct consequence of the standardized “best practices” corporate governance regime imposed under Arthur Levitt’s supervision. (I point out that his knowledge of AIG is as a result of a book he co-authored with Hank Greenberg, who has a dog in this particular hunt, but Larry’s careful and scholarly approach give me confidence in the veracity of his reporting.)
I would do a disservice to Larry by attempting to summarize this careful and thorough piece of scholarship, so I suggest that you read it. He does an excellent job of understanding and explicating the theoretical legal place of DPAs (not quite contract, not quite regulation), as well as providing a thorough analysis of the costs and benefits of his own proposal. I will say that he left me with many questions, not least of which are the role of compensation structure, the efficacy of deterrence versus prevention, the role of punishment, and the decision to engage with the corporation rather than prosecute individual malefactors. But this, to me, is a sign that Larry has done a superb job. Indeed he has stimulated me to engage in my own research to address some of these questions. I can think of no higher praise.
Cite as: Ezra Mitchell,
Governance by the Sword, JOTWELL
(February 10, 2015) (reviewing Lawrence A. Cunningham,
Deferred Prosecutions and Corporate Governance: An Integrated Approach to Investigation and Reform, 66
Fla. L. Rev. 1 (2014)),
https://corp.jotwell.com/governance-by-the-sword/.
Jan 7, 2015 Saule T. Omarova
Erik Gerding’s recent book, Law, Bubbles, and Financial Regulation, is an ambitious and fascinating project that seeks to explain how asset bubbles—a perennial staple of economic history—lead to and, in turn, are exacerbated by financial regulation. Gerding makes it clear from the outset that his goal is to move beyond “fixing immediate symptoms” of a financial crisis and try to uncover the fundamental factors that explain how disasters happen. To this end, he advances what he calls the Regulatory Instability Hypothesis, a conceptual framework for explaining how financial markets (traditionally, a realm of private ordering) and financial regulation (the public sphere) get locked into a deadly spiral leading to a crisis. Gerding identifies five key dynamics that define this interaction: the regulatory stimulus cycle, compliance rot, regulatory arbitrage frenzies, pro-cyclical regulation, and promoting of investment herding. His Regulatory Instability Hypothesis holds that these five distinct dynamics pose danger to financial stability by undermining laws and regulations designed to protect it.
In my opinion, one of the most interesting and novel elements of Gerding’s argument is his concept of the “regulatory stimulus cycle.” Various scholars before Gerding wrote about the multiple causes and consequences of various deregulation campaigns, including privatizations of previously public functions and repeal of specific laws viewed as constraining private markets. In the aftermath of the latest financial crisis, in particular, many were searching for specific legal mechanisms that enabled unsustainable growth in risk and leverage within the financial system in the pre-crisis decades. For example, some scholars argued that the latest crisis could be traced directly to the partial repeal of the Glass-Steagall Act in 1999 and/or the passage of the Commodity Futures Modernization Act of 2000—the two most significant deregulatory legislative acts in recent times. Others (including myself) have focused on specific regulatory or legislative actions enabling financial institutions to conduct business activities that fed the pre-crisis asset bubble.
Gerding brings together all of these strands to construct a convincing and creative explanation of the entire complex of legislative and regulatory actions and failures to act, which form a single historical pattern that cannot be reduced to a simple notion of “deregulation.” Gerding argues that asset bubbles and busts create similar cycles of “regulatory stimulus” (which encompasses “loosening” of various legal restrictions on bubble-conducive financial activities) and “regulatory backlash” (which inevitably follows an implosion of the bubble). He analyzes this phenomenon of regulatory stimulus through three theoretical lenses—public choice, behavioral economics, and social norms—and demonstrates the complexity and multiplicity of factors that create and reinforce pernicious regulatory cycles. Gerding’s argument is original, thoughtful, and quite illuminating even for those of us who are well-versed in this subject-matter.
Gerding follows a similar approach when he examines the complex factors behind the other four aspects of his Regulatory Instability Hypothesis. He continues this densely packed discussion, which forms the bulk of the book, by applying his conceptual framework to the Panic of 2007-08. Here, Gerding shows his mastery of the rise and growth of the so-called shadow banking system, which he uses as a vivid example of the bubble-bust dynamics not only in financial markets but also in financial regulation.
The last part of the book lays out the author’s vision of how to design a more effective and adaptive financial regulation that would be less vulnerable to the pernicious dynamics of regulatory instability. It’s a sweeping but thoughtful discussion of high-level principles of regulatory design that could potentially alleviate specific problems he identifies earlier. While admitting “profound challenges” of trying to counter these deeply-rooted dynamics, Gerding methodically catalogues a wide range of measures aimed at redesigning regulatory institutions, with a view toward breaking the historical pattern of boom-and-bust cycles. Necessarily lacking in specificity, this forward-looking discussion nevertheless is very impressive and effective as a conceptual framework outlining the avenues for future policy work in the area.
As with any large-scale and ambitious work, Gerding’s book may invite legitimate criticism on a variety of specific points. I do not agree with every statement, diagnosis, or recommendation for future reform that he advances in his book. I would even argue against some of his assertions (and, especially, some of his recommendations). If I were writing this book, I might have chosen a different theoretical device to construct the argument. Yet, none of these disagreements diminish the significance of the book. On the contrary, by defining the contours of the debate and creating a helpful vocabulary for discussion, Erik Gerding’s new book provides a great benefit to the scholarly community. To be sure, this book is a dense read that requires an extra effort from its readers. Yet, the result if well worth the effort.
