Ideoblog

Backdating and the story that got away

Remember backdating? The story of the century? Winner of a Pulitzer Prize? Surely you must, because a guy got sentenced to 21 months in jail and fined $15 million for it.

That comes to mind because John Carney tells us:

In his Capitol Hill testimony today, Markopolis revealed that he contact[ed] a WSJ reporter in December of 2005. The reporter seemed interested in the story but his editors never greenlighted an investigation, Markopolis says. * * *

Around the time that Markopolis was talking with the WSJ, the paper was gearing up to launch its ground-breaking investigation into a scandal involving the misdating of options grants. That story got played up big time in the Journal, picked up by both the SEC and journalists across America, and eventually won the Journal a Pulitzer Prize. Of course, it quickly fizzled out as regulators came to realize that it wasn't quite the big deal almost every one thought it was. It became obvious that, far from uncovering the financial crime of the century, the WSJ had uncovered some minor accounting errors that had become common practice in the tech community. Meanwhile, the WSJ was missing the actual financial crime of the century. They were so convinced that corporate CEO pay was somehow criminal that they missed the real criminality even after it was delivered to them on a silver platter. No one would expect that the Madoff story, which is basically about a fraud at a little known securities firm, would garner anyone a Pulitzer.

As I said at the time, "backdating is not a business scandal. It is a scandal of credulous (or worse) business journalism."  Now we're learning that this scandal also had opportunity costs.

What would you give to see somebody with a real company making actual money and employing real people doing an IPO today? How much would it bother you to find out that the CEO got stock options on a different day than he said he did?

Meanwhile, when this stuff was front page news, Bernie Madoff was stealing billions from investors. Markopolos couldn’t interest the SEC in the story, either. If Greg Reyes loses his appeal, he'll go to jail. I wonder if Madoff will ever see the inside of a jail.

The stupid bailout pay caps

I’ve been lax in blogging about the bailout because there’s so much stupidity I haven't been sure where to begin. Well, now I have an idea where to begin – the President’s plan to curb pay for recipients of “exceptional assistance” to less than $500,000/year other than restricted stock, with an effective hurdle set at the payout of the debt.

The proposal will also include shareholders "say on pay" for senior executive compensation, which I’ve described as “quack corporate governance,” but which our President nevertheless sponsored in the Senate.

According to the WSJ:

the president intends for these standards to mark the start of a long-term effort to institute a "sensible framework" for executive compensation that promotes sound risk management and long-term growth while preventing future financial crises. Possible steps for the future include requiring compensation committees on all public financial institutions to review and disclose strategies for aligning compensation with sound risk-management.

Note that this proposal applies not just to the executives who messed up, but to new hires that might lift the firms out of their morass. It therefore not only doesn’t focus on the bad, but helps free them from competition in the executive talent market.

This is so blindingly stupid that it would barely deserve comment but for the fact that it threatens to help further impede a desperately needed recovery. Here's John Carney:

[W]e'll find ourselves in a strange world in which competition for talent is severely limited. * * * [T]his would have the effect of allowing dead in the water firms to continue on without fear of losing their best performers. This, in turn, might actually encourage Wall Street to further misbehave. * * *

The exit of talented people is typically a signal of financial distress on Wall Street. * * * Once you max out compensation at five hundred grand, you'll find that this signal becomes useless.

Overall, this could hurt our economic recovery by limiting the rewards for making smart bets on the companies and sectors that will lead us into economic health. * * * Basically, we'll wind up creating a zombie version of Wall Street that will have little incentive to rebuild our economy.

Carney's skeptical that it will work because financial pros will find "work-arounds" for the limits.  But that won't eliminate the costs because the work-arounds will not necessarily be incentive equivalents.

But I do have one good thing to say about the proposal: it could hasten the flight of talent out of the traditional corporate firms that created the mess. Private equity may not be thriving now, but this bodes well for these firms’ ability to attract the best talent in the future, despite the risk.

Update:  Here's some of the proposal.  Though it's limited in scope to a few executives and companies, these are the executives and companies for which incentive pay is most important.  Plus, this could be a model for the future.

Markopolos on the SEC as accessory

I have been sharply critical of the SEC’s role in the Madoff affair – essentially giving Madoff cover by purporting to regulate, and yet not. Along those lines, Harry Markopolos’s testimony about his inability to get the SEC to respond to his extensive sleuthing on Madoff over the years (summarized here) is must reading.

Markopolos concludes that “"the SEC securities' lawyers if only through their ineptitude and financial illiteracy colluded to maintain large frauds such as the one to which Madoff later confessed." This supports my characterization of the SEC in the post linked above as an “accessory” to the fraud.

It is important to recognize that this wasn't a matter of the SEC simply missing fraudster's obscure machinations.  Madoff's scheme was designed to fool the unsophisticated regulators he knew would be watching him.  Moreover, the SEC didn't just fail to find the problem -- over many years the agency deliberately refused to follow up on what Markopolos, at significant risk to himself, had found.

Hopefully Markopolos will spur a significant rethinking of the SEC’s role and performance as a market watchdog. It obviously needs new people and new procedures.  If the SEC doesn't get a bite it should have its bark removed and leave this task to the market, which in this case did a way better job.

Executive health and mandatory disclosure

Should Apple have to disclose the full facts of Jobs’ health? Harvey Silverglate, writing in today’s WSJ, says

the notion that investors were entitled to every detail, when they knew the CEO's health history and saw his obvious weight loss, is ludicrous. That a man's desire to maintain a shred of privacy under these circumstances can justify a fraud investigation tells us much about the lack of legal precision, not to mention decency, with which federal investigators and prosecutors too often operate.

Under current law there’s probably no affirmative duty to disclose. For reviews of the law and recommendations for SEC disclosure rules on this see Joan Heminway and Allan Horwich. Corporations can’t lie or misleadingly disclose, which is now giving rise to the Apple investigation (which will probably be subject to the Apple Rule, discussed most recently here). And executives’ health could be material inside information that insiders can’t trade on even if there’s no duty to disclose.

Should the law go further? I’m sympathetic with Mr. Silverglate, though appeals to “decency” are unsatisfying as a principle for interpreting and applying the securities laws.

How about this solution: let the shareholders decide. After all, non-disclosure mainly hurts the company – the lack of information raises investor risk, and therefore the company’s cost of capital. The shareholders ought to be able to balance the extra recruiting and retention costs of a full disclosure rule (and “decency,” for what it’s worth) against traders’ needs to know all the facts. Conversely, how can a regulator possibly decide that tradeoff for all firms, executives with varying degrees of importance, and the full range of diseases known to medical science?

But once we’ve gone down the shareholder-choice road, where should we stop? Are the issues regarding executive health disclosure all that different from, say, executive pay, internal controls disclosures under SOX, or the plusses and minuses of securities fraud class actions? Here is Henry Butler and me on optional SOX in Forbes, Adam Pritchard on optional securities class actions, and a post tying all this together (watch for more forthcoming from Washington Legal Foundation).

Where would this optional stuff lead? State law?  If this sounds odd, then you go figure out one size fits all rules that cover situations like Steve Jobs.

More on the billable hour

Bruce MacEwen takes issue with the NYT's death knell for the billable hour, which I discussed yesterday. Since Bruce's judgment on such issues deserves a lot of weight, it's worth an additional comment.

Bruce reviews the pros and cons of the billable hour. The cons, as discussed yesterday, include the perverse incentive to run the clock. Moreover, Bruce notes that there are better ways to charge for legal services – flat fees on certain types of litigation, set with actuaries' help; negotiated fees set with reference to clients' expected results (as discussed yesterday). Yet Bruce says:

Are we, then, about to witness in some grandiose fashion the "death" of the billable hour, much less its dropping back into the shadows of small-beer practices or quaint and creaky backwaters? As you can tell by how I phrased the question, I see no such incipient revolution. And the primary source of life-support I would cite is clients, not law firms.

Clients gain, Bruce says, because it helps them explain lawyer fees to "their financial green eye-shade types."

Let us start with the following gambit: All of you out there who think that the dominance of the billable hour for legal work – as opposed to any other kind of work – reflects inherent unique qualities of legal advice raise your hands.

As for those of you who are still wagging your hands, I would wager you think there's something special about work that might end up in court. But keep in mind that what happens in court is also up to lawyers. It might be that if we solve the billable hour we could also bring down basic litigation costs.

Ok, now that we've disposed of that one, we can ask why the billable hour persists. Can it be clients? To be sure, it's a convention that's easier to monitor, which is important when you're lazy about monitoring. But if legal work would be better value to the client if charged some other way, then this monitoring convention is basically an agency cost issue within clients as well as between lawyers and clients.

As I suggested yesterday, we come back to the monopoly status of law work under licensing laws and ethical rules, and the effect of these rules on law firm structure. These rules do not make all lawyers better off than they would be without the rules. Rather, like any cartel, they make the group as a whole better off. Cartels break up when the gains to individuals of splitting off become big enough. And, as I suggested yesterday, client cost pressures may force them to reevaluate their relationships with lawyers.

Wall Street pay

Obama thinks Wall Street bonuses are "shameful," and Sen. McCaskill introduced a bill that would ensure that executives at bailout financial companies would get no more than the president (does that include free rent?). These moves are about as surprising as sunset in view of the meltdown and facts like this:

From 2002 to 2008, the five biggest Wall Street securities firms paid an estimated $190 billion in bonuses. Those companies churned out $76 billion in combined profits during the same period. Last year, the companies had a combined net loss of $25.3 billion, yet paid bonuses of roughly $26 billion.

The fact is that there is a problem. As Jon Macey was quoted as saying in the story that the above appeared in, "the foxes have been guarding the henhouse."

Yet we don't want the government to decide this stuff. After all, compensation laws determine who works where. As a WSJ editorial says today:

The danger of targeting what capitalists we have left for abuse or prosecution is that they will stay on strike, as they did in the 1930s. It won't be pretty this time either.

The last thing the financial markets need is Atlas Shrugged.

The problem, as Macey suggests, is governance – specifically corporate governance. I said that at the outset of the blowup, back in September, when Lehman, AIG and Merrill blew up on Black Sunday:

I think this is the wake up call for corporate governance. Despite all the regulators, independent directors and Gretchen Morgenson, big firms were taking catastrophic risks under the radar. And, yes, the culprits were the conventionally governed big corporations. * * *

And now it’s the similarly governed private equity firms that are waiting in the wings to pick up the wreckage. 

In other words, the Uncorporation. Uncorporations control not only risks, but pay. In the Uncorporation, pay can be very big, but it's designed to provide incentives. You don't keep getting bonuses in good years and bad. If the investors hurt, you hurt until the investors get well and you clear your hurdle.

Political manipulation of Wall Street or any other pay is just scapegoating that accomplishes nothing. In this case the pay is a symptom of a deeper governance problem that needs to be fixed.

The real danger is that Congress will regulate the cure, too -- private equity, hedge funds and the other uncorporate alternatives to corporate governance.

Blagojevich: the governor as goldfish

Ever watch a goldfish?  They swim around, seemingly aimlessly. But put food in the tank and they swim right for it and nibble at it.  Then they go back to swimming aimlessly. 

The governor of my state was like that.  Unfortunately, he nibbled at the wrong food and ended up sinking to the bottom of the bowl.  Time to clean up.

Too bad.  The people of Illinois voted for him.  Twice.  What did they think they were getting?  This is a man who looks as dumb as he is -- no mean feat. The first time they voted for him because the other guy had the same last name as the previous governor, who went to jail. I don't think we'll be having anymore candidates named Blagojevich, so it's not clear what's going to happen in the next election.

Well, at least Blagojevich has made history -- the first governor in the history of the state not to meet Illinois's strict standards for retention.  When you keep in mind that a sizable fraction have gone to jail, that's another prodigious accomplishment.  

Is the economy killing the billable hour?

As I said last month:

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.

Indeed, I suggested that the survival of the billable hour was itself evidence of serious problems with law firm structure.

Today's NYT suggests that the billable hour may be the next victim of the economy. Even Cravath may be rethinking it!

“This is the time to get rid of the billable hour,” said Evan R. Chesler, presiding partner at Cravath, Swain & Moore in New York, one of a number of large firms whose most senior lawyers bill more than $800 an hour. “Clients are concerned about the budgets, more so than perhaps a year or two ago,” he added, with a lawyer’s gift for understatement. Big law firms are worried about their budgets, too. * * *

The article cites a case in which a firm negotiated a fixed fee with a bonus of amount saved from the worst case scenario. Lawyers settled for less than the target, got more than the hourly rate and made the client happy.

Compare the billable hour result:

In litigation, firms that charge by the hour can suffer if they are too successful and end a lawsuit — and the stream of payments from continuing work — too quickly. One law firm that recently collapsed, Heller Ehrman, was hurt in part because a number of cases had settled.

Fear of settlement might otherwise be called "agency costs."

The article points out that

If lawyers set too low a price, they lose money. Many lawyers may not be good enough businessmen to pick the right price. . .

Oy. Does that mean that lawyers may actually have to become "good businessmen"? Yes, sharper competition can have even that drastic effect.

The billable hour survives because it's convenient for law firms. This convenience is a form of seller's surplus that the economy is squeezing out of law practice.

The death of the billable hour will make it much harder to sustain the current law firm model – a pyramidal structure of many associates supporting a few partners. Talented lawyers will have to find some other financial structure to leverage their skills. That, in turn, will put pressure on the ethical rules that sustain the current structure.

In other words, big law firms are meeting Elvis's fate, as I said on Monday.

Hot off the press: The Mystery of Delaware's Success explained

Way back in the fall of 2007 I helped organize a program at the University of Illinois on the “Mystery of Delaware Law’s Success.” As discussed here, the conference featured an article by William Carney and George Shepherd suggesting that Delaware’s success was a mystery because its law was so indeterminate. Chancellor William Chandler, one of the leading "manufacturers" of Delaware law, responded with an article (co-written by Anthony Rickey) refuting Carney & Shepherd's disparaging comparison of Delaware and other corporate law. Bob Thompson and I provided comments. My contribution, The Uncorporation and Corporate Indeterminacy, blamed any problems on the corporation and offered the uncorporation as a solution. Bob Thompson said it’s all federal law anyway.

Now it's all been published by the University of Illinois Law Review. The published papers are here. It’s a significant contribution to corporate law, so you should read it!

Reconciling oppression with an LLC agreement

The application of the “oppression” remedy is one of the stickiest remaining problems in LLC law. This is really a holdover from the law of close corporations, where the courts and legislatures had to give members some way out of very closely held firms that had not adopted the partnership solution – dissolution at will.

The remedy might have been thought to be unnecessary once closely held firms could be LLCs and have limited liability without being “durable” corporations. But LLC statutes generally do not provide for dissolution-at-will. So there is still some need for the oppression remedy in this context. 

The problem with the remedy is that it may be hard to square with the contract. After all, the whole reason for the remedy is that the contract does not provide for exit, yet the court is providing one. One might say that the parties in effect adopted the statutory default rules, including the oppression remedy. But it still may not be clear how the parties wanted those defaults to fit with their agreement. Also, if the oppression remedy is mandatory, did they really have a choice?

Chancellor Chandler’s recent (January 13) opinion in Fisk Ventures, LLC v. Segal, 2009 WL 73957 (HT Pileggi) provides the best way yet out of this conundrum.

First some background. The two parties to this biotech firm sharply disagreed over its future. One of the parties that had provided the funding to date refused either to provide more or to drop its power to veto additional funding that would have diluted its interest. So this was basically a disagreement over the firm’s future.

In an earlier opinion, discussed here, Chancellor Chandler refused to limit the member’s power to exercise its veto power under the LLC agreement, emphasizing freedom of contract under Delaware law. So this set up the deadlock. What to do?

The Chancellor held that the deadlock made it not “reasonably practicable” to continue operating:

When such a company has no office, no employees, no operating revenue, no prospects of equity or debt infusion, and when the company's Board has a long history of deadlock as a result of its governance structure, more than ample reason and sufficient evidence exists to order dissolution.

Again, the Chancellor emphasized that “Limited Liability Companies are creatures of contract, ‘designed to afford the maximum amount of freedom of contract, private ordering and flexibility to the parties involved.’"

But what about the oppression remedy's potential to trump the agreement? Well, here the agreement itself provided for dissolution per the LLC Act.

That left it for the court to apply the act. The Chancellor did so by parsing carefully through the agreement. The directors were obviously deadlocked. The key question is whether the obstinate member had to use its “put” under the agreement to sell out and get out of the way. The court held that the agreement didn’t require exercise of the put.

Also, although the put-holder was acting in its self interest, it had a right to do so under the agreement:

* * * Fisk Ventures has the right to protect itself against what it perceives as Company actions that would diminish the value of its stake in Genitrix. This Court will not substitute its business judgment for that of Fisk Ventures simply because Segal believes that will be in his best interest.”* * *

Finally, Segal's argument that Fisk Ventures cannot seek judicial dissolution because it comes to the Court with unclean hands is without merit. The LLC Agreement is a negotiated contract and Fisk Ventures has the right to attempt to maximize its position in accordance with the LLC Agreement's terms. If Fisk Ventures chooses to exercise its leverage under the LLC Agreement to benefit itself, it is perfectly within its right to do so. 

The plaintiff thought that dissolution would destroy the value of the firm’s non-transferable patent license. But:

The value of the Whitehead Agreement is hotly contested and I am unconvinced that any potential value it theoretically might have could not be accessed through a fair and proper sale of the asset. One thing is certain, however. These parties will never be able to reach agreement on how to dispose of this asset, whatever its potential value.

The court concluded:

Ultimately, even if the financial progress of Genitrix is impeded by the deadlock in the boardroom, if that deadlock cannot be remedied through a legal mechanism set forth within the four corners of the operating agreement, dissolution becomes the only remedy available as a matter of law. The Court is in no position to redraft the LLC Agreement for these sophisticated and well-represented parties.

This case involves a long-lived corporate dispute that resulted in devastating deadlock to Genitrix's Board and the loss of significant value to all involved. Genitrix's Board is hopelessly deadlocked, and the LLC Agreement fails to anticipate that risk by prescribing a solution to the Board conflict.

This is how you reconcile the seemingly unreconcilable: the agreement, and a statutory remedy that is, and is not, part of the agreement.

One more thing: Delaware does offer a way around oppression: you can enforceably waive the remedy in the agreement.  This is arguably a critical piece of the overall contractual approach to oppression. In Delaware, even if the parties had not (as here) put the oppression remedy in the agreement, they would essentially have agreed to it without waiving it.  Indeed, that argument is potentially available outside of Delaware, since the parties can agree everywhere to oppression by organizing in Delaware. 

Keeping up with the rules

Tom Kirkendall has a guide to the rules about Apple, Dell, Buffett, GM, Geithner, Steel.  Now if only we had a policy.

More on The Law Market

As previously announced, my book with Erin O’Hara, The Law Market, is now out. Get yer copy from Amazon (apparently going fast, and soon available on Kindle) or direct from Oxford. And, for those in the DC area, there's the AEI event this Thursday.

Why should you be interested? Because our proposal could be the last chance for saving state law before the coming federalization of everything.

Further note:  Wanna peek?  

Elvis (and Big Law) are dead

"Elvis Lives." Nathan Koppel, writing in today’s WSJ, tells us that was on Heller Ehrman's coat of arms. Of course Heller is dead. As well as Thelen, Thacher Proffitt. And, as described in the article, many behemoths are bleeding and there will be more dissolutions this year.

Nevertheless, the basic idea of the big law firm seems to live on, just as Elvis himself does in the heads of many of his friends.

Koppel’s story of what happened to Heller should give these people pause. Consider this:

• "Many law firms are susceptible to the phenomenon that led to Heller's collapse. Their main assets are their senior lawyers. * * * [L]awyers with big books of business now commonly shop themselves to more profitable firms that can offer larger compensation packages."
• "The economic downturn has prompted lawyers to jump to firms perceived to be more financially stable. If enough partners head for the exit, a firm can crater in a hurry."
• "[I]n 2007 * * * over 45 days, [Heller] lost about one-quarter of its litigation business due to settlements * * * Some Heller lawyers saw this as more than a temporary blip. They believed large-scale litigation matters -- the sort that can occupy 30 or more lawyers for years and that had been the key driver of Heller's growth -- were permanently on the wane, as companies increasingly used mediation or adopted other cost-saving measures.
• "At a shareholder gathering last spring in Colorado Springs, Colo., Heller's chairman, Mr. Larrabee, said the firm had plenty of choices of merger partners, according to lawyers who were there. Last summer, Baker & McKenzie LLP, one of the nation's largest firms, emerged as a serious candidate. But after weeks of negotiations, the deal cratered in August, partly because of business conflicts. Heller lawyers had sued many of Baker's clients. * * * Then a new suitor, Mayer Brown, emerged, but that fell through because “Mayer had grown nervous about Heller's financial state.”"
• "Heller distributes its income to shareholders at year end. As a result, at the beginning of each year, it has to tap a bank credit line to pay salaries, rent and other expenses. As revenue rolls in, it pays down the credit line. It is usually finished by August. Last year, however, revenue dropped off so much that it had trouble paying down its loan. By September, its debt hovered around $30 million, according to a lawyer knowledgeable about the finances. The formal departure of the intellectual-property group on Sept. 14 put Heller in breach of a loan covenant that limited the number of shareholders who could depart in a 12-month period. On Sept. 26, with banks controlling how Heller spent its money, shareholders voted to dissolve the firm.

So, in a nutshell:

• The major assets can walk
• These firms need lots of debt because of mismatching revenue and expense streams.
• The combination of these two conditions can make the financial condition of even the largest firms tenuous.
• Medium sized firms can’t survive these pressures. Yet client conflicts constrain growth through merger or otherwise.
• Fundamental changes in the law business, such as the long-term decline in Heller’s litigation, are changing the basic business model.

Most other industries could evolve to meet the new challenges. But the law business can’t change as easily because it’s choked by ethical rules that developed based on a century-old model of law practice that seeks to preserve the illusion that law practice is a “profession” rather than what it plainly is – a business. These rules include:

• Rigid restrictions on client conflicts.
• Prohibitions on noncompetes that prevent attorneys from binding themselves to their firms.
• Prohibitions on non-lawyer owners that prevent investments of the sort of permanent capital that sustains most other firms, and that prevent synergies between law and other businesses.

These rules have been developed by lawyers, for lawyers.  They are not in clients' long run interests.  I suspect that market pressures will kill the cartel over time, because the law business as a whole will have to see that the rules are no longer in its interests either. The economic crunch will make this happen sooner rather than later.  But not instantaneously.  After all, some people still think Elvis lives.

For some of my writing on these points, see my lawyer archive and the following articles: Law Firms, Ethics, and Equity Capital: A Conversation (with Regan and MacEwen); On My Mind: Lawyers Don't Make Enough, Forbes, October 29, 2007 at 40; Ethical Rules, Agency Costs and Law Firm Structure, 84 Virginia Law Review 1707 (1998); Ethical Rules, Law Firm Structure and Choice of Law';  Law Firms as Firms.  

The SEC acting its age

I suppose when you’re 75 years old you realize your best days are behind you. You find it hard to keep up with the fast pace of the modern world. All these new things that are happening! You stick with what you know.  The easy stuff. 

Well, the SEC is 75 years old, and it's investigating Wachovia's Robert Steel. The agency must be frustrated by all these massive frauds it had no clue about until hearing from some newspaper or blogger or the fraudster himself. But even a dog can catch a parked car.

So we see the SEC investigating whether Steel lied when, just before his bank started exploring merger possibilities and then unraveled, he said that Wachovia had a

great future as an independent company, but we're a public company, so we're going to do what's right for shareholders, I can promise you that. But we're also focused on the very exciting prospects when we get things right going forward.

See WSJ and Blodget.

The only arguable misstatement here is “great future as an independent company.” If Steel knew or had strong reason to know that the bank was going to go bust or merge, then maybe there’s a problem here. Conceivably the SEC could prove something, after considerable discovery and sorting through exactly the details of the actual facts and what Steel knew and didn’t know at that moment (which, remember, was when the market was melting down in mid-September 2008).

And if the SEC does prove something, what exactly will it have accomplished? Punished an executive who was trying hard to save his company when everything was crumbling? No potential merger partner would be fooled by this statement. Possibly some traders plunged into the stock on the basis of this statement.

Do we want to make sure that investors of the future bet their farms on this kind of puffery? Or should we be devoting our resources to understanding how Wachovia and the rest of the banking and financial industry so suddenly got to the point that it found itself in in 2008?

The Geithner rules

In my last post I alluded to the problem created by appointing a Treasury Secretary who has taken a casual approach to the tax laws.  A couple of comments to that post follow up on that issue.  Specifically, does Geithner's compliance level set a new de facto standard?  How does the IRS justify higher penalties or stricter enforcement against "ordinary" taxpayers for the same conduct.  How does it enforce strict rules against its own employees?  What other kinds of conduct does the Geithner rule apply to?

I also noted the relevance of the "Apple Rule" of non-prosecution of important or well-regarded executives.  Is there now a comparable rule for government appointees?  When do misdeeds that used to be disqualifying no longer count?  Do the same rules apply to Supreme Court appointments?  Republicans? 

I can't make up my mind whether this nomination is more appalling for its arrogance or its stupidity.

And as for the argument that we need somebody in place as soon as possible, I have seen little evidence over the last few months that the economy has been helped by having a Treasury Secretary.  How about if we trying getting along without one in this administration?

Why Geithner shouldn’t be but will be confirmed

It’s about Geithner's tax "mistakes."  Here’s Joe Weisenthal:

A series of easy choices [e.g., TurboTax says it’s ok], where someone decides that they can get away with something tiny, knowing it's not that big of a deal and that they'll probably just get a slap on the wrist. * * *

We know that not everyone would've made the same decision here. We've worked with people in our professional life, who everytime they encountered something legally or ethically murky opted to make the conservative choice that wasn't immediately beneficial to them. They do exist, believe it or not. We suspect a guy like Warren Buffett would've asked for a professional opinion on the tax issue, were he in that same position. * * *

The speed of the banking crisis means the full Senate will sign off on today's finance committee vote. But we will soon have a Treasury Secretary who was basically of the same mindset as everyone else, rather than a real clean break from the failed, convenient thinking of the past.

After all, here’s a guy whose jurisdiction includes the tax laws, which in turn rely heavily on voluntary compliance, deciding that he’s going to try to get away with what he can get away with. Moreover, it’s not at all clear that he really is the savior he's being portrayed to be.

And then there's “The Apple Rule” aspect. The Curious Capitalist over at Time.com has picked up on this in explaining why Geithner will be confirmed despite his conduct:

mainly it's that the global financial system is showing signs of falling apart again and getting a strong, competent leader into the corner office at Treasury—pronto—has become something of a bipartisan national priority. * * *

This reminds me a lot of what University of Illinois law professor Larry Ribstein has dubbed the Apple Rule. As Ribstein put it in January 2007:

It's become clear by now that a major job for our legal system is trying to figure out a way that we can simultaneously (1) punish those greedy backdating wrongdoers; and (2) keep Steve Jobs out of jail.

Ribstein later defined the rule thusly:

The Apple Rule provides for an exception from corporate criminal liability when a popular business executive is accused of, or presides over a company that is accused of, misconduct. "Popular" is defined as "liked by journalists." * * *

Basically, what bothered and bothers me is the injustice of crimes being judged by public expediency rather than guilt. 

Of course the confirmation's going to happen. But I thought I would post this so I can pull it out again when the ultimate irony emerges -- we learn that Geithner’s no more indispensable than his predecessor turned out to be.

Is there a “national interest” exception to the securities laws?

It turns out that losses at Merrill going into the BoA deal were so big that Merrill was essentially worthless. At least that’s the stock market judgment, since BoA’s stock market value in the wake of the deal has dropped more than the amount it paid for Merrill. Yet this story in yesterday's WSJ discusses how Thain didn’t clue the Merrill board in on the fact that the deal could have been in jeopardy.

There's a possible explanation for Thain's conduct in Dennis Berman’s column yesterday.  The column deals with why BofA's Kenneth Lewis didn’t tell his shareholders about the Merrill losses. Berman wonders:

Did Mr. Lewis stay quiet on his own or at the request -- subtle or explicit -- of Messrs. Bernanke and Paulson? A person close to the Fed said no such request was made. Divining the government's intentions, however, still are murky. In a conference call last week Mr. Lewis said that "we spoke to and were in close coordination with officials from both the Treasury and the Federal Reserve," adding that "the government was firmly of the view that terminating or delaying the closing...could result in serious systemic harm." * * *

Corporate-law observers said the Merrill deal puts the federal government on an inevitable crash course with shareholders-rights attorneys. By Delaware laws, board directors' loyalties are to shareholders, not to the federal government or a vague national interest. "If it's harmful to your company, I don't believe Mr. Paulson could impose his will on you to act against your shareholder interest," said Jerry Silk, an attorney at plaintiffs firm Bernstein Litowitz Berger & Grossmann LLP.

Lawyers said that it is possible a new legal standard could eventually emerge from transactions like Merrill: that of a "national-interest" doctrine, absolving companies of governance actions that may be potentially harmful, but are important to an economic or defense emergency.

I’ve been writing a lot about the problems of shareholder voting as an aspect of the whole flimsy corporate monitoring structure. But here, informed shareholders might have acted effectively (though the activist hedge funds that might have intervened have their own problems lately). So this is one place where disclosure might have made a difference.

Would shareholder intervention to block the BoA/Merrill deal have been socially inefficient? Or is the market still the best guess as to what is socially efficient? I’m still betting on the latter conclusion. Perhaps more interesting for present purposes, the market's key role in resource allocation happens to be a foundational principle of the securities laws. Or at least that's what the government used to think.

Treating my cold

I’ve had a cold for a week. So, like billions of others, I have bought a shelf full of remedies – stuff for coughing, stuff for congestion, stuff for fever (even though I don’t have a fever), stuff for coughing, congestion and fever (even though, again, I don’t have a fever). When the sneezing improves, the coughing and sinus get worse.

It’s misery, but I do have two consolations. First, I'm doing something, right?  And second, at least it’s not costing me a trillion dollars.

The US as a corporation

I know it's churlish of me to point this out on this historic day, but in case you didn't notice (and the Wall Street Journal web page made it unusually hard to notice today) the stock market plunged as the President was speaking. 

Now I don't believe the two events were related at all.  I think the inauguration is one of those things we expect the stock market to have discounted.  But it reminded me that the main thing going on right now -- the performance of the economy -- happens to be something that the stock market does a good job of measuring.  This isn't about wealth distribution or national security or gross national happiness, but about creation or preservation of financial wealth. People might care a lot about the other stuff in flush times, but right now they're thinking about their retirement accounts.

So while the President did not send the market down today by being inaugurated, his fine words did not seem to have much positive impact.  The government right now is like a corporation in the sense that the stock market is watching its deeds closely.

Ding dong the witch is dead

For years, since well before the current campaign, we've been seeing images like this.

So at last the big day is arriving. Everybody can have a big parade. Once again, time to celebrate somebody from Kansas!

Now it's off to see the Wizard (hey, they play in DC, don't they?). 

If only this were Oz.

I have every wish for the new President's success. I'm just hoping he's not crushed by impossible expectations.

Today is one last day off.  Tomorrow, back to the hard job of focusing on the wreckage of the business world.