Business Law Prof Blog

Ryan v Lyondell "Clarification"

In denying a motion for an interlocutory appeal of, Vice Chancellor Noble, explained his early July 29th opinion denying summary judgment to the defendants in the case.  The company, Lyondell Chemical, had a 102(b)(7) charter amendment in place. The Court held, in its earlier opinion, that the lack of good faith precluded reliance on the charter provision.  In this opinion, Chancellor Noble explained his earlier holding saying that the defendants "may have exhibited a conscious disregard for their known fiduciary obligations."  This definition of lack of good faith is in accord with the Supreme Court's language in In re Walt Disney Company Derivative Litigation (906 A.2d 27(Del.2006)).  We then, in the footnotes, must suffer a tortured discussion of psychological states of mind ("two states of mind may coexist in the same person....").  Most use "conscious disregard" language to characterize recklessness, not bad faith, but no matter the new opinion brings the case back in line with Stone v Ritter and Disney.  The case does show, however, the elusiveness of this branch of doctrine -- later the court notes the "slothful indifference" of the directors.  This is apparently another version of "conscious disregard" of duties.  What of "[not] sufficiently attentive" or "remaining passive", also later in the opinion?  So do we have a new category of acts, those in which the board's decision on information presented is to acquiesce, gets special treatment?  Boards must "do something" to get summary judgment protection under 102(b)(7) language.

Bartels Book Makes Classic Mistake in Logic

The left is pushing a book by Larry M. Bartels entitled "Unequal Democracy" to argue that Democrats are better for the economy than are Republicans.  Bartels, a professor of political science at Princeton, is a formidable critic.  He notes, among other things, that annual GDP growth under Democrats exceeded that under Republicans (2.78 percent to 1.64 percent).  Alan Blinder in the NYTs uses the data to trumpet that Democrats are better for the economy (Sunday, Aug. 31th).  The error:  There is no relevant market index to which we can compare the data. Or to put it more succinctly -- what was the rest of the developed world doing at the time -- was the United States better or worse off than the rest of the world?  Data from the IMF, for example, shows that US GDP under Bush expanded faster than the GDP of France, Japan and Italy over the same period.  The annual rate of the US was 2.2 percent from 2000 to 2008, not great, but better than most other developed countries over the same period.  As good economists know, you do not look at stock price of a company alone, you compare stock price of a company to an industry index to evaluate the performance of the CEO.      

Nocera on Ichan at XO

Joe Nocera of the New York Times went after Carl Ichan's management of XO Communications in Saturday's business section.  He sided with an unhappy hedge fund R2 that had invested in XO.  Ichan bought control of the company when it was in bankruptcy; he bought majority control of the stock and bought 90 percent of its new debt.  He became board chairman and put buddies on the board.  The company has continued to struggle and Ichan has flirted with recapitalizing the company to keep it afloat.  Entire Nocera:  1) Charge I: Ichan has cronies on the board.  Privately- held companies and not run like public companies and do not use independent directors as monitors, they use directors as business resources and for advise.  This may make them run more efficiently not less.  2) Charge 2: Ichan is conniving to get control of the XO tax loss.  Since the Tax Reform Act of 1986, this game has been over.  Tax loss transfers in acquisitions are now capped at modest levels in most ownership changes.  3) Charge 3:  He is attempting to dilute existing shareholders without a shareholder vote (because XO is not listed).  Ichan is thinking of purchasing XO preferred stock for cash. Since stock prices are very low (less than a dollar) he will dilute existing shareholders.  No shareholder vote is required if the stock is authorized in the charter but under Delaware law (and the law of most states) one is advisable if the board is controlled by a dominant shareholder (which is true here).  The obvious conflict of interest will empower courts to set the deal aside and courts will look for a vote of disinterested shareholders to aid in that deliberation.  The affirmative vote of a majority of the independent directors, in a separate negotiating committee, is also critical to the decision.  So a vote will probably be necessary to do the offering.  XO shareholders minority are not without powerful remedies in such an offering and Ichan knows it; he must price the deal and structure the deal to get it though court.  Nocera is the unwitting agent of a clever minority investor seeking to maximize its bargaining position on an otherwise impudent investment.  No an uncommon position for the New York Times business opinion writers.

US v Stein: The Second Circuit Weighs In With a Terrible Opinion

The Second Circuit has affirmed, in a 3-0 decision, Judge Kaplan's dismissal of criminal indictments against 13 KPMG employees on the grounds that the Justice Department violated their right to counsel.  Consider how hard the court had to stretch to make the ruling:  1) State Action? The government's prosecution guidelines in the Thompson memo induced a private actor to cap paying attorney's fees.  2) Causation?  KPMG would have paid attorney fees if not for the government policy. 3) Sixth Amendment? a) It applies to pre-indictment payment of attorney fees (which were capped at $400,000 and conditioned on cooperation with the government and no persona indictment) if the payments would affect post-indictment selection of attorneys. b) It applies to a right to payment of attorney fees from a third party, KPMG, of millions even though the defendants themselves have net assets of between 1 and 4 million dollars.  The Wall Street Journal editorial page, the defense bar, and company executives everywhere were delighted.  Company executives can once again get free access to the corporate treasury to defend themselves from charges of severe mismanagement.  There is no comment from an unrepresented public - the Justice Department can certainly say little critical of a Second Circuit decision.

Two comments:  First one has to be careful to separate the policy debate -- should the government consider payment of attorney fees to executives in deciding whether to prosecute the company itself? -- from the constitutional argument.  The first question is difficult, I am of two minds on it.  The second question is not--there should be no constitutional violation if a company decides not to pay.

Consider the effect of the holding:  The Second Circuit never talked about the corporate law behind KPMG's decision.  It matters folks.  A quick and dirty summary: Most companies reserve the option to pay attorney fees of employees under standards articulated in corporate codes and corporate law.  Payments are business decisions and affirmative decisions required a finding of good faith on the part of the executives under investigation.   Some companies bind themselves to pay "to the maximum extend allowed by law " ahead of time.  This means only that any payment must be contingent on a board finding of "good faith" and the board agrees to make the decision at the time of payment.  If the defendants win, companies must pay.  If the defendants lose, company can pay based on a finding of good faith.  Advancements of expenses must depend on a promise to repay if the board later cannot find good faith if the defendant loses.  Judge Kaplan held that executives had an "expectation" and therefore a property right to attorneys fees unaffected by government action.  This is bunk and the Second Circuit bought it -- hook, line and sinker.    Now, after the opinion, any time a board decides not to pay attorney fees of executives under investigation, for whatever reasons -- based on business reasons (if the company has not pre-committed) or based on a finding of a lack of good faith -- it will create a sixth amendment defense (and potential exoneration with a required payment of fees!!!) if a government prosecutor smiles at or otherwise approves of the decision.  What a mess!!  Time after time judges in constitutional settings ignore the corporate rights that set up the constitutional analysis.  KPMG is now required to pay all the attorney fees (millions of dollars to the most expensive attorneys in the country) of the 13 defendants -- they won!.  One can only hope the Supreme Court will take this case and clean the mess up.

Rule 2a-7 and Independent Directors

The SEC has proposed dropping the requirement that boards of money market funds purchase only securities rating by licensed rating agencies.  The boards themselves have lobbied against the change -- their argument -- we are too dumb to handle the new power.  Even the trade association of independent directors, ICI, wants the old rule.  The lobbying is odd, to say the least, because under the revised rule the boards can still seek and rely on securities ratings they are just not required to do so.  The position of the independent directors ought to make one wonder what it is that these boards do.  We have become so enamored with the director as monitor slogan that the directors themselves can no longer make decisions related to the substantive matters of the businesses they monitor?  Sad.

2nd Q GDP Shows Growth

The figures for the GDP growth for the second quarter (April to June 2008) are in, and they show growth of 3.3 percent.  On the heels of a 1st quarter of .9 percent growth, it appears that our economy, which never was in a recession but was in a short period (less than six months) of slow growth, has picked up some steam.  The growth is the highest since the 4.8 percent growth we enjoyed in the 3 Q last year (July-Aug 2007).  A second government release documented that tax returns on personal income show an average increase from 2000 to 2006 [given the 2001 do.com crash and 9/11, this is remarkable], with the smallest increases shown in the highest brackets. This is not to say that individual states or cities have not suffered spot recessions, however.   Once again, the doom-sayers were and are wrong about a recession and exaggerated our economic problems to further their own aims and ambitions. For pete's sake, we cannot suffer six months of slow growth without wailing to the heavens???

SEC Announcement on Accounting Rules: We are Going International

I must admit, I did not expect the SEC announcement today that it had proposed a rule that encourages and may even require all United States companies to follow international accounting rules by 2014.  This is a major policy change.  Prior to the announcement, the SEC has consistently taken the position that in all things related to publicly traded companies, the rules of the United States are the gold standard for which others should strive.  Companies will love the change;  earnings will look more robust and there will be no disadvantage to joining United States markets or reporting in foreign markets. The SEC has abandoned the position. 100 countries use other accounting rules -- we had better get on board.  Will this apply to rules that regulate stock exchanges as well?  What about disclosure obligations? Sarbanes-Oxley?  Does the same principle apply -- are we to abandon these rules that are stricter than those in many other countries to stay competitive in international markets?  If not, why are accounting rules different??  Accounting rules are a fundamental and inherent part of any disclosure legal regime?  This is big, folks, big news.

A Judge as Lobbyist

The Justice Department announced today the reversal of its company prosecution guidelines.  No longer will a company's decision to fund legal fees of indicted executive officers or a company's decision to stand on attorney client privilege to protect indicted executive officers be considered in whether or not to indict the company itself.  This is a victory for Judge Lewis A Kaplan of the Southern District of New York.  Judge Kaplan dismissed charges against 13 of the defendants in a major tax-shelter prosecution against KPMG, saying, among other things, that prosecutors had violated the constitutional rights of KPMG officers by pressuring the company to cut off paying legal fees over $1 million.  The constitutional argument was bunk, of course, but it did not matter.  He had a point to make.  For those who believe the constitution contains a "right to fairness in all things," the attack gave a public argument to an argument otherwise floated by the defense bar and and the executives of companies who wanted to do business with each other using the company's cash.  For those who wonders why Judges get carried away with dicta on social justice in their opinions?  It works.   

The Primary Lesson on Fannie Mae and Freddie Mac: Purpose Creep

Government officials are debating what to do with Fannie Mae and Freddie Mac, and their shares swoon in the markets.  There is no longer any doubt that the companies have been very poorly run and the taxpayer will pay something, in some way, for the mess.  Will Treasury nationalize the companies? Inject equity? Buy their distressed debt at a discount?  Financial historians have detailed how the companies got into such poor shape -- purpose creep.   Whenever management made decisions that hurt the companies bottom line, the justification was "public interest" in low cost mortgages.  Whenever critics asked Congress to look into the mess, politicians, accepting cash donations from the companies managers, responded with defending the "public purpose" of the companies.  The companies had "purpose creep."  The managers became unaccountable for their business decisions, hiding behind "purpose creep" to justify whatever decisions they made.  The only real winners were companies managers who took comfortable salaries and politicians who kept campaign contributions.  We are the losers.

Disclosure Versus Business Confidentiality

The efforts of the Federal Reserve and the Office of the Comptroller of the Currency to keep abreast of the situation in struggling banks is yet another illustration of problems in our disclosure theory of securities law.  Both government agencies have issued "memorandums of understanding" to struggling banks.  The Memorandums can force banks to raise capital, cut back on taking risky loans, and suspend dividend payments.  The documents are an "early warning" signal.  Shareholders of these publicly-held banks understandably want to know about the existence and detail in the Memorandums; the documents are surely "material" under any body's definition. But the Memorandums  are "confidential."  Rumor and insider leaks roil the bank market on which banks have been issued the documents.  Once again investors are reminded that the concept of "materiality" has numerous, ad hoc, holes.