ProfessorBainbridge.com

Lost maxims of equity

I recently ran across a very short article by my friend and UCLAW colleague on "The Lost Maxims of Equity," 52 J. Legal Educ. 619 (2002):

Equity abhors a nudnik.

Equity delights in a good practical joke.

He who seeks equity must do so with full pockets.

Equity is not for the squeamish.

Equity, schmequity.

Equity can be grumpy before its first cup of coffee.

Equity is crunchy on the outside, soft and chewy on the inside.

Equity is a mean drunk.

Equity, like all of us, prefers the rich and good-looking.

Clawback Mary Schapiro's pay

Alison Frankel recently reported on a major new court decision on using clawbacks to punish executives under whose watch firms made financial misstatements:

The SEC is demanding that the Arthrocare officials, former CEO Michael Baker and former CFO Michael Gluk, return to the company the unspecified bonuses, stock options and stock-sale profits they received in 2006 and 2007 — even though Baker and Gluk were not involved in the accounting misconduct that forced Arthrocare to restate its financials in those years. 

In upholding the SEC's claims, U.S. District Judge Sam Sparks of Austin, Texas, "all of the challenges, including constitutional arguments, that the former top officials of ... Arthrocare raised in the SEC’s so-called clawback suit under [Sarbanes-Oxley] Section 304."

As Kevin LaCroix noted:

... there have been prior rulings upholding the SEC”s right to pursue clawback actions under Section 304 even in the absence of allegations that the corporate executives from whom compensation clawback is sought were involved in or even aware of the misconduct that led to the restatement. However, Spark’s opinion provides a broad theoretical justification for the SEC’s use of the provision and may represent something of an encouragement to the agency to use  its authority under the statute ...

Although I support 304, I'm not unsympathetic to LaCroix's concern that "that Section 304 represents part of a dangerous legal trend that tends to want to try to impose liability without culpability (as [he] discussed at length here)." Even so, Section 304 is on the book and whether the trend as a whole is a good idea, there are good policy reasons to impose liability without moral culpability in this context. As Frankel explains:

By demanding that they return bonuses and other incentive compensation to the company, the provision “creates an incentive for (officials) to be diligent in carrying out those (certification) duties,” the judge wrote, noting that Congress deliberately drafted the law to apply to officials who weren’t involved directly in cooking the books. “The absence of any requirement of personal misconduct is in furtherance of that purpose: It ensures corporate officers cannot simply keep their own hands clean, but must instead be vigilant in ensuring there are adequate controls to prevent misdeeds by underlings.”

Moreover, as LaCroix notes:

Section 304’s requirements are “crystal clear”; the Act “tells executives precisely what they must do to avoid reimbursement liability.” They must, Sparks noted, “ensure the issuer files accurate financial statements.” They are to do so by establishing and maintaining internal controls. Judge Sparks went further to find that there is a “reasonable relationship” between the conduct and the penalty; “where, as here …corporate officers are asleep on their watch,” they are liable for a penalty that is limited to the amounts of their bonus compensation.

Obviously, Section 304 applies only to corporate executives (and only to performance pay), but outgoing Securities and Exchange Commission Chair Mary Schapiro's announcement that she is stepping down raises the question of why she gets a free ride on precisely the same sort of conduct for which corporate executives are subject to having their pay clawed back.

During Schapiro's tenure, the Government Accountability Office has consistently found that the SEC's internal controls are seriously flawed. In a 2012 letter to Schapiro, for example, the GAO explained that:

In our audit of SEC’s fiscal years 2011 and 2010 financial statements, we identified four significant deficiencies in internal control as of September 30, 2011. These significant internal control deficiencies represent continuing deficiencies concerning controls over (1) information systems, (2) financial reporting and accounting processes, (3) budgetary resources, and (4) registrant deposits and filing fees. These significant control deficiencies may adversely affect the accuracy and completeness of information used and reported by SEC’s management. 

Some of these deficiencies "resulted in misstatements in SEC’s liability balances."

And then there are the appalling "allegations of serious misconduct, failure of internal controls, and whistle blower retaliation" advanced by SEC whistleblower David Weber:

Weber’s titillating testimony turns its focus on other executives within the Commission, including the COO and chair Mary Schapiro. Weber’s charges of nepotism and a lack of meaningful internal controls expose the risks that the Commission presented in its daily management of operations and beyond that as well. One does not need to read very hard to understand Weber’s belief that the SEC’s COO utilized a “pay to play” practice. Additionally, in a scene fit for the classic movie Dumb and Dumber, Weber asserts that SEC representatives brought highly sensitive computer code and encryption data to monitor activity on our equity exchanges to a hacker’s conference in Las Vegas. You cannot make this stuff up, folks.

Saving some venom for Ms. Schapiro as well, Weber paints her as a “LIAR” for perjuring herself during a presentation before the House and Senate Oversight Committee regarding the SEC’s bungled attempt to move to new office quarters. Weber would not be the first to label Ms. Schapiro with the big L. Recall that Attorney Richard Greenfield did just the same in the case brought on behalf of Standard Chartered v FINRA, Mary Schapiro et al.

In sum, as Hester Pierce observes, under Schapiro's tenure there has been "a continuing embarrassment for the SEC" when the GAO annually identifies "new and continuing significant deficiencies in the SEC's internal controls over financial reporting." 

At the very least, Mary Shapiro has been asleep at the switch while the SEC has continually failed to remediate serious internal control deficincies that the SEC would never tolerate in a private company. As the late Larry Ribstein once quipped:

Suppose a company or executive civilly or criminally charged with disclosure or internal control violations after a sudden market decline magnifies risks the company ignored tells the SEC or Justice: “we’re making significant strides on disclosure and we’ll do a better job the next time.”  The SEC or Justice will tell the company:  “We understand.  You have to be looking around the next corner or beyond the next horizon, and that’s very hard.  Just do the best you can.” Something like that.

If clawing back executive pay is necessary to give corporate executives "an incentive for (officials) to be diligent in carrying out" their duties over corporate internal controls, maybe clawing back government official pay when they "are asleep on their watch,” would give future SEC chairs the necessary incentive to avoid Schapiro's manifold failures to fix the SEC's internal problems.

The WSJ is shocked to discover insider trading in Corporate America

In what may be the dumbest piece of reporting I've seen in a while, the Wall Street Journal offers up a breathless "expose" showing that corporate insiders often beat the market when trading in their own company's stock. This is "news"?

Red flags and the H-P board of directors' liability exposure re the Autonomy acquisition

In connection with the growing controversy over Hewlett-Packard's acquisition of Autonomy, the WSJ is reporting that HP is accusing Autonomy of having "made 'outright misrepresentations' to inflate its financial results" prior to the acquisition:

Last week, the company wrote down the value of Autonomy by $8.8 billion, blaming more than half the charge on what it said was Autonomy's misleading accounting. ... Autonomy used aggressive accounting practices to make sure revenue from software licensing kept growing—thereby boosting the British company's valuation. The firm recognized revenue upfront that under U.S. accounting rules would have been deferred, and struck "round-trip transactions"—deals where Autonomy agreed to buy a client's products or services while at the same time the client purchased Autonomy software, according to these people. ...

A person familiar with H-P's investigation said the company is confident the deals are improper even under the international accounting standards Mr. Lynch cites. "We've looked at this very closely," this person said.

In a statement issued Saturday, H-P said its "ongoing investigation into the activities of certain former Autonomy employees has uncovered numerous transactions clearly designed to inflate the underlying financial metrics of the company before its acquisition" ....

As a corporate governance teacher/scholar, my immediate thought was to ask "where was HP's board" and then "what's their liability exposure."

I can imagine two claims on the facts as we know them. First. H-P shareholders might sue the H-P board of directors for having made an uninformed decision to approve the merger. The key precedent here is Smith v. Van Gorkom, about which I have written here. In brief, that case held that directors who make an uninformed decision are not entitled to the protections of the business judgment rule. Instead, they face liability for damages caused by their breach of the duty of care. Instructively, Van Gorkom also involved a merger (although it was the target board being sued rather than the acquirer, as would be the case here).

Second, the shareholders might sue the H-P directors for having failed to exercise adequate oversight of the merger process. The key precedent here would be in re Caremark, about which I have written here. The Caremark decision asserted that a board of directors has a duty to ensure that appropriate “information and reporting systems” are in place to provide the board and top management with “timely and accurate information.” The claim here would be that the H-P board failed to ensure that such systems were in place to supervise both the pre-merger negotiations and the post-merger integration process.

In either case, a key question will be whether the board ignored red flags that should have alerted it to problems with Autonomy's books. 

Because liability generally requires a sustained or systematic failure on the board’s part, rather than just a few instances of inattention, red flags need to be "numerous, serious, directly in front of the directors, and indicative of a corporate-wide problem." Regina F. Burch, Director Oversight and Monitoring: The Standard of Care and the Standard of Liability Post-Enron, 6 Wyo. L. Rev. 481, 498 (2006).

An instructive Delaware precedent on this issue is Chancellor Chandler’s opinion in Ash v. McCall,[1] in which plaintiff shareholders sued the board of directors of McKesson HBOC, Inc. for, inter alia, failure to exercise proper oversight of financial matters in connection with the merger that formed the corporation. Plaintiffs relied heavily on “red flags” supposedly thrown up by various news reports casting doubt on the quality of the target corporation’s financial statements. In contrast, the defendant relied on the “clean bill of health” given those financial statements by the acquiring corporation’s financial advisors. Chancellor Chandler concluded that the plaintiffs had failed to state a claim:

When plaintiffs’ “red flags” are juxtaposed with the clean bill of health given by DeLoitte and Bear Stearns after due diligence reviews, the complaint permits one conclusion: that the McKesson directors’ reliance on the views expressed by their advisors was in good faith. What would plaintiffs have the McKesson board do in the course of making an acquisition other than hire a national accounting firm and investment bank to examine the books and records of the target company?[2]

In addition, the fact that HBOC’s management had responded to some of the media reports constituting plaintiffs’ red flags was not deemed to give the board of directors either constructive or imputed knowledge of the alleged accounting irregularities.[3] Post-McCall decisions have further explained that alleged “red flags” must be “either waived in one’s face or displayed so that they are visible to the careful observer.”[4]

So did the H-P board have sufficient such red flags to have been put on alert? The WSJ story recounts a certain amount of aggressive and unpleasant behavior on the part of senior Autonomy management, but that's not the sort of red flag in question. Instead, the issue is whether there were red flags that should have led the board to inquire into Autonomy's accounting practices. 

Here the Journal's Heard on the Street column is suggestive:

Consider the multiple reports published about Autonomy by accounting research firm CFRA. Dating back to 2007, these raised questions about its lack of nonacquisition-driven revenue growth and unsustainable contributions to cash flow, among other issues. It would be surprising if no one at H-P doing due diligence on the Autonomy deal was aware of such concerns. And what of the back-office integration work once the deal closed? It isn't uncommon for small software companies to have funky revenue-recognition policies that need updating. Such issues are typically discovered immediately by acquiring companies. ...

Autonomy isn't the first problematic acquisition during [Chief Financial Officer Cathie Lesjak's] tenure as CFO. Others include H-P's purchases of EDS and Palm.

In light of Deloitte's giving the deal a clean bill of health, nothing in the Journal's reporting strikes this observer as rising to the level of serious and pervasive red flags that are required for liability, at least on sofar as the decision to merge with Autonomy. 

As for board oversight of the merger integration, the main story reports that:

The company began seeing potential problems with Autonomy's business shortly after the deal closed earlier this year, say people familiar with the matter. The company clawed back some of the commissions paid to salespeople using questionable accounting methods, they said.

Autonomy tried to continue certain accounting practices that the new parent wouldn't allow, say people familiar with the matter. H-P fired Mr. Lynch in May, and soon afterward a member of his inner circle still at H-P told the company's general counsel about possible accounting problems.

Those look like pretty serious red flags. Having said that, however, what could an attentive board have done to prevent the loss? It's not at all clear that the board could have done anything sooner to reduce the damage suffered.

Obamacare joke

I concede that it hovers on the edge of being lame, but it nevertheless amused me:

Of course, YMMV

Ridge Three Valleys (Sonoma County) 2010

A blend of 72% Zinfandel, 12% Carignane, 12% Petite Sirah, 2% Syrah, 1% Grenache, and 1% Alicante Bouchet from seven vineyards in Sonoma County. Deep and rich blackberry, plum, and cherry flavors and aromas. Young, but quite drinkable now. Probably not a wine for the cellar, but over the next three or four years it should be perfect for steaks, barbecue, roast chicken, and the like. Grade: B+

I would love to talk to Paul Draper about the decision to include such minuscule amounts of Syrah, Grenache, and Alicante Bouchet. Was it just that they had some left over or does he really think those minor additions made a significant difference? Towards that end, it would be fascinating to taste a blend that had omitted them to compare it to this bottle.

How far should the Fed be able to go to save the economy?

The indispensable Alison Frankel reports on an 89-page opinion by U.S. District Judge Paul Engelmayer dismissing claims againt the Fed by a former major AIG shareholder:

Starr’s lawyers at Boies, Schiller & Flexner and Skadden, Arps, Slate, Meagher & Flom offered a different (and singular) view of recent financial history, in which the U.S. government pushed AIG to the brink of bankruptcy by refusing it access to capital; seized control of the company via an offer AIG’s board had no choice but to accept; plundered the company’s assets while paying off AIG’s credit-default swap counterparties in full; and then illegally engineered a reverse stock split to dilute the interests of AIG’s pre-bailout shareholders. “Starr’s amended complaint paints a portrait of government treachery worthy of an Oliver Stone movie,” Engelmayer wrote.

What's striking about Engelmayer's opinion is that he decided the case as a matter of law. In other words, assuming all of Starr's claims to be true, what the Fed did was okay as a matter of law because of dire economic necessity:

The judge, in a gracefully written decision, concluded that, indeed, Delaware fiduciary law is pre-empted by the Fed’s mission. “(The Fed’s) challenged actions with regard to AIG during the financial crisis were integrally bound up in the rescue loan packages it furnished AIG in fall 2008, made with the goal of stabilizing the American economy,” he wrote. “And, where imposing state-law duties upon a federal instrumentality would squarely conflict with its federal responsibilities, as would subjecting (the Fed) to Delaware fiduciary duty law in connection with the terms of its serial rescues of AIG, such state law is pre-empted.”

One wonders what if any limits will remain on the Fed's power to screw creditors and shareholders if Engelmayer's analysis is upheld. If the government can "treachery worthy of an Oliver Stone movie,” could the Fed use unmanned drones to conduct targeted assassinations? And, if not, where's the damned line?

Fortunately, as Ms Frankel reports:

Judge Thomas Wheeler of the U.S. Court of Federal Claims kept alive Starr’s parallel claim that the Fed’s takeover of AIG, including the company’s common shares, was unconstitutional under the takings clause. Wheeler said that the takings claim rests on whether AIG’s board was forced to accept the terms of the government bailout or did so voluntarily; he split with Engelmayer and said that Starr had presented sufficient facts to support the theory that AIG had no choice.

Starr counsel at Boies Schiller sent an email statement, pointing out that Monday’s ruling by Engelmayer will have no impact on the Court of Federal Claims case, which also seeks $25 billion. 

Unfortunately, since Kelo, I've completely lost faith in the court's willingeness to use the takings clause to defend private property from government theft.

I agree with JHA that the "University of Iowa’s law faculty should be ashamed of themselves"

Adler:

The Des Moines Register ha an interesting article following up on the lawsuit against the University of Iowa law school alleging ideological discrimination in hiring. The judge declared a mistrial because the jury was deadlocked. According to interviews with jurors, however, there was genuine agreement that Teresa Wagner was denied a position because of her conservative views and political activism, but disagreement over whether the Dean could be held responsible. Given the nature of the claim, the Dean was the named defendant, rather than the university (or the faculty, who largely control academic hiring decisions).

jurors said they felt conflicted about holding a former dean personally responsible for the bias. They wanted to hold the school itself accountable, but federal law does not recognize political discrimination by institutions.

“I will say that everyone in that jury room believed that she had been discriminated against,” said Davenport resident Carol Tracy, the jury forewoman.

Meanwhile, attorneys for Teresa Wagner on Tuesday filed a motion for a new trial in the case that scholars agree could have national implications in what some argue is the liberally slanted world of academia.

The jury’s belief that Wagner was a victim of discrimination is significant as the case heads toward a retrial that will cost the state thousands of dollars to litigate and could cost the university hundreds of thousands of dollars should it lose or settle out of court, scholars following the case said.

Paul Caron has more here.

As I noted before, as a general matter I do not think faculty hiring decisions should be second guessed in courts. Ideological discrimination in faculty hiring is contrary to the principles of academic freedom and is incompatible with a genuine commitment to liberal education. But this does not mean such conduct should be illegal, particularly in private institutions. If the allegations are true the University of Iowa’s law faculty should be ashamed of themselves.

Smoked Turkey Hash with Foxen Tinaquaic Vineyard Syrah (Santa Maria Valley) 2010

On Thanksgiving Day, I grill-roasted a heritage breed, free range, organic 9 lb turkey from D'Artagnan using apple and hickory wood chips for smoke (one of the best things I ever did was to install a gas line on my back porch so I can run a natural gas grill and patio heater without ever having to worry about running out of propane on a long cook like this one, and hard wood charcoal purists can bite me).

Since it was just Helen and I, we had two drumsticks, one thigh, and one breast left over. A mid-morning snack today revealed that the leftovers had intensified in smokiness. I also had some leftover boiled new potatoes, green beans, and carrots. (The leftover cornbread dressing didn't make it past that midmorning snack). As I pondered tonight's dinner, I immediately thought: hash. So here's how I (mostly) cleaned out my refrigerator.

You definitely want to have your mise en place ready to go before you start cooking, as it goes pretty damned quick.

• ½ medium yellow onion, diced
• white parts of 3 green onions, diced finely
• 1 Serrano chile, seeded, minced finely
• 3 garlic cloves, minced finely
• 2 cups shredded turkey meat
• 8 golf ball sized boiled new potatoes cut into small dice
• ¾ cup cooked carrots, diced fine
• dried parsley flakes
• ¾ cup cooked haricot verts, diced fine
• green parts of 3 green onions, sliced finely
• olive oil
• unsalted butter
• salt
• pepper
• Worcestershire sauce
• 2 eggs
• Tabasco sauce

I heated my trusty All-Clad Master Chef 2 Nonstick 12-Inch Fry Pan over medium-high heat and added a tablespoon of olive oil and a tablespoon of butter. When the oil-butter mix stopped foaming, I added the onions and chili. I hit them with a small pinch of salt. I sauteed them until they had softened and were just beginning to color at the edges. I then added the garlic and cooked it another 30 seconds. Next I added the turkey and stirred it through. Next I added the potatoes, carrots, and a big pinch of the dried parsley. A big pinch of salt and 10 grinds of black pepper (using my Turkish pepper mill) followed. I tossed the hash around in the pan for a while, smoothed it out to an even level, and then pressed it down to let it brown. I spread the green beans and green onions on top of the mix.

While the hash browned, I heated a pat of butter in my Calphalon Nonstick 8-Inch Frying Pan. When the butter stopped foaming, I fried two eggs over easy. I seasoned them with salt, pepper, and a few dashes of Tabasco. As the eggs fried, I stirred the hash to mix in the beans and green onions. I then dished up the hash and topped each plate with one egg. Because I like heat much more than Helen does, I refrained from hitting her serving with the several more dashes of Tabasco to which I subjected mine.

What wine to serve with this hash? Granted, you could make a case for beer, cola, or iced tea being better matches. But I like wine. Specifically, red wine. I wanted something young, fruity, not super tannic, with some smoke being a plus. The 2010 Foxen Tinaquaic Vineyard Syrah worked surprisingly well. 

The bouquet suggests black cherry, raspberry, and cola. The palate picks up those elements, but adds smoky bacon, tar, and plums. Grade: B+

An ideal wine for Tim Burton to serve for Thanksgiving

Why shareholder empowerment is dangerous, at least for banks

In Corporate Governance after the Financial Crisis, I explained that: 

... regulators and some commentators identified executive compensation schemes that focused bank managers on short-term returns to shareholders as a causal factor in the financial crisis of 2007-2008.[1] As we have also seen, shareholder activists long have complained that these schemes provide pay without performance. This was one of the corporate governance flaws Dodd-Frank was intended to address, most notably via say on pay.

The trouble, of course, is that shareholders and society do not have the same goals when it comes to executive pay. Society wants managers to be more risk averse. Shareholders want them to be less risk averse. If say on pay and other shareholder empowerment provisions of Dodd-Frank succeed, manager and shareholder interests will be further aligned, which will encourage the former to undertake higher risks in the search for higher returns to shareholders.[2] Accordingly, as Christopher Bruner aptly observed, “the shareholder-empowerment position appears self-contradictory, essentially amounting to the claim that we must give shareholders more power because managers left to the themselves have excessively focused on the shareholders’ interests.”[3]

Now there's additional evidence that sharehjolder empowerment is dangerous, at least for banks. From Ferreira, Daniel, Kershaw, David, Kirchmaier, Tom and Schuster, Edmund-Philipp, Shareholder Empowerment and Bank Bailouts (November 2, 2012). Available at SSRN: http://ssrn.com/abstract=2170392:

We investigate the hypothesis that shareholder empowerment may have led to more bank bailouts during the recent financial crisis. To test this hypothesis, we propose a management insulation index based on banks’ charter and by-law provisions and on the provisions of the applicable state corporate law that make it difficult for shareholders to oust a firm’s management. Our index is both conceptually and practically different from the existing alternatives. In a sample of US commercial banks, we show that management insulation is a good predictor of bank bailouts: banks in which managers are fully insulated from shareholders are roughly 19 to 26 percentage points less likely to be bailed out. We also find that banks in which the management insulation index was reduced between 2003 and 2006 are more likely to be bailed out. We discuss alternative interpretations of the evidence. The evidence is mostly consistent with the hypothesis that banks in which shareholders were more empowered performed poorly during the crisis.

Somehow, however, I don't expect the apologists for shareholder empowerment to admit their error anymore than I expect the apologists for turning corporate governance over to the SEC to admit theirs.

One wonders what the SEC apologists will say post-Weber?

There is a contingent in the corporate law academy whose preference for federalization of corporate governance leads them to be kneejerk Delaware bashers and SEC apologists. Using the sex scandal aspects of the David Weber case to socre off them woul be cheap (albeit fun). But the allegations of serious misconduct, failure of internal controls, and whistle blower retaliation at the Securities and Exchange Commission are a different story:

Weber’s titillating testimony turns its focus on other executives within the Commission, including the COO and chair Mary Schapiro. Weber’s charges of nepotism and a lack of meaningful internal controls expose the risks that the Commission presented in its daily management of operations and beyond that as well. One does not need to read very hard to understand Weber’s belief that the SEC’s COO utilized a “pay to play” practice. Additionally, in a scene fit for the classic movie Dumb and Dumber, Weber asserts that SEC representatives brought highly sensitive computer code and encryption data to monitor activity on our equity exchanges to a hacker’s conference in Las Vegas. You cannot make this stuff up, folks.

Saving some venom for Ms. Schapiro as well, Weber paints her as a “LIAR” for perjuring herself during a presentation before the House and Senate Oversight Committee regarding the SEC’s bungled attempt to move to new office quarters. Weber would not be the first to label Ms. Schapiro with the big L. Recall that Attorney Richard Greenfield did just the same in the case brought on behalf of Standard Chartered v FINRA, Mary Schapiro et al.

What did Weber receive in return for running these tales of sex, lies, and stupidity up the chain of command? A pink slip, a defamed reputation, and much more. In his defense, Weber points out that an independent investigation by an Inspector General outside of the SEC who looked into charges made against him ultimately cleared him of allegations made against him by those inside the SEC.

If Weber's charges borne out even in part, how will the SEC's apologists be able to credibly continue to insist that the SEC can do a better job of regulating corporate governance than Delaware?

One thing's for sure, the SEC's apologiests won't be able to dismiss this as a one-off event. Not only does Weber's complaint allege pervasive internal controls, his allegations are not the only ones that have been lodged against the SEC.

For example, an April 2012 GAO report found that:

In our audit of SEC’s fiscal years 2011 and 2010 financial statements, we identified four significant deficiencies in internal control as of September 30, 2011. These significant internal control deficiencies represent continuing deficiencies concerning controls over (1) information systems, (2) financial reporting and accounting processes, (3) budgetary resources, and (4) registrant deposits and filing fees. These significant control deficiencies may adversely affect the accuracy and completeness of information used and reported by SEC’s management. ...

We also identified other internal control issues that although not considered material weaknesses or significant control deficiencies, nonetheless warrant SEC management’s attention. 

Or, as I observed all the way back in May 2005:

As the SEC continues pressing forward with enforcement of the internal controls provisions of SOX, something very amusing has come to light in a GAO report:

In GAO's opinion, SEC's fiscal year 2004 financial statements were fairly presented in all material respects. However, because of material internal control weaknesses in the areas of recording and reporting disgorgements and penalties, preparing financial statements and related disclosures, and information security, in GAO's opinion, SEC did not maintain effective internal control over financial reporting as of September 30, 2004.

Ouch! Mayhap the SEC needs to get its own house in order first? Or, at least, consult Matthew 7:3-5? It's a serious institutional embarassment for the SEC.

In sum, the current SEC leadership shouldn't be regulating a dog catcher operation, let alone the world's biggest capital markets.

BTW, if the SEC really is one of our finest agencies, as many prominent SEC apologists have claimed, what on earth must be going on at the bad ones? As for me, I'm filing this episode away in my list of reasons why federal agencies should not encroach upon areas of corporate governance traditionally relegated to state regulation.

So much for investor confidence in the markets

The SEC is always bitching and moaning about how insider trading undermines "investor confidence in the market place." Of course, it doesn't (see here). But as Wonkette's analysis of the brewing SEC scandal makes plain, the SEC itself may have done vastly more harm to investor confidence in the markets than any inside trader ever did:

 Rolling Stone brings us the ewww tale of SEC Inspector General David Kotz (ALLEGEDLY) boning every lawyer (like this pretty lady) with business before the agency, as well as his successor, Noelle Maloney, who then refused to meet with said lawyers because
“DAVID WAS FUCKING THAT LADY!” Until we see pix, it’s no Broadwell-Kelley Tampa Tap-Out. So what else is in this 77 page whistleblower complaint, you might be wondering? Is it all seks and lies and intrigue?

Well, sure there is some! But more hilarious are the accusations of gross malfeasance and incompetence, the likes of which (if true) may be egregious enough to compromise the functioning of Stock Exchange itself (to the degree that it functions right now, of course). No big deal though! ...

PAGE 35:

SEC examiners assigned to the Division of Trading and Markets performed “penetration testing” of the computer infrastructure of the NYSE, NASDAQ, and all other major exchanges. […]

The information obtained by this ARP examination program is of an extremely sensitive nature. In the wrong hands, this information could be used to disrupt trading activities on all of the exchanges, either individually by exchange, or at all exchanges simultaneously…In the OIG inquiry into the alleged misuse of computer equipment, Weber and his investigators found that the laptops which were used by SEC examiners during these examinations, and on which all the information from the examinations were stored, neither contained virus protection, encryption programs, or firewalls, nor were they ever wiped clean after testing. Some of the computers at issue were used in every stock exchange in the United States, and therefore exposed exchanges to infections or compromises that could be brought from exchange to exchange…

Some of these laptops were brought to foreign countries by SEC management, and by certain SEC management and employees to the “Black Hat” Conference in Las Vegas, Nevada.

Many of these unsecured laptops were probably brought to a hacker convention in Vegas.

PAGE 36:

The “Black Hat” Conferences are infamous for the illegal activities that occur during the Conferences. In an August 4, 2009, CNN article describing these conferences, the author notes, “[a]t a hacker conference no one is safe.” Indeed, senior IT security personnel at the SEC had acknowledged to Weber as part of the investigation that they were themselves too afraid to attend this Conference.

a.            During the 2009 Conference, websites belonging to security researchers were hacked and passwords, private e-mails, and other sensitive documents were released on a vandalized website.

b.            During the 2008 Conference, a thumb drive that was passed around by attendees was found to contain a computer virus.

c.            During the 2008 Conference, some attendees, themselves security experts, who used the Wi-Fi networks had their passwords “sniffed” and then posted on an electronic bulletin board called the “Wall of Sheep.” One “Wall of Sheep” participant remarked how surprising it was that so many Black Hat attendees were insecure.

d.            Also during the 2008 Conference, three French reporters were caught hacking into the press room network.

It’s cool though. No big deal.

PAGE 38:

When Weber questioned the SEC examiners as to why they would bring their laptops, containing extremely sensitive information, including the architecture and trading engines of the major stock exchanges, to the Black Hat Conference, they replied to the effect that they didn’t “think it was a big deal.”

So what happened, in the end, after this Weber guy became absolutely panicked at the thought of SEC employees or contractors, who may or may not have been given security clearance, taking unsecured laptops to a hacker convention in Vegas filled with foreigners, networking experts, and French reporters? Weber was canned, and forcibly escorted off SEC property.

<SARCASM>It sure fills me with confidence in the SEC and the markets.</SARCASM>

 

"Corporate Governance After the Financial Crisis" reviewed

Karen I. Heusel in Keeping Up with New Legal Titles, 104 Law Library Journal 579 (2012):

¶1 In his latest book, Corporate Governance After the Financial Crisis, Professor Stephen M. Bainbridge asserts that, in the wake of the significant economic setbacks of the past decade, Congress abandoned its traditional reticence on the matter of corporate governance, yielded to emotionally charged mainstream political demands, and enacted a deeply flawed set of corporate reforms. Specifically, Bainbridge objects to the various corporate governance provisions included in the Sarbanes-Oxley Act of 20021 and in 2010’s Dodd-Frank Act.2 Soundly denouncing both laws, he rejects these purported reforms as “quackery . . . lack[ing] strong empirical or theoretical justification” (p.15) and submits that the offending “provi- sions erode[] the system of competitive federalism that is the unique genius of American corporate law by displacing state regulation with federal law” (id.).

¶2 A prolific author and blogger and a self-proclaimed “Burkean conservative,”3 Stephen M. Bainbridge serves as the William D. Warren Distinguished Professor of Law at UCLA where he teaches courses on business associations, corporations, and corporate governance. In the past few years, Bainbridge has written several law review articles and books addressing the law and governance of public corporations.4

¶3 In Corporate Governance After the Financial Crisis, Bainbridge argues that Congress blundered badly with both of its recent efforts to regulate in these areas, in each case reacting hastily to a postcrisis atmosphere dominated by anticorpo- rate sentiment and passing legislation that usurps state corporations laws (most critically those of Delaware) and effects federal control over significant aspects of corporate governance. In the late 1990s and early 2000s, the bursting of the dot- com bubble and the massive corporate and accounting fraud uncovered at companies like Enron and Worldcom prompted populist pleas for federal intervention, pleas that soon led to the Sarbanes-Oxley Act. In 2007–08, as the collapse of the housing bubble and the subprime mortgage meltdown were followed in quick succession by the failures of Bear Stearns and Lehman Brothers and the ensuing credit crisis, federal legislators received similar pleas and reacted again, this time with the Dodd-Frank Act. Bainbridge sees a pattern here: “scandals and economic reversals” (p.38)5 regularly mark the aftermath of economic boom times, leading Congress to intervene in corporate governance with reactive bubble laws that are passed quickly under rising political pressures provoked “by populist anti-corpo- rate emotions” (p.16). This cycle, according to Bainbridge, “tends to result in flawed legislation” (id.).

¶4 Bainbridge presents his argument in a straightforward fashion, defending his position chapter by chapter and provision by provision, and he employs a scholarly style well suited for legal and academic audiences with preexisting knowledge of basic corporations law and economic theory. The book’s title, Corporate Governance After the Financial Crisis, however, is something of a misnomer; Bainbridge devotes far more space to detailing the faulty corporate governance provisions in Sarbanes-Oxley than he does to discussing Dodd-Frank, legislation actually passed in response to what is commonly known as “the financial crisis.” (As Bainbridge admits, it may yet be too early to fairly assess the full effects of Dodd-Frank.) Throughout the book, Bainbridge assiduously champions the views of Roberta Romano, a Yale law professor who maintained in a partisan 2005 article that the federal legislative process typically—in the case of Sarbanes-Oxley, specifically—produces “quack corporate governance.”6 Bainbridge specifies in rather redundant terms how both Sarbanes-Oxley and Dodd-Frank meet the cri- teria that define such legislation, but his arguments are less than completely per- suasive, and his persistent allusions to “quack” governance impart a polemical tone to what is otherwise a thoughtful treatise.

¶5 Bainbridge’s analysis of federal legislative responses to economic crises is generally well presented, and his position is bolstered by a variety of academic studies. However, many of Bainbridge’s arguments can be and are countered by authors with similar credentials citing equally credible studies in support of their assertions. Columbia law professor John C. Coffee, who dubs Bainbridge, Romano, and similarly disposed academics the “Tea Party Caucus,”7 suggests in a recent article that even flawed federal legislation is better than nothing and proffers, in direct response to the caucus, that with time and reflection most statutory defects will be corrected.8 With respect to Sarbanes-Oxley, scholars Robert A. Prentice and David B. Spence, both with the University of Texas at Austin’s McCombs School of Business, reject the notion that the act interferes unduly with state authority, argu- ing convincingly that it more accurately represents “a congressional attempt to shore up a federal system of securities regulation that has generally served the nation well.”9 They further assert that the very “empirical evidence that [Sarbanes- Oxley’s] critics believe Congress ignored strongly indicates that vigorous securities regulation is necessary for capital markets to reach their potential.”10

¶6 Ultimately, it is Bainbridge’s evident concern over the “creeping federalization of corporate governance” (p.19) that delineates his position within the wider political context. Federal versus state, reform versus free market, shareholder versus management, main street versus Wall Street—these are the constructs that make up the overarching themes of this book. These topics are also particularly relevant in light of today’s highly divisive political climate, and despite some weaknesses, Cor- porate Governance After the Financial Crisis is a worthy contribution to the debate. It is recommended for academic libraries, particularly those associated with schools of law or business, and to anyone interested in corporate governance practices. 

1. Sarbanes-Oxley Act of 2002, Pub.L.No.107-204,116 Stat. 745 (codified as amended in scattered sections of 15 & 18 U.S.C.).

2. Dodd-Frank Wal Street Reform and Consumer Protection Act,Pub.L.No.111-203,124Stat. 1376 (2010) (codified as amended in scattered sections of 7, 12, 15, 18, 22, 31 & 42 U.S.C.).

3. Stephen Bainbridge@ProfBainbridge, Twitter, http://twitter.com/profbainbridge (last visited Aug. 14, 2012).

4. Stephen M. Bainbridge, Response, Director Primacy and Shareholder Disempowerment, 119 hARv. L. Rev. 1735 (2006); Stephen M. Bainbridge, Dodd-Frank: Quack Federal Corporate Governance Round II, 95 Minn. L. Rev. 1779 (2011).

5. Quoting MarkJ.Roe,Washington and Delaware as Corporate Lawmakers, 34DeL.J.Corp.L. 1, 8 (2009).

6. Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, 114 Yale L.J. 1521 (2005).

7. John C. Coffee, Jr., The Political Economy of Dodd-Frank: Why Financial Reform Tends to Be Frustrated and Systemic Risk Perpetuated, 97 Cornell L. Rev. 1019, 1024 (2012).

I make Rod Dreher's "list of conservatives/GOP public personalities we don’t hear enough from"

Really