ProfessorBainbridge.com

Sokol and Buffett sued by Berkshire-Hathaway shareholder

Predictably, the news that former Berkshire-Hathaway executive David Sokol bought stock of Lubrizol before recommending that to Berkshire boss Warren Buffett that Berkshire acquire Lubrizol has prompted a shareholder derivative suit:

Mr. Sokol was widely considered Mr. Buffett’s heir apparent until he resigned abruptly last month after it emerged that he had personally bought $10 million worth of stock in Lubrizol shortly before bringing Lubrizol to Mr. Buffett’s attention. In March, Berskhire announced that it had agreed to purchase Lubrizol for $9 billion — causing its shares to surge and increasing the value of Mr. Sokol’s holding by $3 million.

The shareholder derivative complaint, filed in the Delaware Court of Chancery by the Berkshire shareholder, Mason Kirby, asks the court to disgorge Mr. Sokol’s trading profits in Lubrizol and to award damages because of the damage done to Berkshire’s goodwill. ...

The lawsuit said that Mr. Sokol’s actions violated his duties to Berkshire and impaired the company’s reputation by spawning an S.E.C. inquiry. Moody’s Investors Service and Standard & Poor’s, the two largest credit ratings agencies, also flagged concerns over the incident’s impact on the company, the complaint says.

It's an interesting case. Let's start with the proposition that there is a state law cause of action for insider trading. In Pfeiffer v. Toll, 989 A.2d 683 (Del.Ch. 2010), Vice Chancellor Laster explained that the law in this area rests on the old chestnut Brophy v. Cities Service Co., 70 A.2d 5 (Del.Ch. 1949):

In Brophy, Chancellor Harrington [allowed] a derivative claim brought against the executive secretary of one of the directors of Cities Service Company. 70 A.2d at 7-8. The secretary allegedly knew that Cities Service planned to make open-market purchases that would likely boost its stock price. The secretary purchased shares for his personal account in advance of the corporate repurchase and later sold the shares for a profit after the market price rose. Id. at 7. Chancellor Harrington recognized that “in the absence of special circumstances, corporate officers and directors may purchase and sell its capital stock at will, and without any liability to the corporation.” Id. at 8. He nevertheless held that because the secretary acquired knowledge about the corporation's plans in the course of his employment, i.e. it was confidential corporate information, “the application of general principles would seem to require the conclusion that he cannot use that information for his own personal gain.” Id. In broad language, Chancellor Harrington rejected the argument that the corporation suffered no harm as a result of the secretary's activities. He explained: “In equity, when the breach of a confidential relation by an employee is relied on and an accounting for any resulting profits is sought, loss to the corporation need not be charged in the complaint.” Id. He continued: “Public policy will not permit an employee occupying a position of trust and confidence towards his employer to abuse that relation to his own profit, regardless of whether his employer suffers a loss.” Id.

Brophy is not squarely on point, however, because it involved a case in which the insider traded in the stock of his own corporation.

Here, however, Sokol traded in the stock of a different corporation. Sokol was not a fiduciary of Lubrizol. He owed Lubrizol and its shareholders no duty. The question therefore is whether Sokol's trades breached his fiduciary duties to Berkshire.

In other words, does a Brophy claim sound in cases resembling those covered by the federal misappropriation theory of insider trading as well as in those covered by the classic disclose or abstain theory?

I am unaware of any Delaware precedent holding that a state law cause of action for breach of fiduciary duty lies when the facts fit within the misappropriation framework. It would not be surprising if such a cause of action existed, however. In effect, when an executive misappropriates information and uses it to make a profit by trading in the stock of a potential takeover target the executive has usurped a corporate opportunity.

As I explain in my book, Corporation Law (Concept and Insight Series), a corporate opportunity claim entails a two step inquiry: (1) Was the challenged transaction a corporate opportunity? (2) Did the corporation reject the opportunity, so that the officer may take advantage of it? (Technically, under Delaware law, formal presentment of the opportunity to the board is not required, but it is surely the prudent course of action.)

As to the former issue, it is true that “Delaware courts have recognized a policy that allows officers and directors of corporations to buy and sell shares of that corporation at will so long as they act in good faith. A corporation generally has no interest in its outstanding stock or in dealing in its shares among its stockholders.” Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 833 A.2d 961, 973-74 (Del.Ch.2003), aff'd, 845 A.2d 1040 (Del.2004) (internal citations and quotations omitted). In this case, however, the executive traded in the stock of a different company and one in which his employer might well have an interest in acquiring.

So we would apply the multi-factor test developed in Delaware law: (1) Is the corporation financially able to take the opportunity? (2) Is the opportunity in the corporation’s line of business? (3) Does the corporation have an interest or expectancy in the opportunity? (4) Does an officer or director create a conflict between his self-interest and that of the corporation by taking the opportunity for himself?

Applying that test to the known facts, I would conclude: (1) Yes. (2) Berkshire's a multi-line conglomerate. Most anything is in its line of business. (3) and (4) find positive answers because, as Henry Blodget observed:

"Wait--an investment banker suggested to Sokol in Sokol's capacity as a Berkshire executive that Berkshire should buy Lubrizol--and, before taking the idea to Warren Buffett, Sokol rushed out and bought the stock? How is that kosher? How could Sokol possibly think that making that trade--and risking the appearance of impropriety--will be okay?"

When an investment banker brings you an idea in your capacity as an executive, I think that gives your employer an expectancy in it. In turn, buying stock in the target, which you presumably would later sell to Berkshire (or on the market) at a handsome project creates a clear conflict of interest. Not only are you making a side profit on the deal, which agents are not supposed to do, but you also have an incentive to make sure Berkshire buys Lubrizol.

As to the second prong, recall that Buffett allegedly knew about Sokol's trades when the latter proposed the deal to Buffett.  A corporate opportunity claim cannot lie where the corporation has properly rejected the opportunity. Buffett's decision, however, cannot constitute such a rejection. As the Delaware Supreme Court explained in Telxon Corp. v. Meyerson, 802 A.2d 257 (Del.Supr. 2002):

While presentation of a purported corporate opportunity to a board of directors, and the board's refusal thereof, creates a safe harbor for an interested director, that safe harbor does not extend to an opportunity presented only to the corporation's CEO. See Broz v. Cellular Info. Sys., Inc., 673 A.2d 148, 157 (Del.1996). Rejection of a corporate opportunity by the CEO is not a valid substitute for consideration by the full board of directors.

Buffett's subsequent decision to go forward with the deal and the Berkshire board's approval of that decision likewise do not help Sokol. The former is another CEO action, while there is no evidence to date that the board specifically approved Sokol's trades (which should have been done ex ante).

Our friend Francis Pileggi reportedly has opined that:

This suit was inevitable. In my view, Sokol will have a very hard time convincing a court of equity that his actions were consistent with his fiduciary duties based on what has been reported.

I concur.

If there is a corporate opportunity claim on these facts, it affects the remedy. In Pfeiffer, VC Laster explained that:

Harm to the corporation is generally not measured by insider trading gains or reciprocal losses. ... Disgorgement of insider trading profits (or recovery of reciprocal trading losses) is also not the appropriate measure of damages because insiders who trade on an impersonal market typically are not engaging in the type of self-dealing transaction to which a disgorgement remedy historically applies. ... [T]rading in the market [for the employer's stock] typically does not involve the usurpation of a corporate opportunity, where disgorgement has been the preferred remedy.

In a misappropriation-type case like this one, however, disgorgement would be a proper remedy.

SEC can't be held liable to Madoff victims for its gross incompetence

I think just about everybody who doesn't get their paycheck from the Securities and Exchange Commission (and probably some who do) believes the SEC was grossly incompetent in failing to spot and prosecute the Madoff frauds years (decades?) ago. Yet, as Barbara Black reports, no action lies against it:

In Molchatsky v. U.S. (S.D.N.Y. Apr. 19, 2011), the federal district court held that two Madoff victims could not sue the U.S. government under the Federal Tort Claims Act for the SEC's "gross negligence" in failing to discover the fraud.  The opinion recounts at some length the allegations of the agency's ineptitude, largely taken from the SEC Office of Inspector General's Report, but nevertheless ultimately agrees with the government that the agency's conduct is protected under the Discretionary Function Exception (DFE) of the Federal Tort Claims Act.  Because the SEC's decision regarding whom to investigate and how to conduct an investigation are discretionary,  any negligence or even abuse of that discretion is shielded from suit by sovereign immunity.

I think that has to be the right answer. After all, if the federal government could be held liable for every act of negligence it commits, the federal budget deficit would be at least twice as big as it is now.

Indeed, the result seems so obviously correct that one is tempted to characterize the lawsuit as frivolous.

Ordinarily, of course, I have no patience for frivolous lawsuits. But I think I'll make an exception in this case. The lawsuit may have been frivolous, but maybe--just maybe--it will have the redeeming virtue of holding the SEC's enforcement failure up to renewed--and well deserved--mockery.

Indeed, the court itself used the lawsuit as a vehicle for ripping the SEC a new one:

Swain excoriated the SEC, calling its behavior “sloppy,” “uninformed,” and “irresponsible.”  That said, continued Swain, “that the conduct in question defied common sense and reeked of incompetency does not indicate that any formal, specific, mandatory policy was ‘likely’ violated.” Click here for Swain’s opinion; here for the Dow Jones Newswires story; here for the Bloomberg story.

The other reason I'm giving this suit a pass is that it reminds me of that wonderful scene in Animal House in which Otter concludes that "that this situation absolutely requires a really futile and stupid gesture be done on somebody's part."

Whoever brought this suit were "just the guys to do it."

Skeel slaps down FDIC Dodd-Frank fantasy

The FDIC would like us to believe that Dodd-Frank would have prevented the financial crisis. David Skeel slaps that idea down rather convincingly in 3 short paragraphs, which ought to tell you something about the report by itself.

SEC Investor Bulletin re Say on Pay

The SEC has issued an investor bulletin explaining how the new say on pay rules work. Here's the executive summary:

• Say-on-Pay Votes. The new rule requires public companies subject to the proxy rules to provide their shareholders with an advisory vote on the compensation of the most highly compensated executives. Say- on-Pay votes must be held at least once every three years.
• Frequency Votes. These companies also are required to provide their shareholders with an advisory vote on how often they would like to be presented with the Say- on-Pay votes - every year, every second year, or every third year.
• Golden Parachute Disclosures and Votes. These companies are required to disclose compensation arrangements and understandings with those executive officers in connection with an acquisition or merger. In certain circumstances, these companies also are required to conduct a shareholder advisory vote to approve the golden parachute compensation arrangements.

I still think this is a lousy idea. See Say on Pay: An Unjustified Incursion on Director Authority.

Epstein on the federal budget

True confession time: Richard Epstein is one of my heroes. Libertarian law professor and author of so many wonderful books. So when he writes, I pay attention. Here's the opening of his latest piece on the federal budget:

President Barack Obama’s budget speech was delivered at George Washington University Law School on April 13, 2011. What is most notable about the speech was not the predictable and partisan reaction to it. Rather, it was the president’s deft use of rhetorical tropes to pull off his increasingly transparent maneuver of talking right while moving left.

As is par for the course, the speech contains enough platitudes to make it appear that the president is a fair-minded man—a man who understands the difficult trade-offs that must be made in order to balance the imperatives of market growth with the just provision of government resources to all individuals. In the end, however, this presidential straddle will fall to ruins because of its implicit assumption that transfer payments will do no harm to total production, even as they redress the inequality of fortunes in this country. Not so. ...

And here's the conclusion:

In the end, it is growth, and only growth, that can cure the national malaise. And that means letting the rich get richer so that they can bring the rest of us along with them. But just as King Canute could not stop the tides, so it is that President Obama cannot draw blood out of a stone. What the president thinks are zero-sum policies are in fact no such thing. Given how they distort market incentives and increase political strife, Obama’s progressive policies translate into a profoundly negative-sum game, which, when replicated over time, will strip this nation of the entrepreneurial spirit that accounted for its past greatness.

In between the two is a concise and brilliant exposition of political and economic theory on which the conclusion is based. Go read the whole thing. Now.

Judging Cases and Grading Law Students

A very interesting study of judicial behavior reported in the latest issue of the Economist:

Justice, say the cynics, is what the judge had for breakfast. Now they have proof.

A paper in the Proceedings of the National Academy of Sciences describes how Shai Danziger of Ben-Gurion University of the Negev and his colleagues followed eight Israeli judges for ten months as they ruled on over 1,000 applications made by prisoners to parole boards. The plaintiffs were asking either to be allowed out on parole or to have the conditions of their incarceration changed. The team found that, at the start of the day, the judges granted around two-thirds of the applications before them. As the hours passed, that number fell sharply (see chart), eventually reaching zero. But clemency returned after each of two daily breaks, during which the judges retired for food. The approval rate shot back up to near its original value, before falling again as the day wore on. ...

The researchers offer two hypotheses for this rise in grumpiness. One is that blood-sugar level is the crucial variable. This, though, predicts that the precise amount of time since the judge last ate will be what matters. In fact, it is the number of cases he has heard since his last break, not the number of hours he has been sitting, which best matches the data. That is consistent with a second theory, familiar from other studies, that decision making is mentally taxing and that, if forced to keep deciding things, people get tired and start looking for easy answers. In this case, the easy answer is to maintain the status quo by denying the prisoner’s request.

The closest law professors like your truly come to judging things is grading law students. In large classes, I have for many years relied on multiple choice exams. Candidly, when I first made the shift from essay exams to objective questions, I did so because I was teaching two sections of Business Associations in the same semester and the thought of slogging through 250 blue books was more than I could bear.

If pressed today, however, I'd point to this study as a reason for preferring multiple choice machine graded exams. I know from personal experience (dirty laundry being aired here) that the time of day affected how carefully I read essay exams. So did my mood, blood sugar levels, and so on. I'm not sure that the effect always cut in a specific direction. Being tired often probably meant leniency (not having to worry about justifying one's grade) but being hungry or grumpy probably meant being tougher (bad mood). How being tired, hungry, and grumpy all at once cut is unclear, but it surely made a difference.

As the study suggests, this seems to be generally true. One's exercise of critical evaluative judgment necessarily depends on these sort of physical and mental considerations. Any professor--law or otherwise--who denies the point is fibbing (at best). To be sure, we can try to mitigate the problem. I'd always give at least 3 essay questions. I'd grade all the answers to question 1, shuffle the stack, and repeat two more times. Shuffling increased the odds that things would come out in the wash.

But the great glory of machine read standardized exams is that it takes all those issues out of the equation. The student's grade depends on their performance, not whether I just had a cup of coffee and a doughnut.

Macey on the Galleon Trial

Jon Macey's WSJ op-ed on the Galleon insider trading trial is a particularly good read. The subhead gets the piece off with a bang by capturing the essence of what's going on here:

The prosecution of Raj Rajaratnam is part of a war between the SEC and the law as articulated by the Supreme Court.

Macey then explains that:

The prosecution of Mr. Rajaratnam is not an isolated fight but rather part of an ongoing doctrinal war pitting the rather extreme views of the Securities and Exchange Commission against the carefully considered law of insider trading articulated by the Supreme Court. The SEC does not draw a distinction between trading on the basis of legitimate albeit unorthodox research and illegal trading on the basis of improperly acquired proprietary information. But it should.

Despite the court's rejection of the view that all trading on the basis of material nonpublic information is illegal, the SEC persistently litigates this issue. In landmark cases like U.S. v. Chiarella (1980), Dirks v. SEC (1983), and U.S. v. O'Hagan (1997), the court has distinguished trading on the basis of information that was legitimately ferreted out from trading on the basis of information that has been wrongfully obtained through fraud or theft.

The SEC long has contended in litigation and in regulation that trading on the basis of any information advantage, no matter how obtained, is illegal. It takes the view that even if a trader does legitimate research to get information about a company, then that person should have to disclose that information before trading. Such a rule would destroy the incentives of analysts and traders to do research.

Right. (The SEC's refusal to live by the rules laid down by the Supreme Court was a major theme of my article Insider Trading Regulation: The Path Dependent Choice between Property Rights and Securities Fraud, 52 Southern Methodist University Law Review 1589-1651 (1999), which also discusses at some length why the SEC's preferred equal access rule makes no policy sense.)

As for the case at bar, Macey argues that:

Some of the government's accusations in U.S. v. Rajaratnam appear well-grounded in the law. For example, on Feb. 8, 2010, former Intel executive Rajiv Goel pleaded guilty to leaking information to Mr. Rajaratnam about Clearwire that he learned at Intel. The government alleges that Mr. Rajaratnam made about $579,000 trading on this information, and that he "paid" for the tips by placing profitable trades for Mr. Goel's benefit in a private brokerage account. Paying for confidential corporate information is and should be illegal because it is improper to bribe an executive to betray his duty of confidence to his employer.

However, some of the government's other allegations accuse Mr. Rajaratnam of simply talking to people and then trading. But if the information did not come from an insider, or if it was being relayed for a legitimate corporate purpose such as to set the record straight about the company, then it is not illegal.

Which strikes me as being exactly right on both scores.

Laptops and the Socratic Method

I'm not a fan of the Socratic Method as a pedagogical technique. See my essay, Reflections on Twenty Years of Law Teaching: Remarks at the Rutter Award Ceremony (April 2008).

So I was struck by the implications of new data on the use of laptops in the classroom, as reported in a new study:

The study suggests that the choice of whether to cover content by lecture, calling on students, or through discussion (identified in Table 8 as “Student-Volunteered Comments”) makes little difference to student attention (though of course it may matter for such things as student mastery of the material the amount of time it takes to cover a topic). Thus, for upper-year students, the level of distraction varied from only 34 to 37% for those three activities while for the first- semesters it was in the 15-17% range for all three.

In other words, at least when laptop use is permitted, the vaunted Socratic Method isn't holding the students any more riveted than other pedagogical techniques.

S&P issues warning on USA creditworthiness, efficient markets yawn

Buttonwood reports that:

S&P has said that

We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns. ...

The US has better growth prospects than most European nations and has the "exorbitant privilege" of issuing debt in the world's reserve currency, which keeps the cost down. But it resembles one of those Greek myths when the hero's power is accompanied by a curse; in this case, a political system that is not designed for serious deficit-cutting (the point made by S&P). The world's dominant power tends to think its financial strength will never drain away. But Spain, having absorbed all that gold and silver from Latin America, still defaulted on its debts in the 16th century; Louis XIV, the sun king whom other monarchs dreamed of emulating, set France on the road to financial ruin; and Britain started the 20th century with a huge empire and piles of overseas assets but was rationing food in peacetime by the late 1940s.

US federal spending as a percent of GDP has fluctuated around 20% for the last 40 years.

I figure that's probably a reasonable figure. It's time to cap spending at 20% of GDP and raise revenues to match that figure, before we go the way of Greece, because unlike the weak countries of the EU, we don't have Germany to bail us out.

Part of the problem is that the left just doesn't seem to get it. TPMDC, for example, opines that:

The White House -- and the bulk of mainstream economists -- have warned that a failure to increase the debt limit would lead to an economic catastrophe.

Of course, that's either uninformed or disingenuous. S&P's warning is focused on getting spending under long term control--"We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013"--not the short term debt ceiling issue.

Having said all that, the market reaction to the S&P announcement has been modest. Free Exchange reports and opines that:

This is "news" in the sense that S&P said something and lots and lots of news organisations have opted to write about it. But is it news? No, it isn't. Neither the American fiscal position or its political dysfunction will come as a surprise to anyone who's been paying attention. S&P has not struck out boldly in fretting about American borrowing; that's practically the national pasttime.

And so I'm a little sceptical of the ubiquitous headlines asserting that the Dow's morning tumble, of near 2%, is a result of the S&P information. Writers are going a little crazy over something that's not, actually, news. Time's Rana Foroohar, for instance, says, "Is this the first domino in the next global financial crisis? It's possible." I uttered the same thing a moment ago after pouring myself another cup of coffee, and it was equally true.

I look at the markets today, and I see that equities were off around the world; Asia and Europe were down well before the S&P news came out. I see that yields on peripheral European debt are skyrocketing while American yields are mostly down for the day. I see that the euro is down sharply today, and the dollar is up against the euro, against sterling, and against the Canadian and Australian dollars. Now it's possible that markets saw the S&P announcement and concluded that American austerity and opted to shed risk, paradoxically increasing the appetite for American debt. Or maybe traders woke up grumpy. My read of markets is that they're mostly worried about Europe.

This is, of course, exactly what would expect in efficient capital markets. The fundamentals of the US financial system and its feckless political system are all well known and have long since been priced into the markets. Only new information--such as the political system suddenly becoming even more feckless, if such a thing is possible--should affect prices.

As such, however, Krugman is dead wrong to imply that the lack of market reaction to the S&P story refutes the need for prompt spending cuts.

Attorneys fees in shareholder derivative actions

Ted Frank reposts an extended treatment of the issue by Michael Perino. Good read.

Unocal and takeover defenses in hard to value firms

Can takeover defenses create value? Mark Humphrey-Jenner's paper Anti-Takeover Provisions as a Source of Innovation and Value Creation argues for an affirmative answer in some cases:

Managers are risk averse. Excessive risk-aversion can destroy shareholder wealth. A key source of risk is the threat of an opportunistic takeover designed to take advantage of depressed market prices. This is especially the case in innovative or hard-to-value ('HtV') companies whose price may be depressed due to valuation difficulties rather than managerial under-performance. For these HtV firms, the threat of an opportunistic takeover can destroy value by inducing agency conflicts of managerial risk aversion. managers and regulators argue that ATPs can ameliorate this problem. This article presents a theoretical model and empirical results that show that for HtV firms, ATPs encourage managers to make value-creating takeovers and increase innovation and do not induce agency conflicts of managerial entrenchment. This implies that for innovative or hard-to-value firms, ATPs can ameliorate managerial risk aversion and encourage value-creation.

Assuming that's true (models and empirical data together, yikes!), how would one incorporate his conclusions into Delaware's Unocal framework for judicial review of takeover defenses? I am reminded of Shamrock Holdings, Inc. v. Polaroid Corp., 559 A.2d 278 (Del.Ch. 1989).

Shamrock made a hostile takeover bid for Polaroid. The target responded by issuing convertible preferred stock to friendly investors and initiating a substantial stock buyback program. Polaroid also had a poison pill "containing 'flip-in' and 'flip-over' provisions. In addition, although the company does not have a staggered board of directors, several provisions limit a dissident stockholder's ability to gain control of the company. Polaroid's charter prohibits stockholder action by written consent. Pursuant to the bylaws, stockholders may not call special meetings and must give written notice of their intention to nominate directors for election ninety days prior to the annual meeting." Shamrock sued, claiming the defensive tactics violated the Unocal standard.

The court held that:

Polaroid directors [satisfied the first Unocal prong because they] acted in good faith and reasonably investigated Shamrock's offer. The board met on at least six occasions over a four month period to review Shamrock's original and amended offer and to discuss appropriate responses with management as well as its financial and legal advisers. Only two of Polaroid's thirteen board members are present or former officers of the company and there is no evidence from which the Court could make a preliminary finding that the outside directors were seeking to entrench themselves.

The second prong of Unocal is the proportionality test under which Polaroid's response must be balanced against the Shamrock threat. ...

Here is where the case becomes relevant to Humphrey-Jenner's paper. In assessing whether the Shamrock bid posed a threat to Polaroid, the court took into consideration that fact that Polaroid was ... you will have guessed it ... hard to value. Polaroid has recently won the liability phase of a major patent lawsuit against Kodak. Critically, however, the damages phase of the suit remained unresolved. Nobody knew exactly what the damages were likely to be, but it seemed fair to assume that the damage claim represented a very significant chunk of Polaroid's value. Hence, as the court explained, Polaroid argued that:

Shamrock's offer is also considered a threat because, in the board's view, it does not offer full value for the Kodak judgment. That judgment is, by far, Polaroid's most valuable asset. The directors fear that Shamrock will either exploit or impair that asset: "(a) ... Shamrock may undervalue the award because of its uncertainty and Shamrock's lesser knowledge of the full merits of Polaroid's claim; (b) ... because of Shamrock's need to pay down its acquisition debt promptly, Shamrock may be willing to quickly settle the litigation for less than full value; and (c) ... the court in the Kodak action may be inclined to award less damages to a takeover acquiror than to the original victim."

The Court agreed:

In sum, Polaroid is anticipating a monetary recovery that may exceed $5 billion as the result of a complicated patent infringement claim that spans more than a decade. In the foreseeable future, the amount of the damage award will be quantified if not paid. Until that time, it seems appropriate to consider a non-coercive but inadequate tender offer to be a threat. Although the stock market has “valued” the Kodak judgment and analysts have made estimates, Polaroid's stockholders really have very little way of assessing the present worth of this extremely valuable asset. Under these circumstances, there is a real possibility that the Polaroid stockholders will undervalue the Kodak judgment and it does not appear that the mere dissemination of information will cure this problem. Thus, I am satisfied that the Polaroid directors were entitled to treat the Shamrock tender offer as a threat. There is evidence that the offered price is inadequate (and the board so found) and there is a valid basis for concern that the Polaroid stockholders will be unable to reach an accurate judgment as to intrinsic value of their stock in light of the current status of the Kodak litigation.

The issue then becomes whether the Management Transactions constitute a reasonable response to the threat presented by this arguably inadequate bid. The purported purpose of the self-tender and buyback is to offer some immediate value to those stockholders interested in cash while increasing the equity interest held by the remaining stockholders. The Preferred Stock issuance is said to be an advantageous form of financing for the repurchase program. ...

In sum, although I am not entirely satisfied that the issuance of the Preferred Stock was simply a financing device, I am unable to conclude preliminarily that either the Corporate Partners transaction alone or the Management Transactions as a whole are unreasonable either because they are disproportionate to the Shamrock threat or because they were improperly motivated.

Humphrey-Jenner's paper suggests that the court in Shamrock holdings got it exactly right. Where targets are hard to value, even more deference than usual may be appropriate in applying the Unocal standard.

Takeover Theory

Steven Davidoff has posted to SSRN a very interesting paper, Takeover Theory and the Law and Economics Movement. From the abstract:

Beginning in 1965 with Henry Manne's famous theory of the market for corporate control and ending with the 2011 decision in Air Products v. Airgas, this chapter is a survey history of the law and economics field as applied to takeovers. It is also about possible new directions and topics for this field and its future use in structuring and analyzing takeover theory.

Self-publishing legal scholarship

A while back, I explored some of the pros and cons of bypassing the law review/university press publication venues in favor of self-publishing legal scholarship. Roger Alford kindly notes that he found the discussion "interesting" and then goes on to make some very interesting points of his own. His argument that e-publishing would actually increase the availability of one's scholarship is especially worth consideration:

What we strive for in legal scholarship is to be part of the marketplace of ideas. Our ideas–at least those published in books–are hidden behind a giant paywall established by legacy publishers. We currently reach hundreds of readers when we could reach thousands if the price were right.

Legacy publishers are loathe to reduce the price of ebooks despite the fact that the marginal cost of each additional download is nil. They do so because they don’t want ebooks to cannibalize hard-copy and paperback sales. That makes perfect sense if you are a publisher. But authors don’t care about cannibalizing print sales, because royalties are of no consequence to most scholars. They just want their stuff to be read.

Legacy publishers of legal scholarship assume that they can continue to pay authors fifteen percent royalties, regardless of whether the book is published digitally or in print. But that pay structure actually creates incentives to self-publish.

Why should established legal scholars agree to put up artificial barriers between themselves and their readers? For example, how many more readers would purchase Mary Ann Glendon’s latest book, The Forum and the Tower, if it were available on Kindle for $4.99 instead of in hard copy priced at $27.95 (or on Amazon for $18.45)? Do we really need the OUP label to tell us that Mary Ann Glendon’s books are worth reading? Glendon’s wonderful book, A World Made New, costs $11.99 for downloading on Kindle. If she were in control of the pricing, she could drop the price of her ten-year-old book down to $2.99 or $0.99, so that it would actually be cheaper to buy digitally than purchasing it used for $10.33 ($6.34 plus $3.99 shipping) on Amazon. How many more people could learn about Eleanor Roosevelt and the Universal Declaration of Human Rights if they could purchase Glendon’s book without a tinge of financial guilt?

Great question -- it goes straight to the core of the cost-benefit analysis.

Alford's conclusion is especially apt in light of recent developments:

Ten years ago none of us had ever heard of SSRN. What SSRN did to law review articles, self-publishing could do to casebooks, treatises and law-related non-fiction. The new age of self-publishing is fast approaching the world of legal scholarship. It will just take a few legacy scholars to create a norm cascade that will rock the world of legacy publishing.

Speaking of SSRN, SSRN now allows users to purchase a hard copy of articles posted thereto. I was informed of this by email when SSRN notified me that my employer had decided not to opt out of the program. This raises a couple of questions relevant to Alford's analysis:

1. Who's going to pay for hard copies when they can download them for free?
2. Is SSRN making a profit of these sales?
3. If there is a paying market for these articles, why should SSRN get the cash instead of the author?

I'm committed to doing three books for legacy publishers, not counting case book updates and the like. When the last book is finished sometime in late 2012, it'll be interesting to see whether things have developed to the point that self-publishing a 35,000 word ebook makes more financial and reputational sense than giving away free to SSRN and some law review.

Small government capitalists are better, happier people

So reports Jim Lindgren in a new paper. From the abstract:

In debates over the roles of law and government in promoting the equality of income or in redistributing the fruits of capitalism, widely different motives are attributed to those who favor or oppose capitalism or income redistribution. According to one view, largely accepted in the academic social psychology literature (Jost et al. 2003), opposition to income redistribution and support for capitalism reflect an orientation toward social dominance, a desire to dominate other groups. According to another view that goes back at least to the nineteenth century origins of Marxism, anti-capitalism and a support for greater legal efforts to redistribute income reflect envy for the property of others and a frustration with one’s lot in a capitalist system.

In this paper I expand and test the social dominance thesis using sixteen nationally representative General Social Surveys conducted by the National Opinion Research Center between 1980 and 2004. ...

I first show that respondents who express traditionally racist views (on segregation, interracial marriage, and inborn racial abilities) tend to support greater income redistribution. Traditional racists also tend to oppose free-market capitalism and its consequences, wanting the government to guarantee jobs for everyone and fix prices, wages, and profits. ... Those who express less tolerance for unpopular groups tend to favor income redistribution and oppose capitalism.

... Controlling for education, income (log), gender, and age (Models 5 and 6), the effects of the racism and intolerance predictors on redistribution and intolerance are reduced, but remain significant. Thus the preference against income redistribution, for example, is not just the result of income or education - rather, the data are consistent with racism and intolerance continuing to play a small, but significant role in explaining the support for income redistribution and anti-capitalism. The data are broadly inconsistent with the standard belief in the social psychology literature that pro-capitalist and anti-redistributionist views are positively associated with racism.

I then explore an alternative hypothesis, showing that, compared to anti-redistributionists, strong redistributionists have about two to three times higher odds of reporting that in the prior seven days they were angry, mad at someone, outraged, sad, lonely, and had trouble shaking the blues. Similarly, anti-redistributionists had about two to four times higher odds of reporting being happy or at ease. Not only do redistributionists report more anger, but they report that their anger lasts longer. When asked about the last time they were angry, strong redistributionists were more than twice as likely as strong opponents of leveling to admit that they responded to their anger by plotting revenge. Last, both redistributionists and anti-capitalists expressed lower overall happiness, less happy marriages, and lower satisfaction with their financial situations and with their jobs or housework.

Further, in the 2002 and 2004 General Social Surveys anti-redistributionists were generally more likely to report altruistic behavior. In particular, those who opposed more government redistribution of income were much more likely to donate money to charities, religious organizations, and political candidates. The one sort of altruistic behavior that the redistributionists were more likely to engage in was giving money to a homeless person on the street.

Explains a lot. (HT: Cowen)

Proxy advisory firms under scrutiny

BNA reports that:

In the midst of the peak period this year for annual meetings of stockholders, some investors and regulators still have lingering concerns about the integrity of the advice and accuracy of reports provided by proxy advisory firms such as Institutional Shareholder Services (ISS) and Glass Lewis. In preparation for annual meetings, these firms are typically hired by institutional investors seeking advice on how to vote their shares in the best interests of their clients. As the number of shares held by institutional investors steadily grows, so does the influence of the firms hired to advise the institutions on important shareholder issues.

ISS' growing influence, in particular, has caught the attention of the SEC and trade groups in the past. In July 2010, the SEC issued a 150-page concept release announcing its intent to review the current proxy system and consider public comment on a variety of investment issues. In January 2011, the Center On Executive Compensation (the “Center”) published a lengthy paper entitled, A Call for Change in the Proxy Advisory Industry Status Quo: The Case for Greater Accountability and Oversight. Both the SEC and the Center expressed concern over potential conflicts of interest within ISS and similar firms, as well as over inaccuracies and a lack of transparency in the advisory reports that these firms issue. ...

The SEC is also considering whether it should adopt a regulatory model similar to that proposed for the credit ratings agencies. Regulations based on this model might include prohibiting certain conflicts of interest and requiring full disclosure of the statistics and methods used to formulate recommendations and rate issuers.

Given that ISS and Glass Lewis have a duopoly on the proxy advisory services market and the growing importance of those services, some sort of regulation seems essential. They have proven incapable of self-regulation.