Prof. Josh Fershee guest-blogging at Business Law Prof Blog

Professor Josh Fershee is guest blogging at Business Law Prof Blog, a Member of the Law Professor Blogs Network.

 

March 17, 2010 - permalink

Needed: A Study to Determine if Studies Are Effective

The financial reform bills under consideration in both the House and Senate include several studies to determine the likely effectiveness of a variety of proposals. In fact, the New York Times reports, the House bill, includes “a call for a study of how regulations affect small businesses, and another to examine the definition of ‘small.’”

Studies can be helpful, especially in rapidly changing areas; studies can also be used to delay making any changes. Often we are tempted to view such delays as “keeping things the same.” However, this is usually not an accurate way to look at it. As I often tell my students, the status quo is also a choice. Not changing a law or a regulation doesn’t mean the world will stay exactly the same. Instead, it means simply that the law or regulation (or lack thereof) stays the same.

It is hard to say what studies will make it into the final bill (if there is one) and if those studies will become law. However, if lawmakers are putting the studies in place out of fear that the underlying possible changes could be harmful, they need to remember that not making a change runs the same risk.

 

March 15, 2010, permalink

Remarkably Capable Robots to Take Over Senate?

The New York Times reports that Sen. Chris Dodd, chair of the Senate Banking Committee, is ready to introduce a major financial reform bill designed to address concerns raised by the recent financial meltdown. The bill is expected to be broad, dealing with everything from over-the-counter derivatives to credit cards and mortgages. The bill is also designed to have some cross-aisle appeal and will likely have provisions that should appeal to both liberals and conservatives.

Nonetheless, the article reports that Sen. Bob Corker (R-Tenn.) says everything is moving too fast: “If the senators can pass a bill of this substance out of committee in a week — a 1,200-page bill full of substance, that has a real effect on the financial industry — then the states who elect them might as well send robots to the Senate.”

I am not sure what this means. Is it bad to “pass a bill of substance” that is effective if you get it out of committee quickly? Did robots do the work; they just currently serve as staffers? Are these robots even old enough to serve under Article I, Section 3? (Thirty is pretty old for a robot – this would be from the TRS80/Apple IIe range, if memory serves.)

I appreciate careful deliberation of all legislation, and I certainly hope everyone involved is taking this legislation seriously. I have not seen the bill and am not at all sure how effective the bill would be, but I am, frankly, less concerned with the contents of this legislation than other quickly crafted bills. The bailout bills and the USA Patriot Act, for example, were drafted hastily in response to major unforeseen and unexpected (at least in terms of timing and magnitude) events.

Perhaps I am wrong, but I am inclined to believe much of the current reform bill includes a whole host of provisions that have been considered previously. For what ever reason, the timing was just not right for their adoption. Of course, extra time does not make these provisions an inherently good idea, but it is no reason to delay Senate consideration, either.

 

March 12, 2010, permalink

Law Office Space

This blog is about business law, which I am taking to include the business of law (at least for this post). A recent ABA Journal article reports that, according to a consultant, midsize law firms are at "serious risk" because of “complacency.” It may be that the film Office Space has unfairly and forever jaded my view of consultants (remember the Bobs?), but I am skeptical.

I mean, I am sure he’s right to some degree, but I am not sure anyone needed a consultant to figure that out. Complacency is a problem in any profession, including the legal profession. That, of course, applies to legal academics, too. If you think you have it all figured out and you don't need to adjust, evolve, and improve, you’ll get left behind. Someone else will fill the void, and take your spot.

This whole idea might be news if there were a study or some other indication that midsize firms were, on the whole, complacent in some specific way that was likely to lead to problems. However, this appears to be simply an assertion based on anecdotal evidence. The consultant has every right to make such a claim; I’m just not clear how it qualifies as news.

 

March 10, 2010, permalink

Going Canadian

While Lions Gate is considering a move from Canada, a North Dakota pasta company is considering a merger with a Canadian suitor. Dakota Growers Pasta Co. is the third largest pasta company in the United States and has about 1000 shareholders. Viterra Inc., the acquiring company, saw its stock rise more than 2% today, following a positive financial report and news of the proposed acquisition.

This talk of Canadian mergers reminded me of an interesting article I came across awhile back, Analysis of a Merger from a Governance Perspective: The Case of Abitibi-Consolidated and Donohue. The abstract:

Adopting a governance perspective, this clinical study analyses the merger between closely-held Donohue Inc. and widely-held Abitibi-Consolidated Inc. Some key findings emerge. First, the absence of a controlling shareholder and weak board governance at Abitibi might explain both (a) its executives' interests in the transaction and (b) its CEO's compensation increase despite underperformance. Second, an inter-generation shift of control at Quebecor (Donohue's parent company) led to a strategic reorientation that (a) transformed Donohue into a target and (b) insured that Donohue's executives had incentives to pursue a deal. Finally, Donohue's non-controlling shareholders benefited from the transaction while Abitibi shareholders experienced wealth reduction. The merger's aftermath provides some counter evidence regarding blockholders' power in widely-held firms.

 

March 8, 2010, permalink

Do Limits on Ownership Rights Eliminate Ownership?

Last week, I wrote, “A shareholder move seeking a greater voice in corporate governance seems proper to me because it is about the exercise of ownership rights.” Professor Bainbridge disagreed (although he did concede that shareholders’ residual claim on the corporation's assets provides "certain ownership-like rights”). I appreciate Professor Bainbridge’s nexus of contracts theory (the reason he disagrees), and I find it to be a useful tool in conceptualizing some of the relationships between corporate stakeholders. However, it doesn’t completely satisfy my view of the shareholder relationship with the corporation.

I view shareholders as having “an ownership interest” in the corporation, an interest that is, I admit, often quite limited. I think comparing shareholders to those who own homes (or condos) with a restrictive homeowners’ association (HOA) as an apt analogy. When owning a home governed by an HOA, the homeowner gives up a number of rights often attributed to ownership — such as limits on exterior modifications or choice of color. However, just because those rights (and the related decision-making ability) were ceded to the HOA board, we don’t tend to think that means there is a lack of ownership. Beyond HOAs, there often are additional contracts (such as mortgages, easements, etc.) related to (and restrictive of) home ownership. We nonetheless still conceptualize these people as “owners.” (Incidentally, I don’t view the tangible/intangible difference here as significant, because I am of the mind that people can also own patents, copyrights, goodwill, etc., that are similarly created by law.)

I suppose this is just an area in which we'll have to agree to disagree.

 

March 5, 2010, permalink

Escape from Icahn: The Road to Delaware

BusinessWeek recently reported that Lions Gate Entertainment Corp. is seriously considering relocating to the United States in the face of Carl Icahn’s attempts to increase his stake in the company. Icahn is a well-known “shareholder activist” and apparently strikes such fear in the hearts of the board of directors that it is worth considering corporate relocation, even though the company is well aware it would likely face major financial penalties for such a move.

Ironically, it is Icahn who has been using (or at least trying to use) corporate relocation to his advantage. Icahn recently relocated the company American Railcar, Inc., from Missouri to North Dakota to take advantage of the state’s shareholder-friendly corporate law option, and has tried (unsuccessfully) to get other companies, Like Amylin Pharmaceuticals Inc. and Biogen Idec Inc. to follow suit.

Perhaps I am more of a shareholder activist than I originally thought, but the idea of the board moving the company to avoid Icahn’s advances seems wrong to me. Not necessarily illegal, just wrong. Shareholders do, after all, get a vote on relocations like this, so shareholders can always object to the move if they disagree with the board.

A shareholder move seeking a greater voice in corporate governance seems proper to me because it is about the exercise of ownership rights. A costly move initiated by the board to avoid a particular shareholder’s influence seems wasteful and more about self-preservation at shareholders’ expense than about good business judgment. To me, this is one place where what is good for the goose, is not good for the gander.

 

March 3, 2010, permalink

Complexity Does Not Necessarily Mean Evil

According to Reuters (via the New York Times), the SEC is building up its New York City office this year, planning to expand by about eight percent with the goal of “catching cheaters” and aggressively going after Wall Street “bad guys.” The report goes on to note that hedge funds, in their quest to make money, are using complicated derivatives and credit default swaps more and more often.

As someone who tends to be a big-time rule follower, I don’t care much for cheaters or people who take advantage of others (not to imply anyone else really likes those who do), but I am troubled by the implications in this story.

The story implies that complicated financial transactions are somehow inherently designed to cheat and are therefore used by the “bad guys.” I did a (very short) rotation through the derivatives group when I was in New York, and I can confirm that many derivatives and credit default swaps are, in fact, quite complicated. However, I cannot confirm that any of the projects I saw were designed by or for cheaters or bad guys.

There is no doubt that some cheaters and bad guys use complex transactions to hide their nefarious dealings, but this is not transitive. Complex transactions are not used solely by cheaters and bad guys. To the contrary, most such transactions are used by regular (albeit usually wealthy) people, who have their flaws, but are generally neither cheaters nor bad guys.

I support cracking down on those abusing the system, and perhaps we can make the system more transparent in a way that both facilitates markets and reduces cheating. I just don't think it is helpful or productive to view complexity in itself as an evil.

 

March 1, 2010, permalink

Who Knew There Were Net Winners in the Madoff Scheme?

The Wall Street Journal reports that U.S. Bankruptcy Judge Burton Lifland (New York City) today ruled that “net winners” (those who withdrew more funds than their initial investments and later deposits) in Bernard Madoff's ponzi scheme were not entitled to recovery.

The opinion (pdf) explains: “Equality is achieved in this case by [looking] solely to deposits and withdrawals that in reality occurred. To the extent possible, principal will rightly be returned to Net Losers rather than unjustly rewarded to Net Winners under the guise of profits.”

I’m inclined to agree. I am sympathetic to all of the victims of Madoff’s scheme, but to walk away with all of your principal (or more) from this fiasco is about as much as one could reasonably hope. This is especially true given what happened to the market in the time frame of the Madoff investments.

Any investment carries risk, and one of those risks (unfortunately) is fraud. It seems proper to me that those who clearly lost the money they input on the deal should be first in line for recovery.

 

February 26, 2010, permalink

Sticking with the Veil-Piercing Theme

Yesterday the United States Court of Appeals for the Eighth Circuit, in an ERISA action (pdf), issued an opinion that mirrors my response to at least a few exam questions on veil-piecing each year: finish your analysis.

The court made clear that, contrary to the lower court’s analysis, piercing the veil is, in fact, still a two-part test. To pierce the corporate veil in this context, a court must determine: “(1) whether a corporation was controlled by another to the extent it had independence in form only, and (2) whether the corporation was used as a subterfuge to defeat public convenience, justify wrong, or perpetrate a fraud.”

The defendants in the case, among other things, commingled funds (almost always a no-no) and generally disregarded corporate formalities in a way that justified the determination that the corporation lacked independence. However, the court reversed and remanded for a trial on the second issue: “whether the corporation was used as a subterfuge to defeat public convenience, justify wrong, or perpetrate a fraud.”

The Eighth Circuit noted that the district court, as well as the plaintiffs, provided little explanation about why the same facts that established the first prong of the veil-piercing test also satisfied the second prong. Given a lack of evidence and “the lack of explanation on the second prong of the test,” the court found “trialworthy issues” warranting remand.

The lesson: Even when it seems obvious, you need to finish the job. And it’s better sooner rather than later.

 

February 24, 2010, permalink

A Veil Piercing Epidemic in the High Plains?

From 1999 until 2007, the North Dakota Supreme Court did not hear single case seeking to “pierce the veil” of a limited liability entity. This is especially significant because there is not an intermediate court of appeals in the state; litigants in the state appeal directly to the state's Supreme Court. Thus, it’s not as though the Court simply declined to hear any cases on the issue.

Since 2007, however, there has been a (relative) rash of veil piercing cases. The North Dakota Supreme Court has issued four decisions on the issue, piercing the veil in all four cases. Coughlin Const. Co., Inc. v. Nu-Tec Industries, Inc., 755 N.W.2d 867 (N.D. 2008) (piercing the veil of a corporation); Red River Wings, Inc. v. Hoot, Inc., 751 N.W.2d 206 N.D. 2008) (piercing the veil of a limited liability partnership); Intercept Corp. v. Calima Financial, LLC, 741 N.W.2d 209 (N.D. 2007) (piercing the veil of a limited liability company); Axtmann v. Chillemi, 740 N.W.2d 838 (N.D. 2007) (piercing the veil of a corporation).

I have to wonder if this simply a fluke or is there a discernable trend in these kinds of cases (both in their existence and outcomes)? One might expect a surge in veil piercing cases when the economy is poor, but the state of North Dakota has managed to escape most of the ill effects of the nation’s financial crisis. In fact, only North Dakota and Wyoming posted budget surpluses last year. Then again, I arrived in North Dakota and began teaching Business Associations in 2007, so perhaps I was the catalyst. But that can’t be it, either, as the Axtmann and Intercept Corp. cases (at a minimum) would already have been well underway.

Regardless, this could be interesting. I plan to take a look at other states to see if this is a trend around the country or simply a blip on the North Dakota radar. In the meantime, I welcome any thoughts or comments.

 

February 22, 2010, permalink

Would Open Trading Trump Rational Apathy?

In a recent New York Times online opinion piece, William D. Cohen discusses the significant stock sales that many high-level Goldman Sachs executives made in their own company during the worst part of the 2008 stock market fall. Cohen states that if people had had real-time information about the sales made by Goldman’s executives, the market had known would have not looked favorably on the news. I’m not so sure.

Although there are a number of potential downsides, I admit I am intrigued by the concept of making more real-time information available about trades by large shareholders and company employees. I’m not quite ready to agree with Henry Manne, et al., that insider trading should be permitted because it would send the market proper signals leading to more accurate stock price valuations (my apologies to all for the oversimplification), but perhaps more information would lead to better outcomes.

Then again, it seems like Enron should have been discounted significantly, too, given that no one could seem to figure out exactly how they were doing so well. (For a great discussion on this topic, see William D. Henderson & Hon. Richard D. Cudahy, From Insull to Enron: Corporate (Re)Regulation After the Rise and Fall of Two Energy Icons, 26 Energy L. J. 35 (2005)). In light of that, maybe no one would have noticed. After all, shareholders tend to be rationally apathetic, right?

 

February 19, 2010 - permalink

The Murky Rules of the Game After PUHCA

The Energy Policy Act of 2005 repealed the Public Utility Holding Company Act (PUHCA), in part to help spur infrastructure investment through mergers and acquisitions in the electricity sector. Yet four years later, the mergers and acquisitions picking up steam in the energy sector are (according to the New York Times) primarily in the oil and gas area, not the electricity area.

This is yet another indicator that the threat of regulation often has as great an effect on investment decisions than actual regulation. Case in point: there is currently a renewable fuel standard (RFS), which requires a certain amount of U.S. fuel consumption to come from renewable sources (e.g., ethanol, biodiesel), but there is no such federal renewable electricity standard (RES) (there are, however, 29+ widely varied state requirements).

Although the cynic in me might argue that oil and gas companies simply aren’t threatened by the relatively low mandated levels in the RFS (they aren’t), there is more to it than that. The oil and gas companies have a better idea of the rules of the game in which they are playing, and they know there are less readily available options for their product than there are in the electricity arena. Even if there were a significant carbon tax, gas companies (at least in the next decade) would not be competing in any significant way with other resources; they would just sell less of their resource.

Not so on the electricity side, where electricity can come from a whole host of sources (coal, natural gas, nuclear, wind, solar, geothermal, hydro, etc.). In addition, there is continuing uncertainty related to possible cap-and-trade and RES programs (both are included in H.R. 2454 – Waxman-Markey – which passed the House in 2009). In fact, more than twenty-five renewable electricity mandates have been proposed in recent years, but all failed to get support from both the House and Senate in the same session. In light of this, companies (and investors) have remained reluctant to make significant financial commitments in electricity infrastructure.

If we’re really serious about electricity infrastructure investment, let’s tell the potential investors the rules. Now that PUHCA is gone, there should be a bunch more of them out there.

 

February 17, 2010 - permalink

Citizens United: States

Thanks to the Business Law Prof Blog for a chance to share some thoughts. As noted earlier, I teach at the University of North Dakota School of Law where I teach the Business Associations courses, Energy Law and Labor & Employment Law. My research focuses on energy law and corporate law ( and both, where possible).

I had the good fortune to arrive in North Dakota shortly after the state passed the North Dakota Publicly Traded Corporations Act, a shareholder friendly corporate law option supported by several shareholder advocates, including Carl Ichan. There are many views (including mine) on the North Dakota Act (many of them negative, see, e.g., Prof. Bainbridge), but the Supreme Court's decision in Citizens United (pdf) raises some new questions and new opportunities for discussion about the role of state corporations laws (including the North Dakota Act).

Regardless of one’s view of Citizens United, the case fundamentally changed the relationship between shareholders and the company. That is, to the extent Citizens United changed corporations’ ability to use corporate funds in a political manner, corporations now have a power (at least arguably) not contemplated by their charters. (It was not really necessary to consider as part of the corporate charter because such expenditures were generally viewed as not permitted.)

This certainly was not lost on shareholder activists, who are already putting forth a plan to help ensure accountability and disclosure of corporate political activity. Current action items include engaging companies directly to gather information and encourage disclosure, encouraging the SEC to consider rulemaking in this area, and lobbying Congress.

Beyond action at the federal level, it will be interesting to see how, if at all, the states respond. In addition, the shareholder proxy-access provisions of the North Dakota Act could have some significant (and renewed) appeal to those concerned about corporate political spending. After all, this is now an internal governance issue, which is a state-level issue. At least, that’s how I see it.