Ideoblog

Politicians as business people

Professor Bainbridge has a possible cure for our current disease of politicians prescribing industrial policy without a clue what it means to be an entrepreneur:

We amend the US Constitution's provisions on the qualifications required of a President, Vice President, Senator, and Representative to mandate that they have started a small business into which at least 75% of their net worth was invested and have operated said business for no less than three years in order to be eligible for office. Then they too might be alarmed by government taking control of the basic management decisions that determine business success or failure.

Good idea (assuming we’re excluding government contractors). But we don’t seem to have had many successful business people who are interested in government. Strange because the two careers involve basically the same skill – convincing people to buy stuff. Could it be that politics is for unsuccessful salespeople?

So the big problem with Professor B’s idea is that we wouldn’t have enough politicians.

Wait, is that a problem?

The coming big law partner bloodbath

ATL reports about possible big problems with cutting and deequitizing partners at Jenner & Block:

One tipster quips: At this pace Jenner and Block will soon be populated by top level experienced partners (billing clients hundreds of dollars per hour) and nobody else. Service partners are gone. Yet another tipster describes the situation as a "partner blood bath." Our sources explain that high-end rainmakers are demanding a larger share of the profits, at the direct expense of junior partners who do not bring in business.* * *

Is this really an issue that is localized to Jenner & Block? Fundamentally, there is only so much money you can save by laying off associates and cutting salaries (just like there is only so much money you can save by firing staff). Some firms will undoubtedly start taking a hard look at the people who are supposed to be generating business.

I have no information about J & B specifically, and this may or may not be happening there. But I think it’s clear it will be happening eventually at a large number of big law firms.

The basic problem is that the current large law firm model is breaking down. Under this model of associate leveraging, senior partners are supported by the profits generated by a large number of associates. But for various reasons, including but not limited to current market conditions, clients are not continuing to support those profits by paying the billing premium the firm tacks onto to what they pay associates.  They will pay high prices only for the high-end rainmakers that attracted them to the firm. Unfortunately, this means in the near term that associates and lower-end partners in large law firms may be out of luck.

In the long term there will be high demand for law-trained people in an increasingly regulated environment.  The problem, as I've discussed, e.g., here, is that we have an unsatisfactory structure for delivering those services, frozen into place by ethical and licensing rules.  These rules, among other things, restrict law firm capital structure by requiring owners to be lawyers. The rules need to change before we can reach a more satisfactory equilibrium. 

Dismantling capitalism: bank shell games

As discussed in my first “dismantling” post, full disclosure is a foundation of capitalism. I’ve already discussed (here and here) Geithner’s shell game on troubled assets -- the government subsidizes private equity companies to buy assets at inflated values, saving the government from having to pay for the assets more directly, but still leaving the taxpayers with the ultimate bill if the assets are worth what the banks really think they're worth.

Meanwhile, as discussed most recently here, the government is cutting off market mechanisms to discover real asset prices, such as short selling, hedge funds, and informed trading (but not all informed trading).

Keep all this in mind when reading the most recent news on the stress test. The official story, which the press and the market seem to have bought, is that we’re finally getting good information about banks’ capital cushion, and the market, sensing a reliable bottom, is rising.

But in light of the Geithner shell game, I’m inclined toward skepticism. After all, the government wants to get the banks lending, strengthening the economy and, not so incidentally, the administration’s political position. At the same time, it would like to avoid direct government infusions, which anger taxpayers, and force government to take political responsibility for the firms they’re propping up (including their executive compensation). How much easier it would be if the market provided the cash.

I’m all for market vs. government support, but only if the market has the necessary information. Otherwise we get misallocation of resources. So, can you trust the government?

In addition to background mistrust, I have two specific sources of skepticism. First, the two-tiered financing structure invites manipulation.  Banks that need bolstering can exchange existing Treasury preferred shares for mandatory convertible preferred.  The banks can later convert these to common if they need to bolster the tangible common equity in their capital structure, which in turn would support increased lending. The alternative is for the government to take voting common right now, which gives the government control and responsibility. This creates an incentive to make the stress test results more hopeful than accurate, relying on unrealistically optimistic projections, thereby giving the banks some basis for delaying the politically sensitive transfer of control to the government.

This isn't so much a problem if the market gets full information about the stress test results.  Then it could crunch the numbers and apply accurate valuations, whatever conclusions the government reaches.  But that gets to my other cause for unease -- the incomplete disclosure + leaks that we’re getting (probably from the banks) about stress test results. As John Carney says:

It's all happened without much comment about the appropriateness of this kind of material information about public companies being leaked out through the press. * * *Shouldn't the banks involved be making clarifying statements to their shareholders about the accuracy of the leaks? That's * * * what happened back when the banks were complaining about 'rumor mongers' pushing down the prices of their shares.

It's very likely that the banks have been told by regulators that they are not to make statements about the stress tests. But what authority do regulators have to issue this statement? Doesn't it violate disclosure rules? Again, this looks like another case of government lawlessness, of authority exercised without legal warrant and in violation of existing standards.

Will we get full and accurate information about the stress test results? Or are the banks and the government orchestrating an incomplete information regime designed to build investor (over)confidence and take the government off the hook if everything works out?

Maybe I’m being paranoid. On the other hand, I wish I had more confidence in our Treasury chief than I do.

Artist radio royalties and payola

Per the WSJ Congress is considering legislation that would require radio companies to pay royalties to record labels and artists in addition to the royalties they now pay to songwriters and music publishers. Tony Bennett and Sheryl Crow are singing and talking in favor, radio star Eddie "Piolin" Sotelo is talking against.The National Association of Broadcasters is running a radio ad called "Don't Feed the Fat Cat" on Washington area radio stations.  Let's cut through the noise to see what's really at stake.

Both radio and records are struggling financially. Radio points out that they’re already “paying” by promoting artists. The recording industry says radio is not so important for promotion anymore. My question: why not just allow the recording industry to pay for promotion?  If promotion is important they'll pay. If not, they won't.

I discussed this about five years ago, responding to a Surowiecki New Yorker article complaining about record industry "spot buys" on radio.  Surowiecki noted Ronald Coase’s position (in Payola in Radio and Television Broadcasting, 22 J.L. & ECON. 269 (1979)) that payola helps radio stations allocate scarce bandwidth by spotting potential winners. But he didn't like “spot buys” of radio time because of supposed lack of transparency.

I pointed out that regulation just messes with efficient market mechanisms:

When government banned payola of the Alan Freed variety, it blocked a practice that was, after all, getting more air time for new kinds of music. (In general, regulation hurts the newcomers more than it hurts the established players.) But it didn’t stop payola. What Surowiecki refers to as “new payola” (spot buys) arose in response to the banning of the old payola. The new payola, as Surowiecki points out, creates a less informed market than the old payola.

And the idea of new forms of payola isn’t so new. Greg Sidak and David Kronemyer wrote in 1987 about other perverse market and regulatory effects of the banning of the old payola in The 'New Payola' and the American Record Industry, 10 Harv. J.L. & Pub. Pol'y 521, draft here. Payola's effect in making the music market less transparent is analogous to the effect of insider trading regulation. Insider trading, like payola, helps disseminate information. Regulation forces the trading underground, making markets less informed.

As usual, regulation begets more regulation. Seems like we could solve the royalty problem by just allowing payola.  

The SEC's quixotic pursuit of insider trading in CDS's

Per the WSJ, the SEC has decided to bring its first insider trading case involving credit default swaps.

CDS’s have gotten a lot of bad press as a key factor in the financial meltdown. But we should keep in mind that they also have a positive function of providing a public market mechanism for revealing information concerning otherwise closely held securities. Very simply, the price of the swaps depends on the risk of default, as revealed by what traders are willing to pay. Informed traders mean more informed prices.

The SEC claims that a Deutsche Bank salesman gave inside information to a trader who used it to make a $1.2 million profit on CDS’s tied to DB debt. There are a few problems with this case, like the fact that CDS’s themselves aren’t securities, and they relate to European securities that aren’t regulated by the SEC. According to the WSJ, “[t]he SEC said it has jurisdiction because the swaps are "security-based," and the two traders are based in the U.S.”

I haven’t researched these problems, and anyway want to focus on the bigger picture: should the SEC be bothering with this?

I wrote on this almost three years ago, after the WSJ revealed a supposed insider trading scandal in CDS’s. The reporters cited a study by Acharya and Johnson, Insider Trading in Credit Derivatives, which found evidence of insider trading in this market. As I pointed out:

The problem with this story is that this is one of the most sophisticated markets around. The investors trade in $5 million lots. That's not you or me. Surely they know about the risk, and price the securities accordingly. And this provides a research opportunity. If insider trading is a problem (and it probably isn't) it's because it reduces liquidity by increasing the cost of trading because the market makers know they're trading against insiders. The counter is that insider trading makes the market more informed, which can decrease traders' risks and trading costs. So the empirical question is: in a sophisticated market like this, where everybody knows about the big risk of insider trading, does this reduce liquidity?

This is what the Acharya and Johnson article was really about. The authors conclude:

We find no evidence, however, that the degree of asymmetric information adversely affects prices or liquidity in either the equity or credit markets. If anything, with regard to liquidity, the reverse appears to be true.

The authors note that there are a number of possible explanations for the lack of a liquidity effect that warrant further study. But the point is that the really interesting aspect of this paper that the WSJ reporters rely on so heavily is not the scandal that there is insider trading in the credit default swap market, but that insider trading may not be a problem after all.

All of this is still true.  Plus the serious question whether the SEC can meaningfully police this market. In order to find a case where they could actually track the information – a big problem in this market – they had to stretch their jurisdiction to swaps relating to European securities.

So the SEC, having dropped the ball on Madoff’s multi-billion dollar fraud, has been trying to restore its reputation by cracking down on the legitimate information-revealing mechanisms of short-selling and hedge funds. Now it’s flown off to Europe to find a miniscule profit that probably hurt nobody.

This is not the way the SEC can prove its value.

Dismantling the foundations of capitalism: the TARP repayments

Banks are now being told, per the WSJ, that in order to repay TARP funds, which several want to do to escape from regulation of TARP debtors, they have to show that they don't need the FDIC guarantee of unsecured debt made available last fall. 

As John Carney shows, this appears inconsistent with a provision in the relevant law making repayment subject to "consultation" with banking regulators, not "approval" as in the agreements for the original TARP loans. See also here and here.

Is this new requirement a legitimate interpretation of the law? Does anybody care?  We should, because as pointed out in my previous post, respect for these rules is a critical requirement for a well-functioning capital system.  Whether or not the new requirement is prudent, our system demands that the rules in place at the time transactions occur will be respected even if some bureaucrat changes his mind later on.

Dismantling the foundations of capitalism: the Chrysler haircut

Over centuries the US has built the greatest capitalist system in the world. Though capitalists make lots of mistakes, but they have strong incentives to fix these mistakes, and will do so as long as the underlying structure remains sound.

But over recent weeks, the Obama administration has been dismantling this structure out of short-term political expedience: let’s get nice headlines, cover that pig with lipstick, and damn the long-term consequences. It’s the kind of short-term thinking that hedge funds have been accused of. But even if hedge funds were inclined in this direction, they don't have the powers the federal government can wield.

More specifically, what business needs is a clear idea of what the rules are when investors put their money at risk, and full disclosure of these risks. Government’s job in our capital markets is to follow and enforce the rules, including those on disclosure. If these conditions aren’t met, risks and the costs of capital rise and investment declines. Worse, resources are allocated to the bribers, favor-seekers and cheaters rather than the builders and suppliers of productive assets.

I’m going to consider examples of what’s been happening over the last few weeks, beginning here with the Chrysler haircut. 

First some background. Firms raise money by promising certain terms to their creditors. Equity holders take more risk and get more reward. Secured lenders take the least risk because they have rights to specific company assets. But these rules are inconvenient for a government that has different priorities about who should get what in a high-profile US company like Chrysler. The UAW wants some of what the secured lenders are contractually entitled to. The Obama administration, in addition to having been elected with key labor support, finds it politically expedient to get union support for the deal by extracting benefits from secured lenders. Specifically, the government wanted the lenders to settle for a third of what they were owed while labor got half. The lenders can agree to modify their rights, but they don’t particularly want to.

Against that background, the President calls the lenders “speculators” who were “refusing to sacrifice like everyone else” and who wanted “to hold out for the prospect of an unjustified taxpayer-funded bailout.”

These words distort reality. It’s the banks that are getting the bailouts. The hedge funds just wanted what they had paid for. They have not gotten bailed out. Moreover, the “sacrifice” Obama is calling for is, by another name, a breach of fiduciary duty by the managers to their investors.

At one level these are just words. But keep in mind that Congress is as we speak considering regulating hedge funds, that tax changes are in the air, and that executive branch lately has been wielding some awesome powers.

The President’s remarks elicited an angry, and perhaps courageous, response from Clifford S. Asness, managing partner of AQR Capital Management, which is not involved in Chrysler. Asness pointed out in an open letter that when “hedge funds, pension funds, mutual funds, and individuals, including very sweet grandmothers, lend their money they expect to get it back.” Bankruptcy law has certain procedures and protections, set forth in “rules of the game lenders know before they lend. . . . [W]ithout this recovery process nobody would lend to risky borrowers. Asness points out that investment managers are not allowed to “give away their clients’ money to share in the “sacrifice”.” When they do this, “they are stealing” – including from pension funds. “Shaking down lenders for the benefit of political donors is recycled corruption and abuse of power."

Maybe you don’t feel sorry for the hedge funds and their investors. But consider what else Asness has to say:

Let’s also mention only in passing the irony of this same President begging hedge funds to borrow more to purchase other troubled securities. That he expects them to do so when he has already shown what happens if they ask for their money to be repaid fairly would be amusing if not so dangerous. That hedge funds might not participate in these programs because of fear of getting sucked into some toxic demagoguery that ends in arbitrary punishment for trying to work with the Treasury is distressing. Some useful programs, like those designed to help finance consumer loans, won’t work because of this irresponsible hectoring.

The bottom line is that the rapidly increasing power of government over recent months entails a rapidly increasing opportunity for abuse, a toxic entanglement of government with business, and an accelerating loss of confidence in markets just when we most need this confidence.

Hedge fund registration: another run at a bad idea

Per the WSJ, the SEC’s head of investment management, Andrew Donahue, thinks we should have a law getting rid of the 15-client exemption on hedge fund adviser recommendation. He said "unless someone can come up with a pretty good reason why it should be there, I think it's a gap that probably should be closed."

Well, whether there's a "gap" depends on whether you think the regulatory glass is half full or half empty. If everything in the world should be regulated, then the exemption is a “gap.” But suppose you need some justification for regulation?

Congress doesn’t need much of a justification for a hedge fund registration law, which has been proposed by Levin & Grassley and will be the subject of a hearing later this week.

But the SEC did. It proposed a useless registration rule several years ago in reaction to the market timing so-called scandal (remember that?).  The DC Circuit flunked the SEC and threw out the rule in Goldstein v. SEC. The court said the SEC's rule based on number of clients "bears no rational relationship to achieving [the] goal" of excluding small operations and that it "creates a situation in which funds with one hundred or fewer investors are exempt from the more demanding Investment Company Act, but those with fifteen or more investors trigger registration under the Advisers Act. This is an arbitrary rule."

I suggested at the time that despite the court’s opinion hedge funds could still opt into registration and thereby get more credibility. Most didn’t do so. So the rule flunked the market test as well as the judicial test.

But one investment adviser did opt in – Bernie Madoff.

I've said that it's "likely that the regulatory costs" of a registration rule would exceed the benefits, and that "more laws lull investors into falsely assuming that the government has all potential problems in hand."

Well, the Madoff scandal certainly has borne that out. 

The fundamental problem is that the SEC simply lacks the expertise to provide enough value added to be worth the regulatory costs and to justify the signal of safety registration gives investors.

And if we needed any additional proof of that, see Bernard & Boyle, Mr. Madoff's Amazing Returns: An Analysis of the Split-Strike Conversion Strategy:

It is now known that the very impressive investment returns generated by Bernie Madoff were based on a sophisticated Ponzi scheme. Madoff claimed to use a split-strike conversion strategy. This strategy consists of a long equity position plus a long put and a short call. In this paper we examine Madoff's returns and compare his investment performance with what could have been obtained using the split-strike conversion strategy based on the historical data. We also analyze the split-strike strategy in general and derive expressions for the expected return, standard deviation, Sharpe ratio and correlation with the market of this strategy. We find that the Madoff's returns lie well outside their theoretical bounds and should have raised suspicions about Madoff's performance.

If the SEC couldn't figure out Madoff, it's not going to do much good for the next fraud.

Friedman and the Geithner rule

In the latest installment of its valuable "USA Inc" series, the WSJ asks some important questions about NY Fed chair Stephen Friedman, former GS CEO and continuing Goldman board member, who not only continued to hold Goldman stock after GS became a bank holding company, a violation of Fed policy which the Fed eventually waived, but bought more Goldman shares while retaining his Goldman and Fed positions.

The Fed’s and NY Fed’s general counsels say the waiver was justified because they needed his expertise, particularly in the search for Geithner’s replacement at the NY Fed.

You remember Geithner – the tax cheat who now heads Treasury. I’ve already written on the “Apple rule” aspect of the Geithner confirmation – that the rules apparently only apply to the unpopular. Friedman, particularly his additional GS purchases, takes the issue into a new dimension.

Now, I understand the problem of forcing Friedman to sell his holdings in a market plunge when the conflict was created after he joined the NY Fed board. On the other hand, the stock ownership does create the problem of potentially conflicted decisionmaking on the Fed board, which is a reason why we have insider trading rules.

I’ve long argued for the property rights theory of insider trading liability, which is basically that firms ought to be able to make their own rules about use of their information. But our lawmakers don’t accept this approach. Anyway, this theory doesn’t apply to government servants. The argument that Friedman was needed on the Fed board is the sort of cost-benefit balancing we don’t allow private firms to make. Why should we allow the government to do it?

Friedman says he wasn’t involved in the Fed's decision to give AIG an $85 billion bailout, part of which was used to repay debts to Goldman. Well, maybe. But the rule against insider trading is supposed to be a prophylactic and its application doesn't depend on whether the insider participated in a particular corporate decision.

Even if there’s no problem with Friedman’s initial GS share position, the additional purchases are a different matter, particularly since Friedman never told the Fed about those purchases and never asked for a waiver.

Friedman says he bought the shares because they were “cheap.” What does that mean?  In an efficient market, shares are “cheap” only if you know something. What did Friedman know? He bought shares in a bank while he was working for a branch of the agency that was running banking (not to mention the rest of the economy). Could he have known something?

As it turned out, Friedman bought the shares at prices ranging from $66 to $80/share which were trading at $127.08 on Friday, for an accrued gain of $2.7 million.

While Congress and the SEC are investigating those hedge funds, do you think maybe they could find some time for Mr. Friedman?

Notes from the destruction of American capitalism: Chrysler

Chrysler, which has managed to lose money in every possible configuration so far, has now been pushed by the government to find a new one -- a partnership between a union and an Italian auto company.  The deal the Administration is pushing calls for the secured creditors to take a two thirds haircut while the union gets fifty percent value. As the WSJ notes, "if the current plan is pushed through, then good luck to any unionized firm trying to raise secured debt on decent terms in the future." Nobody seems to be asking what customers will pay for the products of this so-called company. 

Rearranging the deck chairs at BOA

Ken Lewis was ousted as board chair at BOA. There’s no sign he’ll be replaced as CEO. The new chair is the 71-year-old president emeritus of Morehouse College in Atlanta who has no professional banking experience. "I don't know what Mr. Massey will do.” Charles Elson told the WSJ. According to the article, Massey was suggested in

conversations earlier this week among a small group of directors, including Mr. Lewis” because he “would present a "positive image" . . . and can devote plenty of time to the task because he is retired. . . . No other names were mentioned, and the directors voted unanimously in favor of Mr. Massey. By the time the vote totals and chairman change were announced, the directors were on their way home, said one person familiar with the events.

The new chairman will now deal with “a capital hole in the billions of dollars at the bank.”

Today I discussed my ideas about the uncorporation.

Rise of the Uncorporation: Tomorrow at Searle

Tomorrow I’m going to a Searle Center Research Roundtable on Jon Macey’s book, Corporate Governance: Promises Kept, Promises Broken and my forthcoming Rise of the Uncorporation. I’ve enjoyed past roundtables, but this is my first stint as target. It's a good group and should be interesting.

The book is nearing completion – watch for more on the book in coming weeks. At last, in one place, everything you wanted to know about the uncorporation, big and small, past, present and future.

The future of the auto industry (and the death of American capitalism)

Well, it looks worse than I hoped. Per the WSJ, the government may get a majority of GM, with most of the rest belonging to the workers (who are also in line to control Chrysler). So the once proud US auto industry will become a WPA project. 

I wonder if the car of the future will look like this. Which government agency will handle our complaints about the windshield wipers?  Or can we go right to the president?  Does this mean that the government will use regulation to hammer its competition?  Here's more on that sort of thing.

Well, at least the government won't have to worry about auto industry cooperation with its environmental or whatever agendas.  We can replace corporate social responsibility with the more straightforward corporate social duty.  And they will finally get me, by force of law, to invest in a car company. 

But I do know this: they can harass me, they can torture me, they can force me to walk on a bed of nails, but I will never, ever, buy a government-built car.

Big fins and a ragtop

So it seems that GM is planning on dumping Pontiac along with Saturn, Hummer and Saab. That would leave Chevy with about 80% of GM's market, plus GMC, Buick and Cadillac. I’m not sure where the synergy is with GMC, so let’s dump that, too. Buick's market is literally dying.

So here’s my plan for post-bankruptcy General Motors: Chevrolet and Cadillac.

Why Cadillac? Now, I’m a BMW guy myself. But here's the car I’ve always really wanted. And here's the song.

Some thoughts about business, film and law

The Illinois Business Law and Policy Roundtable on the portrayal of business in film, previously noted here, wrapped up yesterday. After a day of thought-collecting I have some details and observations.

First, the details. The participants were a sort of intellectual Noah’s ark of folks who brought a variety of perspectives, including an entrepreneur (Virginia Boyd), a journalist (John Carney of Clusterstock), law professors with general interests in film and law (John Denvir, USF, David Papke, Marquette, Barak Orbach, Arizona, David Ritchie, Mercer), journalism professors (Matthew Ehrlich and Amy Gajda of Illinois (who also teaches law)), a non-law academic with an interest in popular culture (Judith Grant, Ohio University), and corporate law scholars with interests in culture and film (Peter Huang, Temple, Mae Kuykendall, Michigan State, and Usha Rodrigues of Georgia). My colleague Christine Hurt was the main organizer, and Christine, Nicola Sharpe and I kept the discussion going.

I had a couple of other roles in the conference – target, and curator. As target, I provided the theory that the participants could shoot at, via my papers Wall Street & Vine and Imagining Wall Street. My theory is that what might seem to be negative view of business in film is, more accurately, a negative view of capitalists. I think the most important (though not the only) explanation of this view lies in film artists’ resentment of the constraint that capitalists put on their self-expression.

This theory matters because it affects the story (or what some would call “narrative”) of business that is presented in countless films: the heroic artist (sometimes represented by journalists, gunfighters, athletes, entrepreneurs) struggling against the capitalists and often exposing the evils they would prefer to hide. Since the general public lacks a clear countervailing view, this narrative directly or indirectly affects decisions made in the jury room, voting booth, boardroom, and the halls and offices of Congress and administrative agencies.

As curator, I picked the movies. Here they are, detailed for the academics and others out there who may want to follow up on this subject or present it in class. Film clips are identified by approximate timings or scene numbers on the DVDs. For general descriptions of the films, see www.imdb.com.

Introductory movie: The Insider. Here we see both sides of the narrative – the evil corporations (Brown & Williamson and CBS) and crusading journalist.

Session #1; The Evil Corporation: Analyzing and preliminarily discussing Hollywood’s negative view of business. Michael Clayton 1:47:47-1:52:31; Erin Brokovich, 1:55:44-1:57:55; Tucker, 1:39:10-1:42; The Aviator, 1:57:37-2:03:15. Note that these clips presented two alternative views of the corporation -- as evil manipulator, and as the victim of government. My point was that there is more than one possible way of characterizing corporations.  Why do we see mainly the first, and rarely the second?

Session #2; How films deal with specific participants in firms (capital, labor, management): Executive Suite, 37:10-40:00; It's a Wonderful Life, 1:07:36-1:12:45; Wall Street, 1:34:20-1:38; Hudsucker Proxy, Scene 5; Glengarry Glen Ross, Scene 3; The Big Knife, Scene 13; Hudsucker Proxy, Scene 4.

Session #3; Explaining Hollywood’s View of Business: Executive Suite, 1:31:20-1:41:52; The Insider, 1:43:53-1:48:22; Big Night, 22:50-29:15; Quiz Show, 2:05:31-2:09.

Session #4; To what extent does the Hollywood view reflect the reality of business? Pursuit of Happyness, 1:48:25-1:51:30; Other People’s Money, 1:24:31-1:30:27.

Session #5; The Political and Public Policy Impact of Film: Silkwood (2:04:30-2:08:20); China Syndrome, 13:00-21:30 (plus the commentary from around 5:00 explaining the making of this scene). In this session we also discussed a Dubner-Levitt NYT article, The Jane Fonda Effect, about the public impact of this film and the Three Mile Island incident, which happened only a few days after the film’s release, on the nuclear power industry.

Session 6 was intended to be an open-ended discussion about the film industry and how the evolution of that business might affect films' portrayal of business. But our scheduling of the conference in conjunction with a major local film festival, Ebertfest, paid an important dividend. We were able to induce an actual filmmaker, Nina Paley (whose film Sita Sings the Blues is playing today at Ebertfest), to join us.

Of course I couldn’t resist the temptation to ask Nina what she thinks of business and how this is reflected in her films. Given Nina’s complete independence, enabled by her low budget, the standard story of the artist’s capital constraint would not seem to apply. And this may be an important model going forward, as films can be independently financed and produced at low cost on personal computers. This is basically what Nina said.

So will the evil corporation retreat to the sidelines in films – where it already is in plays and books? Maybe not. our filmmaker also pointed out the sharp constraints placed on her work by the extended copyrights controlled by large corporations. And her next work is going to deal with these issues.

Throughout the conference the participants pushed from all sides at my story. They pointed out that there were a lot of other things going on in films that contribute to what we see – audience demands, other things artists have on their minds, etc. For example, audiences are looking for convincing villains, and alien, impersonal corporations are handy targets.

But I’m sticking to my story. Filmmakers could make corporations more personable and user-friendly if they wanted to. Hence the clip I showed from Pursuit of Happyness. See also, e.g., Tom Hanks in Cast Away. Audiences may resent corporations, but they don't necessarily care as much about capitalists as the artists do.  Maybe that's why we don't see more films like Office Space.

And if you’re looking for a villain, why not government? There’s no better example than the critical confrontation between Howard Hughes (Leonardo DiCaprio) and Senator Brewster (Alan Alda) in The Aviator. Brewster (who’s portrayed as being in the pocket of PanAm’s Juan Trippe) threatens to put TWA out of business by giving a monopoly on overseas flights to PanAm. Brewster tells Hughes that he should go along, explaining: “It's not me Howard. It's the United States government. We just beat Germany and Japan. Who the hell are you?"

The bottom line is that it is pretty clear that a narrative of business is being constructed both in film and the popular press (though Mae Kuykendall has her doubts). Law and economics types like me generally eschew narrative theory as soft stuff, lacking rigor. But that leaves the construction of the critical stories to others. Moreover, this is an area that is susceptible to both rigorous public choice analysis and data about the construction and effect of the story. That’s the discussion I’m trying to promote.

Finally, this conference further convinced me of the value of this type of gathering. Unlike the typical law school conference, this was not a law-review-driven collection of mini-workshops on papers in process. Though that sort of conference can be valuable, too often it amounts to the retailing of ideas that are best done in other ways. This was instead an extended discussion that, I hope, contributed to the process of forming ideas. In our digital age, this could end up being the primary function of physical meetings among academics.

Morgenson still silent on the NYT

As I have pointed out before (e.g.), the NYT’s Gretchen Morgenson, while loudly complaining about undemocratic corporate governance throughout corporate America (see my archive), hasn’t said anything “about the Stalinist corporate structure in her own backyard.”

And of course she’s railed even more loudly about executive pay. Nevertheless, as reported recently (HTBainbridge), her silence about her own employer continues even as the NYT pays its executives significant bonuses in the face of dismal financial results while asking employees to take pay cuts.

Surely Morgenson could provide special insight on this story. Could it be that the Times doesn’t want this story told about itself, even as it sold the story on others? Just asking.

Me on tv on Madoff

I have condemned the SEC as an “unwitting accessory” to the Madoff fraud. This view is also expressed today by one of Madoff’s investors. 

Now you can see a somewhat more extended presentation of my views of the SEC’s Madoff performance (“one of the most spectacular regulatory failures of all time”) on a U of I-produced TV show also featuring my colleague Christine Hurt. We're on the first two segments.

VC Strine on LLC fiduciary duties

A recent decision by Delaware VC Strine in Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC, decides a number of issues involving the implied covenant of good faith and fair dealing, fiduciary duties of LLC managers, fraud and aiding and abetting breach. Francis Pileggi does his usual excellent job of analyzing the case, so I will simply refer to that for the longer analysis and highlight a couple of specific points.

First, the court interprets an agreement that did not clearly opt out of fiduciary duties as providing for the full range of corporate-type fiduciary duties of the LLC’s manager. VC Strine reasoned (footnote omitted):

the interpretive scales also tip in favor of preserving fiduciary duties under the rule that the drafters of chartering documents must make their intent to eliminate fiduciary duties plain and unambiguous.

I’ve discussed this Strine approach in my Uncorporations and Corporate Indeterminacy (2009 Illinois L. Review 131, 165), noting that

Vice Chancellor Strine’s admonition to lawyers not to address fiduciary duties “coyly” could require such careful and costly drafting that it makes fiduciary duties in effect mandatory. Even a moderate insistence on careful drafting could put fiduciary duty waivers out of the reach of smaller firms. In other words, by making very skilled drafting the price of avoiding indeterminacy, Delaware’s uncorporate law may be trading lower litigation costs for higher fees to transactional lawyers. This may reserve the benefits of the uncorporate approach only for the largest and most sophisticated uncorporations.

While I still think this drafting burden issue is a potential concern, I’m not worried about it in the seemingly significant number of cases, like this one, in which the agreement seemingly is at war with itself.  Here the agreement provided:

Section 6.1 Relationship of Members. Each Member agrees that, to the fullest extent permitted by the Delaware Act and except as otherwise expressly provided in this Agreement or any other agreement to which the Member is a party: . . . (b) The Members shall have the same duties and obligations to each other that members of a limited liability company formed under the Delaware Act have to each other.

Section 6.2 Liability of Members. . . . Except for any duties imposed by this Agreement . . . each Member shall owe no duty of any kind towards the Company or the other Members in performing its duties and exercising its rights hereunder or otherwise.

Maybe the lawyers carelessly used boilerplate, or maybe the parties just hadn’t made up their minds how much they wanted to opt out of fiduciary duties. In either case it is sensible for the courts not to give the parties an agreement they were unable or unwilling to give themselves.

A second issue is whether affiliates of a managing member can be liable for breach of fiduciary duties. This liability has often been recognized in partnership cases. See Bromberg & Ribstein Section 6.07(a)(8). I note in Ribstein & Keatinge (§9.9, n. 6) that it may also be recognized in LLC cases, citing Federalpha Steel LLC Creditors' Trust v. Federal Pipe & Steel Corp., 368 B.R. 679 (N.D. Ill. 2006) (where the LLC to which duties were owed owned the manager). VC Strine says it’s a case of first impression in Delaware LLCs, and that may be true.

Finally, and perhaps most importantly, the court held that liability for fraud may lie against the individual owner and manager (Nevis) of the managing LLC. The court reasoned that under settled Delaware law [footnotes omitted],

[a] corporate officer can be held personally liable for the torts he commits and cannot shield himself behind a corporation when he is a participant.” This includes situations where a corporate agent participates in corporate fraud. Nevis does not argue that he cannot be held individually liable for his participation in fraud committed by PKI, or that he did not participate in the activities that Bay Center alleges were fraudulent. Instead, Nevis argues that PKI’s actions were not fraudulent because PKI had no duty to speak, so there was no fraud for Nevis to participate in. But, as discussed above, I find that Bay Center has stated a claim that PKI’s conduct constituted fraud. Bay Center may therefore also move forward on its claim against Nevis individually for his participation in the alleged fraud.

This reasoning, taken too far in this context, could eviscerate the liability shield. I’ve noted in Ribstein & Keatinge, Section 12:4, n. 1, that

some cases amount to findings that the act of managing an LLC may result in personal culpability. This may be justified where there is a strong need for such culpability * * * In other cases, the liability may be an unjustified abrogation of the limited liability shield.

I cited as a particular example Estate of Countryman v. Farmers Co-op. Ass'n, 679 N.W.2d 598 (Iowa 2004), which reversed summary judgment in favor of manager and 95% that provided managerial services, including ‘‘safety management,’’ in a suit arising out of explosion of propane gas provided by LLC.

The problem here is that a business entity has to be managed by someone. If when the LLC commits the tort the manager is the tortfeasor, what’s left of limited liability for torts?

I can understand that you wouldn’t want to let an LLC manager lie with impunity. But in Bay Center the fraud claim was based on a breach of the managing member's duty to disclose. That member was the LLC, not Nevis.  Without some basis for veil-piercing, this theory gets pretty close to, if not crosses, the line I’m drawing.

Offshore vs. onshore

There's an interesting review of my and Erin O'Hara's new book, The Law Market, in the Cayman Financial Review. Here's the gist:

Surely, it couldn’t simply be a popular distraction designed to take away from the onshore greed and incompetence which gave rise to the world’s current economic crisis? Erin O’Hara and Larry Ribstein’s new book, The Law Market may suggest to some that it is. I hope that President Obama will find time from bailing out US banks and insurance companies from the consequences of their fiscal irresponsibility and inept behaviour to read it; he may (or may not) be surprised to learn from this book how many states have sought, and still seek, to emulate the offshore centres which he so publicly denounces. * * *

The authors give interesting insights into other areas where the domestic states compete with each other for business in much the same way as do offshore jurisdictions. * * *

I * * * found it fascinating to learn that Delaware and South Dakota repealed their usury laws in order to attract credit card companies which, as a result, are legally unconstrained in the interest rates and late fees which they can charge customers. One can only wonder if an offshore financial centre would be allowed to get away with that.

Interesting question.  I'm working on it.  

Coming soon: The Illinois business movie roundtable

The Illinois Business Law and Policy Program Roundtable Beyond Wall Street: The Interplay Among Film, Business and the Law is coming on Thursday. Here’s my prior post.

I’ll be posting about insights and so forth from the conference. And watch this space for news about the film I’ve selected to kick off the Roundtable.