Steven Davidoff Solomon and I opine on a recent opinion dismissing cases brought by Fannie and Freddie shareholders against the government in DealBook. A taste:
In one Washington court, Maurice R. Greenberg, the former chief executive and major shareholder of A.I.G., is suing the United States government, contending that the tough terms imposed in return for the insurance company’s bailout were unconstitutionally austere.
In another closely watched case in a different Washington court, the shareholders of Fannie Mae and Freddie Mac, led by hedge funds Perry Capital and the Fairholme Fund, lost a similar kind of claim.
Parsing what the United States District Court did in the Fannie and Freddie litigation offers a window into the ways in which the government’s conduct during that crisis might finally be evaluated.
There are three main points to the decision. For one, the court held that the government’s seizure of Fannie’s and Freddie’s profits did not violate the Administrative Procedure Act’s prohibition on “arbitrary and capricious” conduct. It also found that the Housing and Economic Recovery Act barred shareholders of Fannie and Freddie from bringing breach of fiduciary duty suits against the boards of the companies and that the government’s seizure of profits was not an unconstitutional “taking.”
In an exciting day for the University of Georgia, PepsiCo's CEO Indra Nooyi spoke on campus yesterday. Her remarks were titled "The Role of the Corporation in the Modern Age," and she spoke to our business and law students about Pepsi's "Performance with Purpose" initiative. She drew a sharp contrast between two visions of corporate social responsibility. The first, dominant in the 90s when she joined Pepsi, focused on "what we do with the money we make" (corporate philanthropy, volunteering at local organizations). The second type of corporate social responsibility focuses on "how we make our money," and has led Pepsi towards acquisitions like Tropicana and Quaker Oats, to diversifying their offerings with more nutritious foods, and to working towards water conservation in its manufacturing around the globe. Of course, there are limits to diversification: the public seems to be moving away from fruit juices. And Nooyi stressed that Quaker Oat's Gatorade was for athletes, not "people sitting on the couch watching athletes."
One student asked about the NFL domestic violence controversy, and she said she's said publicly all she would about that. But then she said that they were a corporate partner and held them to high ethical standards, and they were waiting to see the results of the Mueller investigation.
Asked for advice about becoming a CEO, Nooyi said this (I'm paraphrasing) "Don't go in thinking you want to be a CEO--that guarantees you won't ever become one. If you have an office with two windows, don't be thinking about how to get one with three. Instead, be brilliant at the job you're doing. Ask for the hard jobs. You might think you want the easy jobs, but you don't get noticed if you do an easy job well."
Interestingly, Nooyi said she had never asked for a promotion, but instead had always been recognized for doing a good job and tapped for the next level. The standard advice to women in the corporate world used to be to ask for raises and promotions, like men do. But recent studies suggest there is a social cost to women who do negotiate.
All in all, a great day for UGA. It's not every day the world's 13th most powerful woman visits campus.
In this post, which follows our earlier discussion of legal strategy, we’ll offer examples of companies situated within each of the five pathways. As Robert and I mentioned in our article, most companies follow the compliance pathway. Such companies insource legal compliance through their in-house legal department, or they may choose to partner with an external compliance verification service. A firm such as ISN, for example, has built a business handling compliance issues for corporations and their subcontractors. According to the Society of Compliance and Corporate Ethics, compliance is a thriving industry due to the increased legal penalties and regulations that companies face in today’s heightened legal environment.
The avoidance pathway is less frequent, given the high stakes and liability attached to this type of strategy. General Motors may have engaged in avoidance if it misled regulators about its faulty ignition switches. Avoidance issues tend to be costly to deal with, given the loss of trust and enhanced penalties that arise from this behavior.
The more interesting and rare pathways involve prevention, value, and transformation. An interesting and controversial prevention legal strategy involves trademark policing, which, in its most egregious form, devolves into the unethical and legally dubious practice of trademark bullying. For example, Chik-fil-A employs an aggressive strategy that targets large and small companies alike and uses the threat of trademark litigation to prevent anyone from encroaching upon its trademarked brands and brand equity. Setting aside the overreaching and legally dubious aspects of this approach, some companies legitimately use a preventive legal strategy that involves cease and desist letters, litigation, and U.S. Patent and Trademark Office administrative oppositions to protect the value of their brands and advertising. The Chik-fil-A case serves as a useful reminder, however, that aggressive legal strategies may push the boundaries of ethical behavior, sound legal argument, and public opinion.
Two recent examples illustrate how employing a legal strategy in the value pathway can generate positive and tangible financial returns. The first instance involves hedge funds investing in a corporate acquisition target and then filing suit in Delaware to challenge the valuation and seek an appraisal from the court. This legal strategy is referred to as appraisal arbitrage. Many of these cases either settle or result in substantially higher prices for the party seeking the appraisal.
Another value strategy that has been in the headlines recently involves tax inversions. Burger King’s recent decision to acquire Canada’s Tim Horton’s will yield business synergies, but it also exploits a legal maneuver allowed under current tax law permitting a company acquiring a foreign entity to reincorporate in the foreign jurisdiction. By reincorporating in Canada, Burger King will effectively lower its tax rate from 35% to 15%.
The last and rarest of legal strategies is transformation. This occurs when the top executives in a corporation integrate law as a core aspect of the firm’s business model to achieve sustainable competitive advantage. Few companies are able to achieve this strategic pathway, and it’s certainly not for everyone. One company that notoriously used law to achieve abnormally large market share and margins in the ticket processing industry was Ticketmaster. The ticket service provider used venue ticket licensing contracts that included several key provisions such as long term renewable exclusivity terms (up to 5 years), and more infamously, fee sharing provisions. Ticketmaster’s business model was, essentially, to take the bad rap for charging exorbitant convenience fees and sharing those fees with the venue, thus contractually locking them into a highly profitable and exclusive business system. It didn’t hurt that Ticketmaster’s pioneering CEO Fred Rosen was a Wall Street attorney turned impresario.
Another company that is showing signs of attempting to pursue a transformative legal strategy is Tesla Motors. Tesla’s recent announcement to offer open licensing terms for its battery and charging station patents illustrates a pioneering mentality that seeks to build a business ecosystem with other auto manufacturers. By doing so, Tesla has made a major legal bet that giving up patent exclusivity rights in the short term will yield long-term competitive advantage by helping to diffuse electric battery and recharging technology. The other legal strategy Tesla has pursued relates to its pioneering distribution model of direct sales to the consumer, bypassing the traditional dealership model established for conventional automobiles. To achieve this direct-to-customer model, Tesla has engaged state regulators to achieve exemptions from state dealership franchise laws. Tesla is clearly strategizing and innovating along many fronts that involve business, technology and law. It remains to be seen, however, whether these legal strategies will offer Tesla a long-term sustainable competitive advantage.
In our next and last post, we’ll discuss our experience teaching the five pathways of legal strategy to business students and how it has been a valuable resource in the classroom.
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This American Life has a banking supervision story (!) that turns on secret recordings made by a former employee of the New York Fed, Carmen Segarra, and it's pretty good, because it shows how regulators basically do a lot of their regulating of banks through meetings, with no action items after. That's weird, and it's instructive to see how intertwined banking and supervision are. There's a killer meeting after a meeting with Goldman Sachs where Fed employees talk about what happened, and - though we don't know what was left on the cutting room floor - the modesty of the regulatory options being considered is fascinating. Nothing about fines, stopping certain sorts of deals, stern letters, or anything else. The talk is self-congratulation (for having that meeting with Goldman) and "let's not get too judgmental, here, guys."
The takeaway of the story, which is blessedly not an example of the "me mad, banksters bad!" genre, is that this kind of regulation isn't very effective. It clearly hasn't prevented banks from being insanely profitable until recently, in a way that you'd think would get competed away in open markets.
But here's the case for banking regulation:
- Imagine what it would be like if Alcoa and GE had EPA officials on site, occasionally telling them to shut down a product line. That's what bank regulators do, and, more broadly, did with things like the Volcker Rule (with congressional help).
- Since the financial crisis (and that's the time that's relevant here), regulation has made banking less profitable, not more, share prices are down, so are headcounts, etc.
- Regardless of how it looks, regulators that essentially never lose on a regulatory decision - that includes bank supervisors, but also broad swaths of agencies like Justice and DoD - don't experience themselves as cowed by industry. Kind of the opposite, actually. So what you really worry about is the familiarity leading to complacency, not fear. Regulators can fine any bank any number they like. If they want someone fired, they could demand it without repercussion.
The fact that TAL pulled off this story, given that it was centered around an employee who lasted at the Fed for 7 months before being fired, who made secret recordings of her meetings with colleagues (who does that?), who mysteriously and obviously wrongly alleged during her time at the Fed that Goldman Sachs did not have a conflict of interest policy, whose subsequent litigation has gone nowhere, and whose settlement demand was for $7 million (so that's one million per month of working as a bank examiner, I guess), is impressive. But that's the former government defense lawyer in me, your mileage may vary.
Morover, even skeptical I was persuaded that maybe the Fed could do with a more ambitious no-holds-barred discussion among its regulators, at the very least.
UConn's James Kwak has joined Medium's Bull Market, a collection of interesting business writers doing long and semi-long form work. His first post is here, on the Silicon Valley no-poaching litigation. Welcome to the blogosphere! If that's the right term for this. Anyway, Medium has that cool design thing going on, so it will be nice to class the law professor writing on the internet median up a bit.
Earlier this week, the SEC announced that it would award $30 million to a whistleblower in an enforcement action. Here is the press release and here is the more interesting order. If you are like me, it may be hard to wrap your mind around a one-time payment of $30 million for anything short of selling your start-up or single-handedly producing an Avengers movie, but I guess that is what happened. But, I think I'm not convinced this kind of award is an awesome idea. Here are a few reasons.
First, to preserve the anonymity of the whistleblower, which may not be possible anyway, all facts of the case are not disclosed. Any information that could have been provided to other companies or to the public are unknown. Other companies receive no guidance on what sorts of behaviors were problematic and I suppose the investors in that company aren't told. (I would think that the enforcement action would need to be disclosed to shareholders, which is another reason anonymity may be delayed if not illusory).
Second, this is $30 million we are talking about. If we believe that the optimal level of whistleblowing is higher than the current level, is this much money really necessary to achieve that level? The standard is 10-30% of the penalty received, and I guess the theory is that the SEC would never have uncovered the fraud but for the whistleblowing, so the SEC is up $270 million? Are we over-incentivizing whistleblowing? (Since enacting the whistleblower program, the SEC has given 14 awards, but has received over 6500 tips.) I heard someone on NPR arguing that those in the position of being whistleblowers for reporting companies make so much money that the carrot has to be worth losing their job. The speaker argued that if the average salary of someone on Wall Street is $26 million, then the carrot has to be bigger than that. I'm not sure that most SEC whistleblowers average seven figure salaries, but we can't know because of the anonymity! Surely this is a large carrot to incentivize people to be honest. If honesty is that expensive, wow.
Third (really Second - A), money is fungible. The SEC emphasizes that this money does not come from taxpayer funds or investor recoveries. But, the money is going out the door, so it could be used for other things, like more personnel, really good enforcement work, etc.
Fourth, let's think who we are giving the $30 million to. The whistleblower argued to the SEC that the $30 million was too low. (That's some chutzpah.) The SEC countered that the $30 million may have been lower than the average whistleblower fee paid as a percentage because of the whistleblower's unreasonable delay in reporting. So, our whistleblower doesn't exactly have clean hands. But they are full of money.
In our last post, we discussed our framework for legal strategy called the five pathways. Today, we’d like to address how companies navigate within these pathways to attain the best results. As we mentioned in our MIT Sloan article, there is no one-size-fits-all approach to developing a legal strategy. Companies and industries are simply too diverse for such a simplistic solution. Instead, what we find is that legal strategy often is dependent on internal and external variables, such as company size, corporate culture, regulation, pace of technological change and the company’s maturity stage.
That is not to say, however, that a large and mature company in a regulated industry cannot cross the divide from risk management to a value creation pathway. One well established transportation company recently engaged in a strategic and cross functional (legal and finance) assessment of freight contracts to evaluate which ones to renew, cancel or negotiate. The company, which was operating at full capacity, changed its legal strategy to optimize its operations for the near and medium terms. This type of strategic contract assessment clearly fits within the value pathway.
To cross the divide and move from a risk management pathway (avoidance, compliance, prevention) to a value-enabling pathway (value and transformation) we suggest that C-level executives must view the law as an important and enabling resource for achieving strategic goals. This perspective requires a strong working knowledge of law, or legal astuteness, and organizational commitments such as the deployment of resources and authority to develop and test legal strategy.
Our research suggests that successful legal strategies require a champion, or what we refer to as a chief legal strategist. This is someone who is authorized by top management and recognized across the organization as the point person for driving legal strategies. Sometimes that individual is the general counsel, such as Twitter’s former chief legal officer, Alexander Macgillivray, who once stated that fighting for free speech is more than a good idea, it is a competitive advantage for the company. We find, however, that an associate general counsel is more often able to devote time to legal strategy execution. These individuals often possess strong legal and business fluency, leadership capabilities and the ability to work dynamically in teams.
For our next post, we'll offer more examples of companies operating within each pathway.
Philadelphia's own Charles Plosser, an economics professor, and Richard Fisher, an investor, have retired from their perches atop Fed regional banks, meaning that the Federal Open Market Committee has lost two of its hawks. Dan Tarullo has stayed, which means that there is a law professor on that most essential of government committees still. But it used to be that the Fed was run by lawyers, and they have disappeared. Plosser and Fisher's retirement offers the opportunity to reflect on a fascinating chart:
The transformation of the FOMC into a redoubt of the economics profession makes it just about the only such place in the federal government that has such a role.
Robert and I would like to thank The Conglomerate and its readers for providing us with this valuable opportunity to share our thoughts on a topic we research and teach at our respective business schools: corporate legal strategy. In several guest posts, we'll discuss various issues related to this subject. This first post will discuss the framework we developed called the five pathways of legal strategy. The pathways framework describes the various strategic legal scenarios available to companies and the elements necessary to navigate within these scenarios.
The Wall Street Journal recently published an article that mentions how companies are increasingly insourcing legal services by expanding their in-house legal departments. As with many prior examinations of in-house legal departments, the article emphasizes the cost-cutting benefits of insourcing. The article discusses an important trend involving the rising status of in-house legal departments; however, it neglects to discuss how companies are increasingly looking to their legal departments as strategic partners and value co-creators.
An article we wrote that was recently published in the MIT Sloan Management Review examines corporate legal strategy and the value-creating activities of legal departments. According to our five pathways framework, every company is situated within a spectrum of five different areas of legal competence: avoidance, compliance, prevention, value or transformation.
Avoidance involves attorneys reacting to legal mishaps. Attorneys serve in a reactive emergency role or enable questionable legal practices, and when these issues become public we often read about them in the front pages of a newspaper. Think of MF Global. Most companies choose instead to operate in the compliance pathway, in which in-house attorneys serve, and are perceived by managers, as "cops" who ensure compliance with existing laws and regulations. The next pathway called prevention is the first step towards strategic legal decision making. In this pathway, managers work with attorneys to mitigate future and identifiable business risks. Each of these three initial pathways fit within the traditional domain of risk management.
The remaining two and much rarer pathways involve managers working with attorneys to generate legal strategies that create identifiable, measurable value for the firm. The value and transformation pathways are distinguished by the high level of attention that top managers (C-level executives) pay to legal matters and their focus on value creation, not just risk management. A value pathway is achieved when a legal strategy can be causally connected to a financial metric, such as revenues that can be accounted for on a financial statement. The final transformation pathway is achieved when the legal strategy creates value, provides a source of long term competitive advantage and is integrated in the company's underlying business model. Increasingly, legal departments are being called on to help companies navigate towards a higher legal pathway. How this is achieved will be the subject of our next post.
Despite a delayed start, Alibaba's IPO seems to have gone off without the technical glitches that have marred some recent public offerings. Priced at the very top of its range at $68, it opened at $92.70. That's some kind of pop!
Investors apparently aren't listening to Harvard Law's Lucian Bebchuk, who earlier this week expressed governance worries about the firm, particularly its control by insiders.
In Alibaba, control is going to be locked forever in the hands of a group of insiders known as the Alibaba Partnership. These are all managers in the Alibaba Group or related companies. The Partnership will have the exclusive right to nominate candidates for a majority of the board seats. Furthermore, if the Partnership fails to obtain shareholder approval for its candidates, it will be entitled “in its sole discretion and without the need for any additional shareholder approval” to appoint directors unilaterally, thus ensuring that its chosen directors always have a majority of board seats.
For my money (or lack thereof--not a penny of mine is going to Alibaba), the bigger concern is the VIE structure whereby Americans can invest. As Dealbook explains, "the company that is going public is technically an entity based in the Cayman Islands that has contractual rights to the profits of Alibaba China, but no economic interest."
The concern is that Chinese courts will fail to honor these contractual rights. Dealbook quotes a U.S. lawyer who has worked in China as saying "“It’s prohibited for foreigners to own an Internet company of any kind in China — not discouraged, but prohibited” ... “Every lawyer agrees that if this goes to court in China, those contracts are void; they’re illegal.”
In a letter to the SEC, Senator Bob Casey tried to link VIEs to fraud-plagued Chinese reverse mergers of the past. This comparison misses the mark. In a reverse mergers a shell corporations that is publicly traded acquires a pre-existing Chinese corporation. The Chinese firm avoids the IPO process entirely, hence the colloquial "back-door IPO" moniker. It turns out that many of these firms had shoddy accounting practices, and some U.S. investors got burned.
The risk of accounting fraud appears to me to be a risk that you run when investing in any publicly traded comany where you know that the firm's main asset never got that initial SEC scrutiny and, while subject to the '34 Ac'ts periodic disclosure requirements, operates overseas in a country where corruption and fraud are widespread. That seems...risky. Whereas with Alibaba you're buying into a structure knowing that the Chinese government could declare it illegal and worthless at any time. That seems...like an act of faith.
Mark Mobius of Franklin Templeton and the WSJ editorial page share my skepticism about the VIE structure. Let's see how it goes.
For the next couple of weeks, we'll have the chance to hear from two law professors who, like me, are posted at business schools, David Orozco at Florida State and Robert Bird at UConn. They've got an interesting collaboration going on corporate legal strategy, and other subjects of note as well. So welcome David and Robert!
They've been doing some interesting hiring at OSU, lately, and this year they will be doing some more. The position announcement is after the jump.
Many of you may remember that a year ago this month, I won the New Yorker Cartoon Caption Contest.
I was very excited. Then, my husband told me that I was due a prize for this noble honor. Embedded in the rules for the contest is this paragraph:
The Qualified Winner of each Cartoon Caption Contest will receive a print of the cartoon, with the caption, signed by the artist who drew the cartoon (the “Prize”). If the winner cannot be contacted or does not respond within three (3) days, an alternate winner may be selected, and awarded to the person whose caption received the next greatest number of votes. The approximate retail value of the Prize is $250. Income and other taxes, if any, are the sole responsibility of the winner.
I was not alerted to this by my contact at the New Yorker. Let's call him "M." M emailed me to tell me that I was a finalist, and asked for my address and agreement, which I gave him immediately via email. After I won, I emailed him and asked about my prize. He said the NY was backed up and to remind him in 3 months if I had not heard from him. As you might imagine, I emailed him again on Jan. 8, and he said give him another month. I emailed him again on Feb. 3, and got the same reply. I emailed him again on Mar. 30, but this time his email bounced back. I then tried to email the New Yorker via the "Contact Us" interface and never heard back from anyone.
I then even emailed The Haggler at the New York Times, but I guess he's too busy fixing other people's bills. Today, I tried calling different numbers at Conde Nast, including the NY headquarter number which is eternally busy. Finally, I was given a number that ended in a human's voicemail. I left a message, but I am not hopeful.
If anyone knows someone at the New Yorker who can get me my prize, please let me know!
UPDATE: Right after I posted this, an awesome editor at the caption contest emailed me to say that would send asap. Unfortunately, the email went to my old UI email address, so I can't reply. I tweeted the editor, so maybe we will connect. Here's to social media! BTW, if you need my new email it's email@example.com or firstname.lastname@example.org.
Enforcement cases, where the enforcers have total discretion about what to do, don't often motivate dissents from one of those enforcers, but one did recently before the SEC, in a case where a CPA CFO misstated earnings, and agreed to a Rule 102(e) suspension, or, if you like, a "wrist slap." Commissioner Aguillar thought that the CPA role was crucial.
Accountants—especially CPAs—serve as gatekeepers in our securities markets. They play an important role in maintaining investor confidence and fostering fair and efficient markets. When they serve as officers of public companies, they take on an even greater responsibility by virtue of holding a position of public trust.
Aguillar appears to be worried that CPAs are getting pled down into relatively innocent offenses even when there is strong evidence of intentional fraud.
I am concerned that this case is emblematic of a broader trend at the Commission where fraud charges—particularly non-scienter fraud charges—are warranted, but instead are downgraded to books and records and internal control charges. This practice often results in individuals who willingly engaged in fraudulent misconduct retaining their ability to appear and practice before the Commission.
So there you go, a commissioner who is particularly insistent on holding the accounting profession to high standards, and thinks the SEC is too willing to plead down everything. As an empirical matter, it is difficult to know whether the SEC is indeed guilty of Aguillar's charge (though he is, presumably, an expert on the matter). It's hard to know how much conduct is going unprosecuted, and for settleed cases, whether stiffer charges would have been likely to stick.
I feel a little guilty about blogging about both of these items, for different reasons, but here goes...
1. I have a piece up on Slate that summarizes my Essay on campaign finance (guilt because all last week as I wrote it I couldn't shake the feeling I was cheating on the Glom)
2. I am the UGA's new M.E. Kilpatrick Professor of Law (guilt because self-promotion/bragging)
17 years of Catholic education. Guilt as a way of life.