ProfessorBainbridge.com

Dodd-Frank at 1 blog symposium

Conglomerate is having a blog symposium on Dodd Frank Year One.

Dodd-Frank at 1: Say on Pay

Lisa Fairfax has a nice write up of the experience to date.

"So What If Corporations Aren't People?"

An excellent essay by two Cato experts--Ilya Shapiro and Caitlyn McCarthy--argues that:

Corporate participation in public discourse has long been a controversial issue, one that was reignited by the Supreme Court's decision in Citizens United v. FEC, 130 S. Ct. 876 (2010). Much of the criticism of Citizens United stems from the claim that the Constitution does not protect corporations because they are not "real" people. While it's true that corporations aren't human beings, that truism is constitutionally irrelevant because corporations are formed by individuals as a means of exercising their constitutionally protected rights. When individuals pool their resources and speak under the legal fiction of a corporation, they do not lose their rights. It cannot be any other way; in a world where corporations are not entitled to constitutional protections, the police would be free to storm office buildings and seize computers or documents. The mayor of New York City could exercise eminent domain over Rockefeller Center by fiat and without compensation if he decides he'd like to move his office there. Moreover, the government would be able to censor all corporate speech, including that of so-called media corporations. In short, rights-bearing individuals do not forfeit those rights when they associate in groups. This essay will demonstrate why the common argument that corporations lack rights because they aren't people demonstrates a fundamental misunderstanding of both the nature of corporations and the First Amendment.

They draw in part on the analysis in my posts Sonia Sotomayor and the Corporate Personhood and Who Owns the Corporation? Nobody.

Are Carl Icahn's Externalities Positive or Negative?

Steven Davidoff has an interesting column on Icahn's performance:

His results are mixed, according to a recent study titled, “Is Carl Icahn Good for Long-Term Shareholders?” Companies that are acquired after Mr. Icahn takes a stake experience average stock gains of 25 percent. Shares in those businesses that remain independent fall roughly 60 percent in the 18-month period after his ownership is disclosed. ...

The net result is that current shareholders get a short-term benefit from Mr. Icahn, but typically profit in the long term only if the company is acquired.

But activism is about enhancing shareholder value over the long term. While Mr. Icahn may do that by pushing companies to sell themselves, he has proved far less adept at driving fundamental change.

The market and the debt limit debate

Despite the warnings of economic apocalypse in the event the debt limit isn't raised, the best evidence--i.e., the behavior of people with skin in the game--continues to be reassuring:

The cost of insuring U.S. debt in the credit default swap market fell, after earlier moving back to its recent highs, though the contracts continued to reflect a very low probability of a default.

Five-year protection costs, the most liquid contract, fell by 2 basis points to 54 basis points, or $54,000 per year for $10 million in debt, according to Markit.

Germany's CDS also fell, though it remained above U.S. protection costs, suggesting that investors see contagion from the euro zone as a larger concern than the potential problems posed by the U.S. debt ceiling debate.

German CDS fell 2 basis points to 62 basis points, Markit data show.

The widening spread between short and long term Treasuries, however, is worrisome. Investors in longer term instruments seem to be worried that the government is not going to be able to fix our deficit and debt problems over the medium- to long-term.

Attn Business Associations Students and Teachers who use Klein, Ramseyer & Bainbridge

You can download the syllabus for the Fall 2011 Business Associations course I am teaching at UCLAW here (31.5K). The syllabus is designed for 30 100-minute classes using the Klein, Ramseyer & Bainbridge case book. My Corporation Law and Agency  and Partnership treatises make good supplements.

Olson amused by Delaware

Walter Olson:

“[The] Delaware [court system] is now almost actively hostile toward cases they think are without merit,” Widener lawprof Larry Hamermesh tells the Wall Street Journal, regarding flimsily based suits in which lawyers seek to block corporate mergers and then collect fees when the target agrees to settle in order to get the deal done. Imagine that — almost actively hostile. If this keeps up, are lawyers supposed to hold back on unmeritorious cases, and only file the meritorious sort? Wouldn’t that be, like, monotonous?

It would certainly be something new and different.

BYU's Gordon Smith Caricatured

Here

Prosecution as Regulation

Whether litigation is an appropriate forum for making policy is a vexing question of long standing. An interesting case study is provided by Richard Cupp's essay Seeking Redemption for Torts Law – A Review of ‘Holding Bishops Accountable: How Lawsuits Helped the Catholic Church Confront Clergy Sexual Abuse’ by Timothy D. Lytton:

In Holding Bishops Accountable, Professor Timothy Lytton presents the Catholic Church child molestation lawsuits as an example to encourage a more careful look at torts litigation’s potential policymaking benefits. In this forthcoming book review (draft available for download), Professor Cupp praises Professor Lytton’s thesis and his impressive scholarship. However, the review raises as an open question whether the clergy abuse cases provide an illustration that is too exceptional to substantially enhance openness to the idea of torts litigation as a policy tool.

Church leaders abusing vulnerable children creates a deeply compelling “morality play,” and a plaintiff’s attorney’s perfect plotline. Finding a more sympathetic plaintiff than a defenseless child or a more deplorable defendant than a corrupt clergyman abusing innocents is not easy. The review acknowledges that in the information age a strong symbiotic relationship exists between news and torts lawsuits that should not be underestimated in assessing torts law’s impact on policymaking. With a scenario as shocking as priests molesting children, the media justifiably flock to cover the scandalous story, the extensive coverage shapes public perceptions, and significant policy change predictably follows.

The review recognizes that under the right circumstances, torts law might play a role as a policymaking tool, but it cautions that the particularly powerful illustration of clergy abuse litigation is just that – particularly powerful – and that torts law’s potential for influencing policy is more limited in most litigation scenarios.

A Balanced Budget Amendment? And an Alternative.

The WSJ editorial board came out against the Balanced Budget Amendment (BBA) today, for several reasons, of which the following strikes me as most cogent:

Nor is it clear that the amendment could avoid unintended consequences. In the current fight over spending and the debt, the GOP Congressional leadership has worked well to protect the defense budget from a President who constantly cites the need to cut it. But under a mandated need to balance spending, the inevitable horse-trading would likely default to cutting defense while ducking fights on domestic programs. ...

Tea party Republicans, to their credit, want to pass a BBA that would include the supermajority tax limitation. But it has no chance of passing, and absent that rule, political pressure could turn the amendment into a driver for the entitlement state as successive Democratic governments raised taxes, most likely with a European-style value-added tax to balance spending commitments.

Norman Ornstein likewise recently opined against the BBA, but for far more left-leaning reasons:

A sagging economy requires what we call countercyclical policy, stimulus to counter a downturn and provide a boost. The need for countercyclical policy became apparent in the 1930s, after the opposite response to economic trouble caused a dizzying collapse; its application early in Franklin Roosevelt's presidency succeeded in pulling the United States out of the Depression (until a premature tightening in 1937-38 pulled us back down into it).

Countercyclical policy is what every industrialized country in the world employed when the credit shock hit in late 2008, to avoid a global disaster far more serious than the one we faced. Under a balanced-budget amendment, however, no countercyclical policy could emanate from Washington. Spending could not grow to combat the slump. And while the Obama stimulus did not jump-start a robust economic recovery, any objective analysis would find that absent the $800 billion stimulus, the economy would have spiraled down much further. ...

The Republican proposal would cap spending each year at 18 percent of gross domestic product. Because the formula is based on a previous year's economy, it would mean, according to Republican economist Don Marron, a cap of more like 16.7 percent of GDP. This in turn means that the House-passed budget proposed by Rep. Paul Ryan, which calls for draconian cuts in Social Security, Medicare, Medicaid and discretionary domestic programs, would not be nearly draconian enough. Accounting for population changes, the 16.7 percent limit would mean slashing Social Security and Medicare well below the levels contemplated by the bipartisan Simpson-Bowles fiscal commission, and cutting discretionary spending by half or more. It is hard to make the case that decapitating food inspection, air traffic control, scientific research, Head Start, childhood nutrition programs and more, as the amendment would almost certainly require, would lead to a healthier economy, itsef a necessity to solve the debt problem.

I'm a bit skeptical of the BBA myself, but what about a TABOR?

The Taxpayer Bill of Rights (abbreviated TABOR) is a concept advocated by conservative and free market libertarian groups, primarily in the United States, as a way of limiting the growth of government. It is not a charter of rights but a provision requiring that increases in overall tax revenue be tied to inflation and population increases unless larger increases are approved by referendum. ...

The basic reason for a TABOR is, as experience has taught, that politicians cannot be trusted:

If government always acted in the best interest of society, TABOR would never be needed. Therefore, the supposed need for TABOR is derived from a lack of trust of the representative democratic system. TABOR is kind of like the Bill of Rights in the U.S. Constitution: the Founding Fathers imposed restrictions on Congress (representatives of the people) from passing laws that restrict speech, establish religion, etc. If the Founding Fathers thought that Congress would always do what's in society's best interest, we wouldn't have needed a 1st Amendment that starts with the phrase "Congress shall make no law..." The Bill of Rights is inherently anti-democratic.

Maybe as a first-best solution (in a world of a purely benevolent government), the First Amendment isn't the best policy. But it's probably a second-best solution given that Congress isn't to be trusted when it comes to actively regulating speech, religion, etc.

And that's the ultimate question with TABOR. If government was purely benevolent, the first-best solution would be some optimal tax-spending mix. But if government is pre-disposed to get larger and larger (when left to its own devices) and be at a size that is far above optimal, a TABOR has the potential to improve societal well-being. It's likely not to lead to a perfect outcome, but it shouldn't be compared to what a perfect, purely benevolent government would do. It should be compared to what an imperfect government is actually doing (and likely to do in the future).

Derivatives and the Legal Origin of the 2008 Credit Crisis

My friend and UCLAW colleague Lynn Stout has posted an interesting paper to SSRN entitled Derivatives and the Legal Origin of the 2008 Credit Crisis:

Experts still debate what caused the credit crisis of 2008. This Article argues that dubious honor belongs, first and foremost, to a little-known statute called the Commodities Futures Modernization Act of 2000 (CFMA). Put simply, the credit crisis was not primarily due to changes in the markets; it was due to changes in the law. In particular, the crisis was the direct and foreseeable (and in fact foreseen by the author and others) consequence of the CFMA’s sudden and wholesale removal of centuries-old legal constraints on speculative trading in over-the-counter (OTC) derivatives.

Derivative contracts are probabilistic bets on future events. They can be used to hedge, which reduces risk, but they also provide attractive vehicles for disagreement-based speculation that increases risk. Thus, as an empirical matter, the social welfare consequences of derivatives trading depend on whether the market is dominated by hedging or speculative transactions. The common law recognized the differing welfare consequences of hedging and speculation through a doctrine called “the rule against difference contracts” that treated derivative contracts that did not serve a hedging purpose as unenforceable wagers. Speculators responded by shifting their derivatives trading onto organized exchanges that provided private enforcement through clearinghouses in which exchange members guaranteed contract performance. The clearinghouses effectively cabined and limited the social cost of derivatives risk. In the twentieth century, the Commodity Exchange Act (CEA) largely replaced the common law. Like the common law, the CEA confined speculative derivatives trading to the organized (and now-regulated) exchanges. For many decades, this regulatory system also kept derivatives speculation from posing significant problems for the larger economy.

These traditional legal restraints on OTC speculation were systematically dismantled during the 1980s and 1990s, culminating in 2000 with the enactment of the CFMA. That legislation set the stage for the 2008 crises by legalizing, for the first time in U.S. history, speculative OTC trading in derivatives. The result was an exponential increase in the size of the OTC market, culminating in 2008 with the spectacular failures of several systemically important financial institutions (and the near-failures of several others) due to bad derivatives bets. In the wake of the crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). Title VII of the Act is devoted to turning back the regulatory clock by restoring legal limits on speculative derivatives trading outside of a clearinghouse. However, Title VII is subject to a number of possible exemptions that may limit its effectiveness, leading to continuing concern over whether we will see more derivatives-fueled institutional collapses in the future.

Stochastic Process Models of Accounting Fraud

My friend Mike Guttentag has posted an ambitious and very interesting paper to SSRN etitled Stumbling into Crime: Stochastic Process Models of Accounting Fraud:

This book chapter introduces the use of stochastic process modeling to the analysis of how a sequence of minor and seemingly innocuous transgressions may lead to accounting fraud.

Wondering what "stochastic process modeling" is? Candidly, so was I:

Stochastic process models are a mathematical tool used to analyze a phenomenon in which observable “macroscopic” behavior is produced by the cumulative effect of numerous “microscopic” events. Such a model is especially useful when the “microscopic” events cannot be easily observed. This is likely the situation if seemingly minor and inconsequential transgressions lead to accounting frauds.

Three related types of stochastic process models are well-suited to describe the dynamics within a firm that could lead to accounting fraud. The first type of model is based on the movement of a random walker. To apply a random walk stochastic process model to accounting fraud, it is helpful to assume that the illegality of behavior within a firm can be measured along a single dimension and that movement along this “illegality” dimension is determined by a sequence of minor decisions. The resulting random walk stochastic process model of accounting fraud yields testable hypotheses about when and where accounting frauds are likely to occur.

However, a simple random walk model fails to incorporate several important aspects of the process by which minor transgressions might lead to accounting fraud. For one thing, a random walk model is non-stationary, so that over time the walker wanders farther and farther away from the starting point. However, one would not expect the level of lawful or unlawful activity within a firm to become more and more extreme over time. To account for the fact that the level of misbehavior within a firm usually stays within a given range, a mean-reverting force can be added to the simple random walk stochastic process model. The resulting stochastic process model is stationary, which may better describe the dynamics within a firm that lead the level of misbehavior to only occasionally become highly aberrant.

A second limitation of the simple random walk model is that it cannot be used to model a situation in which, once a certain boundary is crossed, it is difficult to return to where one has been. There are likely many instances during the process leading to accounting fraud in which actions are taken which are difficult to undo. For example, once a firm makes a public disclosure about its financial condition, the firm’s ability to restate past performance will be limited. To take into account the likelihood that certain behaviors (such as publicly reporting financial performance), once made, will be difficult to reverse, the random walk model can be supplemented with a running maximum. This is the third type of stochastic process model I consider in this Chapter.

Teaching Business Associations

Interesting roundtable discussion at the Conglomerate of current issues in teaching the basic Business Associations course. teachers of BA will want to check out the website for the Klein, Ramseyer & Bainbridge Business Associations case book.

7-19

That's the Ninth Circuit's record in the last Supreme Court term. Seven affirmations versus 19 cases reversed or vacated:

It was another bruising year for the liberal judges of the U.S. 9th Circuit Court of Appeals as the Supreme Court overturned the majority of their decisions, at times sharply criticizing their legal reasoning.

Appeals from the nine Western states of the circuit dominated the high court's docket, as usual, supplying more than 30% of the 84 cases taken up by the justices during the term that ended last month. ...

In their reversals, the justices often expressed impatience with what they see as stubborn refusal by the lower court to follow Supreme Court precedent. One of the circuit's most renowned liberals, Judge Stephen Reinhardt, was seen by judicial analysts as the main target of the justices' pique.

"It’s baaack: The Shareholder Protection Act"

Ribstein doesn't like it any better than I do.