ProfessorBainbridge.com

Affirmative Action Quotas in Lead Counsel Appointments?

New York Law Journal:

A stir recently erupted in the securities class action bar after Baer issued an order in a case against Gildan Activewear Inc., directing two of the largest firms in the field, Labaton Sucharow and Robbins Geller Rudman & Dowd, to "make every effort" to put at least one woman and one minority lawyer on the case. The ensuing press about the order caused Edward Labaton, a senior partner at his firm, to make a rare court appearance earlier this month to publicly state that his firm was committed to equal opportunity (See Labaton's letter to Baer).

In a follow up order last Friday in In re Gildan Activewear Inc. Securities Litigation, 08 cv 5048, Baer said his initial order "was not intended to be critical in any way" of how the two firms promote diversity or prosecute and staff a case. But he said the diversity considerations "were goals I would urge be met in similar cases that come before me."

The judge is basically saying that if you don't meet my quota, you may not be appointed as lead counsel in a securities case.

Under the the Private Securities Litigation Reform Act of 1995 (“PSLRA”),the court hearing a securities class action is empowered to appoint a lead plaintiff and to approve the lead plaintiff’s selection of lead counsel. The idea was to avoid having the class action lead by whatever plaintiff and his lawyer won the race to the courthouse.

The statutory language is pretty sparse: 15 USC § 78u-4(a)(3)(B)(v) simply provides that “The most adequate plaintiff shall, subject to the approval of the court, select and retain counsel to represent the class.”

Despite this statutory ambiguity, I don't see how Baer's order is consistent with the intent of the PSLRA lead plaintiff and lead counsel provisions. Those provisions were not intended to serve as a vehicle for affirmative action quotas or promoting diversity among law firms. Instead, they were intended to deal with the problem that it was the plaintiff's lawyer who was (and still is) the real party in interest in securities class actions. At the same time, however, the court's discretion in approving lead counsel is limited. The Ninth Circuit observed in Cohen v. U.S. Dist. Court for Northern Dist. of California, 586 F.3d 703 (9th Cir 2009) that:

Consistent with congressional intent in enacting the PSLRA to vest authority for selecting class counsel in the lead plaintiff and our reasoning in Cavanaugh, the district court should not reject a lead plaintiff's proposed counsel merely because it would have chosen differently. See 306 F.3d at 732, 734 & n. 14 (explaining that selection of lead counsel “is not a beauty contest,” that selection of counsel is an “important client prerogative,” and that a contrary rule would “eviscerate” the PSLRA's assumption that the lead plaintiff is as or more capable than the court to select class counsel) (quoting Cendant, 264 F.3d at 276). Rather, like the Third Circuit, we hold that if the lead plaintiff has made a reasonable choice of counsel, the district court should generally defer to that choice.

Hence, imposition of an affirmative action quota-or even a preference--is not justified by the statutory language or its purpose.

Besides which, aren't quotas supposed to be unconstitutional? At the uber-liberal blawg Balkanization, Jason Mazzone writes that:

In an interview published yesterday in the New York Law Journal, Judge Baer said that, given the discretion that Rule 23(g) gives to judges, he saw no reason why diversity could not be taken into account.

I see a reason: the Constitution.

If Rule 23(g) really did authorize a judge to take account of the race (or gender) of lawyers in certifying class counsel, the Rule would likely be unconstitutional. There is only one context in which the Supreme Court has held that, consistent with the Constitution’s equal protection requirements, the government may take account of an individual’s race in order to promote diversity: admission of students to universities. Grutter v. Bollinger (2003), involving a challenge to affirmative action at the University of Michigan Law School, held that government is allowed to pursue the compelling interest in obtaining the educational benefits that flow from a diverse university student body through an admissions process, geared to promoting multiple forms of diversity, that takes account of an applicant’s race as part of a holistic review of the applicant’s file.

Class action litigation is not higher education. It is difficult to see how government would have a compelling interest (or even an important interest, the standard for gender classifications) in promoting diversity among the lawyers appointed to represent a class of litigants. Even if ensuring some level of performance by class action lawyers is a compelling (or important) government interest (rather than just a rational interest), such an interest has little or nothing to do with the demographic characteristics of the lawyers themselves.

(Consider also the desirability of federal judges looking up lawyers on websites to determine--like the train conductors in Plessy v. Ferguson--their race and gender.)

In the New York Law Journal interview, Judge Baer invoked an additional reason for his approach: giving members of racial minority groups and women greater courtroom experience. It is equally doubtful that that’s an interest that rises to the level of a compelling (or important) government interest and there are surely ways for the government to pursue any such interest besides the use of a lawyer’s race (or gender).

Mazzone goes on to note that Baer's logic undermines the central justification for Grutter:

If the claim about broad educational benefits made to the Court in Grutter was correct, then there should be no need under Rule 23(g) to ensure class action lawyers match the racial and other characteristics of the class members. Lawyers who have been trained in a Grutter-endorsed law school should already have the requisite skills to understand, interact with, and properly represent people unlike themselves. The whole point of Grutter was to enable law schools to ensure its graduates have these qualities. On the other hand, if, as Judge Baer reasons, lawyers do not have these qualities, then the key justification for consideration of race by law school admissions offices vanishes.

Behrens & Hitchcock Oakville Merlot Fortuna Vineyard (Napa Valley) 2002

This eminently age worthy Merlot was still in fine fettle when opened tonight. I always worry about the plastic corks B&H used to use, which I believe are the least desirable of all the stopper alternatives, but this wine showed no sign of either oxidation or anaerobic off flavors. Instead, it was a clean wine with some oomph. Deep dark red and black fruits, especially currants and prunes. Some cedar and tobacco. Delicious. Could probably continue to develop for several more years before peaking. Grade: B++

The Corporate Governance Provisions of Dodd-Frank

I was recently asked to write up a brief summary of the corporate governance provisions of the Dodd-Frank Act. The result has now been posted to SSRN. It's not a think piece, but folks looking for a quick overview of the Act's requirements and a concise critique thereof may find it useful:

The Corporate Governance Provisions of Dodd-Frank

Abstract: This essay provides a brief overview of the seven principal corporate governance provisions of The Wall Street Reform and Consumer Protection Act of 2010 (better known as “The Dodd-Frank Act”).

1. Section 951 creates a so-called “say on pay” mandate, requiring periodic shareholder advisory votes on executive compensation.

2. Section 952 mandates that the compensation committees of reporting companies must be fully independent and that those committees be given certain specified oversight responsibilities.

3. Section 953 directs that the SEC require companies to provide additional disclosures with respect to executive compensation.

4. Section 954 expands Sarbanes-Oxley Act’s rules regarding clawbacks of executive compensation.

5. Section 971 affirms that the SEC has authority to promulgate a so-called “proxy access” rule pursuant to which shareholders would be allowed to use the company’s proxy statement to nominate candidates to the board of directors.

6. Section 972 requires that companies disclose whether the same person holds both the CEO and Chairman of the Board positions and why they either do or do not do so.

7. Section 989G affords small issuers an exemption from the internal controls auditor attestation requirement of Section 404(b) of the Sarbanes-Oxley Act.

Keywords: corporate governance, Wall Street reform, Dodd-Frank, proxy access, say on pay, executive compensation, disclosure

JEL Classifications: K22

I knew I was famous, but this is ridiculous

I was checking Amazon to see if the forthcoming paperback edition of one of my books was listed (it wasn't), but I stumbled across this:

I'm almost tempted to blow the $14 to find out what this thing is:

Texas Law Based on Vulcan Philosophy?

iO9 reports:

Ruling in Robinson vs. Crown Cork Seal Company (PDF), Justice Don Willett writes:

Appropriately weighty principles guide our course. First, we recognize that police power draws from the credo that "the needs of the many outweigh the needs of the few." Second, while this maxim rings utilitarian and Dickensian (not to mention Vulcan), it is cabined by something contrarian and Texan: distrust of intrusive government and a belief that police power is justified only by urgency, not expediency. ...

See STAR TREK II: THE WRATH OF KHAN (Paramount Pictures 1982). The film references several works of classic literature, none more prominently than A Tale of Two Cities. Spock gives Admiral Kirk an antique copy as a birthday present, and the film itself is bookended with the book's opening and closing passages. Most memorable, of course, is Spock's famous line from his moment of sacrifice: "Don't grieve, Admiral. It is logical. The needs of the many outweigh . . ." to which Kirk replies, "the needs of the few."

The mind boggles.

Liberalism is a genetic defect

At least, that's how I chose to interpret this report:

An article published in the Journal of Politics looked at 2,000 subjects from the National Longitudinal Study of Adolescent Health, examining their genes, social networks, and political affiliations. What they found was that adolescents who possess a certain variant of the dopamine receptor gene DRD4 were more likely to grow up to be liberal adults. Furthermore, that correlation only existed when adolescents had active social lives.

Remember I was a biophysical inorganic chemist before I was a lawyer, so I know of what I speak on these matters.

Insane Institutional Investors Pick Nits

Proponents of institutional investor activism constantly tell us that activists will not micro-manage their portfolio companies. Well, that's just total bullsh*t. Case in point:

Activist investors are turning up the heat on companies that give relocating executives generous benefits to cover the cost of their depressed home values. ...

The root problem: The protracted housing downturn in the U.S. is colliding with a rebound in management hiring. So more employers help pick up the tab for relocated executives losing money on their home sales.

Home-loss provisions are a hot-button issue with our institutional clients," explains Patrick McGurn, special counsel for ISS. "We have been seeing extraordinary relocation payments being made to bail out transferred executives."

One has long thought that ISS was too powerful, but at least one thought it was sane. One now sees that one was wrong.

In the first place, isn't the point of executive compensation to attract and retain competent executives? If relocation reimbursements help do that, isn't that a good thing?

Proponents defend the perk as necessary for businesses to attract and keep star players. "They simply need those executives to move," says James D.C. Barrall, head of the global executive compensation and benefits practice at Latham & Watkins LLP.

In the second place, isn't what really matters not specific items of pay but rather the total effect of pay has on executive incentives? Marty Robins writes that:

I’m a lot more concerned with management and board performance, as it translates into company performance, than I am with pay per se. To the extent pay is relevant, this should be on account of either its overall incentive effects regarding performance or whether it has any connection to “market value” for the position in question. Simply protesting this (or any individual) item of someone’s pay package has nothing to do with company performance. It makes no sense to address any individual line item for someone, without addressing their aggregate pay and assessing its implications and level.

Money being fungible makes it pointless and counterproductive to protest reimbursement for a home sale loss, if the beneficiary’s overall package is well structured for incentive purposes and in line with the market. If a corresponding increase in salary or bonus would not prompt shareholder protest, why should a protest result from the name of the payment? Similarly, if there is good reason to protest total compensation, the rationale still exists, notwithstanding the formal designation of a portion of it. Good performance relative to total pay should not lose its luster because of a home sale provision … and vice versa!

Finally, self-appointed shareholder spokespersons like Lucian Bebchuk, Nell Minow, Robert Monks, and their ilk have told us over and over that their institutional clients will not seek to micromanage portfolio firms. And now we see that that's bullsh*t. If picking nits like home relocation reimbursement isn't micromanagement, I don't know what is.

For more on the case against shareholder activism, see my articles Shareholder Activism and Institutional Investors and The Case for Limited Shareholder Voting Rights.

Allowing Executives to Hedge

Dodd-Frank Section 953 requires that each reporting company’s annual proxy statement must contain a clear exposition of the relationship between executive compensation and the issuer’s financial performance. The disclosure must give investors an easy way of comparing executive compensation and firm performance over time. The proxy statement also must disclose whether employees are allowed to hedge the value of company stock they own.

Those interested in that last point will want to take a look at Pledge (and Hedge) Allegiance to the Company by David F. Larcker and Brian Tayan of the Stanford University School of Business.

Companies include equity in a compensation package to align the interests of management with those of shareholders. It is not uncommon for an executive who has been employed at a company for many years to accumulate a substantial dollar ownership position in the company. With a concentration of wealth in a single financial asset, the executive may want to limit his or her exposure by hedging a portion of the position through financial instruments or pledging shares as collateral for a loan.

While there are many reasons why a board may want to allow an executive to hedge or pledge an equity ownership position, there are also many reasons why this may be a cause for concern. We examine these issues in detail.

Can boards explain why they do or do not allow executive hedging? If an executive has hedged the equity position, why does the board continue to grant new equity and not cash?

The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. These free instructional materials may be used in the classroom and by practitioners who want to develop a more sophisticated understanding of governance practices.

Even though the materials are designed for a business school case study, I think they'd be useful to law professors wanting to address hedging and executive compensation.

Surveying Shareholders re Pay

James McRitchie reports that:

Towers Watson launched an online survey tool to help companies better understand their shareholders’ views and perceptions on their executive compensation programs.

Dodd-Frank requires publicly traded companies to conduct periodic shareholder votes on their executive pay programs, including how often to conduct say-on-pay votes. In preparation for the say-on-pay era, many companies are trying to engage their key shareholders in a dialogue about executive compensation and related issues. According to Eric Larré, a Towers Watson consulting director who spearheaded the survey’s development:

For most U.S. companies, giving shareholders a say on pay will be a new experience when the 2011 proxy season arrives.  And most companies are still trying to determine how to address the shareholder engagement process. This survey offers shareholders an easy way to express specific views that Congress and the SEC determined they were entitled to communicate via the proxy process.

The Towers Watson online survey tool allows shareholders to complete a questionnaire and provide their views on a wide range of executive compensation programs and issues including pay philosophy, performance measurement, pay levels, governance and shareholder preferences regarding the frequency of future say-on-pay votes. The questionnaire consists of both multiple-choice and open-ended questions. Companies receive a detailed report summarizing shareholders’ responses, including an analysis of differing views of shareholders and what percentage of all company shareholders the respondents represent.

Obviously, on line surveys are hopelessly unscientific and replete with problems of all sorts. Even so,one can imagine companies using this to (a) take a pre-check of shareholder sentiment before the say on pay vote and (b) to have data on what shareholders want when activists come calling. Suppose a union pension fund comes to management and says we don't X, Y, and Z about your compensation policies, so we're going to vote no. Management may be able to point to support for retain investors to justify the union demands.

Recognizing oneself in another

Lyrissa Lidsky blogs that:

I came to the study of law because it seemed like a good career for someone who loved reading, writing, and analyzing texts but was not creative enough to make it as a novelist nor independently wealthy enough to risk becoming a medievalist.

Goodness. If you tossed in sucked at math too much to be a theoretical scientist or economist and was too butter fingered to be an experimental scientist, you'd have an almost exact description of how I came to law.

It turned out okay, of course. Indeed, I suspect I make a good deal more money than 99.99% of the science fiction writers I wanted to emulate when I was a kid or the historian I briefly toyed with being. Plus, it's been fun.

Corporate Governance and U.S. Capital Market Competitiveness

I've posted to SSRN an essay entitled Corporate Governance and U.S. Capital Market Competitiveness

Abstract: This essay was prepared for a forthcoming book on the impact of law on the U.S. economy. It focuses on the impact the corporate governance regulation has had on the global competitive position of U.S. capital markets.

During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.

Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.

This essay argues that litigation and regulatory reform remain essential if U.S. capital markets are to retain their leadership position. Unfortunately, the article concludes that federal corporate governance regulation follows a ratchet effect, in which the regulatory scheme becomes more complex with each financial crisis. If so, significant reform may be difficult to achieve.

Keywords: corporate governance, securities litigation, federalism, Sarbanes-Oxley

JEL Classifications: K22

I have a cold. I blame Bush.

I'm coming down with a cold. And it's going to be a bad one, I suspect. And I blame President Bush. Not for giving me the cold, but for making the symptoms worse. Here's why.

There was a story in today's WSJ that the safety nannies have been giving the makers of Pom a hard time for claiming that there are health benefits to drinking pomengrate juice:

Fewer than 4% of Americans had tried the fruit before 2002, when marketing mavens Lynda and Stewart Resnick launched the 100% fruit juice they call POM Wonderful. It's since become a top seller, in its curvy hourglass-shaped bottle.

The Resnicks, who also owns the Teleflora and FIJI water businesses, invested in orchards in California in the 1980s. They've also commissioned research on the anti-oxidant properties of pomegranates—too much research, according to a Federal Trade Commission (FTC) complaint last month alleging deceptive advertising. "Any consumer who sees POM Wonderful products as a silver bullet against all diseases has been misled," said David Vladeck, who runs the agency's Bureau of Consumer Protection.

This is hyberbole—no POM ads claim the pomegranate can cure "all diseases." But the complaint is a stalking horse for the agency's more radical position: that health-food companies now need to get Food and Drug Administration approval for scientific claims, similar to the process pharmaceutical companies follow for drugs.

In the case of Pom, it looks like there's actual scientific evidence that pomegranate juice has some health benefits. But so what?

Suppose people believed that pomegranate juice was good for them. So they switch from drinking soft drinks to Pom. And some of them, believing that Pom is good for them, really do get better from whatever ails them. Isn't that a good thing?

Placebos work, after all, at least for some people. Some of my fellow UCLA faculty have proven it:

... for some people, the placebo works nearly as well as the medication. ... Placebos are thought to act by stimulating the brain's central reward pathways by releasing a class of neurotransmitters called monoamines, specifically dopamine and norepinephrine. These are the brain chemicals that make us "feel good." Because the chemical signaling done by monoamines is under strong genetic control, the scientists reasoned that common genetic variations between individuals - called genetic polymorphisms - could influence the placebo response. ...

Leuchter noted that this is not the sole explanation for a response to a placebo, which is likely to be caused by many factors, both biological and psychosocial. "But the data suggests that individual differences in response to placebo are significantly influenced by individual genotypes," he said.

What does all this have to do with Bush? I'm getting there.

For a long time, I've taken Airborne religiously at the first sign of a cold. At first, it really seemed to work. My colds were a few days shorter and the symptoms were not as bad. Really.

But then back in 2008 I started reading stories in the press about how the Bush FTC was going after the makers of Airborne for making false claims. Specifically, the FTC complaint that "there is no competent and reliable scientific evidence to support the claims made by the defendants that Airborne tablets can prevent or reduce the risk of colds, sickness, or infection; protect against or help fight germs; reduce the severity or duration of a cold; and protect against colds, sickness, or infection in crowded places such as airplanes, offices, or schools."

Ever since then, Airborne doesn't seem to work as well. I still take it, but my colds seem to last longer and be more severe. The same thing happened to behavioral economist and Predictably Irrational author Dan Ariely:

Assume Airborne is/was a placebo. As far as I can tell from some cursory research, open placebos can work but no where near as well as closed ones. As Ariely says, you have to at least mostly believe it works. So telling people something is a placebo seriously undermines its effectiveness. Even so, the FTC turned Airborne into an open placebo without so much as a by your leave.

As long as something like Airborne is not hurting people, why should the government come along and advertise the fact that it's a placebo? If millions of people are getting over their colds faster and with less suffering, isn't that a good thing? And, if so, shouldn't the government just keep its damn mouth shut? (All the more so in the case of Pom, where there apparently is preliminary evidence that it has benefits?)

Which is why I blame Bush.

Basel Committee's Corporate Governance Recommendations

Jim Hamilton reports that:

The Basel Committee has issued corporate governance principles emphasizing transparency, aligning executive compensation with prudent risk taking, and making more and better use of internal and external auditors. A central principle envisions the board and senior management making very broad use of internal audit and effectively engaging the independent outside auditor. Independent and qualified internal and external auditors, as well as other internal control functions, are vital to the corporate governance process, said the committee.

The lengthy post has extensive details.

The Behavioral Economics of Regulators

There was a very interesting article in Saturday's WSJ on a problem that we've noted before; namely, that the policy prescriptions of behavioral economists tend towards regulatory rather than market solutions. Hence, the oxymoron, "libertarian paternalism" advocated by BE types like Cass Sunstein and Richard Thaler.

The Journal reports that:

...while there is a lot of interest in the psychology and neuroscience of markets, there is much less in the psychology and neuroscience of government. Slavisa Tasic, of the University of Kiev, wrote a paper recently for the Istituto Bruno Leoni in Italy about this omission. He argues that market participants are not the only ones who make mistakes, yet he notes drily that "in the mainstream economic literature there is a near complete absence of concern that regulatory design might suffer from lack of competence." Public servants are human, too.

Mr. Tasic identifies five mistakes that government regulators often make: action bias, motivated reasoning, the focusing illusion, the affect heuristic and illusions of competence.

... The issue of action bias is better known in England as the "dangerous dogs act," after a previous government, confronted with a couple of cases in which dogs injured or killed people, felt the need to bring in a major piece of clumsy and bureaucratic legislation that worked poorly. Undoubtedly the rash of legislation following the current financial crisis will include some equivalents of dangerous dogs acts. It takes unusual courage for a regulator to stand up and say "something must not be done," lest "something" makes the problem worse.

As we all know, of course, I am reticent when it comes to blowing my own horn. But even so, I think it's worth noting that I was complaining about the lack of attention to the behavioral biases of regulators years ago in Mandatory Disclosure: A Behavioral Analysis, 68 University of Cincinnati Law Review 1023 (2000)

Law Schools to Close?

ABA Journal:

As large law firms continue to hire fewer highly paid associates, law school applications will eventually drop and the number of law schools will likely contract, two professors predict in a recent article.

The most prestigious “super elite” law schools will remain, according to the article by University of San Diego law professor David McGowan and academic fellow Bernard Burk of the Center for Corporate Governance at Stanford. Outside the super-elite, schools attracting more applicants will have good placement records, lower tuition because of state subsidies, or will be in regions less served by other institutions....

The article is available for download at SSRN.

Regular readers will recall my post Is Law a "Mature" Industry?, in which I suggested that: