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.
Steven Davidoff Solomon and I have, as you may recall, been working on a Fannie and Freddie litigation paper - the question is what to do with the newly profitable firms, Treasury says: we'll take the money, the still extant shareholders say: we want a dividend. We say an entire fairness remedy. We've got an overview of the paper up over at the Harvard Law School Forum on Corporate Governance and Financial Regulation. You can find the paper here. Here's an excerpt, see the rest over there:
Our legal analysis  suggests that
- The equitable nature of the entire fairness remedy is consistent with administrative procedure’s commitment to equitable, as opposed to damages, remedies.
- The conflict of interest faced by the government in deciding whether to keep or share the firms’ profits provides an exception to many of the administrative law hurdles faced by shareholders seeking to subject the action of a government conservator to administrative law.
- The fact that two government agencies were involved in the decision about what to do with the profits from the firms does not authorize the dividend decision, as the agencies did not act at arm’s length.
- The firms were not in a zone of insolvency that might relax the fiduciary obligations of a controlling shareholder at the time the dividend decision was made, as some have suggested, and, even if they were, the government gave nothing of value to senior creditors in exchange for its decision to take all of the profits of the firm, to the detriment of shareholders.
- The Takings Clause offers another doctrinal remedy to the plaintiffs, and it is also plausible, in part because the government’s conflict of interest overcomes many of the doctrinal hurdles posed by the government’s usual defenses against takings claims.
The Basel Committee is doing a lot of Basel III capital accord implementation this week. Page 10 of this report makes it look like the largest banks hold slightly less capital than smaller banks, which is the opposite of what you would want (smaller banks hold more variable capital though). And this report suggests that the effort to have banks deal with a hypothetical effort to adopt the new capital rules was messy. Not to worry, though! As is the case with all Basel documents, bland positivity about the success of the regulatory effort is the tone of the day.
One of the reason that bank capital regulation became an international affair was to ensure a regulatory "level playing field," which would be paired with market access to the US and UK. That is, as long as the rest of the world complied with the Anglo-American vision of capital requirements, access to London and New York would be assured.
But as former law professor and current Fed Board member Daniel Tarullo will testify to Congress today, as those global (call them "BCBS") rules have become more elaborate and comprehensive, some countries have elected to depart from them - only upwards, not downwards. Switzerland is trying to use very, very heightened capital requirements to shrink its universal banks into asset managers. And now the United States is enacting global rules with its own pluses. For example, the liquidity coverage ratio, which requires banks to keep a certain percentage of their assets in cash-like instruments,
is based on a liquidity standard agreed to by the BCBS but is more stringent than the BCBS standard in several areas, including the range of assets that qualify as high-quality liquid assets and the assumed rate of outflows for certain kinds of funding. In addition, the rule's transition period is shorter than that in the BCBS standard.
The Fed is also imposing an extra capital requirement on the largest American banks:
This enhanced supplementary leverage ratio, which will be effective in January 2018, requires U.S. GSIBs [very large banks] to maintain a tier 1 capital buffer of at least 2 percent above the minimum Basel III supplementary leverage ratio of 3 percent, for a total of 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments
And another such requirement based on the amount of risk-based capital,
will strengthen the BCBS framework in two important respects. First, the surcharge levels for U.S. GSIBs will be higher than the levels required by the BCBS, noticeably so for some firms. Second, the surcharge formula will directly take into account each U.S. GSIB's reliance on short-term wholesale funding.
I think of the global efforts in financial regulation as being notable precisely because they created, incredibly informally, some reasonably specific and consistently observed rules that comprise most of the policy action around big bank safety and soundness. The little new trend towards harmonization plus is a bit comparable to the trade law decision to create the WTO for global rules, but to permit regional compacts like NAFTA and the EU to create even freer trade mini-zones. Some find this multi-speed approach to be inefficient and, ultimately, costly to the effort to create a consistent global program. We'll see if the Basel plus approach rachets up bank regulation, or just disunifies it.