In my previous blogpost, I granted the merit of defense counsel’s argument that the actions of discrete individual defendants—when the law is not permitted to consider the coordination of those actions—may not satisfy the elements of a prosecutable crime.
But what is the coordination of individuals for a wrongful common purpose? That’s a conspiracy. And, for exactly the reasons that defense counsel articulates, these types of crimes cannot be reached by other forms of prosecution. The U.S. Supreme Court has recognized that conspiracy is its own animal. “[C]ollective criminal agreement—partnership in crime—presents a greater potential threat to the public than individual delicts.” When we consider the degree of coordination necessary to create the financial crisis, we are not talking about a single-defendant mugging in a back alley—we are talking about at least the multi-defendant sophistication of a bank robbery.
Conspiracy prosecutions for the financial crisis have some other important features. First, the statute of limitations would run from the last action of a member of the group, not the first action as would be typical of other prosecutions. This means that many crimes from the financial crisis could still be prosecuted (answering Judge Rakoff’s concern). Second, until whistle-blower protections are improved to the point that employees with conscientious objections to processes can be heard, traditional conspiracy law provides an affirmative defense to individuals who renounce the group conspiracy. By contrast, the lesson Wall Street seems to have learned from the J.P. Morgan case is not to allow employees to put objections into writing. Third, counter to objections that conspiracy prosecutions may be too similar to vicarious liability, prosecutors would have to prove that each member of the conspiracy did share the same common intent to commit wrongdoing. The employee shaking his head “no” while saying yes would not be a willing participant, but many other bankers were freely motivated by profit at the expense of client interest to cooperate with a bank’s program.
My next blogpost will ask: where are the prosecutions for corporate conspiracy?
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It is a pleasure to be guest-blogging here at The Glom for the next two weeks. My name is Josephine Nelson, and I am an advisor for the Center for Entrepreneurial Studies at Stanford’s business school. Coming from a business school, I focus on practical applications at the intersection of corporate law and criminal law. I am interested in how legal rules affect ethical decisions within business organizations. Many thanks to Dave Zaring, Gordon Smith, and the other members of The Glom for allowing me to share some work that I have been doing. For easy reading, my posts will deliberately be short and cumulative.
In this blogpost, I raise the question of what is broken in our system of rules and enforcement that allows employees within business organizations to escape prosecution for ethical misconduct.
Public frustration with the ability of white-collar criminals to escape prosecution has been boiling over. Judge Rakoff of the S.D.N.Y. penned an unusual public op-ed in which he objected that “not a single high-level executive has been successfully prosecuted in connection with the recent financial crisis.” Professor Garett’s new book documents that, between 2001 and 2012, the U.S. Department of Justice (DOJ) failed to charge any individuals at all for crimes in sixty-five percent of the 255 cases it prosecuted.
Meanwhile, the typical debate over why white-collar criminals are treated so differently than other criminal suspects misses an important dimension to this problem. Yes, the law should provide more support for whistle-blowers. Yes, we should put more resources towards regulation. But also, white-collar defense counsel makes an excellent point that there were no convictions of bankers in the financial crisis for good reason: Prosecutors have been under public pressure to bring cases against executives, but those executives must have individually committed crimes that rise to the level of a triable case.
And why don’t the actions of executives at Bank of America, Citigroup, and J.P. Morgan meet the definition of triable crimes? Let’s look at Alayne Fleischmann’s experience at J.P. Morgan. Fleischmann is the so-called “$9 Billion Witness,” the woman whose testimony was so incriminating that J.P. Morgan paid one of the largest fines in U.S. history to keep her from talking. Fleischmann, a former quality-control officer, describes a process of intimidation to approve poor-quality loans within the bank that included an “edict against e-mails, the sabotaging of the diligence process,… bullying, [and] written warnings that were ignored.” At one point, the pressure from superiors became so ridiculous that a diligence officer caved to a sales executive to approve a batch of loans while shaking his head “no” even while saying yes.
None of those actions in the workplace sounds good, but are they triable crimes??? The selling of mislabeled securities is a crime, but notice how many steps a single person would have to take to reach that standard. Could a prosecutor prove that a single manager had mislabeled those securities, bundled them together, and resold them? Management at the bank delegated onto other people elements of what would have to be proven for a crime to have taken place. So, although cumulatively a crime took place, it may be true that no single executive at the bank committed a triable crime.
How should the incentives have been different? My next blogpost will suggest the return of a traditional solution to penalizing coordinated crimes: conspiracy prosecutions for the financial crisis.
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Thank you to our eminent group of contributors -- Brian Broughman (Indiana -Bloomington), Trey Drury (Loyola - New Orleans), Eric Helland (Claremont McKenna), Joan MacLeod Heminway (Tennessee), Karl Okamoto (Drexel), and our own Christine Hurt (Illinois) -- for a stimulating roundtable on teaching corporate finance. I learned a great deal that will shape my own teaching.
Our next roundtable will focus on teaching Corporations and Business Associations and will take place on July 18-19.
Among the conundra that we business law teachers face is where, when, and how to teach M&A. A number of my students go on to work in M&A with small local and medium-sized regional firms. They typically do private-private deals. Of course, I cut my lawyering teeth on much larger transactions, so teaching the subject to this audience meant refocusing more than a bit . . . .
Most law students at Tennessee do not go further than the basic Business Associations course. Yet, many of them will later need to know something about M&A. So, I do spend a few hours talking about the basic M&A structures and the overlay of securities regulation in covering the larger issues of fundamental corporate change transactions and change-of-control transactions. But there needs to be more somewhere, in my view. I do another few hours on M&A structures in Corporate Finance, for the few folks that take the course. But, given the fact that we do not have resources to teach a full M&A course in addition to our Corporate Finance offering, the main place I get to teach M&A in a skills-based context is through our transaction simulation course, Representing Enterprises. There, I can teach a 14-hour module focused on M&A in a practice context. What I teach in the module has varied from year to year, but it gets much more granular and always focuses around transaction documents.
As I earlier noted, one area of focus, once I figured out the basic subject matter that I wanted to teach, was finding the right book. I always employ PowerPoint slides that I created for my own use in going over the different deal structures. But I keep yearning for a non-casebook (or two short non-casebooks) that explains M&A structures and connects them to the statutory law, and also, at the same time, walks through the components of a business combination agreement and unpacks the legal and practical issues--all in a digestible, yet rigorous, way. I have coauthored a series of annotated M&A agreements for our business law journal over the years (all of which are available through my author page on SSRN), and I sometimes assign one or more of those. In addition, I use excerpts from Jim Freund's Anatomy of a Merger where I can, but it is quite dated now on a number of issues and cannot be assigned in its entirety as a text. It is also frightfully expensive to buy when one can find a copy.
In the hopes that I could find part of my solution, I picked up Ken Adams's new book, The Structure of M&A Contracts, available for download in .pdf. The first thing I noticed was its abbreviated length--94 pages of primary text, all in (110 pages cover-to-cover). The book addresses the structure of M&A agreements and related drafting issues and not much more. So this is not the soup-to-nuts teaching resource I am looking for, but it may well serve as a component piece of the M&A teaching materials puzzle. I plan to "give it a go," as a supplement to other resources, my next time teaching this module. Here are some things that I like about the book, apart from its short length:
- It is written in a very accessible, user-friendly style.
- It includes a series of helpful charts showing, e.g., linkages between and among the different component provisions in an M&A agreement and where in the agreement one would address various client issues.
- Where relevant, it cites to the 2009 Private Target Deal Points Study from the Mergers & Acquisitions Market Trends Subcommittee of the Committee on Mergers and Acquisitions of the ABA Section of Business Law, a resource on transactional norms with which business law students should become familiar. Ken also cites to Jim Freund and to two other former Skadden colleagues, Lou Kling and Eileen Nugent (whom I respect and also cite in my work), as well as further important resources for M&A drafters.
- Those who have read and appreciate A Manual of Style for Contract Drafting (like me) also will appreciate this book. It is written in a similar format and makes many of the same points. (FYI, I do not always agree with Ken's judgments, but I always appreciate them. And where we disagree, the basis of the disagreement usually is an excellent basis for class discussion.)
- The book makes a valuable point up front--which I also make (in a different way using stronger language) in class: "A note to junior lawyers: before embracing the more novel recommendations made in this book, you should consider getting the approval of someone more senior."
- The cost of the book is $25, and it will be useful well beyond law school for those with business law practices (which include most of the students in my course).
Do you all teach M&A in your Corporate Finance courses? As a stand-alone? And do you all cover M&A at some level in your Business Associations or Corporations course? What materials do you use? Comments are invited.
In response to Christine’s “what now?” query, I end where I started. What world events - financial crisis, housing meltdown, deficit debacle, the looming retirement crisis, etc. – should teach us is not so much that we should teach our corporate finance classes differently but that we should teach finance (and its application to law and policy) to more people.
Imagine a world in which every citizen understood just a little bit about option pricing theory. They would understand that options are more valuable if the underlying asset is more volatile. They might recognize that options are everywhere. They might therefore understand how the proliferation of options increased risk-taking.
Even among lawyers, finance is more a basic literacy problem than an advanced, sophisticated understanding one, in my opinion. The details of the contracts will change, but the archetype of an option (asymetric payoff profiles) and the dynamics (moral hazard, etc.) that come with it won’t. So that’s why, Torts (a la Christine) or Civil Procedure (a la Helland’s use of Easterbrook) or maybe even Con Law (wherever the big social issues of the day get talked about) ought to be the place to start.
Enough sermonizing. I’m off to the woods with a bunch of rising 2Ls. We’re backpacking the Loyalsock Trail, a personal favorite. In addition to the normal gear, everyone is required to bring an HP-12C. Beats ghost stories.
Erik et al, thanks for having me.
Take two businesses that are identical in all respects other than their Capitalization. One has Total Assets of $100M and no Debt. The other has a Market Capitalization of $40M and $60M of Debt. Which company is worth more? OK, a trick question.
Let’s try slightly different questions. If you are offered one percent of the common stock of one, which would you pick? No brainer. How about if you are being offered all of the assets? Another trick? What if you are being asked to lend $1M on a fixed set of terms? What if all of the existing debt (if any) will be subordinated?
Yes, some folks won a Nobel Prize for examining versions of these questions. Several times, I have taught “MM” in the hope that its theoretical insights will lead to greater skill in drafting bond covenants or setting performance targets for performance bonus plans. I’ve found greater success by going at it the other way around.
From reading the posts (and as I suspected), it appears that you could take each of our corporate finance courses (and whatever cool thing Karl is teaching instead of corporate finance) and learn something completely different from each of them. However, there does seem to be one thin shred of common ground - finance concepts, and particularly the idea of net present value, are at the heart of this course.
Even my class, which seems to be the most "law-heavy" of the courses, spends a considerable amount of time on basic concepts of finance, and net present value in particular. I believe strongly that this is something our discipline can contribute to the broader legal world. If you don't understand NPV, you cannot negotiate a divorce settlement where, for example, a family business is an asset; you cannot advise your client whether and when to accept a settlement that is paid in installments, or compare a lump sum to an installment payment; you cannot make estate plans that rely on minority or marketability discounts; you cannot make a coherent argument about lost future wages in an employment claim.
The more you look, the more often you find it. Pretty soon, it appears everywhere, just like one of my favorite Woody Allen characters. While I applaud and admire my friend Christine for introducing NPV into her torts class, I worry that she is in the distinct minority on that front. Until more people recognize the essential place for NPV in every lawyer's toolkit, we all do a great service by providing it in our corporate finance classes.
As the “try outs” for last year's Transactional Lawyering Meet team at Drexel, I created a little exercise. I gave the participants the following vignette. Imagine a client has come to you with a proposed term sheet for a round of venture capital financing. One of the terms set out in the term sheet reads as follows:
In the event that the Company issues additional securities at a purchase price less than the current Series A Preferred conversion price, such conversion price shall be reduced to the price at which the new securities are issued.
I then told the students they needed to upload to Youtube a short video of themselves explaining the provision and their proposed response. The students did a good job. Some examples here, here and here.
Personally, I consider well-drafted anti-dilution clauses to be a shibboleth of skilled lawyering. An exercise like this should be on the bar exam. We could call it the “Ratchet,” as in “did you survive the Ratchet?”
Kidding aside, the most satisfying part of this exercise was the common refrain from the students. It went like this: "Having to explain the provision really forced me to understand it."
And I replied, "welcome to the club."
This roundtable has gotten so juicy that I am going to exercise my prerogative as convenor to step in briefly and talk about a theme that underlies many of the posts so far. I do so with humility: I have taught corporate finance only in the context of a Business Planning course organized around numerous long drafting and negotiation exercises. These exercises involve entrepreneurs starting a company and (in later exercises) venture capitalists. The class seems a lot like what Joan describes she does at Tennessee and what I know Karl has done in many of his classes.
For me, the real joy of the class is having the students fit puzzle pieces together. I hope most of them have the following "aha" moment. Instead of arguing that the there is a "right" answer that is works for the corporation, they realize that whether a particular feature -- whether it is a conversion right, a liquidation preference, or whatever -- is "good" depends on where their client falls in the firm's capital structure. It is a leap beyond the management-shareholder relationship that is central to business associations. And it goes beyond debtors versus shareholders. (I think it also goes to the questions in Eric's class on AIG bankruptcy versus bailout.) Even two shareholders with the exact same preferred shares (or bonds) may have different interests with respect to a particular provision depending on their holdings, time horizons, discount rates, degree of risk aversion, and estimates of the firm's prospects.
As I mentioned in the Contracts roundtable, the negotiation dynamic is key for me in teaching. Not because I aim to teach negotiation skills, but because I think this lens helps students see how these concepts apply in practice. There are few times a transactional lawyer just drafts an agreement of any complexity without some negotiation. There are going to be some room for value creation in crafting the terms of debt or preferred stock (which can throw off students inclined to fight every inch). There is also a large domain of distributive/zero sum issues (which is discomfiting for students who want to find a win/win in everything).
Knowing which issues are important, for whom, when, and why involves some facility with math.
This can be borne by two handles. Here's the negative spin: there is a large helping of "eat your vegetables" in this kind of course. But being innumerate means someone will steal your lunch money on the playground and you won't even know it. I agree with Karl, that this is true not only for transactional lawyers - but for any lawyer. Not understanding the time value of money means potential malpractice in the context of settlement agreements.
Here's the positive spin: being familiar with corporate finance helps lawyers create enormous value for clients, it helps students get jobs in a tough market, and the puzzle solving dimension can be immensely gratifying intellectually.
If students leave a class with a deep understanding for the "where you stand depends on where you sit in the capital structure" point and having sharpened some quantitative reasoning and realized why that is so critical, I'm a lot closer to happy.
There are several ways we may want to change the way we teach corporate finance after the financial crisis. Off the top of my head, it may make sense to include/increase the prominence of derivatives, securitization, systemic v. firm-specific risk, and/or moral hazard in our syllabi. All of these seem like good ideas, but my primary response has been a different one - I leave an intentional gap in my syllabus, 3-4 classes where nothing at all is planned.
I was teaching a corporate finance class in the fall of 2008 as the financial system was imploding. It was an unnerving but exhilirating time to be doing this, and we would spend the first 15 minutes of every class (and sometimes much longer) discussing the issues of the day. I recognized fairly early on that this was wreaking havoc on my syllabus and did not want to lose the last part of it (where we talk about fundamental transactions, a particular interest of mine). So, early on in the semester, I axed a substantial chunk of my syllabus - about 4-5 classes - to make room for our discussion of current events.
The following year, instead of re-inserting the old material, I left a 3 session gap designated as "Current Issues in Corporate Finance - materials to come." During the semester, the students and I watch the news, and together we choose something to fill the gap with. While I go into the semester with a couple of off-the-shelf ideas about what those current issues might be, I have never used the pre-prepared stuff. Each year, something new and interesting comes along tht warrants in depth investigation.
This spring, we dug into Facebook's offering - what does a $50 billion valuation mean?, who calculated it and how?, why did Goldman Sachs close the offering to US investors?, what are the SEC rules about going public, and how are they claiming to comply?, what are these private secondary markets that are operating in the meantime? It has been a big success every year, and I am glad I resisted the temptation to stick the old stuff right back into my course.
I had the good fortune (perhaps that’s the wrong way to put it) to be teaching this course right through the worst of the financial crisis. I think Brian’s point is well taken. Even if I wanted to stick to a book, any book, the events in 2008 were moving too fast. I remember having a set of institutional background slides on the remaining distinctions between investment and commercial banking and realizing that it completely irrelevant by time I got to the lecture. As I remember it not a single bullet on the slide was still correct.
Like Brian I organized the course around finance topics but I always started the class with something in the news. Give how fast things moved that semester these topics sessions, which I had to cut off at 10-15 minutes, were some of the most interesting discussions in the class. My favorite was whether AIG would have done better in bankruptcy than being bailed out. The general consensus of the class was that AIG would have done better even if the systemic risk created by its default was too large for the US government to allow that to happen. That discussion could have motivated about half the topics I covered.
I am very much enjoying reading all the posts, and I'm grateful for Erik's hosting of this topic. I wanted to chime in to the discussion and add little except the follow-up question: What next?
1. I have also taught Corporate Finance more than once, and I have also gone from using a business book and adding in law to using a law book and adding in finance. Neither is very satisfactory, and neither strategy satisfies all students. We have been trying to fashion a course out of what is there, but what should be there? What should law students know about finance that is different than an undergraduate course? I agree that many students simply need to be introduced to finance topics. But then what -- what legal overlay should be there? The law books merely have cases in which finance topics arise -- valuation, dilution, etc. If law doesn't interfere much with a firm's financial structure choices, then is there more to the course than just getting transactional attorneys ready to speak the lingo?
2. Which leads to my real question. After the financial crisis, some fingers pointed to the lawyers at the SEC. The prevailing wisdom was that SEC attorneys were competent litigators but did not understand the financial products they were (not) regulating. The sense was that this needed to change. Would this vacuum have been filled if every attorney graduating from law school took corporate finance? My sense is that the corporate finance course provides a foundation but would get nowhere near the type of sophisticated and even esoteric knowledge required for the SEC to stay one step ahead of the market. Is it a losing battle?
3. As an aside, I teach NPV in Torts. I don't know if everyone does, but I get the feeling many in my class have never thought about it before (and hope never to think about it again).
I wanted to follow up on one of Eric’s earlier posts. I suspect that most of us are doing some variation of the hybrid method (this also comes through in Joan's description of her class).
First, a straightforward adoption of the undergrad (or MBA) version of corporate finance would duplicate what is done elsewhere on campus, and would not really be tailored to the needs of law students. Thus, I suspect that most professors who use a business style textbook have to supplement with a fair amount of additional law-related reading material, which as Eric notes can be a lot of work.
Second, law casebooks have been for several decades directly incorporating finance concepts, interspersing this material between cases. In essence, casebook authors have been creating a type of hybrid which differs substantially from the standard law school format.
I think the choice ultimately comes down to organization rather than substance. I organize my class through the underlying finance concepts, which I think is easier to implement with a business textbook. In this sense I don’t think corporate finance, at least the version that I teach, fits easily on the standard law school classification between litigation versus transactional focus. Rather, the course is more of a tool kit or set of analytic methods that lawyers can use in various aspects of their practice.
I wanted to follow up on Karl’s post on present value. This seems to me to be one of the most important things for a student in corporate finance (or anyone) to learn. It is also a deep concept in the sense that it is easy to learn and yet once you start thinking about the assumptions you realize how much this very simple model clarifies your thinking about intertemporal decisions. My preferred way to teach the concept, which came from Eric Talley, is to use Judge Easterbrook’s opinion in the Amoco Cadiz oil spill case. There is a lot in the opinion but Easterbrook’s discussion of why the plaintiffs should be awarded prejudgment interest is wonderfully clear.
By committing a tort, the wrongdoer creates an involuntary creditor. It may take time for the victim to obtain an enforceable judgment, but once there is a judgment the obligation is dated as of the time of the injury. In voluntary credit transactions, the borrower must pay the market rate for money. (The market rate is the minimum appropriate rate for prejudgment interest, because the involuntary creditor might have charged more to make a loan.) Prejudgment interest at the market rate puts both parties in the position they would have occupied had compensation been paid promptly.
To see this, consider what would have happened if the French parties had borrowed $60 million to finance the cleanup in April 1978, and Amoco had put that sum in trust to fund an award of damages (just as Amoco actually put 77 million francs in trust in France). The victims would have had to pay the market rate of interest, which at times during this case has exceeded 20% per annum. If they arranged to repay the debt in a single balloon payment at the end (when they recouped from Amoco), and if the rate of interest averaged 12%, then by April 1991 the victims would owe their creditors $262 million. Meanwhile the trust fund, lending out its assets at the market rate of 12%, would have grown to $262 million. Scores would be fully settled if Amoco tendered its interest in the fund: it would thus "pay" $60 million as of 1978, and the victims would receive $60 million as of 1978; the lenders who financed the cleanup would receive full payment for the use of their money.
Let me start off with a big disclaimer. I’ve taught corporate finance exactly once (at UCLA) and am not a lawyer. Although I do research in the area I don’t teach this course at CMC either. That said I spent a lot of time before teaching the course at UCLA trying to figure out exactly how I wanted to teach the course and ultimately what I wanted law students to know about finance. I also asked several law professor friends about how they teach the course. The responses as fall into three categories: undergraduate corporate finance, casebook or some hybrid (what I finally went with). There is a lot to recommend each one.
The undergraduate course is the easiest to teach because there are several good corporate finance books for undergraduates. My favorite is Brealey and Myers Principles of Corporate Finance. The benefit for law students is that these books have lots of institutional details, are strong on the quantitative parts of finance and are much easier to read than cases. The downside is that a sizable fraction of my students at UCLA had an undergraduate course and I suspect that’s generally true.
I’ve been told by several people that the casebooks method is the safer bet with law students since it looks like other law course. Bill Carney has a good book aimed at law students that I used frequently. The issue here is one that’s been discussed in previous posts already. Is corporate finance a legal subject area or a tool kit that law students can use in other classes? The casebooks approach necessarily covers less of the finance tool kit than say Brealey and Myers but provides cases that illustrate the topics.
I ended up going with a hybrid course suggested by Eric Talley. Eric’s version has a lot of articles and cases designed to illustrate key from a good undergraduate book which he requires students to read. The key advantage is that the topics are ones emphasizing the legal aspects of corporate finance but covering more topics than a casebook. The downside is it’s a lot of work both for the faculty member and the students since the cases and articles are uncondensed.