January 30, 2015
The Causation Link Between Securitization and Fraud, Used Car Edition
Posted by Christine Hurt

When I practiced in the mid-1990s, I occasionally worked on projects we called "asset securitizations."  We didn't talk about it to our friends or families, because their eyes would glaze over and then they would pass out from boredom.  Because of our client base, our asset securitizations were generally either used car loans from the finance side of large auto companies or franchise loan securitizations from oil and gas companies.  Only when the financial crisis hit did everyone seem to become conversant in asset-backed securities, and the process of wide-spread securitization of mortgages seemed to be at the root of all the mortgage troubles.

The hypothesis is this, and it has some support:  If lenders held their loans, particularly their mortgages, then they would only make good loans.  By having a market to dump loans into, lenders loosen criteria to make more mortgages.  Ignorant bond holders can't buy enough MBS, so lenders loosen criteria even more to meet demand.  Lenders may even engage in fraud or encourage borrowers to engage in fraud.  The Dodd-Frank Act tries to remedy these ills by having regulation at the lender end and the MBS end.  We'll see if it works.

But the NYT this week tells us the securitization evil has spread to used car loans.  Because I'm pretty sure used car loans have been securitized since at least 1993, I don't see this as news.  However, the article suggests that because of less fun in MBS, those investors now have poured their money into used car loan-backed securities (let's say UCBS).  The article doesn't state it's hypothesis, but suggests this is bad because (1) car buyers are defaulting and losing their vehicles and (2) financial players who package UCBS are getting rich.  But, the article doesn't go so far as to provide evidence that (1) car buyers are defaulting more than usual or (2) that the demand for UCBS has caused lenders to be more unscrupulous than they have been in the past.  

In addition, problems in the MBS market, particularly mortgage defaults, have pretty big negative externalities:  foreclosures, neighborhoods with empty houses, dislocation of families, home prices, etc.  When car borrowers default, the lender takes the car back.  The borrower is out the car payments that were made (the NYT focuses on car buyers who never made any payments, so not particularly left worse off), but the car lot now can resell the car again.  Cars are more liquid than houses, and repossession is quicker and cheaper than foreclosure.  

So, I'm not getting very worried about the used car loan bubble just yet.  If we think that used car loan rates are too high, then that's another concern.  If we think that used car sales people are pressuring or misleading customers, that's another concern.  But I don't think securitization is the problem.

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January 29, 2015
SEC ALJ Orders: It's How It Does It's Anti-Bribery Rule
Posted by David Zaring

While defendants are gearing up to make arguments against the constitutionality of the SEC's increasing inclination to use its ALJs, rather than the courts, to serve as the venue for fraud cases, it looks like it has already flipped that way for foreign corrupt practices cases.  Mike Koehler did the counting:

More recently, the SEC has been keen on resolving corporate FCPA enforcement actions in the absence of any judicial scrutiny.  As highlighted in this 2013 SEC Year in Review post, a notable statistic from 2013 is that 50% of SEC corporate enforcement actions were not subjected to one ounce of judicial scrutiny either because the action was resolved via a NPA or through an administrative order.  In 2014, as highlighted in this prior year in review post, of the 7 corporate enforcement actions from 2014, 6 enforcement actions (86%) were administrative actions.  In other words, there was no judicial scrutiny of 86% of SEC FCPA enforcement actions from 2014.

It is interesting to note that the SEC has used administrative actions to resolve 9 corporate enforcement actions since 2013 and in none of these actions have there been related SEC enforcement actions against company employees.

Maybe we are seeing an agency decision to prefer administrative adjudication to, you know, adjudicative adjudication.

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January 27, 2015
The SEC's New Preference For Administrative Proceedings
Posted by David Zaring

Peter Henning has a nice overview of recent claims made against the SEC's growing inclination to take fraud cases before its handful of agency-judges (ALJs), instead of to court.  Why should that be okay?

From a policy perspective, there's reason to worry.  I did some litigation before an administrative tribunal, and it's not that different from in court litigation, with the exception of evidence admissability and objections.  But it could be really quite different.  Hearsay is in theory fine, there's no requirement that you be able to present evidence in person, and the judge works for the agency that is suing you.  It's fair to say that defendants get less process from an ALJ than they would from a federal judge.

But not that much less.  ALJs are required to hold hearings, permit the introduction of rebuttal evidence, the statute that governs them makes what they do ("formal adjudication" in the verbiage of administrative law) pretty similar to a trial.

That matters for the equities, as does the almost absolute discretion that agencies have to prosecute in the way they see fit.  The SEC can drop claims, send scoldy letters, use ALJs, take you to court, or refer you to the criminal lawyers at DOJ with the recommendation that imprisonment could be sought.  Because we wouldn't want judges second guessing the decisions to, say, emphasize insider trading prosecutions over accounting fraud claims, we leave those policy calls to the agency.

Which then begs the question: why now with the constitutional case against the ALJ, a thing that has existed since the end of WWII?  

Well, the SEC hasn't used its ALJs for high profile cases very often, at least until recently.  But the claims against the turn to administrative tribunals aren't getting a lot of love, and I predict that will continue to happen.  Judge Lewis Kaplan, who isn't afraid to savage a government case alleging financial wrongdoing, concluded that he didn't have the power to judge whether an ALJ proceeding violated due process or equal protection standards, given that other, similar cases had been brought in court.  The SEC recently ignored a declaratory relief case filed by an S&P executive when it brought an administrative complaint against her.

Some well-heeled defendants may have been emboldened to bring these cases by the Free Enterprise Fund decision in the Supreme Court, which constrained the number levels of tenured officials that could separate the president from policymakers.  But administrative adjudication is simply too resource intensive and carefully done to be rendered illegal because of its insulation.  The alternative would be to replace ALJs with political hacks, and no one wants that.  So I'm not predicting a lot of luck for the defendants in these cases.

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January 20, 2015
Litigating The Financial Crisis, By Moi
Posted by David Zaring

I've written a paper on the judicial history of the financial crisis, and it's now out in the Virginia Law Review, and up on SSRN.  Here's the abstract:

The government’s response to the financial crisis was dramatic, enormous, and unprecedented, and nothing about it has been overseen by the courts. In our federal system, the courts are supposed to put the policies of presidents and congresses to the test of judicial review, to evaluate decisions by the executive to sanction individuals for wrongdoing, and to resolve disputes between private parties. But during and after the financial crisis, there has been almost none of that sort of judicial review of government, few sanctions on the private sector for conduct during the crisis, especially criminal ones, for the courts to scrutinize, and a private dispute process that, while increasingly active, has resulted in settlements, rather than trials or verdicts. This Article tells the story of the marginal role of courts in the financial crisis, evaluates the costs of that role, and provides suggestions to ensure a real, if not all-encompassing, judicial role during the next economic emergency.

Do give it a download, and let me know what you think.  And thanks in advance for supporting us around here - we do like downloads!

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January 16, 2015
Trimming Back Dodd-Frank
Posted by Christine Hurt

Glass-Steagall may have lasted only 65 years, but the actual life of the Volcker Rule may be measured in months, if at all.  Several pieces of legislation entitled "A bill to repeal the Dodd-Frank Act" have been introduced in Congress, but one bill has passed the House that seeks to dampen a handful of its provisions, including the rule requiring banks to get rid of its collateralized debt obligation businesses.  (The Promoting Job Creation and Reducing Small Business Burdens Act, H.R. 37).  However, one legislation tracking site gives the bill a 7% chance of passage.  Also, Elizabeth Warren is on the case.

For us boring Securities Regulation professors, the bill also would give the SEC more marching orders (as if they had finished their original Dodd-Frank marching orders).  Specifically, the Bill requires that the SEC:

Not later than the end of the 180-day period beginning on the date of the enactment of this Act, the Securities and Exchange Commission shall take all such actions to revise regulation S–K (17 CFR 229.10 et seq.)—
(1) to further scale or eliminate requirements of regulation S–K, in order to reduce the burden on emerging growth companies, accelerated filers, smaller reporting companies, and other smaller issuers, while still providing all material information to investors;
(2) to eliminate provisions of regulation S–K, 2 required for all issuers, that are duplicative, overlapping, outdated, or unnecessary; and
(3) for which the Commission determines that no further study under section 1003 is necessary to determine the efficacy of such revisions to regulation S–K.
STUDY ON MODERNIZATION AND SIMPLIFICATION OF REGULATION S–K. (a) STUDY.—The Securities and Exchange Commission shall carry out a study of the requirements contained in regulation S–K (17 CFR 229.10 et seq.). Such study shall
(1) determine how best to modernize and simplify such requirements in a manner that reduces the costs and burdens on issuers while still providing all material information;
(2) emphasize a company by company approach that allows relevant and material information to be disseminated to investors without boilerplate language or static requirements while preserving completeness and comparability of information across registrants; and
(3) evaluate methods of information delivery and presentation and explore methods for discouraging repetition and the disclosure of immaterial information.
REPORT.—Not later than the end of the 360-day period beginning on the date of enactment of this Act, theCommission shall issue a report to the Congress containing—
(1) all findings and determinations made in carrying out the study required under subsection (a)
(2) specific and detailed recommendations on modernizing and simplifying the requirements in regulation S–K in a manner that reduces the costs and burdens on companies while still providing all material information; and (3) specific and detailed recommendations on ways to improve the readability and navigability of disclosure documents and to discourage repetition and the disclosure of immaterial information.
RULEMAKING.—Not later than the end of the 360-day period beginning on the date that the report is issued to the Congress under subsection (c), the Commission shall issue a proposed rule to implement the recommendations of the report issued under subsection (c). 

Wouldn't that be awesome? Why hasn't Congress done that before -- told the SEC to make Regulation S-K easier, clearer, shorter, but still as effective? I can't wait to see what happens.

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January 15, 2015
The Harvard Shareholder Rights Project v. Professor Grundfest and Commissioner Gallagher
Posted by Christine Hurt

So, I suppose the Glom should mention one of the weirder but more interesting securities fraud issues around these days.  Joseph Grundfest (Stanford) and SEC Commissioner Daniel Gallagher posted a paper on SSRN entitled "Did Harvard Violate Federal Securities Law?  The Campaign Against Classified Boards of Directors."  One could presume that the authors believe the answer to be "yes," or they would not have taken the time to ask the question.  Here is Jonathan Macey's reply to the question and the paper, and his reply is "no."  There has been more volleying back and forth, so here is the summing up of links at Bainbridge (as of today).  Here is a letter from 34 senior law professors at Top 17 law schools in support of Harvard's Shareholder Rights Project.  I was not asked to sign it, but I would have if asked.

Interestingly, many of us who teach Securities Regulation begin with "Materiality."  If so, then this case fits right in.  The thrust of the argument is that the Shareholder Rights Project (SRP) wrote shareholder's proposals for over 100 firms, proposing that each firm declassify its staggered board of directors.  In this proposals, which must not be over 500 words long, the authors of the proposal cite studies that show that staggered boards depress firm value and only one study that supports an opposite conclusion (staggered boards are good).  And, the proposals fail to cite a recent study supporting staggered boards.  This omission constitutes securities fraud.  The counterargument (besides "what the heck?") is that the exclusion of all relevant studies on either side is immaterial, particularly a very recent study that may not have been posted publicly yet or for a short time.  The proposals may have been subject to counter-argument, but that is not the same thing as false or misleading.

So, if you say "see, e.g." is that better?

Stay tuned.

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January 13, 2015
What Can We Learn From The Impending S&P Settlement?
Posted by David Zaring

The Times reports that S&P will soon be paying a billion dollar fine - or roughly one year's annual profits - to make a case that it commited fraud in relation to a financial institution go away.  What should we make of this decision to settle?

  • The government is using FIRREA to go after S&P, the obscure statute that combines harsh penalties with a civil burden of proof.  To apply, FIRREA has to be about fraud "affecting a federally insured financial institution," and that has been conceptually challenging when applied to banks who have defrauded themselves by overstating the quality of various financial products to their counterparties and in their quarterly statements (you see?  doesn't that sound like the opposite of defrauding yourself?  It sounds like fraud affecting someone doing business with an FI?), but is more easily fit into a case against S&P's allegedly fraudulent ratings of banks.
  • S&P hired Floyd Abrams, who has in the past successfully invoked the First Amendment to defend credit ratings agency rights to offer opinions about securities.  I've never really understood why this works, as no one has a First Amendment right to defraud someone.  A one billion dollar settlement doesn't suggest that the free speech at stake here is something that, you know, the Reporters' Committee for Freedom of the Press is really willing to get behind.
  • This is something of a "first principles" observation, but fraud.  Doesn't that sound like a bad word?  Fraud!  S&P is a fraud!  Intentionally deceiving someone?  Or omitting information you had a fiduciary duty to disclose?  I don't think fraud means "fraud," anymore.  I think it means something more like reckless wrongheadedness, at least in the financial markets.
  • Why settle?  The Times has a nice blurb on this:

Most Wall Street institutions, when faced with the threat of a Justice Department lawsuit, eventually cut a check rather than go to court: JPMorgan agreed to pay $13 billion to settle a crisis case;Bank of America more than $16 billion.

That settle-at-all-costs mentality stems from fears that a courtroom fight might antagonize the government and unnerve shareholders. It also spares a company the embarrassment of paying the same or even more after a trial, where an anti-Wall Street sentiment might sour the jury pool.

Financial institutions still manage to wring concessions from the government, often persuading prosecutors to water down a statement of facts that accompanies a settlement or provide immunity from other charges. And for all the leverage the government possesses, its approach has not translated into criminal charges against a single top Wall Street executive.

 

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December 17, 2014
The Revolving Door And Steve Cohen
Posted by David Zaring

The Times reports:

The billionaire investor, who managed to fend off a criminal insider trading investigation of himself, if not of his former hedge fund, is looking for a former prosecutor and several agents from the Federal Bureau of Investigation to join his new $10 billion investment firm, Point72 Asset Management, said several people briefed on the matter, who spoke on the condition of anonymity.

Look, one of the reasons to feel good about the revolving door is that it salts financial institutions with people who expect law compliance.  So maybe that explains this development, and we should celebrate Cohen's search for g-men.  Or maybe it is, as the Times reports, that he was heartened by the insider trading ruling of the Second Circuit requiring the trader to know both that he was trading on inside information and that the information was obtained in exchange for a benefit, and just wants to grow the enterprise on a number of different fronts.

I'm not sure he should be too heartened by that ruling.  It only may free one of his convicted lieutenants, and certainly wouldn't do anything about Matthew Martoma, who both paid for and traded on information provided by a pharma insider.

 

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December 05, 2014
CEO Health Disclosures: JPMorgan Edition
Posted by David Zaring

Not to pile on, but there's the slightly unsettling trned of CEOs talking, or not, about their health.  Surely material information a real investor would want to know about when deciding whether to buy or sell a stock in these days of the imperial CEO.  But deeply unprivate.  Anyway, here's Jamie Dimon's letter to the staff, in part, on the very good news that, after been stricken with throat cancer, he now appears to be free of it.

Subject: Sharing Some Good News
Dear Colleagues -

This past summer, I let you know that I had been diagnosed with throat cancer. Having concluded my full treatment regimen a few months ago, I wanted to give you an update on my health. This week I had the thorough round of tests and scans that are normally done three months following treatment, including a CAT scan and a PET scan. The good news is that the results came back completely clear, showing no evidence of cancer in my body. While the monitoring will continue for several years, the results are extremely positive and my prognosis remains excellent.

The stock is up 2% on the day.  It will be interesting to see whether this email makes its way into a securities filing.

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November 19, 2014
Conflict Minerals Rule Heads For Panel Rehearing
Posted by David Zaring

Which means a redo of the argument.  We'll outsource, via Corporate Counsel, to Cooley:

The D.C. Circuit court of Appeals has granted the petitions of the SEC and Amnesty International for panel rehearing (and the motion of Amnesty to file a supplemental brief) in connection with the conflict minerals case,National Association of Manufacturers, Inc. v. SEC. (The Court also ordered that the petitions filed for rehearing en banc be deferred pending disposition of the petitions for panel rehearing.)

...

[In prior litigation, the D.C. Circuit,] "specifically citing the NAM conflict minerals case, ... indicated that “[t]o the extent that other cases in this circuit may be read as holding to the contrary and limiting Zauderer to cases in which the government points to an interest in correcting deception, we now overrule them.”

Zauderer applies a lenient standard of review to requirements of disclosure of purely factual information.  Looks good for the SEC.

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October 27, 2014
The SEC's Anti-No-Admit Policy Only Goes So Far
Posted by David Zaring

It is one data point, but the cases where the the SEC would settle without requiring an admission of guilt or statement of facts were always likely to be those civil suits following criminal cases that did not go well.  Rengan Rajnaratnam, Raj's brother, proved to be the one inside trader defendant that the Manhattan USAO could not convict.  So the SEC is picking up sticks as well, in exchange for $840,000 bucks and a "let's just move on" kind of attitude.  It's the kind of case where seeking an admission would likely just make the defendants dig in their heels, as I suggested here.  And indeed, here's Rengan's lawyer, sounding threatening:

“The S.E.C. elected to offer, and Rengan elected to accept, a no admit/no deny settlement,” said Daniel Gitner, a lawyer for Mr. Rengan. “Rengan is moving on to the next phase of his life. If the S.E.C. has further comment, so will we.”

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September 25, 2014
The $30 Million Whistleblower
Posted by Christine Hurt

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.

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August 26, 2014
Dodd-Frank Whistleblowing Check-In
Posted by David Zaring

Joe Nocera thinks that the new SEC whistleblower program is a winner, as it is rewarding people who go first to the firm, and only then to the agency, and the promise of a payday.

The Dodd-Frank law has provisions intended to protect whistle-blowers from retaliation, but there are certain aspects of being a whistle-blower that it can’t do anything about. “People started treating me like a leper,” recalls Lloyd. “They would see me coming and turn around and walk in the other direction.” Convinced that the company was laying the groundwork to fire him, he quit in April 2011, a move that cost him both clients and money. (Lloyd has since found employment with another financial institution. For its part, MassMutual says only that “we are pleased to have resolved this matter with the S.E.C.”)

In November 2012, MassMutual agreed to pay a $1.6 million fine; Lloyd’s $400,000 award is 25 percent of that. It was a slap on the wrist, but more important, the company agreed to lift the cap. This will cost MassMutual a lot more, but it will protect the investors who put their money — and their retirement hopes — on MassMutual’s guarantees. Thanks to Lloyd, the company has fixed the defect without a single investor losing a penny.

Could be.  The most difficult cases of this kind are those posed by lawyers or compliance officers who go outside their firm, rather than staying within it, when they raise questions.  That's something that seems to be happening at Vanguard right now, and Dave McGowan thinks such disclosures should be okay.  Disclosing private documents more broadly, he feels, looks more like theft:

a former in-house lawyer who has filed a complaint in NY alleging Vanguard has underpaid federal taxes.  Vanguard is reported to accuse the lawyer of breaching confidentiality; the lawyer has asked the SEC to intervene on his side.

Such cases may raise two distinct issues: the report itself, which may fall within exceptions to confidentiality in a Model Rules jurisdiction or under the SEC's rules, and backup for the report in the form of information--such as documents either in hard copy or digital form--the reporting lawyer might take from his or her employment.  Even if we assume the report is protected the taking of documents raises distinct issues regarding client property.  

I tend to think those issues should be resolved as issues regarding the report are resolved--i.e., taking such information does not violate a duty to a client to the extent the information is reasonably necessary to facilitate a permissible report.  In essence the report would create a privilege (in the tort law sense) covering the disclosure to enforcement officials or courts; no privilege would attach if the lawyer put the documents up on the internet or mailed them to a reporter.  

 

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August 19, 2014
Does the Public/Private Divide in Federal Securities Regulation Make Sense?
Posted by Usha Rodrigues

Like Lisa, I participated in this excellent discussion group at the SEALS conference co-organized by Joan Heminway.  As I told co-organizer and friend-of-Glom Mike Guttentag, for a week I had a Word document open with the titular question at the top.  Participants were supposed to submit a 2-3 page paper before the meeting.  I totally lamed out.  I kept trying to write, but couldn't come up with anything coherent. 

I do have an answer to the question, though: Yes, the public/private divide does make sense.  But it's gone, daddy, gone. 

As I said at the conference, I think I'm essentially a conservative person: I'm resistant to change.  And when I learned the world of securities, it seemed to me that there was this Grand Bargain.  If you wanted to go public, you got many benefits, most notably a high degree of liquidity and access to public capital markets.  But you had to take the bitter with the sweet: mandatory disclosure and increased liability risks.  If you stayed private, your equity was far less liquid, and you couldn't make use of general solicitation.  Your capital raising was much more circumscribed.  But within those limitations you were free to order the firm more or less as you saw fit.  Other substantive areas of law of course constrained private firms--environmental law, labor law, etc.--but in terms of corporate and securities law, they were relatively free.  I realize this is a simplification, but in broadstrokes I think it's true.

No more.  The Grand Bargain is gone. General solicitation for private firms.  Conflict minerals rules.  Emerging growth companies.  Disclosure of executive pay ratios. Private secondary markets.  Dodd-Frank, the JOBS Act, and technology have made a hash out of it.  Or at least, the line between public and private is blurred.

This blurring makes me uneasy.  I feel like there's a disruption in the natural order of things. But I can't tell if that's my innate conservatism talking, or if there really was something we lost with the Grand Bargain. 

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August 09, 2014
Disruptive Legal Technologies: Benefit Corporations and the Crowdfunding of Firms
Posted by Eric Orts

Two recent developments in the law and practice of business include:  (1) the advent of benefit corporations (and kindred organizational forms) and (2) the application of crowdfunding practices to capital-raising for start-ups.  My thesis here is that these two innovations will become disruptive legal technologies.  In other words, benefit corporations and capital crowdfunding will change the landscape of business organization substantially.

A disruptive technology is one that changes the foundational context of business.  Think of the internet and the rise of Amazon, Google, etc.   Or consider the invention of laptops and the rise of Microsoft and the fall of the old IBM.  Automobiles displace horses, and telephones make the telegraph obsolete.  The Harvard economist Joseph Schumpeter coined a phrase for the phenomenon:  “creative destruction.”

Technologies can be further divided into two types:  physical technologies (e.g., new scientific inventions or mechanical innovations) and social technologies (such as law and accounting).   See Business Persons, p. 1 (citing Richard R. Nelson, Technology, Institutions, and Economic Growth (2005), pp. 153–65, 195–209).  The legal innovations of benefit corporations and capital crowdfunding count as major changes in social technologies.  (Perhaps the biggest legal technological invention remains the corporation itself.)

1.  Benefit corporations began as a nonprofit idea, hatched in my hometown of Philadelphia (actually Berwyn, Pennsylvania, but I’ll claim it as close enough).  A nonprofit organization called B Lab began to offer an independent brand to business firms (somewhat confusingly not limited to corporations) that agree to adopt a “social purpose” as well as the usual self-seeking goal of profit-making.  In addition, a “Certified B Corporation” must meet a transparency requirement of regular reporting on its “social” as well as financial progress.  Other similar efforts include the advent of “low-profit” limited liability companies or L3Cs, which attempt to combine nonprofit/social and profit objectives.  In my theory of business, I label these kind of firms “hybrid social enterprises.”  Business Persons, pp. 206-15.

A significant change occurred in the last few years with the passage of legislation that gave teeth to the benefit corporation idea.  Previously, the nonprofit label for a B Corp required a firm to declare adherence to a corporate constituency statute or to adopt a similar constituency by-law or other governing provision which signaled that a firm’s sense of its business objective extended beyond shareholders or other equity-owners alone.  (One of my first academic articles addressed the topic at an earlier stage.  See “Beyond Shareholders:  Interpreting Corporate Constituency Statutes.”  I also gave a recent video interview on the topic here.)  Beginning in 2010, a number of U.S. states passed formal statutes authorizing benefit corporations.  One recent count finds that twenty-seven states have now passed similar statutes.  California has allowed for an option of all corporations to “opt in” to a “flexible purpose corporation” statute which combines features of benefit corporations and constituency statutes.  Most notably, Delaware – the center of gravity of U.S. incorporations – adopted a benefit corporation statute in the summer of 2013. According to Alicia Plerhoples, fifty-five corporations opted in to the Delaware benefit corporation form within six months.  Better known companies that have chosen to operate as benefit corporations include Method Products in Delaware and Patagonia in California.

2. Crowdfunding firms.  Crowdfunding along the lines of Kickstarter and Indiegogo campaigns for the creation of new products have become commonplace.  And the amounts of capital raised have sometimes been eye-popping.  An article in Forbes relates the recent case of a robotics company raising $1.4 million in three weeks for a new project.  Nonprofit funding for the microfinance of small business ventures in developing countries seems also to be successful.  Kiva is probably the best known example.  (Disclosure:  my family has been an investor in various Kiva projects, and I’ve been surprised and encouraged by the fact that no loans have so far defaulted!)

However, a truly disruptive change in the capital funding of enterprises – perhaps including hybrid social enterprises – may be signaled by the Jumpstart Our Business Start-ups (JOBS) Act passed in 2012. Although it is limited at the moment in terms of the range of investors that may be tapped for crowdfunding (including a $1 million capital limit and sophisticated/wealthy investors requirement), a successful initial run may result in amendments that may begin to change the face of capital fundraising for firms.  Judging from some recent books at least, crowdfunding for new ventures seems to have arrived.  See Kevin Lawton and Dan Marom’s The Crowdfunding Revolution (2012) and Gary Spirer’s Crowdfunding:  The Next Big Thing (2013).

What if easier capital crowdfunding combined with benefit corporation structures?  Is it possible to imagine the construction of new securities markets that would raise capital for benefit corporations -- outside of traditional Wall Street markets where the norm of “shareholder value maximization” rules?  There are some reasons for doubt:  securities regulations change slowly (with the financial status quo more than willing to lobby against disruptive changes) and hopes for “do-good” business models may run into trouble if consumer markets don’t support them strongly.  But it’s at least possible to imagine a different world of business emerging with the energy and commitment of a generation of entrepreneurs who might care about more in their lives than making themselves rich.  Benefit corporations fueled by capital crowdfunding might lead a revolution:  or, less provocatively, may at least challenge traditional business models that for too long have assumed a narrow economic model of profit-maximizing self-interest.  James Surowiecki, in his recent column in The New Yorker, captures a more modest possibility:  “The rise of B corps is a reminder that the idea that corporations should be only lean, mean, profit-maximizing machines isn’t dictated by the inherent nature of capitalism, let alone by human nature.  As individuals, we try to make our work not just profitable but also meaningful. It may be time for more companies to do the same.”

So a combination of hybrid social enterprises and capital crowdfunding doesn’t need to displace all of the traditional modes of doing business to change the world.  If a significant number of entrepreneurs, employees, investors, and customers lock-in to these new social technologies, then they will indeed become “disruptive.”

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