ProfessorBainbridge.com

Shareholders and corporate political speech

Lucian Bebchuk's acolytes continue to spread the claim that shareholders ought to be actively involved in an ever-expanding array of corporate decisions. The latest case in point is Robert Jackson's post at the Harvard Forum, which asserts that the SEC should "give shareholders a greater role in corporate political speech decisions."

Jackson praises the SEC's recent shift in position on Rule 14a-8, which allows shareholders to include proposals on the company’s proxy ballot for a vote by shareholders. Formerly, the SEC took the position that proposals affected corporate political speech could be excluded from the company's proxy statement under rule 14a-8(i)(7) as ordinary business matters. Recently, however, the SEC has changed its position and has begun requiring companies to include such proposals. As Jackson explains:

This proxy season, a Home Depot shareholder, NorthStar Asset Management, asked the company to include on its ballot a proposal recommending, among other things, that the board disclose its policies on electioneering contributions—and give shareholders an advisory vote on those policies. Home Depot sought permission from the SEC to exclude the proposal from its ballot, arguing that the proposal related to Home Depot’s ordinary business operations. In a letter opposing Home Depot’s request, and citing our article, NorthStar argued that Rule 14a-8 required the proposal to be included.

In March, the staff agreed with NorthStar, concluding that the proposal could not be excluded on the ground that it related to Home Depot’s ordinary business operations. Home Depot’s proxy statement, filed two weeks later, now includes the proposal on the ballot—along with management’s statement opposing the proposal.

One wonders why the SEC's shift in position on this issue doesn't raise the same sort of issues raised in the ADSCME v. AIG case. AFSCME's pension fund owned a substantial block of AIG stock, and advanced a shareholder proposal that would have amended the firm’s by-laws effectively to turn the firm’s proxy solicitation material into a ballot: the firm would be required to include in its proxy material not just the incumbent board’s slate, but also rival slates proposed by insurgents. AIG management asked the SEC whether it could exclude the proposal on the grounds that “relate[d] to an election” (Rule 14a-8(i)(8)). The SEC replied that it could (i.e., it issued a no-action letter), AIG excluded the proposal, and AFSCME sued.

The court held that AIG may not exclude the proposal.

Because the interpretation of Rule 14a-8(i)(8) that the SEC advances in its amicus brief-that the election exclusion applies to proxy access bylaw proposals-conflicts with the 1976 Statement, it does not merit the usual deference we would reserve for an agency’s interpretation of its own regulations. … The SEC has not provided, nor to our knowledge has it or the Division ever provided, reasons for its changed position regarding the excludability of proxy access bylaw proposals. Although the SEC has substantial discretion to adopt new interpretations of its own regulations in light of, for example, changes in the capital markets or even simply because of a shift in the Commission’s regulatory approach, it nevertheless has a “duty to explain its departure from prior norms.” Atchison, T. & S.F. Ry. Co. v. Wichita Bd. of Trade, 412 U.S. 800, 808, 93 S.Ct. 2367, 37 L.Ed.2d 350 (1973) (citing Sec. of Agric. v. United States, 347 U.S. 645, 652-53, 74 S.Ct. 826, 98 L.Ed. 1015 (1954))....

Why doesn't the same logic require an explanation here? Preferably by way of a formal rule making subject to APA checks and balances, with opportunity for comment by affected parties?

In any case, as is typical with Bebchuk and his acolytes, Jackson is not satisfied with this victory:

... under current corporate-law rules shareholders’ role in this area remains far too limited. For example, NorthStar’s proposal, consistent with Delaware law, merely recommends that the board disclose its policies on political spending and give shareholders a say on those policies. Even if shareholders overwhelmingly vote for NorthStar’s proposal, Home Depot will not be bound to follow it.

To the extent that the interests of directors and executives in corporate spending on politics diverge from those of shareholders, corporate-law rules should give shareholders meaningful authority with respect to those decisions.

One increasingly wonders if there is any issue Bebchuk and his acolytes think ought to be outside the scope of shareholder decision making.

State corporate law provides clearly that the corporation’s business and affairs are “managed by or under the direction of a board of directors.” The vast majority of corporate decisions accordingly are made by the board of directors acting alone, or by persons to whom the board has properly delegated authority. Shareholders have virtually no right to initiate corporate action and, moreover, are entitled to approve or disapprove only a very few board actions. The statutory decision-making model thus is one in which the board acts and shareholders, at most, react.

Shareholder voting thus is simply one of many corporate accountability mechanisms—and not a very important one at that. In theory, of course, shareholders could vote incompetent directors out of office. In the real world, however, so-called proxy contests are subject to numerous legal and practical impediments that render them largely untenable as a tool for disciplining managers. Accordingly, the product, capital, and employment markets are all far more important than voting as a constraint on agency costs. To the extent voting matters, it does so solely because it facilitates the market for corporate control. If agency costs get high enough, it will become profitable for some outsider to acquire a controlling block of shares and exercise their associated voting rights to oust the incumbent board.

Jackson's complaint that Home Depot is not bound by the proposal thus ought to fall on deaf ears. As Delaware’s Chancellor William Allen observed, our “corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.” Paramount Communications Inc. v. Time Inc., 1989 WL 79880 at *30 (Del. Ch. 1989), aff’d, 571 A.2d 1140 (Del. 1990).

Allen further recognized that the fact that many, “presumably most, shareholders” would have preferred the board to make a different decision “does not . . . afford a basis to interfere with the effectuation of the board’s business judgment.” In short, corporations are not New England town meetings.

It's also worth remembering that the beneficiaries of Bebchuk's incessant pressing of ever expanding shareholder power will not be ordinary investors. Instead. as Roberta Romano observed with respect to union and public pension fund sponsorship of shareholder proposals:

It is quite probable that private benefits accrue to some investors from sponsoring at least some shareholder proposals. The disparity in identity of sponsors—the predominance of public and union funds, which, in contrast to private sector funds, are not in competition for investor dollars—is strongly suggestive of their presence. Examples of potential benefits which would be disproportionately of interest to proposal sponsors are progress on labor rights desired by union fund managers and enhanced political reputations for public pension fund managers, as well as advancements in personal employment. … Because such career concerns—enhancement of political reputations or subsequent employment opportunities—do not provide a commensurate benefit to private fund managers, we do not find them engaging in investor activism.[1]

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[1] Roberta Romano, Less Is More: Making Shareholder Activism A Valued Mechanism Of Corporate Governance, 18 Yale J. Reg. 174, 231-32 (2001).

I've dealt with these issues in greater length elsewhere, most notably The Case for Limited Shareholder Voting Rights, 53 UCLA Law Review 601-636 (2006), which explained that:

Recent years have seen a number of efforts to extend the shareholder franchise. These efforts implicate two fundamental issues for corporation law. First, why do shareholders - and only shareholders - have voting rights? Second, why are the voting rights of shareholders so limited? This essay proposes answers for those questions.

As for efforts to expand the limited shareholder voting rights currently provided by corporation law, the essay argues that the director primacy-based system of U.S. corporate governance has served investors and society well. This record of success occurred not in spite of the separation of ownership and control, but because of that separation. Before changing making further changes to the system of corporate law that has worked well for generations, it would be appropriate to give those changes already made time to work their way through the system. To the extent additional change or reform is thought desirable at this point, surely it should be in the nature of minor modifications to the newly adopted rules designed to enhance their performance, or rather than radical and unprecedented shifts in the system of corporate governance that has existed for decades.

And Director Primacy and Shareholder Disempowerment, 119 Harvard Law Review (2006), which was a response to Lucian Bebchuk's article The Case for Increasing Shareholder Power, 118 Harvard Law Review 833 (2005). In that article, Bebchuk put forward a set of proposals designed to allow shareholders to initiate and vote to adopt changes in the company's basic corporate governance arrangements.

In response, I made three principal claims:

First, if shareholder empowerment were as value-enhancing as Bebchuk claims, we should observe entrepreneurs taking a company public offering such rights either through appropriate provisions in the firm's organic documents or by lobbying state legislatures to provide such rights off the rack in the corporation code. Since we observe neither, we may reasonably conclude investors do not value these rights.

Second, invoking my director primacy model of corporate governance, I present a first principles alternative to Bebchuk's account of the place of shareholder voting in corporate governance. Specifically, I argue that the present regime of limited shareholder voting rights is the majoritarian default and therefore should be preserved as the statutory off-the-rack rule.

Finally, I suggest a number of reasons to be skeptical of Bebchuk's claim that shareholders would make effective use of his proposed regime. In particular, I argue that even institutional investors have strong incentives to remain passive.

Corporate Practice Commentator's "Top 10" Corporate & Securities Articles for 2010

Brian Leiter reports that the list consists of:

Ayotte, Kenneth and David A. Skeel, Jr. Bankruptcy or bailouts? 35 J. Corp. L. 469-498 (2010).

Bebchuk, Lucian A. and Ehud Kamar. Bundling and entrenchment. 123 Harv. L. Rev. 1549-1595 (2010).

Bebchuk, Lucian A. and Holger Spamann.  Regulating bankers’ pay.  98 Geo. L.J. 247-287 (2010).

Bratton, William W. and Michael L. Wachter.  The case against shareholder empowerment.  158 U. Pa. L. Rev. 653-728 (2010).

Choi, Albert and George Triantis.  Strategic vagueness in contract design:  The case of corporate acquisitions.  119 Yale L.J. 848-924 (2010).

Choi, Stephen, Jill Fisch and Marcel Kahan. The power of proxy advisors: Myth or reality? 59 Emory L.J. 869-918 (2010).

Kahan, Marcel and Edward Rock. Embattled CEOs. 88 Tex. L. Rev. 987-1051 (2010).

Roe, Mark J.  Delaware’s shrinking half-life.  62 Stan. L. Rev. 125-154 (2009).

Squire, Richard.  Shareholder opportunism in a world of risky debt.  123 Harv. L. Rev. 1151-1213 (2010).

Strine, Leo E., Lawrence A. Hamermesh, R. Franklin Balotti, and Jeffrey M. Gorris. Loyalty's core demand: The defining role of good faith in corporation law. 98 Geo. L.J. 629-696 (2010).

Goodwin Liu meet Miguel Estrada

The GOP successfully filibustered (with help from one Democrat, Ben Nelson) law prof Goodwin Liu's nomination to the Ninth Circuit. It's been widely reported that the Obama administration was trying to get Liu some judicial experience so as to continue grooming him to be the first Asian-American nominated to the Supreme Court. It is occasioning a good deal of angst and some hypocrisy among liberal legal circles.

Liu may or may not be qualified to be a judge. My guess is that he probably is. But I'm reminded of the case of Miguel Estrada, who the Democrats blocked from taking a seat on DC Circuit. As Wikipedia notes: "Estrada's was the first filibuster ever to be successfully used against a judicial nominee who had clear support of the majority in the Senate (Fortas only had the support of 45 Senators and ended up resigning his position a year later in disgrace), and the first filibuster of any court of appeals nominee." Why were the Democrats so determined to stop Estrada? Because they thought Bush 43 was grooming him to be the first Hispanic nominee to the SCOTUS.

It's no way to run a railroad, but payback nevertheless is a bitch.

So if Liu's looking for somebody to blame, he ought to start with the list of Democrats who filibustered Estrada.

Jack McCord

Paul Caron passes on some sad news:

Tax Prof John (“Jack”) H. McCord (Illinois) died of lung cancer on Wednesday at the age of 76. Please see this moving obituary by his son, Paul, and A Tribute to John H. McCord upon His Retirement, 2000 U. Ill. L. Rev. 741-62:

• Tribute (with a complete bibliography), 2000 U. Ill. L. Rev. 741
• Thomas M. Mengler (Dean, Illinois), A Salute to Professor John H. McCord, 2000 U. Ill. L. Rev. 749
• Charles C. Bingaman (Chapman), Professor John H. McCord: Bridging the Gap Between Law School and Law Practice in Illinois, 2000 U. Ill. L. Rev. 751
• Ora Fred Harris, Jr. (Illinois), Professor John H. McCord: A Marvelous Human Being, 2000 U. Ill. L. Rev. 755
• David Laro (Judge, U.S. Tax Court), Tribute to Professor John McCord, 2000 U. Ill. L. Rev. 757
• Jeffrey G. Sherman (Chicago-Kent), My First-Grade Teacher, 2000 U. Ill. L. Rev. 761

Visitation will be on Sunday (May 22) at Renner-Wikoff Chapel and the funeral on Monday (May 23) at St. Patrick's Catholic Church.  See here to sign the guest book or send a sympathy card, private condolences, or flowers. Memorial contributions may be made to St. Patrick's Catholic Church,  University of Illinois College of Law or Carle Cancer Clinic.

I remember Jack with great affection from our days as colleagues at Illinois. He was the epitome of scholar and gentleman. Plus, he loved dogs, which formed a bond, as he helped Helen and I get through Sam's trying puppy days.

Smith reviews Schools for Misrule

Law prof/blogger Tom Smith reviews Walter Olson's book Schools for Misrule: Legal Academia and an Overlawyered America:

Walter Olson thinks that American law schools are the origin of some very bad ideas, in something like the way bats are said to be the reservoir of certain nasty viruses in Africa: the germs of pernicious concepts incubate there in relative obscurity between epidemics, erupting occasionally to spread destruction and misery. Sadly, Olson is not entirely wrong.

Schools for Misrule is a broad complaint against American law schools, especially perhaps the Yale Law School, alleging that they promulgate terrible jurisprudence. ...

It is not clear, however, whether law schools are responsible for the abuses Olson identifies or merely reflect their professional and political environment. Law schools also should get credit for incubating intellectual movements that have proven powerful tonics for the very problems Olson complains about. The law and economics movement, for example, which evolved at the University of Chicago law school, has deeply undercut theories that everybody should be liable for everything and has increased respect for common-law rules and adjudication. Public choice theory, sprouting in part from the law school at George Mason University, and now widely influential, has made the idea of benevolent judge-reformers seem hopelessly naïve. Harvard Law School hired Jack Goldsmith ’89JD, outspoken critic of the grander claims of international human rights law. Even Berkeley has not seen fit to extradite torture memo author and law professor John Yoo ’92JD to the mercies of his many adamant critics. ...

In other words, the problem is liberal law professors not law schools. Smith concldues, however, that:

Olson’s book, if one-sided, is nevertheless well worth reading. His histories of liability expansion, the role of wealthy private foundations, and international human rights law activism, as well as the ever potentially corrupting influence of money, amount to a sobering crash course in how bad things can happen to good schools and countries. Olson writes with a humorous touch and wears his considerable erudition about the history of legal education lightly. Anyone interested in how law schools influence our broader political debates should read this book, even if it is not the only book on this topic one should read.

More on scientific consensuses: Species extinction rates overestimated

Apropos of the discussion we had the other day about the scientific consensus on climate change comes news that:

The most widely used methods for calculating species extinction rates are "fundamentally flawed" and overestimate extinction rates by as much as 160 percent, life scientists report May 19 in the journal Nature.

However, while the problem of species extinction caused by habitat loss is not as dire as many conservationists and scientists had believed, the global extinction crisis is real, says Stephen Hubbell, a distinguished professor of ecology and evolutionary biology at UCLA and co-author of the Nature paper. ...

"The overestimates can be very substantial. The way people have defined 'extinction debt' (species that face certain extinction) by running the species-area curve backwards is incorrect, but we are not saying an extinction debt does not exist."

The point is not that we should ignore environmental concerns. The point is that we should be wary about claims that massive social and economic changes are necessary simply because the scientific consensus of the moment claims they're desirable. Like the medical claims about salt I mentioned in my earlier post, and like this latest news, the consensus of the moment can turn out to be seriously flawed.

Corporate Governance after the Financial Crisis

Oxford University Press has announced my (newly renamed) book: Corporate Governance after the Financial Crisis:

The years from 2000 to 2010 were bookended by two major economic crises. The bursting of the dotcom bubble and the extended bear market of 2000 to 2002 prompted Congress to pass the Sarbanes-Oxley Act, which was directed at core aspects of corporate governance. At the end of the decade came the bursting of the housing bubble, followed by a severe credit crunch, and the worst economic downturn in decades. In response, Congress passed the Dodd-Frank Act, which changed vast swathes of financial regulation. Among these changes were a number of significant corporate governance reforms.

Corporate Governance after the Financial Crisis asks two questions about these changes. First, are they a good idea that will improve corporate governance? Second, what do they tell us about the relative merits of the federal government and the states as sources of corporate governance regulation? Traditionally, corporate law was the province of the states. Today, however, the federal government is increasingly engaged in corporate governance regulation. The changes examined in this work provide a series of case studies in which to explore the question of whether federalization will lead to better outcomes. The author analyzes these changes in the context of corporate governance, executive compensation, corporate fraud and disclosure, shareholder activism, corporate democracy, and declining US capital market competitiveness.

Features

• Clearly explains complex technical legal and economic issues in ways that the educated generalist will understand
• Identifies and clearly explains which regulations and laws make good policy sense, and which do not
• Sophisticated in its economic analysis of the law to be persuasive to the professional, yet sufficiently clear for the educated lay person
• Thoroughly researched in its coverage of important contributions to the legal and economic literature on corporate governance

While you wait for it to be published in November, of course, you can always buy one of my other books:

Del CJ Steele on Dodd-Frank

In an interview with The Metropolitan Corporate Counsel, Delaware Chief Justice Myron Steele opines that:

There are many perspectives. To start, federal legislation tends to be crisis driven and rarely adds anything of enduring quality, as certainly was the case with Dodd-Frank (the Bill). Unfortunately, Dodd Frank and similar initiatives are rarely revisited, after the crisis subsides, to adjust for unintended consequences.

Of the Bill's 2,300 pages, 24 purportedly relate to corporate governance, which is a matter of state law. Traditionally, corporations decide where to charter based on the extent to which a state's legislative and judicial services fit their needs. Any sweeping federal legislation should incorporate sufficient data to convince all constituencies that those changes will result in better performance. Because it is not based on such empirical data, the Bill serves mainly as a sop to certain political constituencies.

Specifically, the Bill is politicized because the proposed changes are skewed in favor of institutional shareholders, many of whom contribute generously to political campaigns of legislators. These shareholders capitalized on what was a brief window of opportunity for sympathetic views by substantial majorities in both houses of Congress and by the President. In merging what had been six individual bills, Dodd-Frank may be less intrusive than would have been the combined legislation, had all six passed. Congress wisely declined to mandate majority voting and did not proscribe staggered boards in exchange for say-on-pay and proxy access.

In theory, requiring expanded shareholder communication about company operations is a positive step; however, broad-based federal requirements are unnecessary and certainly impose additional expense on business operations. When politics drives legislation, we are left to ponder the wisdom of subverting traditional state schemes for the unknown where interested parties in the state can explore legislation alternatives and empirically assess what change actually results in better performance - an option lost when the feds mandate a one-size-fits-all regime.

All of which is consistent with the argument I made in my article Dodd-Frank: Quack Federal Corporate Governance Round II (September 7, 2010), in which I argue that:

In 2005, Roberta Romano famously described the Sarbanes-Oxley Act as “quack corporate governance.” In this article, Professor Stephen Bainbridge argues that the corporate governance provisions of the Dodd-Frank Act of 2010 also qualify for that sobriquet.

The article identifies 8 attributes of quack corporate governance regulation: (1) The new law is a bubble act, enacted in response to a major negative economic event. (2) It is enacted in a crisis environment. (3) It is a response to a populist backlash against corporations and/or markets. (4) It is adopted at the federal rather than state level. (5) It transfers power from the states to the federal government. (6) Interest groups that are strong at the federal level but weak at the Delaware level support it. (7) Typically, it is not a novel proposal, but rather a longstanding agenda item of some powerful interest group. (8) The empirical evidence cited in support of the proposal is, at best, mixed and often shows the proposal to be unwise.

All of Dodd-Frank meets the first three criteria. It was enacted in the wake of a massive populist backlash motivated by one of the worst economic crises in modern history. As the article explains in detail, the corporate governance provisions each satisfy all or substantially all of the remaining criteria.

As for the point that we lose when the feds adopts a "one-size-fits-all regime," see my article The Creeping Federalization of Corporate Law, in which I argue that:

No one seriously doubts that Congress has the power under the Commerce Clause to create a federal law of corporations if it chooses. The question of who gets to regulate public corporations thus is not one of constitutional law but rather of prudence and federalism. In this essay, I advance both economic and non-economic arguments against federal preemption of state corporation law. Competitive federalism promotes liberty as well as shareholder wealth. When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. If one regulator overreaches, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, exit is no longer an option and an essential check on excessive regulation is lost.

It's wonderful to see such a prominent corporate governance figure as CJ Steele advancing thse essential arguments.

"Becoming a Great Law Professor"

Gordon Smith posts an interesting anecdote and some pertinent thoughts on the titular subject, concluding that times have changed. In the old days, he relates, greatness was measued by whether one had written "a casebook, a treatise, and a Restatement." (For the benefit of those keeping score at home, I've notched the first two.) Today, however:

The highest achievement of a law professor today is creating a new concept or theory that is used widely by other academics in the field. In the areas we write about on this blog, many of our foundational ideas were developed by economists or organizational theorists, not law professors, but you might think of the "separation of ownership and control" by Adolf Berle or "transaction-cost engineering" by Ron Gilson. These ideas shape the way we think about the world, and that is no small accomplishment.

Modesty, of course, prevents me from mentioning "director primacy" in this exalted company.

Chandler joins Wilson Sonsini

Dealbook:

Chancellor William B. Chandler III, the chief judge of the Delaware Chancery Court, announced on Thursday that he wold be joining the law firm of Wilson Sonsini Goodrich & Rosati as a partner. Dealbook’s Deal Professor, Steven M. Davidoff, interviewed him immediately after the announcement.

Very interesting interview.

On a related note, I find it curious that none of the movers or shakers in the Delaware Bar have contacted me to implore me to allow my name to be put into nomination as Chandler's replacement. But I remain by the phone.

Are you offended?

"It’s now very common to hear people saying ‘I’m rather offended by that’ as if that gives them certain rights – it’s simply a whine, it’s no more than a whine. ‘I find that offensive’. It has no meaning, it has no purpose, it has no reason to be respected as a phrase. ‘I am offended by that’ – well so f*cking what?” - Stephen Fry at the Hay Festival 2005

CNN sex scandal report omits Spitzer

Chris Ariens:

A TVNewser reader Tweeted at us today:

@tvnewser @HowardKurtz: Did CNN really exclude Spitzer from Malveaux package on Sex Scandals & Politics? Hmm..

The answer: yes it did.

Suzanne Malveaux‘s story, which aired at 2:30pmET, made mention or showed images of politicians ranging from John F. Kennedy to John Edwards; also former Governors James McGreevey and Mark Sanford, and former Sen. Larry Craig and current Sen. David Vitter, former Pres. Bill Clinton, and 2012 presidential candidate Newt Gingrich — their private indiscretions made very public. But no mention of Eliot Spitzer who resigned as Governor of New York after it was revealed he had patronized a prostitution service. Spitzer now hosts CNN’s 7pm show “In the Arena.” We’ve learned the producer/editor on the story, who use their own judgment on what to use and what not to use, chose not to include Spitzer in the story.

Spitzer does appear on a CNN web site slideshow, but it's still a pretty egregious omission. After all, what Spizer did was actually illegal, not just unseemly, even if he caught a break from the prosecutors who decided not to charge him. Plus, of course, Spitzer was a prosecutor charged with oversight of criminal cases and the top law enforcement officer of the State of New York when some of the illegal shenanigans took place. So you could make a pretty good case that Spitzer's a worse offender than those who stories CNN decided were worth dredging up.

Yeah, but they keep changing their minds

Andrew Sullivan:

From The Annals Of Sane Conservatism II

"I'm not a meteorologist. All I know is 90 percent of the scientists say climate change is occurring. If 90 percent of the oncological community said something was causing cancer we'd listen to them," - Jon Huntsman, in Time.

Fair enough. I'm prepared to listen to them too. BUT oncology's an interesting example. Why? because the damned doctors keep changing their mind all the time. Take salt, for example. When I was a kid, we were told to take salt tablets if we got really sweaty, so as to restore our electrolytes. When I got older, I was told to bypass salt or I'd end up having to get a heart bypass. And now there's a brand new study that says:

...liberal use of the salt shaker might actually be more of a cure than a curse when it comes to human health, according to new research.

The study, published Tuesday in the Journal of the American Medical Association (JAMA), followed health trends in 3,681 individuals over a median of almost 8 years, and found that a higher sodium intake was actually associated with a lower incidence of cardiovascular disease (CVD), and that the amount of salt consumed had no correlation with hypertension.

So we listen. But we are justifiably skeptical. Paradigm shifts happen in science all the time. Before we trash the economy, we better be damned sure those 90% of meterologists are really right. (And not just saying what they need to say to, for example, get their next grant.)

Repealing Dodd-Frank piecemeal

BNA reports (sub. req'd) that the House Financial Services Capital Markets Subcommittee has passed several bills that would repeal or revise several of Dodd-Frank's more onerous provisions. Among them are:

The Burdensome Data Collection Relief Act (H.R. 1062), sponsored by Nan Hayworth (R-N.Y.), would repeal Section 953(b) of the Dodd-Frank act. The provision requires public issuers to disclose the median annual total income for all employees except the CEO and the annual total income of the CEO, and to calculate the ratio comparing the two figures.

In my article Dodd-Frank: Quack Federal Corporate Governance Round II (September 7, 2010).  Available at SSRN: http://ssrn.com/abstract=1673575, I explain that:

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.[1] It further requires disclosure of “the median of the annual total compensation of all employees of the issuer,” except the CEO, the CEO’s annual total compensation, and the ratio of the two amounts.[2] This requirement is expected to be hugely burdensome:

[It] means that for every employee, the company would have to calculate his or her salary, bonus, stock awards, option awards, nonequity incentive plan compensation, change in pension value and nonqualified deferred compensation earnings, and all other compensation (e.g., perquisites). This information would undoubtedly be extremely time-consuming to collect and analyze, making it virtually impossible for a company with thousands of employees to comply with this section of the Act.[3]

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[1] Id.

[2] Dodd-Frank § 953.

[3] Warren J. Casey & Richard Leu, United States: New Executive Compensation Disclosures Under Dodd-Frank (August 3, 2010), Mondaq.com, http://www.mondaq.com/unitedstates/ article.asp?articleid=106962. See also Jean Eaglesham & Francesco Guerrera, Pay Law Sparks “Nightmare” on Wall St, Fin. Times, Aug. 31, 2010, at 1 (“The rules’ complexity means multinationals face a "logistical nightmare" in calculating the ratio, which has to be based on the median annual total compensation for all employees, warned Richard Susko, partner at law firm Cleary Gottlieb. "It's just not do-able for a large company with tens of thousands of employees worldwide.”).

The other reform bills include:

Former SEC General Counsel says Rule 10b5-2 is invalid

In an article "inspired" by former SEC General Counsel Ralph C. Ferrara (and written by a couple of his associates), Ferrara takes on an issue with which this blog has often dealt; namely, the validity of SEC Rule 10b5-2. I've explained before that this rule provides "a nonexclusive list of three situations in which a person has a duty of trust or confidence for purposes of the 'misappropriation' theory...." Crucially, the Rule purports that such a duty exists whenever someone agrees to maintain information in confidence. And I have argued that:

Rule 10b5-2's imposition of liability whenever someone agrees to maintain information in confidence is inconsistent with the emphasis in Chiarella and its progeny on the need for a duty of disclosure that arises out of a relationship of trust and confidence. Whether the SEC has authority to create a rule imposing misappropriation liability on the basis of an arms-length contractual duty of confidentiality--as opposed to a fiduciary duty-based duty of confidentiality--has not been tested. In light of the case law discussed above, however, I think the SEC lacked authority to adopt the rule.

Former SEC General Counsel Ferrara agrees (sub. req'd):

Despite the prior, repeated insistence by the Supreme Court that a relationship of trust and confidence must exist upon which to predicate Section 10(b) liability, Rule 10b5-2(b)(1) instead posits that the existence of a confidentiality agreement alone can establish the requisite duty upon which to base Section 10(b) liability. Yet a mere confidentiality agreement does not create a duty of trust and confidence; it is simply a contract not to share information with others – not a prohibition against acting upon such information.

Notably, while the Chiarella, Dirks, and O'Hagan decisions reference the need to establish a fiduciary or similar duty of trust and confidence, Rule 10b5-2(b) speaks of a duty of “trust or confidence.” The use of “or” instead of “and” thus creates new law. District courts prior to the adoption of the Rule had similarly misconstrued the duty requirement. For example, in United States v. Reed, the court misquoted Chiarella as requiring a relationship of “trust or confidence.” ¹⁷ Similarly, the district court in SEC v. Lenfest misquoted the Ninth Circuit, making the same “and” to “or” mutation. ¹⁸ Likewise, the district court in SEC v. Mayhew misquoted the Second Circuit. ¹⁹

¹⁷ Compare United States v. Reed, 601 F. Supp. 685, 704 n.30 (S.D.N.Y. 1985) rev'd on other grounds, 773 F.2d 477 (2d Cir. 1985) with Chiarella, 445 U.S. at 228, 230, 232. Xaphes v. Shearson, Hayden, Stone, Inc., 508 F. Supp. 882, 886 (S.D. Fla. 1981) made the same mistake.

¹⁸ Compare SEC v. Lenfest, 949 F. Supp. 341, 343-344 (E.D. Pa. 1996) with SEC v. Clark, 915 F.2d 439, 443, 447, 452 (9th Cir. 1990).

¹⁹ Compare SEC v. Mayhew, 916 F. Supp. 123, 129 (D. Conn. 1995) with United States v. Chestman, 947 F.2d 551, 564, 565, 566, 567, 568, 569, 570 (2d Cir. 1991), cert. denied, 503 U.S. 1004 (1992).

Moreover, it is evident from the rulemaking process that the SEC intended for the Rule to apply exclusively to personal or familial relationships. The SEC created Rule 10b5-2 to resolve “an unsettled issue in insider trading law” – namely, “under what circumstances certain non-business relationships, such as family and personal relationships, may provide the duty of trust or confidence required under the misappropriation theory.” ²⁰ The SEC described its proposed rule as “determining when family or personal reasons create ’duties of trust or confidence’ under the misappropriation theory.” ²¹ The SEC made no mention of its intent to apply the rule to business relationships. Against this background, it is clear that the SEC exceeded its statutory grant of authority in enacting the Rule.

²⁰ Selective Disclosure and Insider Trading, 65 Fed. Reg. 51716, 51729 (final rule, Aug. 24, 2000) (emphasis added); see also Selective Disclosure and Insider Trading, 64 Fed. Reg. 72590, 72591 (proposed rule, Dec. 28, 1999).

²¹ 64 Fed. Reg. at 72603.

He concludes:

Sooner or later, courts must come to grips with the tension between the “and” of O'Hagan and the “or” of Rule 10b5-2. Until that time, the SEC will continue to pursue traders for conduct that it is either unable or unwilling to define, and will continue to waste its limited resources by exceeding what it may lawfully regulate. Such unchecked agency action may cause undue uncertainty in the financial markets, creating a chilling effect on business and investment. These repercussions, in the current climate of economic instability, should not be taken lightly.