No, this post is not about Mitt Romney. I am thinking about my friend Kent Greenfield, who wrote about Citizens United in a WaPo editorial:

The question in any given case is whether protecting the association, group or, yes, corporation serves to protect the rights of actual people. Read fairly, Citizens United merely says that banning certain kinds of corporate expenditures infringes the constitutional interests of human beings. The court may have gotten the answer wrong, but it asked the right question.

Another reason to protect corporate rights is to guard against the arbitrary and deleterious exercise of government power. If, for example, the Fifth Amendment’s ban on government “takings” did not extend to corporations, the nationalization of entire industries would be constitutionally possible. The Fourth Amendment prohibits the FBI from barging into the offices of Google without a warrant and seizing the Internet history of its users. A freedom of the press that protected only “natural persons” would allow the Pentagon to, say, order the New York Times and CNN to cease reporting civilian deaths in Afghanistan.

There are ways to address inordinate corporate power in politics that avoid razing the house to rid it of termites. Many ramifications of Citizens United can be addressed with more aggressive disclosure rules, limits on political involvement of companies receiving government contracts, or mandates that shareholders approve political expenditures.

As some of you know, Kent and I don't always agree, but he is on the right track here.

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Delaware Vice Chancellor Laster issued a new corporate opportunity opinion yesterday, Dweck v. Nasser. It's not going to replace Broz v. Cellular Info. Sys., Inc., 673A.2d 148 (Del. 1996) in my casebook, but it's an interesting case nonetheless.

Gila Dweck was CEO and 30% stockholder of Kids International Corporation. Albert Nasser was Chairman of the Board and the controlling stockholder. Kids was a successful manufacturer of private-label clothing for discount retailers, like Wal-Mart and Target. Dweck wanted to own a larger share of the company, but Nasser declined to accommodate her, so Dweck took matters into her own hands, establishing two competing companies and eventually appropriating many of Kids' accounts.

In 2005, Dweck and Nasser split, accusing each other of breaching their fiduciary duties in various ways. The claim that most interests me is a corporate opportunities claim against Dweck. Although some of the background facts relating to Kids' ownership structure are complicated, VC Laster describes Dweck's treachery with admirable simplicity: Dweck established "competing companies that usurped Kids' corporate opportunities and converted Kids' resources to the point of literally using Kids' own employees, office space, letters of credit, customer relationships, and goodwill to conduct their operations."

If this seems like a pretty easy corporate opportunity case, that's because it is (with all due respect to VC Laster, who had to deal with 930 exhibits!). The first defense offered by Dweck was a rather lame "line of business" argument: because Kids manufactured private-label clothing, the other companies could enter the market for branded clothing. As VC Laster noted, this was not much of a defense to the claim of disloyalty: "Although Kids primarily operated in the private label business, Kids easily and readily could have expanded into the branded business."

Dweck also claimed that Nasser consented to the branded-label businesses, but VC Laster rejected Dweck's testimony, stating that Nasser was never informed of the new companies.

The most interesting defense was based on an operating agreement of Essential Childrenswear, a company formed by Nasser, Dweck and Dweck's brother, Haim. That agreement had a so-called "free-for-all provision," which read as follows:

Any Member and any of their respective affiliates may engage in or possess any interest in other business ventures of any kind, independently or with others, including but not limited to any business similar in nature to or competitive with the business of [Essential]. The fact that a Member or any of their respective affiliates may encounter business opportunities and may take advantage of such opportunities himself and/or herself and/or itself or introduce such opportunities to entities in which he/she/it has or has not any interest, shall not subject such Member or affiliate to liability to [Essential] or any of the other Members on account of the lost opportunity. Neither [Essential] nor any Member shall have any right by virtue of this Agreement or otherwise in or to such ventures, or to the income or profits derived therefrom, and the pursuit of such ventures, even though competitive with the business of [Essential], shall not be deemed wrongful or improper. . . . [Essential] and each Member hereby waives all right or remedy against the Members with respect to any damage, injury, lost profits or revenue as a result of any competitive business activities on the part of any Member.

Waivers of fiduciary duties have become common in Delaware LPs and LLCs -- see Mohsen Manesh's forthcoming paper, Contractual Freedom under Delaware Alternative Entity Law: Evidence from Publicly Traded LPs and LLCs -- but I haven't seen as much discussion of waivers in the corporate context, outside of DGCL Section 102(b)(7), which permits a waiver of sorts (allowing corporations to include an exculpation clause in a corporation's certificate of incorporation, limiting or eliminating the personal liability of a corporation's director for a breach of fiduciary duty).

The provision above would probably be analyzed under DGCL 122(17) (which I blogged about a long time ago). This provision permits a corporation to "[r]enounce, in its certificate of incorporation or by action of its board of directors, any interest or expectancy of the corporation in, or in being offered an opportunity to participate in, specified business opportunities or specified classes or categories of business opportunities that are presented to the corporation or one or more of its officers, directors or stockholders." (emphasis added)

In Dweck, the provision was in an operating agreement, which may have been authorized by Essential's board of directors (the court doesn't say). But VC Laster rightly observed that even if this provision were effective for Essential's affairs, it could not "eliminate broadly the duty of loyalty for all other business entities formed by the same parties."

Unfortunately for Dweck, a Kids stockholders' agreement, which had a similar provision, was never signed by Nasser. According to VC Laster, "The free-for-all provision never became effective, and Dweck cannot rely on it to justify her conduct. I therefore need not reach the complex legal issues that the provision would raise."

Would the "free-for-all provision" survive under DGCL Section 122(17)? I found only one case citing this code section -- Wayne County Employees' Retirement System v. Corti, 2009 WL 2219260 (Del.Ch.2009) -- and Chancellor Chandler did not rule on the provision because there was no actual controversy touching on the provision. Nevertheless, the issue raised in that case is the same issue that would likely have arisen in Dweck: are the opportunities pursued by Dweck "specified business opportunities or specified classes or categories of business opportunities"? My view is that the identification of "other business ventures of any kind" is not sufficient specification.

Thanks to Kurt Heyman for the tip on the case and to Mohsen for an insightful email on the free-for-all provision.

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Today's WSJ discusses a new corporate form.  Yes, you read that right, a new corporate form!  A few states, beginning with my home state Maryland in October 2010, now allow firms to incorporate as benefit corporations.  As Glom readers know, I'm interested in how entity choice can be an expression of identity.  I was eager to learn more.

So what are benefit corporations?  Although they are for-profit entities, they have as a purpose creating a "general public benefit": '"a material, positive impact on society and the environment, as measured by a third-party standard, through activities that promotes a combination of specific public benefits."  "Specific public benefits" include, among other activities,  providing beneficial products or services, promoting economic opportunity beyond regular job-creation, preserving the environment, improving human health, and promoting the arts, sciences, or advancement of knowledge.  Each year the corporations send shareholders an annual benefit report describing the benefits they have accomplished.

Ordinary corporations become benefit corporations by amending their charters, and according to the WSJ "hundreds of existing businesses" plan to reincorporate as benefit corporations in the coming months--Patagonia already has, and Ben & Jerry's will soon. 

On one hand, it's hard to see the need for the benefit corporation.  The WSJ quotes William Clark, a partner at Drinker, Biddle & Reath LLP, observing that the form's structure "tells directors that it's their duty to consider other interests, rather than say they 'may' consider them."   Sure, this codifies a rejection of shareholder wealth maximization as a governing principle, but all corporate law scholars know that shareholder wealth maximization is squishy. Garden variety corporations can donate to charity or go "green" and plausibly claim that they are, ultimately, increasing shareholder wealth. So why do we need a benefit corporation?  Charles Elson doesn't think we do--he's quoted as saying "for an investor, this is a terrible idea." 

I'm not sure if we need benefit corporations either, but I see the appeal. Again, I think entity matters.  Choosing the benefit corporation form is a kind of credible commitment--it signals to shareholders more powerfully than any slogan can that maximizing wealth isn't the ultimate goal of this particular corporation.  I think, at first blush at least, that this idea sounds a whole lot better than the L3C.  Like Bill Callison, I'm skeptical of that form--largely because it presupposes non-profit minded investors living cheek by jowl with investors who are looking to make a market return. Not only does that seems like a recipe for owner vs. owner conflict--it also dilutes the "warm glow" for nonprofit participants to know that some of their fellows are just looking to make a buck.

In contrast, with the benefit corporation all shareholders are on the same page.  The public benefit corporation won't generate the same kind of warm glow that a nonprofit would, but it may generate enough to succeed.  We'll see...

 Update: J. Haskell Murray has a chart comparing the various state benefit corporation statutes.

Update 2: Bill Callison reminds me that he posted on benefit corps last year.  Sorry, Bill--I'm getting old!

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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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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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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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Although I teach, write and practiced predominantly in corporate and commercial law, I also have an LL.M. in Tax. Granted, my LL.M. coursework largely focused on business taxation, and therefore falls squarely within my interests. Nonetheless, given that tax and corporate/commercial law are treated as separate legal disciplines, I see tremendous opportunities for comparative and interdisciplinary analysis among tax, corporate and commercial law.

For instance, I find it intriguing that courts employ highly divergent decision-making approaches in these realms. In the tax realm, courts tend to focus on the actual economic arrangement of the parties, in an effort to identify economic substance rather than mere contractual form. Courts presiding over tax cases tend to utilize more expansive and contextual interpretive methodologies, and routinely scrutinize objective and subjective intent and other "facts and circumstances." These approaches stand in contrast to the dominant, textualist interpretive paradigm in corporate and commercial law, which relies almost exclusively upon strict interpretive norms (such as rules of contract interpretation) to construe written agreements.

To be sure, these divergent methodologies reflect the differing goals of tax, corporate and commercial law. While jurisprudence across all three disciplines emphasizes the need for certainty, uniformity and predictability in the law, tax law remains manifestly skeptical of the party autonomy that corporate and commercial law strive to protect. Courts presiding over tax cases are often called upon to examine possible crimes against the public fisc; in contrast, courts presiding over corporate and commercial law cases are generally called upon to manage disputes among sophisticated parties to voluntary, utility-maximizing arrangements.

Yet despite these distinctions, courts are increasingly importing tax doctrine into the corporate and commercial law context. A classic example is the "debt recharacterization doctrine." In the federal income tax realm, considerably high stakes turn on the proper classification as debt or equity of a person's interest in a corporation. Generally speaking, the characterization of the investment as a loan means that payments of interest will be includible in gross income. In contrast, to the extent the investment is deemed to be an equity capital contribution, then the principal amount of the investment must be capitalized into the investor's basis in the corporation's stock. The tax treatment of any repayment will be determined pursuant to rules governing corporate distributions, with any amounts deemed to be a dividend includible in gross income. In light of these differing tax consequences, courts have developed multi-factor, highly facts-intensive and contextual analyses to recharacterize a purported debt instrument into an equity investment, and to reassign tax consequences accordingly.

The debt recharacterization doctrine was subsequently imported into the bankruptcy realm. In that context, if a court determines that an investment is equity rather than debt, then the claim will be treated as an equity ownership interest in respect of which no distribution of corporate assets can be made unless creditor claims are satisfied. Even within the less formalistic realm of bankruptcy, the importation of the debt recharacterization doctrine is a major departure from dominant jurisprudential norms. As a general matter, bankruptcy courts look to state contract law when matters arise under private agreements and there is no statutory law on point. For this reason, although bankruptcy courts have wide latitude to exercise legal and equitable powers, most matters that arise in respect of contracts are construed in accordance with state contract law, including rules of contract interpretation.

Of course, the bankruptcy context, much like the tax realm, may provide inherent justifications for the application of more expansive judicial methodologies. In particular, courts applying the debt recharacterization doctrine in bankruptcy matters are frequently responding to the plight of third party creditors who may recover less due to the crafty maneuvers of shareholders.

More recent cases demonstrate a willingness to import tax doctrine into corporate and commercial law even where the justifications for doing so are less obvious. For instance, in Coughlan v NXP BV, C.A. No. 5110-VCG (Del. Ch. Nov. 4, 2011), the Delaware Court of Chancery applied tax law's "step transaction doctrine" to an action brought by a stockholder representative seeking to construe terms of a merger agreement. In tax law, the step transaction doctrine is applied where parties engage in multiple transfers to circumvent rules that would apply to a more direct transfer. In Coughlan, the merger agreement provided that, in the event of a change in control of NXP or of pertinent corporate assets, the person acquiring NXP or the assets would be required to accelerate certain contingent payments or assume the obligations. The stockholder representative argued that NXP's two-step transfer of assets to a joint venture amounted to a change in control. NXP argued that it engaged in two transfers that were each permitted under the merger agreement. The court applied the step transaction doctrine, finding that the two transfers should be analyzed as a single transaction that ultimately effectuated a change in control.

The court explained that the step transaction doctrine has been imported into the Delaware corporate and transactional context as well as the bankruptcy realm. It cited a 2007 case construing provisions in a partnership agreement, whereby the Court of Chancery defended application of the doctrine: "I see no reason as a matter of law or equity why the step transaction principle should not be applied here. Indeed, partnership agreements in Delaware are treated exactly as they are treated in tax law, as contracts between the parties." Twin Bridges Ltd. P’ship v. Draper, 2007 WL 2744609, at *10 (Del. Ch. Sept. 14, 2007).

To be sure, such a rationale denies fundamental differences in tax, corporate and commercial law. However, in terms of judicial decision-making methodologies, the increased application of tax doctrine to cases in the corporate and commercial law realm may signal a movement away from formalism, and a rising interest in identifying the actual economic arrangement of parties as opposed to merely construing contractual form. Indeed, the Court of Chancery articulates this point in Coughlan, issuing words of caution to parties who rely on the written word in their business planning and legal advocacy: "transactional formalities will not blind the court to what truly occurred." Coughlan, C.A. No. 5110-VCG at 23.

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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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Thanks to Usha for plugging the Columbia Law School conference on the Delaware Court of Chancery. The conference is partly aimed at honoring Bill Chandler, the recently retired Chancellor, but it is also looking forward to the court under new Chancellor Leo Strine.

On the first panel, Bill Savitt of Wachtell argued that "dictum" in the Delaware Court of Chancery is different than dictum for other courts. In some ways, he argued, the Court of Chancery is more like a legislator or regulator than a common law court because the judges are so engaged with and knowledgeable about the issues. Thus, they are not subject to the same "availability heuristic" that troubles other courts. See Fred Schauer's article, Do Cases Make Bad Law?, 73 U Chi L Rev 883 (2006).

According to Savitt, one reason the Delaware courts are in a better position than other courts to legislate or regulate, rather than just deciding incrementally, is that Delaware decisions are subject to extensive commentary from academic bloggers! Here is the photo:

You can see our banner in the bottom right-hand corner of Bill's slide. Thanks for the plug!

UPDATE: If you want a blow-by-blow account of the conference, you might try Alison Frankel's Twitter feed.

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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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