We are talking about word frequencies today in Corpus Linguistics, and as my in-class experiment, I created a Wordle cloud from my most recent article, Private Ordering with Shareholder Bylaws:

If you don't know what the article is about, you can read the abstract, but reading the word cloud gives you a pretty good idea at a glance. Could word frequencies help us find the scholarship that most interests us?

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Broc Romanek thinks yes, so we'll outsource to him:

We've told the story about how American capitalist J.P. Morgan is reputed to have had a rule that he would not invest in a company whose CEO was paid more than 50% above the executives at the next level. He reasoned that, if the CEO was paid more, he wouldn't have a team but only courtiers. Internal pay is a primary factor when a company determines how to pay its workforce - why shouldn't that principle apply to how CEOs get paid?

It's shocking to me how few companies employ internal pay equity today. It's use by DuPont, Whole Foods and a handful of others is no secret. And Dodd-Frank's mandate for disclosure is well known. Shouldn't boards demand to see what those ratios look like ahead of the mandated disclosure? And even more important, as noted above, shouldn't boards demand to see those ratios to protect themselves from liability given the known bad data in the peer group surveys they get year after year? Of course, advisors should be willingly recommending the use of this alternative since it's their job to protect the board. Sadly, most advisors blindly adhere to the status quo as too often happens.

I just can't see what is wrong with putting together internal pay numbers for a board to consider. Where is the evil here? I suppose the downside is it likely will reveal how badly the board has been doing its job setting CEO pay levels over the past 20 years when historical numbers are crunched.

Interesting, as always.

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Over the years that I have been attending the AALS Annual Meeting, the Business Associations Section has held consistently good meetings, and this year's session on "The New Corporate Governance" was no exception. The panel discussion on a series of recent topics was particularly good. Robert Clark (Harvard), Meredith Cross (SEC), Margaret Foran (Prudential), Travis Laster (Delaware Court of Chancery), and Kara Scannell (Financial Times) discussed a host of issues, prompted by Hillary Sale (Washington University). In particular, two comments during the section caught my attention.

First, is there room for a Delaware claim on executive compensation in the wake of Say on Pay? Teasing the assembled law professors, Vice Chancellor Laster suggested that the Delaware courts could decide to review pay decisions with a form of enhanced scrutiny (because that standard of review applies to situations involving structural bias), but he rightly observed that such a move would be comparable to Smith v. Van Gorkom in 1985. Plaintiffs lawyers should not get their hopes up, absent a big shift in the debate on executive compensation.

The more likely path to a claim is one already being pursued by a number of plaintiffs lawyers, namely, going after a board of directors for waste of the corporate assets. Does Say on Pay affect this litigation? The text of Dodd-Frank provides, "The shareholder vote ... shall not be binding on the issuer or the board of directors of an issuer, and may not be construed ... to create or imply any change to the fiduciary duties of such issuer or board of directors [or] to create or imply any additional fiduciary duties for such issuer or board of directors...."

The duties of directors in Delaware are not promising for plaintiffs. Citigroup (2009) tells us that "the discretion of directors in setting executive compensation is not unlimited," but the standard for evaluating waste claims as articulated by the Delaware Supreme Court in Brehm v. Eisner (2000) is rough on plaintiffs: "an exchange that is so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration." Nevertheless, in the Citigroup case, Chancellor Chandler held, "there is a reasonable doubt as to whether the letter agreement [containing CEO Charles Prince's retirement package] meets the admittedly stringent 'so one sided' standard or whether the letter agreement awarded compensation that is beyond the 'outer limit' described by the Delaware Supreme Court." So it is possible to state a claim for waste in Delaware. If you couple such a claim with a bad vote on Say on Pay, you might have something. (Cf NECA-IBEW Pension Fund v. Cox for a similar claim in a federal district court in Ohio).

Second, Meredith Cross noted that many people at the SEC would like to take another run at proxy access after the Business Roundtable decision, but the SEC is too busy implementing Dodd Frank. As noted in my most recent article (Private Ordering with Shareholder Bylaws), I would prefer a private ordering solution to proxy access to the SEC's one-size-fits-all proposal, and we live in a world in which some private ordering is possible, but there is still the issue of getting the private ordering right. On that issue, Brett McDonnell believes my co-authors and I have gone "a tad too far" in our proposal.

According to Cross, the SEC has received 15 proposals relating to proxy access since the new Rule 14a-8 went into effect, and it will be interesting to see how this area of shareholder proposals develops. By the way, in our article, we stated "the SEC has not lifted the stay on the new Rule 14a-8," but the terms of the stay provided that it would last only until the "resolution of petitioners' petition for review by the Court of Appeals." Thus, new Rule 14a-8 has been effective since the end of the Business Roundtable litigation. Mea culpa.

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This is the fifth and final installment of a series of previews of the papers being presented at the AALS Financial Institutions & Consumer Financial Services Section events this weekend.  This final paper will be presented at a special off-site event starting at 4 pm on Saturday at American University.  (See here for details on the full weekend of Financial Institutions/Consumer Financial Services Section events).

Peter Conti-Brown (Academic Fellow, Stanford Law, Rock Center for Corporate Governance) will present, Liability Holding Companies, a paper he co-authored with Anat Admati and Paul Pfleiderer (both of Stanford’s Graduate School of Business).  To understand this paper, it helps to read an earlier, influential paper by Admati, Pfleiderer, and a number of co-authors on which it builds.  This earlier work, Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive, countered criticisms of higher capital requirements.  That earlier paper responded to charges that higher capital requirements would impose large social costs, including reducing bank lending.

Yet in Liability Holding Companies, Conti-Brown and his co-authors admit that bank debt may have some benefits; creditors may monitor and discipline bank management.  To balance this disciplinary benefit against reducing the social costs of excessive bank leverage (financial institution fragility, systemic risk, increased risk of bailouts), Admati, Conti-Brown, and Pfleiderer propose a regulatory innovation.  Here is their abstract:      

An international debate continues to unfold in banking law, corporate governance, and finance on whether the capital structure of the world’s largest financial institutions is too heavily dependent on debt, too little on equity. Two of us, with co-authors, have argued elsewhere that there is no socially beneficial purpose for this over-reliance on debt and, indeed, that such reliance increases the likelihood of taxpayer bailouts, with their associated economic, financial, and social costs. Some academics and bankers continue to insist, however, that increased equity is costly for banks and for society. The arguments proffered in defense of these propositions contradict the most basic insights from corporate finance, and often neglect to distinguish private costs from social costs in explaining their preference for debt-heavy capital structures.

While there are overwhelming costs that excessive bank debt can have on the broader economy, some contend that there may be some benefits from debt for a firm’s corporate governance. In particular, some academics have argued that debt is useful because it “disciplines” bank management. The idea suggests that creditors with hard claims against the firm will monitor the firm to prevent bank management from misusing the free cash flows that the banks’ economic activities generate. If these benefits exist and are substantial, we may face a vexing tradeoff: too much debt creates dramatic social costs, moral hazard, and systemic risk, while too little may have negative consequences for firm governance. The challenge is to find a way of optimizing that tradeoff.

This Article engages that challenge, and introduces a new kind of financial institution – called a Liability Holding Company (LHC) – that appropriately balances the social costs of excessive private leverage with the purported benefits for corporate governance that such leverage might create. Our proposal places an increased liability version of the bank’s equity in a conjoined but separately controlled entity, the LHC, that also owns other assets to which the banks’ liabilities have recourse in the event of failure. The equity shares of the LHC—a holding company subject to a unique regulatory regime supervised by the Federal Reserve, similar to Bank Holding Companies or Financial Holding Companies—are then traded in public markets. The LHC thus aims to eliminate or at least greatly reduce the role of the government as the effective guarantor of the systemically important financial institutions (SIFIs), thus reducing the distortions that current implicit governmental guarantees create. It additionally allows banks the benefits of two boards: an advising board, that the bank managers may appoint, and the monitoring board housed at the LHC, appointed by the LHC’s own public shareholders. This dual board structure resolves some important issues raised in the long-standing debate about the role corporate boards should play. We discuss in detail how this proposal would function within the present legal and regulatory environment—particularly within the contexts of bank regulation, corporate governance, and Dodd-Frank—and address counter-arguments and alternative proposals.

 Saule Omarova (North Carolina) will serve as discussant for the paper.

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Update 12/24:  I wrote this post before I learned that Larry Ribstein had fallen ill two days ago.   Sadly, Larry passed away early this morning,  The University of Illinois press release is here.  

I will always be touched by how generous Larry was as a scholar and a person. He reached out to me at a conference several years ago.  I was dumbfounded that someone of his stature cared about the scholarship of someone just starting out and someone who didn't share his (occasionally strong) views.  I will miss him and know my colleagues here will as well.  

When the shock dulls a little, I will share more memories of Larry.

Just in time for the Holidays, the corporate law blogosphere has all lit up. The less-than-festive occasion: a draft paper by John Coffee (not on ssrrn, but I have a copy), in which Coffee, among other things, criticizes Roberta Romano, Stephen Bainbridge, and Larry Ribstein for being members of academic “Tea Party" that has opposed Sarbanes Oxley and other recent federal corporate law reforms. (Posts by Ribstein, Bainbridge, Bodie, Leiter).

Coffee usually doesn’t stain permanently, I don’t like doing laundry, and I know little about civility.  So I will make a few questions and observation to switch the discussion to a more productive track.  Hopefully, this might focus on some important differences in ideas among a group of scholars who I admire.

The immediate debate about Professor Coffee’s civility is obscuring a big difference between two very different scholarly approaches to the political economy of law and “bubbles.” This is a topic near and dear to me. I’ve written about it before, and am feverishly working to finish a book on the topic before Winter Break ends.

First, two introductory points: One, as I’ve written before, the greatest cost of Sarbanes Oxley and its debate was that it distracted attention from the growing storm of the financial crisis. While scholars and policymakers were debating whether or not that statute was too little, too much, or just right, financial institutions were making decisions that would do far greater and more lasting damage to the competitiveness of U.S. capital markets than anything SOX did.  

Two, I have yet to be convinced that corporate governance was a first order cause of the crisis or that fixing corporate governance should be a first-order response. The crisis was about financial institutions, not corporations generally. Instead of focusing on executive pay at the Caterpillars of the corporate world or the board composition at Google, we should be worried about the leverage of the Bank of Americas and risk concentrations at the BONYs.  Even if corporate governance played a role,it's financial institutions, smarty.

Now onto the main course… I do think there is an important difference in focus between Coffee on the one hand, and Romano, Bainbridge, and Ribstein on the other. The latter group has labeled SOX as an example of mis-regulation after financial crises and asset price bubbles. For example, Ribstein, in an article I enjoyed quite a bit, includes SOX in a history of “bubble laws.”

Even if you disagree with Ribstein, Romano and Bainbridge with respect to SOX, there is a long history of misguided legal responses to financial crises and bubbles. Some of this legal history is downright ugly. For example, the collapse of one of the first stock market bubbles, that of England in the 1690s, led to restriction on the number of Jewish stock brokers in the City of London. (See my article, p. 406, n. 74.) (As a footnote, the infamous “Bubble Act,” by which Parliament imposed legal restrictions on the formation of new joint stock companies, was not technically a response to a collapsed bubble. In fact, it was passed at the urging of insiders of the notorious “South Seas Company” before the collapse of the eponymous bubble. The law was an attempt to prevent competitors from entering English capital markets (see that same paper, p. 408)).

However, the focus on legal reactions in the wake of bubbles is only half the historical and political economy story. The criticism of bubble laws misses the ways in which legal change contributed to the formation of bubbles and financial crises. By legal change, I mean more than just deregulation, but also under-enforcement of laws and, in many cases, government subsidization of booming asset markets.

One way governments provide these subsidies is by granting legal monopolies to certain investment ventures. These monopolies are intended stimulate financial investment, foreign trade or the development of certain industries. In my book, I am tracing this practice from the royal charters in the South Seas and French Mississippi bubbles all the way to Freddie and Fannie in the present day. Corporate governance can and has been a part of the bubbles, just not in the way the SOX debate suggests. Indeed, it can be helpful in looking at history to see corporate law as an important tool (albeit a crude one, often used to dangerous effect) in the greater set of financial market regulations. Corporate law and corporate monopolies have been used to stimulate markets. The problem is that it is hard to pull away the punch when the party gets rockin’.

The focus on bubble laws misses the contribution of laws to bubble formation. By contrast, Coffee, in the disputed paper, provides an analysis of the political economy of financial regulation pre-crisis. However, his analysis is too spare. It focuses on Mancur Olson’s writings and leaves out the broader spectrum of theories – public choice and otherwise – that attempt to explain regulation and deregulation of financial markets and otherwise. It also misses the fact that law and regulation can stimulate markets beyond just deregulation and rollback. I argue that governments also subsidize have a history and incentive to provide excessive subsidies to particular financial markets, through corporate law and otherwise.

Coffee seems to miss the government subsidy story and the potential for misregulation.  By contrast, Romano and Ribstein focus on the risk of legal overreaction to bubbles, but do not focus on the perverse political incentives to deregulate or stimulate financial markets during boom times.  

I’ll save my analysis of this political economy of law and bubbles for another day. The story or regulation and bubbles I am writing doesn’t fit into neat political boxes in which de-regulation or re-regulation alone is to blame. Like cloying good cheer at this wintry time of year, there is plenty of blame to go around and provoke (if not inflame).

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Thanks to Erik Gerding for the opportunity to share some of my ideas on corporate criminal liability, Dodd-Frank, corporate influences on individual behavior and educating today's law students only three months into my new academic career. I appreciate the thoughtful and encouraging emails I received from many of you. I even received a request for an interview from the Wall Street Journal after a reporter read my two blog posts on Dodd-Frank conflicts minerals governance disclosures. We had a lengthy conversation and although I only had one quote, he did link to the Conglomerate posts and for that I am very grateful. 

http://online.wsj.com/article/SB10001424052970203733304577102412994084008.html?mod=WSJ_PersonalFinance_PF17#articleTabs%3Darticle

I plan to make this site required reading for my seminar students, and look forward to continuing to learn from you all.  

Best wishes for the holiday season and new year.  

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Law schools are under attack. Depending upon the source, between 20-50% of corporate counsel won’t pay for junior associate work at big firms. Practicing lawyers, academics, law students and members of the general public have weighed in publicly and vehemently about the perceived failure of America’s law schools to prepare students for the real world.

Admittedly, before I joined academia a few months ago, I held some of the same views about lack of preparedness. Having worked with law students and new graduates as outside and in house counsel, I was often unimpressed with the level of skills of these well-meaning, very bright new graduates. I didn’t expect them to know the details of every law, but I did want them to know how to research effectively, write clearly, and be able to influence the clients and me.  The first two requirements aren’t too much to expect, and schools have greatly improved here.  But many young attorneys still leave school without the ability to balance different points of view, articulate a position in plain English, and influence others.

To be fair, unlike MBAs, most law students don’t have a lot of work experience, and generally, very little experience in a legal environment before they graduate.  Assuming they know the substantive area of the law, they don’t have any context as to what may be relevant to their clients. 

How can law schools help?

First, regardless of the area in which a student believes s/he wants to specialize, schools should require them to take business associations, tax, and a basic finance or accounting course.  No lawyer can be effective without understanding business, whether s/he wants to focus on mom and pop clients, estate planning, family law, nonprofit, government or corporate law. More important, students have no idea where they will end up after graduation or ten years later.  Trying to learn finance when they already have a job wastes the graduate’s and the employer’s time.

Of course, many law schools already require tax and business organizations courses, but how many of those schools also show students an actual proxy statement or simulate a shareholder’s meeting to provide some real world flavor? Do students really understand what it means to be a fiducuiary?

Second and on a related point, in the core courses, students may not need to draft interrogatories in a basic civil procedure course, but they should at least read a complaint and a motion for summary judgment, and perhaps spend some time making the arguments to their brethren in the classroom on a current case on a docket. No one can learn effectively by simply reading appellate cases. Why not have  students redraft contract clauses? When I co-taught professional responsibility this semester, students simulated client conversations, examined do-it-yourself legal service websites for violations of state law, and wrote client letters so that the work came alive.

When possible, schools should also re-evaluate their core requirements to see if they can add more clinicals (which are admittedly expensive) or labs for negotiation, client consultation or transactional drafting (like my employer UMKC offers). I’m not convinced that law school needs to last for three years, but I am convinced that more of the time needs to be spent marrying the doctrinal and theoretical work to practical skills into the current curriculum.

Third, schools can look to their communities. In addition to using adjuncts to bring practical experience to the classroom, schools, the public and private sector should develop partnerships where students can intern more frequently and easily for school credit in the area of their choice, including nonprofit work, local government, criminal law, in house work and of course, firm work of all sizes.  Current Department of Labor rules unnecessarily complicate internship processes and those rules should change.

This broader range of opportunities will provide students with practical experience, a more realistic idea of the market, and will also help address access to justice issues affecting underserved communities, for example by allowing supervised students to draft by-laws for a 501(c)(3). I’ll leave the discussion of high student loans, misleading career statistics from law schools and the oversupply of lawyers to others who have spoken on these hot topics issues recently.

Fourth, law schools should integrate the cataclysmic changes that the legal profession is undergoing into as many classes as they can. Law professors actually need to learn this as well.  How are we preparing students for the commoditization of legal services through the rise of technology, the calls for de-regulation, outsourcing, and the emerging competition from global firms who can integrate legal and other professional services in ways that the US won’t currently allow?

Finally and most important, what are we teaching students about managing and appreciating risk? While this may not be relevant in every class, it can certainly be part of the discussions in many. Perhaps students will learn more from using a combination of reading law school cases and using the business school case method.

If students don’t understand how to recognize, measure, monitor and mitigate risk, how will they advise their clients? If they plan to work in house, as I did, they serve an additional gatekeeper role and increasingly face SEC investigations and jail terms.  As more general counsels start hiring people directly from law schools, junior lawyers will face these complexities even earlier in their careers. Even if they counsel external clients, understanding risk appetite is essential in an increasingly complex, litigious and regulated world.

When I teach my course on corporate governance, compliance and social responsibility next spring, my students will look at SEC comment letters, critically scrutinize corporate social responsibility reports, read blogs, draft board minutes, dissect legislation, compare international developments and role play as regulators, legislators, board members, labor organizations, NGOs and executives to understand all perspectives and practice influencing each other. Learning what Sarbanes-Oxley or Dodd-Frank says without understanding what it means in practice is useless.

The good news is that more schools are starting to look at those kinds of issues. The Carnegie Model of legal education “supports courses and curricula that integrate three sets of values or ‘apprenticeships’: knowledge, practice and professionalism.” Educating Tomorrow’s Lawyers is a growing consortium of law schools which recommends “an integrated, three-part curriculum: (1) the teaching of legal doctrine and analysis, which provides the basis for professional growth; (2) introduction to the several facets of practice included under the rubric of lawyering, leading to acting with responsibility for clients; and (3) exploration and assumption of the identity, values and dispositions consonant with the fundamental purposes of the legal profession.”  The University of Miami’s innovative LawWithoutWalls program brings students, academics, entrepreneurs and practitioners from around the world together to examine the fundamental shifts in legal practice and education and develop viable solutions.

The problems facing the legal profession are huge, but not insurmountable. The question is whether more law schools and professors are able to leave their comfort zones, law students are able to think more globally and long term, and the popular press and public are willing to credit those who are already moving in the right direction.  I’m no expert, but as a former consumer of these legal services, I’m ready to do my part.

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Time Magazine’s “person of the year” is the “protestor.” Occupy Wall Street’s participants have generated discussion unprecedented in recent years about the role of corporations and their executives in society. The movement has influenced workers and unemployed alike around the world and has clearly shaped the political debate.

But how does a corporation really act? Doesn’t it act through its people? And do those people behave like the members of the homo economicus species acting rationally, selfishly for their greatest material advantage and without consideration about morality, ethics or other people? If so, can a corporation really have a conscience?

In her book Cultivating Conscience: How Good Laws Make Good People, Lynn Stout, a corporate and securities professor at UCLA School of Law argues that the homo economicus model does a poor job of predicting behavior within corporations. Stout takes aim at Oliver Wendell Holmes’ theory of the “bad man” (which forms the basis of homo economicus), Hobbes’ approach in Leviathan, John Stuart Mill’s theory of political economy, and those judges, law professors, regulators and policymakers who focus solely on the law and economics theory that material incentives are the only things that matter.

Citing hundreds of sociological studies that have been replicated around the world over the past fifty years, evolutionary biology, and experimental gaming theory, she concludes that  people do not generally behave like the “rational maximizers” that ecomonic theory would predict. In fact other than the 1-3% of the population who are psychopaths, people are “prosocial, ” meaning that they sacrifice to follow ethical rules, or to help or avoid harming others (although interestingly in student studies, economics majors tended to be less prosocial than others). 

She recommends a three-factor model for judges, regulators and legislators who want to shape human behavior:

 “Unselfish prosocial behavior toward strangers, including unselfish compliance with legal and ethical rules, is triggered by social context, including especially:

(1)         instructions from authority

(2)         beliefs about others’ prosocial behavior; and

(3)         the magnitude of the benefits to others.

Prosocial behavior declines, however, as the personal cost of acting prosocially increases.”

While she focuses on tort, contract and criminal law, her model and criticisms of the homo economicus model may be particularly helpful in the context of understanding corporate behavior. Corporations clearly influence how their people act. Professor Pamela Bucy, for example, argues that government should only be able to convict a corporation if it proves that the corporate ethos encouraged agents of the corporation to commit the criminal act. That corporate ethos results from individuals working together toward corporate goals.

Stout observes that an entire generation of business and political leaders has been taught that people only respond to material incentives, which leads to poor planning that can have devastating results by steering naturally prosocial people to toward unethical or illegal behavior. She warns against “rais[ing] the cost of conscience,” stating that “if we want people to be good, we must not tempt them to be bad.”

In her forthcoming article “Killing Conscience: The Unintended Behavioral Consequences of ‘Pay for Performance,’” she applies behavioral science to incentive based-pay. She points to the savings and loans crisis of the 80's, the recent teacher cheating scandals on standardized tests, Enron, Worldcom, the 2008 credit crisis, which stemmed in part from performance-based bonuses that tempted brokers to approve risky loans, and Bear Sterns and AIG executives who bet on risky derivatives. She disagrees with those who say that that those incentive plans were poorly designed, arguing instead that excessive reliance on even well designed ex-ante incentive plans can “snuff out” or suppress conscience and create “psycopathogenic” environments, and has done so as evidenced by “a disturbing outbreak of executive-driven corporate frauds, scandals and failures.” She further notes that the pay for performance movement has produced less than stellar improvement in the performance and profitability of most US companies.  

She advocates instead for trust-based” compensation arrangements, which take into account the parties’ capacity for prosocial behavior rather than leading employees to believe that the employer rewards selfish behavior. This is especially true if that reward tempts employees to engage in fraudulent or opportunistic behavior if that is the only way to realistically achieve the performance metric.

Applying her three factor model looks like this: Does the company’s messaging tell employees that it doesn’t care about ethics? Is it rewarding other people to act in the same way? And is it signaling that there is nothing wrong with unethical behavior or that there are no victims? This theory fits in nicely with the Bucy corporate ethos paradigm described above.

Stout proposes modest, nonmaterial rewards such as greater job responsibilities, public recognition, and more reasonable cash awards based upon subjective, ex post evaluations on the employee’s performance, and cites studies indicating that most employees thrive and are more creative in environments that don’t focus on ex ante monetary incentives. She yearns for the pre 162(m) days when the tax code didn’t require corporations to tie executive pay over one million dollars to performance metrics.

Stout’s application of these behavioral science theories provide guidance that lawmakers and others may want to consider as they look at legislation to prevent or at least mitigate the next corporate scandal. She also provides food for thought for those in corporate America who want to change the dynamics and trust factors within their organizations, and by extension their employee base, shareholders and the general population.

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Massey Energy and Walmart made headlines last week for different reasons. Massey had the worst mining disaster in 40 years, killing 29 employees and entered into a nonprescution agreement with the Department of Justice. The DOJ has stated in the past that these agreements balance the interests of penalizing offending companies, compensating victims and stopping criminal conduct “without the loss of jobs, the loss of pensions, and other significant negative consequences to innocent parties who played no role in the criminal conduct, were unaware of it, or were unable to prevent it.”

Massey’s new owner Alpha Natural Resources, has agreed to pay $210 million dollars in fines to the government, compensation to the families of the deceased miners and for safety improvements (the latter may be tax-deductible). The government’s 972-page report concluded that the root cause was Massey’s “systematic, intentional and aggressive efforts” to conceal life threatening safety violations. The company maintained a doctored set of safety records for investigators, intimidated workers who complained of safety issues, warned miners when inspectors were coming (a crime), and had 370 violations. The mine had been shut down 48 times in the previous year and reopened once violations were fixed.  112 miners had had no basic safety training at all.  Only one executive has been convicted of destroying documents and obstruction, and investigations on other executives are pending. However, the company itself has escaped prosecution for violations of the Mine Safety and Health Act, conspiracy or obstruction of justice. Perhaps new ownership swayed prosecutors and if Massey had its same owners, things would be different. But is this really justice? The miner’s families receiving the settlement certainly don’t think so.

Walmart announced in its 10-Q that based upon a compliance review and other sources (Dodd-Frank whistleblowers maybe?), it had informed both the SEC and DOJ that it was conducting a worldwide review of its practices to ensure that there were no violations of the Foreign Corrupt Practices Act (“FCPA”).  Although no facts have come out in the Walmart case and I have no personal knowledge of the circumstances, let’s assume for the sake of this post that Walmart has a robust compliance program, which takes a risk based approach to training its two million employees in what they need to know (the greeter in Tulsa may not need in-depth training on bribery and corruption but the warehouse manager and office workers in Brazil and China do). Let’s also assume that Walmart can hire the best attorneys, investigators and consultants around, and based on their advice, chose to disclose to the government that they were conducting an internal investigation.  Let’s further assume that the incidents are not widespread and may involve a few rogue managers around the world, who have chosen to ignore the training and the policies and a strong tone at the top.

As is common today, let’s also assume that depending on what they find, the company will do what every good “corporate citizen” does to avoid indictment --disclose all factual findings and underlying information of its internal investigation, waive the attorney client privilege and work product protection, fire employees, replace management, possibly cut off payment of legal fees for those under investigation, and actively participate in any government investigations of employees, competitors, agents and vendors.

Should this idealized version of Walmart be treated the same as Massey Energy? (For a great compilation of essays on the potential conflicts between the company and its employees, read Prosecutors in the Boardroom: Using Criminal Law to Regulate Corporate Conduct, edited by Anthony and Rachel Barkow).  Should they both be charged and face trial or should they get deferred or nonprosecution agreements for cooperation? Do these NPAs and DPAs erode our sense of justice or should there be an additional alternative for companies that have done the right thing -- an affirmative defense?

A discussion of the history of corporate criminal liability would be too detailed for this post, but in its most simplistic form, ever since the 1909 case of New York Central & Hudson River Railroad Co v. United States, companies have endured strict liability for the criminal acts of employees who were acting within the scope of their employment and who were motivated in part by an intent to benefit the corporation.  As case law has evolved, companies face this liability even if the employee flouted clear rules and mandates and the company has a state of the art compliance program and corporate culture.  In reality, no matter how much money, time or effort a company spends to train and inculcate values into its employees, agents and vendors, there is no guarantee that their employees will neither intentionally nor unintentionally violate the law.

The DOJ has reiterated this 1909 standard in its policy documents. And because so few corporations go to trial and instead enter into DPAs or NPAs, we don’t know whether the compliance programs in place would have led to either the potential 400% increase or 95% decrease in fines and penalties under the Federal Sentencing Guidelines because judges aren’t making those determinations. The DPAs are now providing more information about corporate compliance reporting provisions, but again, even if a company already had all of those practices in place, and a rogue group of employees ignored them, the company faces the criminal liability. The Ethical Resource Center is preparing a report in celebration of the 20^th Anniversary of the Sentencing Guidelines with recommendations for the U.S. Sentencing Commission, members of Congress, the DOJ and other enforcement agencies. They are excellent and timely, but they do not go far enough.

A Massey Energy should not receive the same treatment as my idealized model corporate citizen Walmart. Instead, I agree with Larry Thompson, formerly of the DOJ and now a general counsel and others who propose an affirmative defense for an effective compliance program- not simply as possible reduction in a fine or a DPA or NPA.

While the ideal standard would require prosecutors to prove that upper management was willfully blind or negligent regarding the conduct, this proposed standard may presume corporate involvement or condonation of wrongful conduct but allow the company to rebut this presumption with a defense.

In the past decade, companies drastically changed their antiharassment programs after the Supreme Court cases of Fargher and Ellerth allowed for an affirmative defense. The UK Bribery Act also allows for an affirmative defense for implementing “adequate procedures” with six principles of bribery prevention. Interestingly, they too are looking at instituting DPAs.

I would limit a proposed affirmative defense to when nonpolicymaking employees have committed misconduct contrary to law, policy or management instructions. If the company adopted or ratified the conduct and/or did not correct it, it could not avail itself of the defense. The company would have to prove by a preponderance of the evidence that: it has implemented a state of the art program approved and overseen by the board or a designated committee; clearly communicated the corporation’s intent to comply with the law and announced employee penalties for prohibited acts; met or exceeded industry standards and norms; is periodically audited and benchmarked by a third party and has made modifications if necessary; has financial incentives for lawful and penalties unlawful behavior; elevated the compliance officer to report directly to the board or a designated committee (a suggestion rejected in the 2010 amendments to the Sentencing Guidelines); has consistently applied anti-retaliation policies for whistleblowers; voluntarily reported wrongdoing to authorities when appropriate; and of course taken into account what the DOJ has required of offending companies and which is now becoming the standard. The court should have to rule on the defense pre-trial.

Instead of serving as vicarious or deputized prosecutors, under this proposed standard, a corporation’s cooperation with prosecutors will be based on factors more within the corporation's control,rather than the catch-22 they currently face where if employees are guilty, there is no defense. And if the employees are guilty, this would not preclude the government from prosecuting them, as they should.

Responsible corporations now spend significant sums on compliance programs and the reward is simply a reduction in a fine for conduct for which it is vicariously liable and which its policies strictly prohibited. A defense will promote earlier detection and remedying of the wrongdoing, reduce government expenditures, provide more assurance to investors and regulators, allow the government to focus on companies that don’t have effective compliance program, and most important provide incentives for companies to invest in more state of the art programs rather than a cosmetic, check the box initiative because the standard would be higher than what is currently Sentencing Guidelines.

Perhaps only a small number of companies may be able to prevail with this defense.  Frankly, corporations won’t want to bear the risk of a trial, but they will at least have a better negotiating position with prosecutors. Moreover, companies that try in good faith to do the right thing won’t be lumped into the same categories as those who invest in the least expensive programs that may pass muster or worse, engage in clearly intentional criminal behavior.  If companies have the certainty that there is a chance to use a defense, that will invariably lead to stronger programs that can truly detect and prevent criminal behavior.

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As mentioned during my inaugural post, I spent the last nineteen years in the private sector, most recently as deputy GC and compliance officer for a multinational Fortune 500 company that manages supply chains for other companies.  As compliance officer, I with others spent time in various countries conducting training and risk assessments, interviewing employees in warehouses, assessing our agents and looking for opportunities for bribery, which would subject our company to liability under the Foreign Corrupt Practices Act, the UK Bribery Act and the admittedly under-enforced local laws.

At the same time, I became passionately interested in the struggles in the Democratic Republic of Congo (“DRC”), a country the size of Western Europe and the fifth richest nation in the world in terms of minerals. For those following the news, you may know that the country is set to announce the winner of its hotly contested election either today or tomorrow and there is such fear of violence after the announcement that many of the wealthy are already fleeing the capital.

Notwithstanding its vast wealth, the UN recently designated this former personal colony of Belgium’s King Leopold II, the least developed country and the rape capital of the world. I first learned of these issues via a 60 Minutes piece in which Anderson Cooper described the atrocities perpetrated by Rwandan genocidaires and Ugandan and Congolese rebel forces that control many of the mines containing the minerals necessary to produce cell phones, computers, cameras, electronics and component parts.   Cooper graphically described the use of mass rape as a weapon of war, and noted that 5-6 million people have died during the various wars in the Congo, making it the deadliest conflict since World War II.  I co-founded a foundation to raise money to provide surgeries for rape survivors and to train midwives to reduce the rate of maternal and infant mortality (www.footprints-foundation-org). A number of Hollywood celebrities have joined the large group of activists working to improve conditions in the Congo, most notably the odd couple of actor Ben Afflek and Cindy McCain (John’s wife, who has worked on Congo issues since 1994). Both testified knowledgably and passionately on behalf of their foundation the Eastern Congo Initiative during a Congressional hearing on the Congo last March.

My seemingly unconnected and disparate background as a corporate compliance officer and nonprofit board member became relevant when I learned about Dodd-Frank’s conflict minerals disclosure provision, which has not yet been implemented due to intense lobbying by industry groups and nongovernmental organizations.  The provision requires U.S. issuers to disclose their use of “conflict minerals” (tin, tungsten, tantalum and gold) and describe the measures taken to conduct audits and due diligence of their supply chains with a statement as the “DRC-conflict free” nature of their minerals (this also includes the nine countries surrounding the DRC). The provision also charges the State Department with developing a Conflict Minerals Map and strategy to “address the linkages between human rights abuses, armed groups, mining of conflict minerals and commercial products.” The Comptroller and Secretary of Commerce must provide a list of all known conflict mineral processing facilities worldwide and report on the quality of the private sector audits. 

When proposing the original Congo Conflicts Minerals Act of 2009 which led to Section 1502 of Dodd-Frank, Senator Sam Brownback (R-KS) explained, "metals derived from inhumanely mined minerals go into electronic products used by millions of Americans. In the Democratic Republic of Congo, many people - especially women and children - are victimized by armed groups who are trying to make a profit from mining 'conflict minerals.' The legislation introduced today brings accountability and transparency to the supply chain of minerals used in the manufacturing of many electronic devices. I hope the legislation will help save lives." 

Dubbed a “name and shame” law by a congressional staffer, the SEC provision has no criminal penalties for issuers who use conflict minerals.  Instead, the provision merely seeks disclosure so that the company that uses conflict minerals can face the reputational pressures from an educated public. The public, presumably, will choose to boycott products or divest from companies deemed complicit in the conflicts minerals trade with the attendant rape, kidnapping and child slavery.  Films called “Blood on the Mobile” have gone viral online. Phone apps such as Free World and Free2work --“transparency shopping aids” -- allow you to see the “slavery footprint” of certain products and send a note directly from your smartphone to the company.

In short, the activist community is doing an excellent job shining a spotlight on the estimated 6,000 affected issuers and their hundreds of thousands of suppliers.  Apple and Motorola are obviously subject to the law, but Kraft, which uses tin in its packaging of cookies will have to work with its hundreds of suppliers to ensure compliance. The California Transparency in Supply Chains Act goes into effect in January, and many U.S. universities have announced that they will divest their funds from companies that are not DRC-conflict free.

The SEC will issue its regulations any day now and the State Department has introduced a public-private partnership to work on the issue. An OECD pilot is also underway, although some believe that it will not succeed either because it does not go far enough or because it goes too far.  The legislation will likely be one of the next targets for litigation by the US Chamber of Commerce and other industry groups using the same theories that undermined Dodd-Frank’s proxy-access provisions. A further hurdle for the legislation- a recent independent study from Tulane University found that the SEC had vastly underestimated the proposed costs of compliance. 

Although many of the Republican presidential contenders have promised to dismantle Dodd-Frank, it’s likely that if conflict minerals legislation survives court scrutiny, it will be here to stay.  It would be interesting to hear what Newt Gingrich, who wrote his PhD thesis on the Congo would have to say about that.

I initially felt conflicted about this well-intentioned law because of the unimaginable suffering going on in the Congo, but I was skeptical about the viability and the logistics of actually complying with it. Having conducted audits myself in the past, you never really know if you’re hearing the whole story or seeing everything that you’re supposed to see. None of the countries I visited in my former life had such allegations of corruption, public officials who go for months without getting paid, or known perpetrators of the Rwandan genocide and other rebel groups involved directly or indirectly in the supply chain.

My foundation work in Congo and Rwanda in September, my dialogue with local Congolese including rape survivors and NGOs, US business leaders, and activists on both sides of the debate and my former experience conducting audits confirmed my skepticism, although many want the law enacted immediately. While I don’t doubt the good intentions of the law and the urgency of stopping the rape, child slavery and forced labor, in my next post, I will discuss why I believe that the legislation will likely have serious unintended consequences, may hurt the very people its designed to help, and what Congress and the SEC should have done differently.

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I am honored to be a guest blogger, especially since I am brand new to the academy having worked in the private sector for nineteen years as a commercial litigator, HR executive, deputy general counsel and compliance/ethics officer for a Fortune 500 multinational corporation.  I will spend the next two years as a visiting assistant professor at the University of Missouri-Kansas City learning to teach (marrying theory and practice) and focusing on scholarship and coursework related to corporate governance, compliance, social responsibility and the future of the legal profession. 

Over the next two weeks I plan to write about two Dodd-Frank provisions- conflict minerals and whistleblower; my call for an affirmative defense for a redesigned “effective compliance program” under the Federal Sentencing Guidelines; the ongoing debate about the value of a law school education; in-house counsel as "gatekeepers"; and a book review of Cultivating Conscience: How Good Laws Make Good People by law professor Lynn Stout, which offers an alternative look at the homo economicus model. I look forward to receiving comments that can inform my research and thank Erik Gerding for the opportunity to share my thoughts. 

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In my office, I have a number of respected treatises on corporate law. Each volume has a section addressing shareholder meetings. In a consistently arid fashion, these treatises remind us that corporations are generally required to hold annual shareholder meetings. Shareholders of record must be given notice of meetings, and are entitled to be represented in person or by proxy. At the annual meeting, elections are conducted with respect to all or some of the corporation’s directors. A quorum must be present to transact business….

And so on.

So what really goes on at shareholder meetings of large corporations?

Fortunately, this curiosity can be readily satisfied. These days, most publicly-traded companies offer live video streaming of shareholder meetings, which can be accessed from links on the company’s “Investor Relations” page. I’ve watched many over the years, and typically these meetings feature reports from division managers, presentations regarding resolutions introduced by shareholders or management, and discussion of various corporate or industry matters. Shareholder meetings are also well attended by journalists and Wall Street analysts.

Most of the time, shareholder meetings are routine, and management frequently uses the time to discuss ongoing projects and future goals. But sometimes, these otherwise orderly, scripted and humdrum meetings take an unexpected turn.

Take, for instance, the 2009 General Electric shareholder meeting. A producer for “The O’Reilly Factor,” along with a number of other shareholders, asked politically charged questions and criticized the industrial conglomerate for an alleged bias in its media division. At the 2008 Yahoo shareholder meeting, shareholders lambasted the company’s executives for their handling of Microsoft’s bid to acquire the company, and attacked the company for its alleged participation in human rights abuses by repressive regimes abroad.

Shareholder meetings are also attractive venues for organized protests. In London, environmental groups protested outside of the 2011 BP shareholder meeting, while shareholders voiced scathing criticisms of the company in the wake of the Deepwater Horizon disaster. In the U.S., hundreds of protesters arrived at the 2005 Halliburton shareholder meeting, criticizing the company’s activities in Iraq. Meanwhile, protesters seeking to advance labor and consumer interests flanked the 2004 Walt Disney Company shareholder meeting.

Dramatic shareholder meetings remind me that even the most powerful corporations are institutions governed by internal constituents, which are also pressured by external constituents. Although I personally believe that the balance of power is unquestionably tilted in favor of dominant economic interests, shareholder meetings nonetheless offer a glimpse of a corporate political architecture that at times veers in a direction that runs contrary to the company’s overall profit-seeking goals.

And, let’s face it, watching a dramatic shareholder meeting is certainly more entertaining than reading about a mundane one.

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McCall argues in this paper that "a corporation is a constituted political community and therefore corporate law is a form of constitutional or political law."  A bold statement, and one that caught my eye because I have an affection for two similar-seeming but unrelated propositions; first, that the corporate form is increasingly defined by its public regulatory components, rather than its private contractual ones, and second, that public organizations, i.e., agencies, and private organizations, i.e., corporations and large partnerships, differ much, much less than fans of the public-private divide think they do (in this, I'm with Weber, or Dilbert, or management departments, or something).

Anyway, I liked McCall's paper, which gets into some fun sources (Aristotle! medieval thinkers!) without concluding that he who understands the Ramayana knows everything there is to know about corporate law.  The cash-out is modest, and perhaps worth some more elaboration in future work.  McCall doesn't think that the constitutive nature of the corporation means that all its stakeholders have rights and duties towards one another in a CSR way.  But he does think that thinking about corporations as motivated towards a particular purpose, like selling computers, or providing professional services, is at least as compelling a way of thinking about what such an institution really is than thinking that it means "owned by shareholders, run by managers for their benefit."  The latter model, he seems to suggest, doesn't tell you much about corporations at all, because it is competely contentless, and accordingly quite unstable.  Which is pretty interesting.

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Danny Sokol at Florida uses my Business Associations casebook, which includes a case study of Enron. One of his students was inspired by the case study to write "Smartest Guy's Paradise" (which is especially hilarious if you have ever heard Gangsta's Paradise by Coolio). You can listen to the song and read the lyrics here.

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A conference produced by our friends in Madison...

Who’s in the House?

The Changing Role and Nature of In-House and General Counsel

Wisconsin Law Review Symposium

November 18-19, 2011

Wisconsin Institutes for Discovery

Program Chair: Jonathan C. Lipson, Foley & Lardner Professor of Law

This symposium will bring together leading scholars and attorneys to discuss the under-explored, but growing, role of in-house and corporate general counsel in the rapidly changing market for legal services. Keynote Speakers include Cynthia M. Fornelli (Center for Audit Quality Control), Gail A. Lione (Retired Executive VP & GC of Harley-Davidson, Inc.) and David Wilkins (Harvard Law School). Distinguished panelists and commenters include Daniel C. K. Chow (Ohio State University Moritz College of Law), Kathleen Cully (New York), Deborah A. DeMott (Duke University Law School), Michael Falk (Wisconsin Alumni Research Foundation), Lawrence A. Hamermesh (Widener University School of Law), Christoph Henkel (Mississippi College School of Law), R. Thomas Howell, Jr. (American Bar Association), Mike Koehler (Butler University), John J. Huber (FTI Consulting), Donald C. Langevoort (Georgetown University Law Center), Stephanie A. Lyons (Northwestern Mutual Life Insurance Co.), Matthew Neco (Docstoc, Inc.), Thomas P. Newman (AIG, Inc.), Jerome D. Okarma (Johnson Controls), Larry E. Ribstein (University of Illinois College of Law), William H. Simon (Columbia Law School), Steven L. Schwarcz (Duke University Law School), Andrew Brady Spalding (Chicago-Kent College of Law), Bill Stone (Outside GC), Eli Wald (University of Denver Sturm College of Law), Jolene Yee (E. and J. Gallo Winery), Joseph Yockey (University of Iowa College of Law), and others to be named. David S. Ruder (Northwestern University Law School) will participate as a Distinguished Symposium Fellow. This event has multiple cosponsors–please see the symposium website for registration & program information.

Wisconsin CLE Credit Approved: 12 Credits (including 5 EPR) – Illinois MCLE approval pending. Certificates will be provided for attorneys seeking CLE approval elsewhere.

Register online by 11/1/11: http://www.law.wisc.edu/ils/2011wlr/homepage.html

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