ProfessorBainbridge.com

Caremark and director oversight liability re natural disasters

Edward McNally ponders the oversight duties of directors with respect to natural disasters:

The recent events in Japan prompt the question of whether the members of a corporation's board of directors have any exposure to liability when a natural disaster strikes their company.  The potential claim would be that as part of their duty to oversee the company's risk management that they should have better protected their company from losses resulting from a natural disaster.  Of course, most people view such national disasters as Black Swans, events no one anticipates will happen.  Surely directors are not responsible for future events no one anticipates.  Or are they?

He concludes:

A large corporation may receive literally thousands of complaints each year from customers, employees or regulators.  It is not reasonable to ask a board of directors to consider each of those complaints as red flags requiring their inquiry.  The board would do nothing else if it had to look into a thousand complaints.  Instead, what the board should do is have in place some process that is designed to catch wrongdoing, filter complaints and sends to the board only those few that warrant further action by the board of directors.

That same analysis applies to the board's duties concerning potential natural disasters.  It is to be expected that some level of natural events may occur and lead to damages to a corporation's infrastructure.  Storms are even classified by how often they are expected to occur, with a "10 years storm" expected at least once a decade.  The board should have in place insurance and other measures it has been advised by experts are sufficient to protect their corporation from a natural disaster that was reasonably likely to occur.  The board should periodically review the company's insurance and disaster avoidance plans, at least to be satisfied that appropriate steps have been taken by management to address that threat to the company.  Not every potential disaster needs to be planned for, just those that are actual threats.  If these basic steps are taken, directors should not be held liable if a natural disaster causes an anticipated harm to their company.  We have not yet reached the point where the courts will expect directors to foresee Black Swans.  Some risk is necessary for success.  A properly functioning board is entitled and indeed expected by its investors to take such risks.

I think that's good advice as a matter of best corporate governance practices. The Delaware courts have consistently explained, however, that the fiduciary duties of directors do not not necessarily require best practices. To the contrary, conduct falling short of best practices has consistently been protected from liability.

As for Caremark liability in this context, I explained in my article Caremark and Enterprise Risk Management that:

Under Stone, the initial question is whether the board “utterly failed to implement any reporting or information system or controls.” Where a Caremark claim is premised on accounting control failures, liability would arise if “the company entirely lacked an audit committee or other important supervisory structures, or that a formally constituted audit committee failed to meet.” Note the emphasis that a mere failure is not enough; there must be an utter or entire failure. This requirement follows inexorably from Caremark’s dictum that “the level of detail that is appropriate for [the requisite] information system is a question of business judgment.” Courts are not to second-guess a board’s determination that the company’s risk management programs are adequate.

I further explained that:

This judicial reticence is appropriate because substantive analysis of board decisions with respect to the nature, scope, and content of risk management programs are themselves business decisions of the sort protected by the business judgment rule. The levers a board can pull when supervising the company’s risk management include, for example, the human capital resources devoted to the task. The board might ask such questions as: To whom do risk management officers report? How are they chosen? How much are they paid? How is their performance evaluated? Personnel decisions like these are core business judgments protected from judicial review by the business judgment rule. Likewise, managing operational risk by choosing among possible business activities is a basic business judgment that should be protected by the rule.

The same should be true of natural disaster preparation. And so I am not too worried about this issue. As my article concluded with reference to the three leading cases:

In Caremark, Chancellor Allen opined that the oversight claims countenanced by that case would be perhaps the most difficult corporate law claim for plaintiffs to satisfy. Guttman likewise emphasized that Caremark claims are difficult to prove. Stone reiterated the same emphasis on creating a high liability bar.

I'd be willing to be a fancy steak dinner that the odds of a tsunami hitting Delaware are higher than the odds of a Delaware court finding a Caremark violation triggered by the fall out (pun not intended) from a natural disaster.

Disclosure Complexity in the US v. the UK

Broc Romanek recently passed on the following news:

GE starts its proxy statement with a four-page "proxy summary." It's a CD&A Executive Summary on steroids; that is, it summarizes all of the key information from the proxy statement, not just executive compensation information related to its "Say on Pay" proposal. ...

It's also a concrete example of the often-discussed concept of "layered disclosure." While not a substitute for the substantive content of the proxy statement itself, it offers readers an additional way to obtain information about the annual meeting and related matters. I expect that some investors will be perfectly satisfied to rely on this summary as their primary (if not only) source of information.

At the same time, they have access to the full proxy statement for further detail. And, in addition to the full Compensation Discussion and Analysis, they have an Executive Summary for reference (as in past years, GE focuses on the details of its CEO's compensation to illustrate its approach to "ay for performance").

In other words, US proxy disclosures have gotten so complicated that GE felt it necessary to provide not just an executive summary of the CD&A section, but also a summary of the whole proxy statement that includes a summary of the executive summary. Cost? High. Utility, especially to retail investors? Low. Absurdity level? Very high.

Meanwhile, in the UK the Government's latest budget includes a section on corporate governance, in which the coalition government promises to "simplify the reporting framework to enable quoted companies to provide clear and relevant information to investors about strategy, performance and risk in a simpler and more concise report, with supporting information provided on the company's
website." (HT: Goddard)

In my essay, Corporate Governance and U.S. Capital Market Competitiveness, I explained that there has been a significant decrease in new foreign listings on U.S. secondary markets. “Martin Graham, director of the London Stock Exchange’s (LSE’s) market services, said that Sarbanes-Oxley has ‘undoubtedly assisted our efforts’ and emphasized the LSE’s ability to draw new listings from foreign companies.”

Another significant advantage of the U.K., which will be further enhanced by the governments proposals, is the reliance on so-called principles-based approach to regulation, in contrast to the rules-based approach of U.S. securities regulation. This distinction plays out in three key dimensions. First, rules generally are detailed and complex, while principles are broad and abstract. Second, rules are defined ex ante with little scope for ex post discretion, while principles are set out broadly ex ante and are developed ex post for application in a highly contextual way. Third, principles entrust a substantial amount of discretion to regulators to make decisions on a case-by-case basis, while rules do not do so.

Proponents of principles-based regulatory schemes argue that they allow firms to adapt their individual compliance procedures to their own unique business needs and practices. In contrast, ruled-based systems assume one size fits all. In addition, principles-based regulatory schemes are less adversarial and litigious than rules-based ones because regulators in the former tend to focus on guidance rather than litigation.

The Bloomberg-Schumer Report argued that these differences put U.S. capital markets at a significant disadvantage:

Without the benefit of accepted principles to guide them, US regulators default to imposing regulations required by various legislative mandates, many of which date back several decades. These mandates are not subject to major reviews or revisions and therefore tend to fall behind day-to-day practice. This failure to keep pace with the times has made it hard for business leaders to understand how the missions of different regulators relate to their business, and this in turn means that regulators have come to be viewed as unpredictable in their actions toward business. The cost of compliance has also risen dramatically over the last several years. Securities firms reported on average almost one regulatory inquiry per trading day, and large firms experienced more than three times that level. The cost of compliance estimated in an Securities Industry Association report had reached $25 billion in the securities industry alone in 2005 (up from $13 billion in 2002). This increase is equivalent to almost 5 percent of the industry’s annual net revenues. Although there are benefits from an increase in compliance-related expenditures, the report found that “a substantial portion of these increased costs were avoidable, reflecting, among other things: duplication of examinations, regulations and supervisory actions; inconsistencies/ lack of harmonization in rules and regulations; ambiguity; and delays in obtaining clear guidance.”

The problem is not simply the rules-based nature of the U.S. system, but also the sheer volume of regulations with which issuers must comply:

A recent study by the Federal Financial Institutions Examination Council, the coordinating group of US banking and thrift regulators, revealed that more than 800 different regulations have been imposed on banks and other deposit-gathering institutions since 1989. Regulations to implement the legislative requirements of the Sarbanes-Oxley Act of 2002 (SOX) are a good example. They are universally viewed by CEOs and other executives surveyed as being too expensive for the benefits of good governance they confer. Consequently, SOX is viewed both domestically and internationally as stifling innovation. “The Sarbanes-Oxley Act and the litigious environment are creating a more risk-averse culture in the United States,” one former senior investment banker stated. “We are simply pushing people to do more business overseas rather than addressing the real issues head on.”

If the UK goes forward with serious simplification of its disclosure rules, the disadvantage with which our markets struggle will simply get worse and our share of the global capital market will continue to decline.

It's time for our legislators and securities regulators to start seriously rethinking the overly complex, costly, and burdensome disclosure regime.

"Rights Are Curtailed for Terror Suspects"

WSJ:

New rules allow investigators to hold domestic-terror suspects longer than others without giving them a Miranda warning, significantly expanding exceptions to the instructions that have governed the handling of criminal suspects for more than four decades.

The move is one of the Obama administration's most significant revisions to rules governing the investigation of terror suspects in the U.S. And it potentially opens a new political tussle over national security policy, as the administration marks another step back from pre-election criticism of unorthodox counterterror methods.

Jeffrey Rosen in 2008:

If Barack Obama wins in November, we could have not only our first president who is an African-American, but also our first president who is a civil libertarian. ... As a former grass-roots activist, Mr. Obama understands the need to make the case for civil liberties in the political arena. At a time when America’s civil-libertarian tradition has been embattled at home and abroad, his candidacy offers a unique opportunity.

How do you like him now, Jeffrey?

Weren't we told ad nauseum back in 2008 that Obama was the anti-Bush? No more military adventures in the Middle East. No more undeclared wars. No more wars without consulting Congress. Respect for civil liberties.

How's that working out for you?

As I observed to a friend the other day, it's like we finally got rid of a case of piles (Bush) only to come down with a case of shingles (Obama). It's enough to make me wish we had Bill Clinton back ... and I was no Clinton fan.

Felix Salmon's Wrong on SOX

 Felix Salmon's half right. He says "fewer companies are going public' and that that's not good:

What we don’t want is a world where most companies are owned by a small group of global plutocrats, living off the labor of the rest of us. Much better that as many Americans as possible share in the prosperity of the country as a whole by being able to invest in the stock market.

But then he goes off the rails:

How about making a public listing more attractive by relaxing rules like Sarbanes-Oxley? Again, I’m not a fan: the literature is far from compelling that Sarbox was a significant contributor to the decline in public listings.

Wrong. very, very wrong.

Self-publishing legal scholarship

Big shake up in the publishing world. Mike Shatzkin:

Joe Konrath and Barry Eisler contacted me on Saturday to tell me what Barry is up to. I’ve read their lengthy conversation about Barry’s decision to turn down a $500,000 contract (apparently for two books) and join Joe (and many others, but none who have turned down half-a-million bucks) as a self-published author.

To use a metaphor that connects with the current news: this is a very major earthquake. This one won’t cause a tsunami and a nuclear meltdown, but you better believe it will lead everybody living near a reactor — everybody working in a major publishing house — to do a whole new round of risk-assessment. Because, in its way, this is more threatening than the earthquake that just hit Japan. This self-publishing author will much more assuredly and directly spawn followers.

As news of Eisler’s decision spreads, phones will be ringing in literary agencies all over town with authors asking agents, “shouldn’t I be doing this?”

I submit a bit of perspective from another part of publishing: scholarly journals. A few years ago I asked my very smart friend Mark Bide, who knows that part of publishing much better than I do, how I’d know if the business model for journals — by which they publish work the university paid the professor’s salary to write and then sell the published version back to the university’s library — was threatened. Mark told me to watch their submissions. As long as the scholar-authors felt the need to be published in journals, the journal business model would continue to function.

I am not alone in having long known that self-publishing would ultimately present big authors with the opportunity to disintermediate their publishers, but I wouldn’t have thought when I asked that question that the sci-tech journal would hold its ground longer. Now I wouldn’t be so sure.

(HT: Scalzi)

Which to my mind raised the question of whether the law review and the case book will hold their ground.

To be sure, I've expressed doubts about whether the Kindle is the future of law reviews. But that's a different question.

I am currently writing a book on corporate governance for Oxford University Press. I also just emailed out e-reprints of an article entitled Insider Trading Inside the Beltway that was published by the Journal of Corporation Law. But why? Why not self-publish them? I can see several reasons that self-publishing would be a good idea:

1. I get all proceeds instead of royalties of 15% of book sales.
2. Law reviews don't pay for articles. An article self-published would generate income.
3. I get to control marketing. I was really disappointed by the (lack of a) marketing campaign for one of my more recent books. If I self-published, I'd control the marketing campaign.
4. I control the price. If I want to maximize the number of readers, I set the price low. If I want to maximize revenue, I can set the price somewhat higher.

The problems? Publishers of legal scholarship tend to act as gatekeepers with respect to quality. Oxford is routinely ranked as the #1 academic press. Having two books published by Oxford (ahem) thus is a signal to one's employer and other relevant observers that one is doing good work. The signal is objective and unbiased, which gives it very useful credibility.

The same is true of law reviews, I suppose, although it's less clear why. Unlike professional academic presses, which have multiple levels of grown-up editors that must be persuaded and make use of peer reviews, law reviews mostly are staffed by twenty-something second-and third-year law students whose knowledge of the law, legal profession, business, and so on is typically modest at best. If the Harvard Law Review turns down an article that Chapman's law review accepts, all it really tells you is that kids who on average scored higher on the LSAT liked your article less than did kids who on average scored lower. Why their choices send signals worth paying attention to is unclear, at least to me, which is not to say that I'd turn down any offer of publication the Harvard Law Review would care to make. I may think that the market is absurd, but I'm still an economically rational actor.

The signaling effect doubtless matters for junior scholars of whom no one has ever heard. It's particularly important when tenure rolls around. In my years in the academy, I've seen very few tenure discussions in which book and article placement did not serve as a proxy for quality. It's not the only quality measure, of course, but it is a factor.

For a more established scholar, however, the signaling effect may not matter all that much. Indeed, I suspect that "Professor Bainbridge" is a more potent brand name than, say, the UCLA Law Review.

Suppose I had taken that last law review article and self-published it as an e-book entitled "Professor Bainbridge on Insider Trading Inside the Beltway" and priced it at, say, $4.99. Could I have sold a couple of hundred copies? How about a whole "Professor Bainbridge on ____" short e-books?

Having said all that, why should the State of California pay me to write self-published books? Isn't part of the deal I make as an academic that I will do scholarship that is publicly accessible to all? Advance mankind's knowledge and all that? This actually strikes me as the biggest and most valid objection to self-publishing scholarship. OTOH, however, if it were a fatal objection the university ought not let me do any writing that produces royalties or, at least, ought to force me to turn my royalties over to the university. As things stand, however, I'm free to decide how to allocate my time between writing law review articles for free, academic press books for modest royalties, and case books for ... well, that's between me and my Mercedes dealer.

But I'm equivocating. It's not obvious to me that self-publishing legal scholarship is intrinsically silly or an idea waiting to happen.

But I am tempted to turn my next 30,000 word law review article draft into a 50,000 word ebook and try selling that baby through Amazon and so on. And when I retire, maybe I will try my hand at a whole series of "Professor Bainbridge on ____" books.

Your thoughts welcome.

BTW, my friend and UCLAW colleague Eugene Volokh did a whole series of blog posts a while back on the future of legal scholarship in the digital age. Well worth reading.

Update: This study sheds interesting light on the choice:

To date, there have been no studies focusing exclusively on the impact of open access on legal scholarship. We examine open access articles from three journals at the University of Georgia School of Law and confirm that legal scholarship freely available via open access improves an article’s research impact. Open access legal scholarship – which today appears to account for almost half of the output of law faculties – can expect to receive 50% more citations than non-open access writings of similar age from the same venue.

So if reputation is what matters to you and cite counts serve as a key metric by which your reputation is assessed, self-publishing is probably not the way to go unless you give it away for free. Inwhich case, you might as well just post it to SSRN.

IPO Dearth

In yesterday's WSJ, the lead editorial dealt with the continuing dearth of US IPOs:

Recent news of a potential $25 billion initial public offering for the Web-based bargain hunting company Groupon is an exception because the overall trend is down. Last year 72 venture-capital-backed companies went public in the U.S., according to data from Thomson Reuters and the National Venture Capital Association. Over the last decade, the annual number has never reached 100 and has averaged fewer than 50.

Yes, it's unrealistic to expect a repeat of the late-1990s Internet boom, when annual IPOs twice exceeded 270. But how about the early 1990s, before the dot-com mania skewed the numbers? The U.S. averaged 160 a year from 1990-1994, three times the current rate.

As the Journal explained, this is a serious problem:

New companies are the lifeblood of a capitalist economy. Every venture-backed start-up that grows into a public company could be the next Google, Intel, Starbucks or Amgen. Venture investment adds up to 0.2% of U.S. GDP, but the revenue of companies created with such investment amounted to 21% of the economy in 2008. The diminished ability of start-ups to hit the long ball with an IPO discourages investments at all the earlier stages. Venture capitalists know they need some equity home runs to offset losses in the thousands of firms that never find a market.

So what's to blame? The Journal targets Sarbanes-Oxley:

A 2009 survey from the Securities and Exchange Commission speaks volumes. The SEC asked public companies about Sarbox's infamous Section 404, which mandates an external audit of an internal audit of a company's financial practices, known as "internal controls," on top of the traditional audits of corporate financial statements. That's as much bureaucracy as any human should be forced to endure under the Geneva Convention.

 

Not surprisingly, 70% of small public companies told the SEC that Section 404 has motivated them to consider going private again, and 77% of small foreign firms said the law has motivated them to consider abandoning their U.S. listings.

Unfortunately, there is now an organized constituency that benefits from Sarbanes-Oxley:

... the accountants who profit from Sarbox and the Treasury maintain that the law is merely one of many factors discouraging new public companies. This view is shared by most in Washington because Sarbox was a bipartisan overreaction to the accounting scandals at Enron and WorldCom and was signed by George W. Bush.

You can add to that list the large companies who find it convenient that small potential competitors are priced out of the capital markets. SOX-related costs do not scale well. As a result, the costs tend to be proportionately higher for smaller firms. Sarbanes-Oxley thus has become a barrier to entry protecting large entrenched firms.

I detail all this, as well as other regulatory failures in the IPO market in my article Corporate Governance and U.S. Capital Market Competitiveness, which explains that:

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.

The organized interest groups that support SOX will simply make all that much harder to unwind the ratchet effect.

No bright-line test for materiality

Barbara Black:

The U.S. Supreme Court unanimously decided, in Matrixx Initiatives, Inc. v. Siracusano (No. 09-1156) (Mar. 22, 2011)( Download Matrixx opinion) that plaintiffs can state a case for securities fraud under Rule 10b-5 based on a pharmaceutical company's failure to disclose reports of adverse events associated with a product even though the reports do not disclose a statistically significant number of adverse events.  Although this outcome was widely predicted, it is something of a surprise that no Justice even felt the need to write a concurring opinion.  Justice Sotomayor wrote the Court's opinion and emphasized that the Northway/Basic definition of materiality cannot be reduced to a bright-line test.  "As in Basic, Matrixx's categorical rule would 'artificially exclud[e]' information that 'would otherwise be considered significant to the trading decision of a reasonable investor.'...Matrixx's argument rests on the premise that statistical significance is the only reliable indication of causation.  This premise is flawed."  Although in many instances reasonable investors would not consider reports of adverse events to be material information, plaintiffs have alleged facts plausibly suggesting that reasonable investors would have viewed these particular reports as material.

Kevin LaCroix has more.

NYT on Bill Stuntz

The New York Times has a fine obituary for my friend Harvard law professor Bill Stuntz:

William J. Stuntz, an influential legal scholar known for his counterintuitive insights, who blamed liberal judges, conservative legislators and ambitious prosecutors for what he saw as a criminal justice system that imprisons far too many people, died on Tuesday at his home in Belmont, Mass. He was 52.

It goes on to summarize his legal scholarship in considerable detail.

Product of the day

Just ordered refill pods for my Dolce Gusto coffee maker:

Tributes to Bill Stuntz

David Skeel rounds up more trubutes to our beloved friend.

Hedge funds aren't perfect ...

... but they didn't cause the financial crisis of 2007-2008.

Hedge funds as activist investors

In today's WSJ, Yale law prof Jonathan Macey offers a largely favorable view of the role of hedge funds in corporate governance.

Conflicts between a public company's top management and shareholders are seldom more intense than when an activist investor emerges with plans to make a substantial investment in the company's stock. These investors sometimes are hedge funds or "value investors" like Warren Buffett. Whoever they are, after they take a huge stake in the target company they have strong incentives to agitate vigorously for reforms that will increase the value of their investments.

Shareholders benefit from the reforms of corporate governance initiated by these activist investors. So does the economy generally, because the overall economy performs better when companies perform better. But managers are not so fond of this process because activist investors push incumbent senior managers hard to improve their performance. Occasionally they even fire them.

Go read the whole thing. It's very good, as typical of Macey. But then come back for my dissent

The following is an excerpt from my forthcoming book Corporate Governance After the Crises (Oxford University Press 2011). I offer it up as a partial dissent from Macey's take on hedge funds:

Van Zandt's Northwestern deanship assessed

Brian Leiter interviews famed Northwestern law professor Ron Allen on the tenure of former Northwestern Dean David Van Zandt. It's of interest for yours truly because it reflects the deleterious effects the current over-emphasis on empirical legal scholarship can have on both the scholarly and teaching missions of law schools:

Leiter:   David van Zandt was Dean at Northwestern for 15 years, an unusually long tenure for any law school Dean.  Van Zandt also seemed to have a  very concrete vision for what a law school should be.  How would you  describe that vision and what did you think of it?

Allen:  The vision had two parts, one of which had beneficial aspects but became harmful; the other was ill-advised from the beginning.  The first part was to increase the emphasis on producing empirical legal scholarship.  In my opinion, this was a courageous move at the time and I think fully justified.  Most legal scholarship is normative in nature, and thus the VZ move went against conventional thinking.  Normative legal scholarship is obviously important, but I concurred in the view that it is over emphasized in law schools, and VZ was willing to take the risk of putting that belief to the test.

However, over the years the shift in emphasis became a radicalized vision, and here is where it became harmful.  In the last five years, essentially the only hiring that could be done was of quantitative Ph.D.'s for whom a JD was irrelevant.  Thus what initially involved a broadening of the scholarly agenda became narrowly focused on one type of work.  VZ seemed oblivious that many fields of law are not easily amenable to this type of work, like, for example, maybe one of the most important within the law schools--constitutional law, or your own field of jurisprudence.  Moreover, he seemed oblivious that truth propositions can be pursued analytically.

This took the law school further and further out of the mainstream of legal scholarship and also compromised the teaching function.  To compensate for the latter point, VZ created a shadow faculty of adjuncts and lecturers who reported only to him to teach hard law, which now comprise about half the teaching load at the law school.  In short, what started out as a laudatory broadening of the research functions ended up becoming narrow minded and exclusive.  The addition of what VZ was interested in to a vibrant law school is a very good idea; remaking a law school in that exclusive vision is not.

I'm not so sure that it's a good idea in any dosage about the most modest of levels, but certainly it's a very bad idea to make it the exclusive emphasis. Anyway, back to Allen:

The second agenda VZ had was ill-advised from the beginning.  He wanted essentially to eliminate so far as possible faculty involvement in the affairs of the school.  He wanted to centralize all authority in the Dean's office and to eliminate any opposition to his policies.  He largely succeeded in doing this, but at great cost to the school.  Very early in his deanship, for example, he eliminated by fiat all faculty committees.  At another point, he simply started announcing new degree programs, even though the University vests the faculty with the power to create degree programs (the faculty finally stood up to him on this one).  At the end of his tenure, he put the small number of people who actually shared his radicalized vision for a law school in charge of the faculty appointments and promotion process.

 In addition, he would literally sanction people who did not comply with his mandates, ranging from threatening, and perhaps carrying out the threat, to fine them (can you imagine?!) to in at least one case removing a tenured faculty person's research funds.  I do not have access to salary data, but I'm confident that it would show that those who were compliant did systematically better than those who were not, controlling for other variables.  We even went through a period where he would give directives to individual faculty members.  More than once over this period I felt compelled to tell him directly that I did not work for him, whatever he might think about the matter.  I'm quite sure that, whatever this did for my self-image, it did not benefit me in any other fashion.

I'm skeptical of the benefits of faculty democracy. At Illinois, when I was there, it had devolved into a clique-ish, highly politicized environment in which a faculty meeting wasn't over until the blood was ankle deep. The old line about academic politics being so vile precisely because so little is at stake applied in full measure. At UCLA, democracy leads to the exact opposite extreme. We are almost always incredibly civil. But our culture is that a faculty meeting is not over when everything has been said. No, a faculty meeting is only over when everything has been said by everyone. Oddly, it turns out that interminable niceness is almost as wearisome as quickly terminated viciousness. More than once, I've therefore expressed the firm belief that my stint in Purgatory will be lessened by the time I've spent in faculty meetings.

Having said that, however, a despotism is only acceptable so long as it is truly benevolent. And so long as it is, at the end of the day, accountable. I'd much rather live under UCLA's norms than those that seem to have prevailed when Van Zandt was dean at NW.

McGinnis on Schools for Misrule

Northwestern law prof John McGinnis reviews Walter Olson's new book, Schools for Misrule: Legal Academia and an Overlawyered America, in today's WSJ:

American law schools wield more social influence than any other part of the American university.

In "Schools for Misrule," Walter Olson offers a fine dissection of these strangely powerful institutions. One of his themes is that law professors serve the interests of the legal profession above all else; they seek to enlarge the scope of the law, creating more work for lawyers even as the changes themselves impose more costs on society. By keeping legal rules in a state of endless churning, lawyers undermine a stable rule of law and make legal outcomes less predictable; the result is more litigation and, not incidentally, more billable hours for lawyers, who must now be consulted about the most routine matters of business practice and social life. ...

Mr. Olson shows that the [legal educational] reforms that had the most baleful effects were those that coincided with the expansionist interests of lawyers. Legal theorists dismissed, for instance, concerns that a wider use of "equitable relief"—a doctrine that judges properly employed to enforce school desegregation—would dissolve the difference between politics and judging. But the concerns we were well placed: Courts ended up playing an important role in managing schools, prisons and welfare agencies. Law professors also helped to develop the class action into an extortionate threat: Companies now pay out million-dollar settlements rather than bet their very existence on a single trial that might well impose massive liability.

Do go read the whole review. But cast a jaundiced eye at McGinnis' concluding argument that:

Today a large part of legal scholarship taps into the ever increasing capacity of computers for precise measurement and quantification. Indeed, the fastest-growing annual conference of law professors is the one that takes up legal empiricism, a field in which scholars measure the effects of laws in the real world (e.g., how certain laws may lead doctors to practice defensive medicine). The other vibrant field is law and economics, where scholars often compare the advantages of the market to other forms of social ordering....

The British Enlightenment ideas that shaped America's legal structure rested on the proposition that markets are central to prosperity and that government actions can be judged by real-world effects. What is novel about law schools today is that, compared with their checkered past, so many more scholars are vigorously returning to the methods that made America.

Maybe that's true at Northwestern. But I very much doubt it's true at most law schools. I'm on record as being professionally skeptical of empirical legal scholarship (ELS), but that's a question for another day. Insofar as the politics of the issue are concerned, I see very little evidence that ELS scholars are committed to the idea that "markets are central to prosperity." To the contrary, most of the ELS scholarship that crosses my desk seems to be determined to find market failures. Ditto the vast bulk of behavioral law and economics work. I thus see no basis for the sort of optimism McGinnis expresses. To the contrary, as I have argued before, network effects dominate the hiring process in ways that continue to reinforce the left-liberal bias amongst law faculties.

All in all, this makes Schools for Misrule an even more important read than McGinnis' favorable review suggests.

Another unitended consequence of SOX: Rents to audit committee financial experts

Interesting paper, Audit Committee Financial Experts and Insider Trading, concludes that:

Sarbanes Oxley Act (SOX) Section 407 requires firms to disclose if there is a financial expert serving on their audit committees. The extant literature has largely documented SOX 407 benefits, ranging from controlling earning management to reducing internal control weaknesses. Our paper investigates whether there is a cost associated with SOX 407. Using a sample of executive and director transactions from 2003 to 2007, we test whether financial experts obtain information rents or expertise rents on stock purchases. Information rent is earned due to access to superior information, whereas expertise rent is earned due to superior processing skill of the same information. We first find that audit committee members obtain significantly higher abnormal returns than other independent board members. This suggests that audit committee members, including both financial and non-financial experts, earn information rent due to their access to privileged information in audit committees. We then find that financial experts on audit committees obtain higher abnormal returns than non-financial experts on audit committees. Because financial experts and non-financial experts have access to the same information in audit committees, our finding suggests that audit committee financial experts earn additional rents due to their financial expertise. The existence of such expertise rents indicates that there is a cost associated with SOX 407.

It's worth noting that only information rents raise concerns about illegal insider trading: "Nor is an insider obligated to confer upon outside investors the benefit of his superior financial or other expert analysis by disclosing his educated guesses or predictions. .... The only regulatory objective is that access to material information be enjoyed equally, but this objective requires nothing more than the disclosure of basic facts so that outsiders may draw upon their own evaluative expertise in reaching their own investment decisions with knowledge equal to that of the insiders." SEC v. Texas Gulf Sulphur, 401 F.2d 833.