In December 2008, Korn/Ferry issued its most recent annual Board of Directors Study, which analyzed information gathered from the proxy data of 891 Fortune 1000 companies as well as information from questionnaires completed by almost 800 directors.  As usual, the Study has some interesting information about board practices both in the US and globally.  For example, it should come as no surprise that directors appear to be spending more time on their board work, and have greater responsibilities.  As a result, directors are being paid more--but no where near as much as their CEOs.  Despite the increased work, directors' satisfaction with their job is increasing.

Something I found particularly interesting was the survey responses with respect to majority voting.  The Study reported that 40% of respondents indicated that their board had adopted the practice of majority voting, and of those that had not adopted the practice, 20% of respondents said that such voting was up for consideration next year.  Yet when asked "do you feel majority voting is a step toward greater shareholder representation or is it a destabilizing factor in corporate governance?,"  80% of the respondents indicated that they believed it was a destabilizing factor.  The survey results certainly indicate that majority voting is not viewed favorably by directors.  And yet, while there are certainly those who question whether or not majority voting truly has any impact, the fact that many boards have adopted majority voting practices despite directors' apparent negative impression of such practices certainly says something about the strength of the majority voting campaign.

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If you have been following my mortgage rates saga, you know that I was hoping for rates in the high 4s before I close on my refinancing. As of this morning, I was locked into 5.125%, but rates went down this week again, and I can re-lock today at 4.875%. The mortgage brokerage that I am using, which happens to be owned by my neighbor, has a policy of re-locking only once. The broker wanted me to wait for the job news on Friday. If it's bad news -- "and we expect it to be bad," he said -- rates could go down again. He was hoping for 4.75%. Aside from the fact that this one-time re-locking policy does not appear to be set in stone, this was a no-brainer: lock me in at 4.875%!

Now, I am clearly no expert in mortgage rates, but I am also not in the habit of taking financial advice from people who are rolling the dice with my money. If everyone is expecting bad job numbers on Friday, I assume that expectation is reflected in the current rates. Thus, the rates will decline as a result of the jobs report only if that report is worse than expected. What are the odds of that? I have no idea, but something far south of 100%.

What if the jobs report is surprisingly good? "Then rates could go up again," he conceded. What are the odds of that? Again, no idea, but way less than 100%.

Is it more likely that the jobs report would be surprisingly bad or surprisingly good? Hmm. I have no way of evaluating that. Let's say these two results are equally likely (each has a 15% probability), but that the most likely result (70% probability) is that the jobs report will be unsurprising.

One last question: is it more likely that we would see big movements down  in mortgage rates following a surprisingly bad report or big movements up  in mortgage rates following a surprisingly good report? On this one, we know that the upward movement is capped by my current lock rate, so even without more concrete information, it seems somewhat more likely that mortgage rates will move down substantially in my favor.

So, roughly speaking, there is a 70% chance that I can get the same rate as today's if I wait until Friday, a 15% chance that I will get a worse rate than today's (as high as 5.125%), and a 15% chance that I could get a better rate than today's (with some chance that the report will be very disappointing, thus giving me a much better rate). The bottom line is that my expected rate from waiting is slightly better than my expected rate from locking in. But my risk aversion -- coupled with the possibility of bending the single-lock policy -- caused me to pull the trigger today.

Besides, can you really complain about a mortgage at less than five percent?

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In the comments to my first post about minority shareholder oppression, Kate Litvak, Elizabeth Brown, and I debate whether it is appropriate to provide any protections to minority shareholders who, after all, failed to bargain for them. Kate raises an important concern, which I share to some extent, that judicial protection of minority shareholders risks a “massive wealth transfer” from controlling shareholders to the minority. In advocating tailored judicial scrutiny based upon minority shareholder voice, my aim is not to create a new substantive entitlement for minority shareholders but to improve the application of existing oppression standards and to create incentives for more inclusive governance. I oppose proposals that would go further and create an automatic right of exit for minority shareholders.

However, my relatively modest insistence that minority shareholder voice is important to the health of close corporations leaves me open to a different kind of objection -- that this is all feel-good nonsense. Allowing a minority shareholder to have her say and then outvoting her is, for all practical purposes, the same thing as just outvoting her. I disagree. Corporate decisions based on transparent, open discussion will more often serve the interests of all shareholders and the minority will more likely accept the results of an inclusive, deliberative process as fair.

The exercise of voice is, or can be, more than the casting of votes. Formal studies indicate that groups have cognitive advantages over sole decision-makers. Many heads are better than one. When minority shareholders participate in decision-making, the majority may benefit from the presentation of opposing arguments and will be pressed to defend its own preferences. If, for instance, payment of dividends depends upon the corporation’s expected need for cash in the coming year, reviewing the corporation’s financial outlook together with minority shareholders will make it more likely for a reasonable consensus to emerge. If the corporation does not truly need to retain earnings, controlling shareholders will find it harder to withhold or reduce dividends.

Conversely, where the majority can articulate an objective basis for its own view, the minority may disagree but will see that there are countervailing considerations and will more likely accept the outcome as fair. Sometimes, it is valuable to be heard on an issue, even when ultimate decision-making authority rests elsewhere. For example, shareholders in public corporations have increasingly demanded the ability to cast nonbinding votes concerning executive compensation. Although the board sets compensation, shareholders want a voice in the process. Among other things, they believe that compensation committees will act with greater deliberation if their work is subject to enhanced scrutiny and meaningful, if nonbinding, feedback from shareholders.

It remains true that majority shareholders ultimately decide all contested questions, but voice is a political mechanism and need not be synonymous with control. A person’s ability to participate and to be heard on issues important to a shared enterprise, whether family, business organization, or nation state, does not turn on the final tally of votes. Voice is not as crude a mechanism as exit; its value lies in its nuance, as a means of shaping the goals of a close corporation to better accommodate the interests of all shareholders.

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Early reports of accounting fraud at Indian outsourcing giant Satyam Computer Services sound eerily familiar:

The final blow came in the past few days. The lenders who had loaned money to Mr. Raju to keep the company running began to sell the pledged shares to meet margin calls, or the forced selling of shares to cover losses.

The leader for the WSJ:

The chairman of one of India's largest information technology companies admitted he concocted key financial results including a fictitious cash balance of more than $1 billion.

10 years ago I was a lowly paralegal, fresh from an abortive career in literature, working on a securities class action against a California chip-maker. I had always thought business was mysterious and impenetrable, and that financial fraud must be sophisticated beyond my ken. It was a revelation that smart, powerful businesspeople occassionally decide that it's a good idea to make numbers up, trusting that "gaps" will close and everything will turn out okay in the end. I may be naive, or even gullible, but my reaction is still, "You really thought no one was going to notice? A billion dollars? Really?"

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Every commercial law teacher and bankruptcy teacher should distribute this story on the first day of class.  About a year and half ago, BofA mistakenly terminated both its and Citibank's financing statements perfecting security interests against Heller Ehrman, the California law firm that is now in dissolution.  Basically, someone checked the wrong box on this form!  This could turn out to be something close to a $57 MM clerical error. 

The firm had already paid the banks $51 MM since the firm announced its dissolution in September.  The banks tried to file a "correction" in October; the firm's dissolution committee discovered the termination document in November; in December the firm filed for Chapter 11 and has asked the court to throw out the banks' attempted October correction.  Assuming a strict application of the UCC, the attempted October correction would be a preferential transfer of a security interest, which would be avoided.  That makes the $51 MM in payments to the banks (or whatever portion was paid within the 90 days before Heller's bankruptcy filing) preferential.  So they have to give it back.  And the remaining $6 MM owed by the firm would also be unsecured.  So the banks might end up with something close to a $57 MM unsecured claim, instead of the secured position they thought they had.  Ugh.  Everyone make sure your malpractice premiums are paid up!

Apologies if your eyes glazed over while reading that last paragraph.  Can you tell I've been grading bankruptcy exams?  I actually thought about saving this fact pattern for next year's exam, but it's just too good not to share!

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Yesterday, I summarized my claim that courts should use the presence or absence of minority voice as an important guide to the adjudication of claims of minority shareholder oppression. My proposal runs counter to what seems to be the prevailing academic view, which is that we should simply make it easier for minority shareholders to exit the corporation. John Matheson and Kevin Maler, for example, have proposed an automatic, statutory right to exit akin to a no-fault divorce.

My principal concern with exit-focused approaches is that they undermine the significance of choosing the close corporation form and the shareholders’ interest in having a locked investment. From the ex ante perspective, it is not clear that shareholders would benefit from a rule that left their investment exposed. Also, as Stephen Bainbridge points out in his Corporation Law and Economics treatise, undermining the stability of the corporate form would require potential creditors to worry about the relationship of the equity investors and this monitoring burden and uncertainty would reduce the attractiveness of investment.

It also seems unclear whether an automatic exit right would actually reduce the cost of litigation. Given the lack of an established market for shares, creating liquidity for close corporations involves considerable valuation difficulties. Under existing doctrine, there must be a showing of harm before any remedy is available, which limits litigation and focuses those lawsuits that do go forward on liability issues which courts are better suited to address. So, even if easier exit promises some efficiency benefits, those savings may not amount to much.

We should further consider the possibility that minority shareholders could gain too much power in the governance of the close corporation. While some boost in exit could enhance voice by backing it with a credible threat, the possibility of shareholder litigation may already serve that function. If the threat of exit becomes too strong, given the need for locked investment, then minority shareholder demands may overwhelm sensible decision-making.

To make this a trilogy, I’ll post on close corporation governance again tomorrow and respond to the so-what objection – why does minority shareholder voice matter?

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The Houston Chronicle is reporting that Jeff Skilling's appeal of his 24-year sentence to the Fifth Circuit was not as successful as it could have been.  Although eight months ago, when the appeal was heard, the tides seemed like they might have been turning for Skilling and other corporate defendants as the demonization of Enron and other companies was fading into history.  However, we are now in a resurgence of scorn and distrust for corporate executives, and it is against this backdrop that much of Skilling's very long sentence will stand.  One of the sentence enhancers that was used to calculate Skilling's sentence under the federal sentencing guidelines required that the defendant's conduct substantially jeopardize the soundness of a "financial institution."  The Fifth Circuit panel did not agree that either of the Enron employee benefit plans were "financial institutions."  (The WSJ blog has a link to the opinion.)

Watchers of the corporate criminal trials of recent years were most interested to see if all or part of Skilling's conviction would be thrown out after the Fifth Circuit determined in other Enron-related cases that the "theft of honest services" theory that the government was pursuing was flawed as applied to these types of executive wrongdong cases.  (See posts at Conglomerate here.)  However, this panel decided not to re-analyze the convictions under that reasoning.  In addition, the convictions seemed to hold despite allegations of prosecutorial misconduct (see Ideoblog for this storyline.)  According to the Houston Chronicle, without the "financial institution" enhancement (which was merely one of many guideline enhancements applied to Skilling's sentence), the sentence may be reduced to something between 15 and 19 years.  Although getting a decade of one's life back must seem like a gift, serving 15 years is still no picnic by any stretch of the imagination.

Will Skilling ask for a rehearing en banc?  Go to the U.S. Supreme Court?  These are once again hard times to be a corporate defendant.  Several Enron Broadband defendants, whose first trial ended in acquittals for some counts and hung verdicts for others, are set to be retried for the second time by prosecutors but have a petition for certiorari waiting at the Supreme Court right now.  Nevertheless, one of those defendants, Joseph Hirko, pled guilty recently (and fairly quietly) in return for serving no more than 16 months.  (Cert was granted for his co-defendants Scott Yeager and Rex Shelby after Hirko pled guilty.)  The prospect of going to trial in these "tough economic times" is fairly dicey for a corporate executive, to say the least.

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Yesterday the House Committee on Financial Services held a hearing on the Madoff ponzi scheme and the “Need for Regulatory Reform.” According to the Committee’s website, the hearing was designed to help guide Congress in “undertaking the most substantial rewrite of the laws governing the U.S. financial markets since the Great Depression.”  It is not clear what that means with respect to the SEC, but testimony from David Kotz, the SEC’s Inspector General, indicated that the Madoff scheme had prompted a more comprehensive review of the SEC and its oversight and enforcement capabilities. Thus, in addition to investigating the allegations related to Madoff and exploring the reasons for the failure to follow up on those allegations (including potential conflicts of interests and undue consideration of the status/reputation of Madoff), Kotz noted that the SEC’s investigation would include “an evaluation of broader issues regarding the overall operations of the Division of Enforcement and OCIE [Office of Compliance Inspections and Examinations] that would bear on the specific questions we are examining, and provide overarching and comprehensive recommendations to ensure that the Commission fulfills its mission of protecting investors, facilitating capital formation and maintaining fair, orderly and efficient markets.” That seems like quite a lot.

According to Kotz, the “broader” investigation would include review of the following

"(a) The complaint handling procedures of the Division of Enforcement, including a review of how complaints are processed, internal incentives that may affect the decision whether to take action with respect to a complaint, an analysis of which complaints are brought to the Commissioners’ and Chairman’s attention, and whether tangible and specific complaints are being reviewed and followed-up on appropriately;

"(b) The OCIE examination and inspection procedures, including an analysis of what policies and procedures were then and are currently in place, whether these policies and procedures are being followed and/or whether there are gaps in these policies and procedures relating to operations involving voluntary private investment pools, such as hedge funds, because they are subject to limited oversight by the SEC, and whether any such gaps may lead to fraudulent activities not being detected; and

"(c) The relationships between different divisions and offices within the Commission and whether there is sufficient intra-agency collaboration and communication between the Agency components to ensure comprehensive oversight of regulated entities."

This broader agenda appears to be a response to concern, from members of Congress and others, that the SEC’s failure to detect the massive fraud associated with the Madoff ponzi scheme may reflect some systemic failure with the SEC more generally. An understandable concern. That is, on the one hand, it seems understandable to wonder how the SEC could have missed such fraud, especially after allegations were raised as early as 1999 with respect to Madoff. And certainly it seems understandable to wonder what other frauds may currently exists that have flown under the radar. On the other hand, the fact that an agency fails to uncover even massive fraud does not necessarily signal the need for substantial overhaul. Indeed, no detection system is perfect, and in some cases ponzi schemes, particularly affinity fraud schemes, are the most difficult to detect. And hence sometimes fraud will occur despite our best efforts. To be sure, while it is too soon to know, it could be that this case does not represent an example of our best efforts. Moreover, I have no doubt that improvements can be made and lessons can be learned from re-evaluating the current regime. In this regard, it is important to determine whether and to what extent there are flaws (big or small) in our current system and what changes can be made to increase the likelihood of detecting fraud in the future--even if those changes do not amount to an overhaul of the system.

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Further to co-blogger David Zaring's excellent post, I'm getting a little weary of financial crisis stories in the popular press of the "so-and-so-saw-it-coming-and-why-didn't-the-rest-of-you(us)" variety.  Here's another Michael Lewis article (another long one) that heralds the end of Wall Street as we know it, and profiles hedge fund manager Steve Eisman, who began shorting the US mortgage market in 2005 and made a killing.  Now, I think Michael Lewis is a terrific writer, and this latest piece is definitely worth a read (funny, insightful, the usual).  And I know nothing about Steve Eisman except what I read in the piece; he's probably a great investor.  But if a meteor struck Far Rockaway tomorrow and wiped it off the face of the map, we could probably find someone that predicted it decades ago, explaining to us how all the signs were there.  In short, there's always a wild survivorship bias in "I-Told-You-So" post-crisis coverage. 

Seeing it coming is no big trick.  Timing is the thing.  Remember they were calling the dot-com bubble as early as '96--when folks were using "burn rate" as a proxy for growth--but all the folks who got out too early gave up some big gains over the next few years  before the bubble popped in 2000.  Too bad no one lionizes the (probably legions of) folks that shorted too soon and lost their shirts, or the folks that were about to make a mint but shorted too late.  It would be fun to read profiles of those people, too.

A better piece reviews a recent book--Mr. Market Miscalculates--by James Grant of Grant's Interest Rate Observer.  While touting Mr. Grant's prescience on matters financial, it readily admits his mis-timings, both of the dot-com bubble burst and the mortgage meltdown.  At the end of the day, I'm with David.  Anyone who thinks the financial meltdown and its solutions are simple is . . . well, simple.
[Bubbles by Debbie & Stan's Saltwater Clip Art Collection.]

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Steve Jobs released a letter about his weight loss yesterday, and Apple's stock rose over 4%, but the legal story here is unfinished. Apple has not been very forthcoming about Jobs' health and even today's letter did not satisfy. "Hormone imbalance"? As WaPo noted, that is "a revelation that didn't reveal anything." Here is some informed speculation:

What strains credibility — and sounds too good to be the whole story — is that the issue was first raised and the cause discovered only a few weeks ago. If it is something as simple and straightforward as a nutritional problem caused by a hormone imbalance, says UCSF’s Dr. Ko, “I doubt his doctors would have missed it all this time.”

What seems more likely is that Jobs, a man who knows something about controlling the message, is telling us a story as carefully crafted as any Apple product. He has said as little as possible about his medical condition — just enough to calm the waters stirred by his decision to skip this week’s Macworld. And he said it before the markets opened on the eve of Apple’s last Expo — just in time to allow the thousands of reporters, analysts, developers and fans descending on San Francisco to “relax,” as he writes, “and enjoy the show.”

Few CEOs are as closely tied to their company's fortunes and Jobs is to Apple's, and while some think it's time for Jobs to go, others believe he is too central to Apple's identity. Should Apple's board of directors disclose more about Jobs' health?

Investors may want more information -- investors always want more information -- but that doesn't mean the company is required to provide it. The Jobs situation reminds me of the situation with Stephen Ross at Time-Warner, which was described by Jayne Barnard in here article, Sovereign Prerogatives, 21 J. Corp. L. 307 (1996):

Sometime in the mid-1980s, Ross was diagnosed with prostate cancer-- "something that (was never) publicly disclosed, and was known only by a handful of people apart from (his) family and closest associates." Apparently he then underwent surgery and  received radiation. After that his doctors regularly monitored his blood chemistry. Then, in November 1991, Ross's prostate cancer recurred and he began chemotherapy. Although the prognosis under these circumstances was poor and his doctors at New York's Memorial Sloan-Kettering Hospital told his family that the treatment at best might give him an extra year to live, Time Warner put out a very positive public statement on the matter: “My physicians are optimistic, and I am maintaining my nor mal work schedule,” Ross said in a prepared press release. In fact, from that day forward, Ross never returned to his office.

Throughout the spring of 1992, Ross continued the pose of being in full command of the company, and in fact, he was quite instrumental in the ouster of his co-CEO, N.J. Nicholas, in favor of Ross's preferred successor, Gerald Levin. One reason the Time Warner board members went along with this maneuver was because they thought that the issue of succession in the short run was largely academic. Participating by phone in the February 1992 board meeting, where the ouster of Nicholas took place, Ross told his directors that he expected to be back in the office before summer. In early June, Ross indicated his intention to be back at work in time to attend the annual shareholders' meeting in July.

It was not until mid-June 1992 that Ross finally conceded publicly the gravity of his illness. Announcing that he was taking a "temporary leave of absence," Ross nevertheless insisted that his relationship with Time Warner would not change. This spin-doctoring apparently worked. "Analysts said the departure of Ross, who began working at home late last year when he began chemotherapy treatments, would probably not have a significant short-term effect because the 64-year-old Ross had been focusing on planning rather than day-to-day management."

Time Warner's official company line throughout this period was optimistic. In April 1992, Time Warner's newly-appointed co-CEO, Gerald Levin, told investment analysts that Ross's cancer was in remission and that he no longer had a tumor. At the annual shareholders' meeting in July, Levin informed those present that "Ross is continuing his treatment. . . . He is responding to his treatment and is eager to get back as soon as his doctors permit." Ross's wife, Courtney Sales, also appeared at the meeting and confirmed Ross's eagerness to return to work. In fact, by July, Ross was gravely ill, drugged for pain, unable to receive visitors outside of his immediate family, and constantly in and out of the hospital where he received transfusions.

In November 1992, Ross entered the University of Southern California Cancer Center in Los Angeles for an operation his New York doctors had characterized as futile. After a ten-hour operation, his new surgeon declared that Ross's tumor was gone at last. The doctor said that what cancer remained "could be treated with chemotherapy once Ross regained his strength." Time Warner issued an enthusiastic press release. The UPI reported that "Time Warner Inc. said Tuesday that chairman Steven J. Ross has undergone successful surgery for prostate cancer . . . . (The company is) pleased to confirm that Steven Ross has made satisfactory progress in the chemotherapy treatments, so much so that he has been able to receive successful surgical treatment."

Ross died on December 20, 1992, after additional surgery, never having left the hospital. Shortly before his death, but more than a year after Ross had stopped coming to work, Time Warner's board had finally requested an accounting of his condition from his surgeon. The doctor told them in writing that Ross would eventually be able to resume some level of participation in the company, but never his full-time duties. Nevertheless, "in mid-December, (Time Warner) executive vice-president Geoffrey Holmes told a group of analysts that Ross would (soon) be returning (to work)."

At what point during all of this did Time-Warner have a duty to disclose Ross' condition? Noting that the disclosure rules are unclear, Jayne opines, "one might reasonably posit that when a CEO has a serious illness, particularly one involving pain, the illness should be treated as presumptively material and the company should disclose the illness as soon as reasonably possible following diagnosis."

Of course, there is no general duty to disclose all material information. The question is whether the company has a duty to disclose the information in question.

More recently, Joan Heminway has addressed the tension between disclosure obligations and privacy rights in Personal Facts about Executive Officers: A Proposal for Tailored Disclosures to Encourage Reasonable Investor Behavior, 42 Wake Forest L. Rev. 749 (2007):

It is clear from the mandatory and antifraud disclosure rules ... that the SEC, under the power delegated to it by Congress, intends that public company executives surrender some of their privacy rights in favor of the compulsory public disclosure of facts about them--at least to the extent that disclosure promotes the policies underlying the federal securities laws.... An insider of a corporation that is asking the public for funds must, in return, relinquish various areas of privacy with respect to his financial affairs which impinge significantly upon the affairs of the company.... However, Congress did not expressly strip executive officers of their information privacy rights (or delegate authority to the SEC to do so). Moreover, no court has found that individuals check all of their information privacy rights at the door when they become public company executives.... Unfortunately, current federal securities disclosure rules do not apparently recognize the tension they create with privacy rights or provide a concrete basis or process for performing the requisite balancing of governmental (or public) and individual interests. Where a duty to disclose exists, what is material must be disclosed.

Again, the key issue is whether the company has a duty to disclose. Both Jayne and Joan lament the fact that federal securities law permits companies like Apple to withhold information about Steve Jobs' health, even though the information seems patently material. But given the present state of the law, unless Jobs' letter were misleading, I don't see a compelling argument for more disclosure in this case. And in the absence of a duty to disclose, the board can reasonably elect to respect Jobs' stated desire for privacy. ("So now I've said more than I wanted to say, and all that I am going to say, about this.")

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