Ideoblog

The angry mob coming to solve the market's problems

Blogging's been light while I'm at the AALS, but I had to join the chorus noting Tom Kirkendall's dissection of the Fifth Circuit's whitewash of the Skilling conviction, and Roger Parloff's reminder that the same angry mob that got Skilling is now on the prowl for a host of current financial executives.  Parloff puts this into helpful perspective: 

To be clear, we're not talking here about sensational, not conceivably legal, out-and-out Ponzi schemes, like the $50 billion one that former Nasdaq chairman Bernard L. Madoff has been arrested for, or brazen forgery and criminal impersonation, like the $100 million spree that glitzy New York litigator Marc S . Dreier has been accused of. Crimes like those typically have only one of two defenses: (a) "It wasn't me," or (b) "Okay, it was me, but I was sleepwalking on Ambien at the time." This article is, rather, about an entirely different category of accusation.The probes being discussed here concern statements that ultimately proved incorrect, but which reasonable, straight-faced people can, and vigorously do, contend were honest when made.

* * * To the chagrin of John Q. Public, there will be serious defenses in most of these cases. To begin with, bad business models - even business models that in retrospect look like prescriptions for disaster - are not crimes as long as they are fully disclosed to investors.

The problem is that the Skilling trial and appeal suggests that the line between crime and non-crime is even thinner than Parloff suggests.  What we need is a system that protects the non-Madoffs from the mobs.  What I fear is that instead of water, as the song goes, the legal system is going to bring more gasoline.

And worse, after the mob leaves, and the prosecutors have gotten their smoking guns, none of the problems will be fixed.

AALS Agency/Partnership Section

The Section on Agency, Partnership, LLCs and Unincorporated Associations, which I'm chairing this year, will meet at Friday, January 9, 1:30 — 3:15 pm, Coronado, South Tower/Level 4, San Diego Marriott Hotel & Marina. 

This year we had a call for presentations

on the application of modern theories and empirical methods of business associations to agency and unincorporated firms. The program has two goals: First, to show how these theories can be enriched by taking them outside the "box" of corporate law; and second, to show the relevance of agency and unincorporated firms to the mainstream of corporate theory and empirics. . .  

The following presentations were selected:

• Kelli A. Alces, Florida State, Learning How to Replace Mandatory Fiduciary Duties by Looking at Unincorporated Firms
• Matthew Bodie, St. Louis University School of Law, NASCAR and the Theory of the Firm
• Mark J. Loewenstein, University of Colorado, The Diverging Meaning of Good Faith
• Marie Reilly, Pennsylvania State, In Good Times and in Debt: The Evolution of Marital Agency and the Meaning of Marriage
• Larry Ribstein, University of Illinois, A Theory of the Uncorporation
• Leonard Rotman, Faculty of Law, University of Windsor, The Impact of Fiduciary Duties on Partnerships and Corporations.

Should be an interesting session.  See you there!

RULLCA's little agency problem

Suppose you’re dealing with a member of a small LLC. You’re about to enter into a transaction that is clearly in the regular course of the LLC’s business. The person proves he’s a member and shows you articles of organization and an operating agreement providing that the LLC is managed by the members. Can the member bind the LLC?

Well, he could if this were an ordinary partnership. And he also could if this were an LLC governed by the laws of 49 of the 51 US jurisdictions. But if you’re unlucky enough to be dealing with an LLC organized in a RULLCA jurisdiction (Iowa or Idaho) (and if you're unlucky enough to have formed an LLC in one of those jurisdictions) you’ve got a problem.

Section 301 of RULLCA says:

(a) A member is not an agent of a limited liability company solely by reason of being a member.

(b) A person’s status as a member does not prevent or restrict law other than this [act] from imposing liability on a limited liability company because of the person’s conduct.

Analyze that. A person is not an agent “solely” because he’s a member. But what if the operating agreement says that members are managers? Should that be enough? Maybe. Or maybe not. After all, RULLCA 407(b)(1) says that “(b) In a member-managed limited liability company . . . (1) the management and conduct of the company are vested in the members. . ." Yet apparently that’s not enough to make a member an agent under 301(a). What difference does it make that the operating agreement and articles say the same thing?

Then you can go to RULLCA 301(b). That says that “other” law can impose liability. What other law? Must be referring to agency law. So what does agency law have to say about the authority of a RULLCA LLC member? Nada. There’s agency law dealing with LLC members’ authority under other acts, but that law is based on those other acts, not on RULLCA.

So I said in my paper, Are Partners Agents? [footnotes omitted]:

RULLCA leaves the law in limbo regarding the extent of members' apparent authority to bind the firm. An LLC member is not an agent – she is a member. As such, she should have some inherent power to bind the LLC. It is up to the statute to specify how much power, perhaps by analogizing to partnerships as do most LLC statutes and ULLCA. By omitting default rules like those in general and limited partnership and LLC statutes, RULLCA gives the courts no guidance on how to proceed. They cannot draw on agency law because a limited liability company is a particular type of firm whose rules are provided by the governing statute and not by agency law. Agency law provides the questions but not the answers.

In my Analysis of RULLCA (p. 61) I add [footnote omitted]: 

Although section 301(b) provides that “[a] person’s status as a member does not prevent or restrict law other than this [act] from imposing liability on a limited liability company because of the person’s conduct,” the courts have yet to develop this law.

I mention all this apropos of a new article in the current Business Lawyer, Rutledge and Frost, RULLCA Section 301 - The Fortunate Consequences (and Continuing Questions) of Distinguishing Apparent Agency and Decisional Authority.  You can access the article here if you're an ABA member. 

Note 57 of this article says:

This criticism [in my Are Partners Agents?] is not well placed. RULLCA section 301(a) is quite clear; member status alone does not convey apparent authority to bind the LLC. Further, it ignores RULLCA section 301(b), which makes express that “other law” may and indeed shall be applied to determine whether the actions of an individual member bind the LLC. See RULLCA § 301(b), 6B U.L.A. 469 (2008). See also RULLCA § 107, 6B U.L.A. 440 (2008) (“[U]nless displaced by particular provisions of this [act], the principles of law and equity supplement this [act].”).

So, readers, I’ll leave the issue with you. If you’re organizing an LLC, do you want to wander into the murk of RULLCA’s agency provision (not to mention the rest of RULLCA’s murk covered in my Analysis article linked above)? Or are you comfortable with “other law” and “principles of law and equity”? If the latter, I’ve got some completely reliable investments I’d like to sell you.

An Iceland bank strikes back

Last month a WSJ article on the Icelandic banking crisis chose to focus on Iceland's role in the financial excess that led to the global meltdown.  I suggested that the WSJ reporter missed a more interesting story -- about how tiny Iceland got caught in the meltdown and then victimized by its powerful neighbor and competitor, the UK. 

In particular, I wrote:

One Icelandic bank, Kaupthing, was still trying to work things out when the Brits seized Kaupthing's UK assets and transferred them to ING. This triggered "a cascade of defaults for Kaupthing, blows it simply couldn't survive." * * *

And what about Great Britain’s role – a rival not only in banking, but for the raw material of its lifeblood – fish and chips (it fought several “Cod Wars” with Iceland). In the banking crisis, Britain claims it needed to protect its depositors. But how exactly did shutting down Kaupthing, precipitating defaults and exacerbating a run in the midst of its salvage efforts accomplish that?

I concluded that "the real story seems to me to be more interesting than the one he chose to tell."

Well, we may get a chance to hear the real story.  From the AP, via Dealbook:  

Iceland’s state-run Kaupthing bank will sue the British government for its decision to force the bank’s British subsidiary into a form of bankruptcy * * * Prime Minister Geir Haarde said Monday that his government supported the lawsuit and could help fund it. ”We think that it is very important that we ascertain if U.K. laws were misused against Icelandic interests,” he said.

How to reduce fraud: abolish the SEC?

Today’s WSJ reports on the numerous investigations of Madoff by the SEC and other agencies that failed to catch him. Of course regulators and other readers will draw the wrong lesson. So in a probably futile effort to prevent this, let me remind readers what I said here and here: that the lesson is not that we need more regulation.  As I said in the last post:

I doubt that any government agency will ever do as good a job as a vibrant market whose participants are alert to the potential for fraud rather than lulled into a false sense of complacency.

What are the options?  Getting a new regulator?  Well consider this from today’s WSJ:

The failure to stop Mr. Madoff also is an embarrassment for Mary Schapiro, the Finra chief who has been nominated by President-elect Barack Obama as the next SEC chairman. Finra was involved in several investigations of Mr. Madoff's firm, concluding in 2007 that it violated technical rules and failed to report certain transactions in a timely way.

Arthur Levitt, our longest-serving SEC chair, offers advice in an op-ed in today’s WSJ:

Let's hope that the Madoff swindle is not a spur to haphazard regulatory responses, which often have unintended consequences, but instead the final prod for a fundamental reform of the financial regulatory structure that protects investors and keeps our markets free and fair.

But let's remember that some of the failed Madoff investigations were on Levitt’s watch.

In fact, if one wanted to follow these observations to their logical conclusion, one might say that we ought to abolish the SEC altogether.

Crazy suggestion? Well, what, exactly, would we lose? Backdating investigations? What came out of that? And recall that the SEC was late to this party too – the problem was spotted by some finance professors in Iowa and WSJ reporters.

What we would gain from abolishing the SEC is less misguided market interference (Reg FD; short sale restrictions) and a more alert marketplace. A market that would not ignore red flags and alarms sounded by profit-motivated watchdogs just because the SEC or FINRA had provided a clean bill of health.

Just a thought.

Additional thought: Well, ok, let's say we keep the SEC.  But remember that the justification for a public agency is to increase investor confidence and encourage investment.  In reforming financial regulation we should ask:  when does the regulation actually justify the extra investor confidence it is intended to inspire?  Because if it doesn't, then the regulation is part of a con game, isn't it?

Hot off the press

You'll want to get your very own copy.

Some perspective for the New Year

From one of the year's best stories:

Rolling up to the meetings at around the same time was Goldman's chief, Mr. Blankfein. A Goldman aide, referring to days of meltdowns and meetings, carped to Mr. Blankfein: "I don't think I can take another day of this."

Mr. Blankfein retorted: "You're getting out of a Mercedes to go to the New York Federal Reserve -- you're not getting out of a Higgins boat on Omaha Beach," he said, referring to the World War II experience of a former Goldman head.

"So keep things in perspective."

Happy New Year!

Iseman v. NYT

Not to pick on the NYT, but Vicki Iseman’s defamation suit against the Grey Lady (HT Law Blog) makes fascinating reading.

This is no fly-by hit job – it’s a careful and persuasive piece of work. The complaint is co-authored by W & L Dean Rodney Smolla, former Richmond dean, expert on the press, whose books include Suing the Press (Oxford 1986).

The complaint alleges that the Times story, though not containing direct allegations of an Iseman-McCain affair, was in fact defamatory because of its intended and conveyed meaning; that Iseman is a private figure, not having been outed prior to the story in question; and that the NYT acted not only with negligence (the Gertz standard for private figures), but actual malice.

The private figure issue might get this case some legal attention. Iseman may not have assumed the risk of attention under Gertz, but she did have media access.  I'm not sure where the current private figure case law stands.

With respect to actual malice, the complaint notes that the Times had been working on the story for a long time, was widely known to have been doing so, had not gotten evidence to back its allegations, feared that its failed pursuit of the story would be the subject of a New Republic story, and buckled to the pressure by publishing an innuendo-laden hatchet job.

It’s been a bunch of years since I’ve taught defamation, so I won’t try to go deep on this right now. But I do have a few quick thoughts.

• The complaint pretty strongly supports plaintiff’s interpretation of the story. So did they (Iseman and McCain) or didn't they? If they didn't, did the Times have a credible enough source to go with the story? 
• If the plaintiff’s side holds up, the only difference between the Times and the average political blogger is that the Times’s reputation protected its story from the skepticism it deserved. A blog post would have been ignored or picked to shreds in the blogosphere.
• I wonder if the Times would have killed this story in its salad days, before current death throes, when it really did deem some news not fit to print.
• Would it have killed an equivalent story about Obama? 
• Though the complaint alleges only $27 million in damages, probably insured, I should think that the risk this suit poses to the reputation of the Times and the reporter-defendants is incalculable.

The Times, the critics, the columnists and the crunch

I have been discussing, e.g., here, the dire straits of the newspaper business. I have also discussed one particular paper, the NYT. As I said back in April 2006:

If the market demands that the NYT adjust to these new voices and technologies and its managers are lagging in that respect it's easy to see why the Times would be suffering and why its shareholders would want change. It's called creative destruction. A system that doesn't accommodate it is doomed to fail. We shouldn't lament its happening at the Times.

The problem is that the NYT’s controlling family has used its power to rebuff activist hedge funds. These moves have a special irony, as I summarized: 

The Times, whose columnists such as Gretchen Morgenson have been hawks on corporate governance and shareholder value, was curiously mum when it came to the company’s own governance.

Now the problems are coming to roost, and even the Times’ controlling owners see the wall right in front of them.  They're seeking to raise cash in the worst possible financial environment by registering to sell Times stock. Per Blodget:

Now, needless to say, is not the optimal time for NYTCo to be raising cash. Seven months ago, the stock was $20. Three months ago, the stock was $15. Now it's just over $6. Similarly, on the debt side, a year ago, the New York Times still seemed like a healthy company, with strong cash flows and a thriving Internet business. In those days, these characteristics would have set debt buyers mouths' watering. Not anymore. Any cash the New York Times raises in the current environment will be outrageously expensive. It's also hard to imagine that the company will attract much interest from equity investors until it can articulate a plan for long-term survival that involves something other than selling off non-core assets (eventually, it will run out of these).

The Times likely would not be facing this dire crunch had it not closed its ears to its critics while its heavily promoted columnists spouted off confidently about how other companies should be run.

The WSJ on Iceland

Looks like Charles Forelle of the famed WSJ backdating/Pulitzer team has got his teeth into another story. This time it's about how the crash of Iceland's banking system and currency. Forelle leads as follows:  

Iceland was one of the international financial bubble's most enthusiastic players. Home to fewer people than Wichita, Kan., Iceland became so leveraged and so deeply intertwined with the global financial infrastructure that its collapse has rattled the world from Tokyo to California to the Middle East. In Japan and Hong Kong, bond buyers got stuck holding all-but-worthless debt. In Beverly Hills, a real-estate developer was forced to default after teaming up with an Icelandic bank to build condos near Wilshire Boulevard. A German regional lender, Bayerische Landesbank, suffered big losses on its Icelandic investments contributing to its need for a €30 billion ($42 billion) bailout package. And in recent weeks, Naomi House, a hospice in southern England, had to cancel a service in which aides made house calls to give the parents of dying children a helping hand. Some £5.7 million ($8.7 million) -- two-thirds of its available cash -- is frozen and may never be fully returned. It was deposited in an Icelandic bank.

Those who don't read much further in this long article will learn that these sympathetic victims were screwed when Iceland lured deposits and buoyed its currency (the krona) with high interest rates. Icelanders paid for tv’s with krona, borrowing in yen. “Like Americans who rode a housing bubble thanks to the U.S. Federal Reserve's maintaining low interest rates for years, Icelanders had found a cheap source of borrowing to finance their consumption.”

Iceland “tried to build a global banking center on top of a tiny currency. So when foreign investors tried to pull out -- converting kronur back into dollars or euros en masse -- its currency fell like a rock, spurring more withdrawals.” “Iceland's new breed of tycoons was living large.”

For human interest, the story focuses on Daniel Herzberg, a Brit “who organizes bicycle and walking tours,” who deposited £10,000 in the Guernsey branch of a British savings bank. Landsbanki [an Iceland bank] bought the branch. In response to his email, Landsbanki told him it would back foreign depositors and that it was strong.

The global financial crisis precipitated a run on Iceland’s banks. Iceland didn't have enough Euros to pay depositors.  British depositors had deposited billions of pounds in Iceland banks. 

One Icelandic bank, Kaupthing, was still trying to work things out when the Brits seized Kaupthing's UK assets and transferred them to ING. This triggered "a cascade of defaults for Kaupthing, blows it simply couldn't survive."

Much of the rest of the article recounts the “global fallout” from the Icelandic collapse, focusing on maximally sympathetic victims of greedy Iceland -- Herzberg the bike tour guy, Naomi House.

Ok, so Forelle has his story. But how about another story: Plucky Iceland bucks the European Cartel Community, and is punished for its temerity. Then it gets brought down by a global financial calamity beyond its control.  Scrambling to fix the problem it's squished by its powerful neighbor. 

And what about Great Britain’s role – a rival not only in banking, but for the raw material of its lifeblood – fish and chips (it fought several “Cod Wars” with Iceland). In the banking crisis, Britain claims it needed to protect its depositors. But how exactly did shutting down Kaupthing, precipitating defaults and exacerbating a run in the midst of its salvage efforts accomplish that?

There are rumors, not mentioned in the story, that Britain held up an IMF rescue loan to Iceland. And Forelle alludes to Britain's "using an anti-terror law to seize other Icelandic assets" -- an incident that especially infuriated the Icelanders [see photo above], but that is not discussed further in the story. As for Mr. Herzberg – why did he leave his money in a Guernsey bank that had no deposit insurance? Because this bike tour operator thought he could figure out the international banking system?

Even without going much beyond Forelle's own factual reporting, this is a story that has apparently been slanted against Iceland because it's a convenient target.  And that's really too bad for Forelle, because the real story seems to me to be more interesting than the one he chose to tell.

Regulation and fiscal stimulus

Cowen on fiscal stimulus: 

neither monetary nor fiscal policy will set right the basic problems from negative real shocks and indeed the U.S. economy is undergoing a series of massive sectoral shifts. That includes a move out of construction, a move out of finance, a move out of debt-financed consumption, a move out of luxury goods, the collapse of GM, and a move out of industries which cannot compete with the internet (newspapers, Borders, etc.)

I've never seen a stimulus proponent deny this point about real shocks but I don't see them emphasizing it either. It should be the starting point for any analysis of fiscal policy but so far it is being swept under the proverbial rug.

Maybe a big enough push to aggregate demand could stimulate useful, productive employment (as opposed to merely boosting measured gdp) right now, but since the U.S. savings rate must rise sooner or later, that would only mean a steeper decline for aggregate demand some time in the future. My discount rate isn't that high.

The alternative to a huge fiscal stimulus is simple: enough pro-active fiscal policy to ensure that cuts in state and local spending do not bring additional contractionary pressure to bear on the economy.

Here’s another suggestion: instead of (or at least in addition to) fiscal stimulus or fiscal policy generally, how about deregulation? What we need to counteract sectoral shifts like the ones Cowen mentions are brand new technologies.

What are they? How should I know? The impact of the personal computer, the Internet or Google couldn't been predicted twenty years ago. Forty years ago, the crazy ideas I was hearing and laughing about included a company that was going to have its own fleet of planes and compete with the post office; and another one that was going to compete with the phone company.

Unless whacky ideas like these can get financed, it's going to take a long time to get a new sectoral shift toward greater productivity.  And this financing depends on regulatory attitudes towards, e.g., new forms of financing (how about disintermediated public offerings?); whether Sarbanes-Oxley and its spawn continue to task risky firms (see my article with Butler in the current Forbes); and whether products liability law serves the economy as a whole rather than trial lawyers.

You're not sure this will work?  Do you honestly think dumping zillions of dollars into the hands of bureaucrats and politicians to be spent willy-nilly on God knows what in the hope of a savings-depleting short-term demand shift has a better chance?  Maybe you deserve a Nobel Prize.

Newspapers pawning jewels

A couple of weeks ago I discussed NYT’s liquidity issues. Now, like Madoff investors and the Chicago Tribune, the NYT is pawning assets to pay the bills – namely, the Boston Red Sox. From Blodget:

We never bought into the idea that newspaper companies should own baseball teams, but we will say this: The New York Times's decision to buy 17.5% of the entity that owns the Red Sox in 2002 was the best financial investment it has made in years.

A recent estimate suggests this particular jewel will buy the Times exactly one year of life.

And this tidbit from today's WSJ suggests baseball is a way better business than newspapers:

Jack Connors, a former ad executive in Boston, and former General Electric Chief Executive Jack Welch took a serious look at the Globe two years ago, valuing it at $550 million to $600 million, people close to them said at the time. Times Co. rebuffed the inquiries. The Globe was recently valued by Barclays at $20 million.

I also note that WaPo and the Baltimore Sun are sharing content. In The Wire's last season, Sun reporters could look at WaPo as the promised land. But they were actually looking at history. While big newspapers are being hit by the same bad economy that’s hurting everybody else, this is just an acceleration of recent trends. In depressions, marginal businesses die.

So soon (five years?) big journalism as we know, or remember it, will be dead. No doubt, though, Gretchen will have a job.  Hey, Slate is hiring.

The Santa scam

Even Clusterstock hasn't even caught up with this one. Turns out parents have been in on the coverup for generations. Their kids grow up believing in the myth. They invest in “Santa,” and the Ponzi scheme continues.

Sometimes the kids transfer their belief to “Santa-proxies” like the stock market, the Internet, tulips or real estate.

Until Madoff I thought that Jewish kids were immune.

Stop the myth now. Tell your kids. They’ll be sadder now, but wiser investors down the road.

Bubbleomics

Holman Jenkins in today's WSJ: 

Policy is always bad to a degree, but long periods of prosperity tend to be self-reinforcing since powerful interests are born with the means and motive to preserve the status quo. That status quo may really be a contributor to prosperity, such as regulatory restraint and moderate tax rates. That status quo may in some respects be ill-advised, such as excessive subsidy to housing debt.

But once prosperity blows up, the quasi-virtuous policy circle becomes an unvirtuous one as new interest groups come to the fore to exploit an appetite, previously weak, to impose their costly or vindictive wish lists. And even well-meaning policy gets twisted and rendered incoherent.

Here's my Bubble Laws, 40 Houston L. Rev. 77 (2003) (not online yet, but it seems so timely that I plan to post after the new year):

In normal and boom times, new regulation would not help any distinct group enough to motivate the group to push for it. Regulated entities therefore have enough clout to defeat significant increases in liability or regulation. Those who might shift the balance, such as consumers or investors, do not see a need for new regulation while they are riding a rising market.

Crashes destabilize this interest group equilibrium in several ways. First, the more marginal firms, start-ups, and others that gained from the boom and opposed regulation that might thwart it, are now financially too weak to have much political clout. Second, pro-regulatory forces can enlist new supporters by arguing that regulation would restore “investor confidence”—code for more buyers and therefore higher prices. Third, reformers can draw on populism and envy of the rich, which abates only as long as the rich generate significant wealth for the rest of us.

Does Regulation Prevent Fraud?

As I’ve said, the Madoff case of “a regulated investment firm stealing $50 billion from under the regulators’ noses should tell us that it’s a mistake to rely too heavily on regulation.”

So how unusual is Madoff? Consider Chidem Kurdas, Does Regulation Prevent Fraud? The Case of Manhattan Hedge Fund:

As the failure of the hedge-fund firm Manhattan Capital demonstrates, both government regulators and market players can make mistakes resulting from cognitive biases. Responding to such mistakes by strengthening government watchdogs, although often recommended, reduces both the watchdogs’ and the public’s incentive to learn, thereby creating a vicious spiral of regulation, regulatory failure, and even more regulation.

An eerily timely story. 

Blago, the bailout and the new New Deal

Last week I said:

Blago is not as much an aberration as some would like us to believe. Let's keep that in mind before we hand over more regulatory power to politicians because we think we can trust them more than the market participants who would be regulated.

In the Christian Science Monitor, GMU and Cafe Hayek's Don Boudreaux puts Blago's behavior into the context of Gordon Tullock's rent-seeking theory:

[I]t's understandable that companies spend considerable effort courting politicians who can bestow . . .  privileges. That's wasteful. Time, energy, and other materials that could be used to expand the output or improve the quality of goods and services are instead used to lobby government for narrow benefits that may harm society at large. And the larger the potential gain from being granted such a privilege – that is, the larger the rents – the more intense will be rent-seekers' incentives to chase after them. That puts tremendous pressure on – and gives tremendous leverage to – politicians. * * *

[The Blagojevich case is] about how government itself creates the very conditions for corruption.

* * * And as Washington embarks on a trillion-dollar-plus shopping spree, the conditions that cultivate rent-seeking – and thus corruption – are sure to grow, too. The antidotes for this poison are integrity and constitutionally limited government. The need for them has never been greater.

We have been focusing on how business screwed up.  But might $750 billion, plus $850 billion, and more, plus massive reregulation of the economy, create opportunities for social-wealth-wasting corruption?  How much was it that Blago wanted for the Senate seat? 

Fortunately politicians are generally more honest than Illinois's sorry excuse for a governor.  And more subtle. But let's be realistic about what to expect from them.

The billable hour as the perfect crime

The WSJ Law Blog writes about a Chicago lawyer who got outed a few years ago, and now faces discipline, for overbilling.  It revives a quote on an earlier post: 

“Bill-padding is the perfect crime,” an ethics specialst told WSJ at the time. It is virtually impossible, he said, for clients to know whether “an attorney really spent three hours doing research instead of five hours.” 

I just paid a roofer $2,000 labor to put on a new roof. How did I come up with that amount?  (a) that’s what he asked for; and (b) I couldn’t get anybody else with the same reputation and lower price. What do I know about roofing? Probably less than a big corporation knows about legal fees.

You gotta wonder how much longer the legal biz can get away with a pricing structure that does so little for clients.  In this economic climate. Just because this is the economic model that is convenient for law firms as currently structured? I don't think so.

More:  In case you didn't know about the manifest problems with billable hour compensation (i.e, you're a lawyer), here's Bruce MacEwen.  I would go further:  How do we know there's a serious problem with law firm structure?  Billable hour.  Q.E.D. 

The endgame of TPW, LLP

It looks like the end for Thacher Proffitt & Wood, which had survived 160 years and the destruction of its headquarters on 9/11. Many of its lawyers are moving to Sonnenschein, Nath & Rosenthal. But, per NYT:

Sonnenschein, based in Chicago, is not acquiring Thacher, choosing instead to take on the lawyers who formed the core of its real estate, finance and corporate practices. * * * “We’re still working on what happens to Thacher,” said Robert E. McCarthy, the chairman of Thacher’s planning committee, who is joining Sonnenschein. “Its viability going forward was not likely.” * * *A handful of partners will be left at Thacher after the moves.

Note that the Sonnenschein transaction is taking place after a merger of the firm with King & Spalding reportedly foundered, per AmLaw Daily, when “King & Spalding grew wary of the bank debt and lease exposure that an outright acquisition would entail, and instead proposed a deal in which it would take a group of approximately 75 Thacher lawyers as lateral hires.”

Thacher is an LLP. This means that, like most law firms these days, its partners have limited liability. If Thacher had been an old-style general partnership, its partners would have vicarious liability for the firm’s debts, and those liabilities would follow the individual partners to their new firm or firms.

Even as an LLP, if TPW had merged with SNR or KS, the firm’s liabilities would move to the new firm. But if the partners individually move to SNR or wherever, the liabilities stay behind, unless the partners have obligated themselves individually.

In other words, the LLP structure enables the firm’s main assets (its lawyers) to walk away from creditors. In the old days, the lawyers arguably had more of an incentive to keep the firm together.

I’m not, however, knocking the firms or the lawyers for adopting this structure. And how could I, given that I’ve got a treatise on it (Bromberg & Ribstein on LLPs)? In fact, as detailed in the treatise, the development and spread of law firm LLPs was a predictable reaction to the ratcheting up of potential lawyer liability in the s & l crisis of the early 1990s. And this, of course, is only one example of how limited liability developed in response to the expansion of tort liability. So if you don’t like limited liability, you should know what to blame.

I should add that LLPs are not the last word in this dialectic. I predict there will be a boom in litigation and case law regarding law partnership bankruptcy (just as during the s & l blowup), as well as on the extent of LLP partner liability. Although LLP partners have no vicarious liability, they can be liable for their own misdeeds, including negligent monitoring and supervision (see Bromberg & Ribstein, section 3.04). Expect plaintiffs’ lawyers to push these individual liability exceptions to the limited liability shield. And then expect a structural response to these new liabilities.

Update:  More on Thacher from Bruce MacEwen. 

The meltdown of the corporate governance mavens

One would think these would be heady days for the stalwart corporate reformers who were sure they had the answers about how firms ought to be run. But just as the retreating tide reveals mollusks like Madoff, it also exposes the bones of those good government advocates. Consider the following:

• The SEIU, which only a few months ago wanted to “take back the economy from the buyout firms” is now revealed as having been one of disgraced governor Blago’s biggest political friends.
• Calpers, perhaps the leading good governance maven, while trying to impose a code of conduct on its portfolio companies, was setting itself up for billions of losses, making disastrous land deals, and threatening the welfare of the California employees who depend on it.
• The NYT reports that "Eliot Spitzer, who as New York attorney general was known as the 'Sheriff of Wall Street' for his crusade against investment fraud, has acknowledged that his family was swindled by the man accused of running what could be the largest Ponzi scheme in history."
• And of course Spitzer had plenty of company in the Madoff camp – e.g., at the SEC, while that agency was spending a lot of its time working on such projects as executive pay.
• I noted that one of the more disastrous meltdowns had bragged that "Lehman Brothers continues to be committed to industry best practices with respect to corporate governance."

The lesson isn’t that firms were well governed after all. Obviously they weren’t. It is that the “good governance” crowd had no idea where to look for the problems and the solutions. Just as we should be more skeptical about get rich schemes, so we should learn to reject platitudes in favor of evidence as to what does and doesn't work. And, as I've been saying for awhile, maybe we should look away from "corporate" governance altogether. 

Dreier, scorpion fish and the theory of the firm

The WSJ’s long front-page story about Marc Dreier depicts him as a high-rolling risk-taker who ate still-living California scorpion fishes impaled on sticks.

So what does this have to do with the theory of the firm? As I’ve discussed, Dreier LLP was a sole proprietorship (though its specific form was in some doubt). This means that he got all the profits (though he did share revenues). As the sole profit-sharer, Dreier had a strong incentive to get maximum value out of the firm’s resources. So it would seem that agency costs were not a problem. That’s why the firm's lawyers were content to delegate all management power to Dreier.

The problem is that while Dreier had strong incentives to coordinate the firm’s team (I refer to the "team production" theory of Alchian & Demsetz, Production, Information Costs, and Economic Organization, 62 Am. Econ. Rev. 777 (1972)) and not shirk, he evidently lacked the ability to coordinate himself. And, of course, since Dreier was the sole owner-manager, nobody else in the firm had the incentive to keep his impulses in check.

The lesson here is that no organizational form is guaranteed immune from human nature.