Ideoblog

Sotomayor on campaign finance

As Jim Copland notes, she has it dangerously wrong when she says 

We would never condone private gifts to judges about to decide a case implicating the gift-givers' interests. Yet our system of election financing permits extensive private, including corporate, financing of candidates' campaigns, raising again and again the question what the difference is between contributions and bribes and how legislators or other officials can operate objectively on behalf of the electorate. Can elected officials say with credibility that they are carrying out the mandate of a "democratic" society, representing only the general public good, when private money plays such a large role in their campaigns? If they cannot, the public must demand a change in the role of private money or find other ways, such as through strict, well-enforced regulation, to ensure that politicians are not inappropriately influenced in their legislative or executive decision-making by the interests that give them contributions. (footnotes omitted)

In fact, the "general public good" is determined by a political process in which all sides, including corporations, are free to present and support their views.  My analysis is laid out in Corporate Political Speech, 49 Wash. & Lee L. Rev. 109 (1992).  

Things we only needed one of

Here's Professor B on Wall Street 2, discussing my article on Wall Street 1.

Let's see if public opinion on capitalism can get any more messed up than it already is.

Dismantling capitalism: nationalization of GM

From Fox via Carney:

"Hey, Obama has just nationalized nothing more and nothing less than General Motors. Comrade Obama! Fidel, careful or we are going to end up to his right."

          --Hugo Chavez.

Don't believe it?  Check out Bainbridge and Lambert.

Lawyer licensing: the elephant in the Bartlett bedroom

Judge Sotomayor is facing criticisms for her decisions (sitting by designation) in Bartlett v. New York State Bd. of Law Examiners, 2001 WL 930792 (S.D.N.Y. 2001), and 970 F.Supp. 1094 (S.D.N.Y. 1997), forcing NY to let a learning-impaired applicant sit for the bar exam. Judge Sotomayor said:

There is no insinuation, and I cannot find, that Dr. Bartlett is incapable of performing the functions of a practicing lawyer. * * * Therefore, while it is undoubtedly true that not every person is physically able to be a Yankees first baseman, it is likewise true that it would be grossly unfair to impede whole classes of individuals like plaintiff, with plaintiff's automaticity and reading rate disabilities, from participating in entire classes of customary professions such as the practice of law because they can not read a professional examination like average law school (or other professional school) graduates.

So Judge Sotomayor seemingly gave short-shrift to arguments that the need to read and understand quickly and accurately was an important test of bar admission.

Now I realize that to some this will sound to some like the case of the one-legged Tarzan. But the missing issue here concerns the general usefulness of bar exam.

In my Lawyers as Lawmakers: A Theory of Lawyer Licensing, 69 Mo. L. Rev. 299 (2004) I criticized lawyer licensing in general, and bar examinations in particular, on the basis that they did not, in fact, protect the public from bad lawyers. The only function of lawyer licensing, I argued, was simply to reduce the supply of lawyers. (I then proposed a modest defense on those grounds – i.e., to encourage lawyers to assist in lawmaking by giving them property rights in their state laws.)

With respect to the bar exam, I said:

Perhaps the most important barrier to entry to law practice in a state is the requirement to take a bar exam. The bar exam usually requires months of study and the risk of embarrassing failure. That states pass a very high percentage of applicants if they take the exam enough times suggests that the bar exam is more a price of admission than an effective screen. On the other hand, the bar exam probably deters some people from attempting to obtain a license. Only four jurisdictions pass fewer than sixty percent of those taking a particular test. These include Louisiana, where the low rate may reflect the state’s idiosyncratic civil law system; the District of Columbia, which is unique in admitting lawyers on motion without prior experience elsewhere; and California, which uses its bar exam to screen graduates of unaccredited California schools. The fourth state is Delaware, whose low passage rate may be particularly significant for present purposes. Since Delaware is the most prominent example of a state where lawyers have played an important role in maintaining the state’s law, this provides some anecdotal evidence of the role of state licensing in encouraging lawyers’ participation in lawmaking.

For other criticisms of bar examinations as a licensing requirement, see Benjamin Hoorn Barton, Why Do We Regulate Lawyers?: An Economic Analysis of the Justifications for Entry and Conduct Regulation, 33 ARIZ. ST. L.J. 429, 434 n.16 (2001); Daniel R. Hansen, Note, Do We Need the Bar Examination? A Critical Evaluation of the Justifications for the Bar Examination and Proposed Alternatives, 45 CASE W. RES. L. REV. 1191 (1995); Andrea A. Curcio, A Better Bar: Why and How the Existing Bar Exam Should Change, 81 NEB. L. REV. 363 (2002); Kristin Booth Glen, When and Where We Enter: Rethinking Admission to the Legal Profession, 102 COLUM. L. REV. 1696 (2002).

I’m not an ADA expert so can’t generally critique Sotomayor’s opinions on this issue. But it’s worth noting that at least some of those criticizing her decisions in this case might be sympathetic with the implications of these decisions for lawyer licensing standards in general, and bar exams in particular, which I for one find indefensible as a means of determining fitness to practice law.

Additional point:  I am not arguing that Judge Sotomayor is taking a Friedmanian position on professional licensing.  As I said, this is only an "implication" of her decision.  Perhaps it would be more accurate to call it a possible effect of watering down the purported screening function of the bar exam.  

Jurisdictional competition for hedge funds

FT reports (HT Dealbook) that hedge funds will leave the UK if Europe decides to apply hedge fund borrowing limits to the borrowing implicit in derivatives. At the same time, hedge funds are trying to get tax modifications in the UK that would induce them to move from the Caymans to London. 

Alternative destinations mentioned in the article are Switzerland and NY. Of course, NY could be a problem if the US gets very serious about restricting short-selling and requiring too much hedge fund disclosure.

Then there's always Singapore and Hong Kong.

Congress reignites war against naked shorting

As the WSJ reports, Congress is telling the SEC to "take further steps to crack down on "naked" short selling."  This follows an abortive attempt to require preborrowing for shorting of financial firms' shares. Congress is reacting to a GAO report that the SEC's Regulation SHO failed to slow "ftds" (failures to deliver).

This is part of a general government war on the shorts, which as I've argued (e.g., here) is also a war on market efficiency. ((Neither business executives nor legislators really want the market to report accurately on how they're doing -- just favorably.) 

Many who are ok with short-selling think the real problem is naked shorting -- that is, short-selling without later delivering the shares.  But I reported recently on evidence that naked shorting, as measured by ftds contra Regulation SHO, is not manipulative and supports market efficiency. 

Let's hope that the SEC and Congress again lose interest in this counterproductive effort to undermine efficient markets.

The economics of Dr. Seuss

Really.  Miller & Watts, "Oh, the Economics You'll Find in Dr. Seuss!":

We provide a list of economic concepts and issues covered in all of the children's books published by Theodor Geisel, writing under the pen names of Dr. Seuss, Theo LeSieg, or Rosetta Stone. We discuss his treatment of the concepts and issues that appear most often and that are treated in greater depth, especially in his works for relatively older readers. We begin with a brief biography to show that much of the economic content in these works reflects Geisel's personal experiences or the major historical events of his lifetime. Some of it may also be attributable to college courses in economics that both he and his first wife completed.

My favorite economics lesson in Dr. Seuss is on agency costs (Miller & Watts categorize it under specialization), from Did I ever tell you how lucky you are?:

Oh, the jobs people work at! Out west, near Hawtch-Hawtch, there’s a Hawtch-Hawtcher Bee-Watcher. His job is to watch… is to keep both his eyes on the lazy town bee. A bee that is watched will work harder, you see.

Well…he watched and he watched. But, in spite of his watch, that bee didn’t work any harder. Not mawtch.

So then somebody said, “Our old bee-watching man just isn’t bee-watching as hard as he can. He ought to be watched by another Hawtch-Hawtcher. The thing that we need is a Bee-Watcher-Watcher.”

WELL… The Bee-Watcher Watcher watched the Bee-Watcher. He didn’t watch well. So another Hawtch-Hawtcher had to come in as a Watch-Watcher-Watcher.

And today all the Hawtchers who live in Hawtch-Hawtch are watching on Watch-Watcher-Watchering-Watch, Watch-Watching the Watcher who’s watching that bee. You’re not a Hawtch-Hawtcher. You’re lucky you see.

Are litigation hedge funds a problem?

The NYT discusses hedge fund litigation financing. The chief executive of a leader in the field, Juridica, crows that “[i]t’s always a good time to invest in litigation.” Juridica is up 24% since December 2007. Is this a bright spot in an otherwise murky investment environment.  If so, is it a problem?  

Walter Olson objects that “this innovation will, of course, encourage the filing of more litigation,” and squirms at a remark by Brooklyn’s Anthony Sebok that this financing will make "funding available for cases that are good cases, cases that from a God's-eye point of view, so to speak, should've been brought." Olson adds:

Don't you love that "God's-eye" wording, with its premise that God wants us to bring lawsuits when we have legal grounds to do so, and is disappointed when we instead decide to forgive, or shy away from the process for fear of hurting someone, or just want to get on with our lives?

So the basic question is whether funding litigation is like feeding pigeons.

The Times of London discussed this development when Juridica was launched in December 2007 and I discuss it in my draft paper on the evolution of law firms as an example of the move toward outside financing of law practice. I had also earlier discussed on this blog nonrecourse financing of litigators.

Litigation financing can be viewed as simply another way for the capital markets to help firms exploit productive assets. Of course there are special problems relating to outsiders stirring up claims by simply funding actions by others (maintenance), particularly where the investor gets some of the proceeds (champerty) or the claims are groundless (barratry).  Also, confidentiality and privilege rules may forbid disclosure of litigation information to outside funders, making these particularly difficult investments. The basic problem, as discussed in my earlier blog post, is that "it turns litigation into a business rather than the search for corrective justice."

With respect to the excessive litigation point, it's worth noting that the hedge funds aren't financing the most abusive types of strike suits. These aren’t consumer class actions, but b2b litigation. For example, the NY Times article discusses a case by isp WaKuL against Ericsson for breach of contract. WaKuL won $3 million in arbitration and was able to use outside financing to fight off a challenge by Ericsson. The article says that the hedge funds focus on readily valued claims, and avoid jury cases or novel issues.

On the other hand, the financing discussed in my earlier blog post and an AmLaw article did support tort class actions. Anthony Sebok, who was also quoted in the NYT article, told AmLaw the loans were a "a safety valve for tort reform."

For yet another approach to litigation funding, see the discussion in this article with Kobayashi of “dumping and suing,” where the lawyer in a securities or derivative suit in effect capitalizes the lawsuit by selling short the corporation that is the subject of the suit and then buying back after the suit is announced.

So what should we think of all this?  it’s important to keep in mind that, like it or not, litigation is a legitimate business. Like other basically legitimate businesses, it can turn bad. The question is whether the problems should be addressed directly by rules constraining improper litigation practices or indirectly by constraining firms’ ability to pursue the litigation.

I would opt for the former. Consider that, as discussed in my recent draft and earlier blog post, the current system clearly permits financing of litigation by lawyers via contingency fees. We have seen, e.g., with Milberg, how the reality of lawyer financing clashes with rules based on the pretense of client control of litigation to produce abuse (see my paper with Kobayashi on that).  I'm not sure outside litigation financing produces worse results.

The NYT article tells us that Juridica focuses on steady cash flows – that is, fairly solid claims whose results can be predicted – rather than novel theories or jury cases. Outside financing of cases like WaKuL's permits exploitation of claims the system has decided clearly should be brought (like Mr. Olson, I’m not sure about God, though). Indeed, financing this b2b litigation arguably helps the law deter socially inefficient opportunism.

Moreover, as discussed in my draft and blog post, there are other potential benefits of outside litigation financing.  Litigation funders could provide expertise and investigation that increases litigation's accuracy and deterrence value. This funding also helps eliminate the potential conflict of interest between a corporate client with diversified investors and a risk-averse lawyer who may have an incentive to settle cases that could be productively litigated.

To some extent, particularly outside the b2b context, outside litigation financing might increase the amount of socially inefficient litigation.  But even in those cases there is a question whether this financing increases the quality of such litigation as compared with a world without outside financing.

Given these many uncertainties about the costs and benefits of litigation financing, I would prefer to to go slow in regulating it, focusing instead on fixing abuses inherent in the underlying litigation.

Lessons from GM

General Motors was the very model of the classic corporation.  It assembled massive property under centralized and durable control.  Just what corporate-style capital lock-in was for.

Now we see the downside.  GM was a great ride on the way up.  But long after its business model was challenged on several fronts, its entrenched labor-management hierarchy was too slow to change, and the business ended a spectacular failure.

Readers of this space know I've advocated the uncorporation as a solution to corporate ills (here's the most recent version of this story). This doesn't mean that I think GM itself should emerge from bankruptcy as a partnership or LLC.  Its cash flow and cash needs will be too uncertain to provide for the investor liquidity and managerial incentives that drive the uncorporate structure. However, it does mean that fickle, market-driven uncorporate investors like private equity and hedge funds have a potential role to play in keeping the new GM management structure suitably responsive to market demands.

Unfortunately, what we have instead, at least for the time being, is the exact opposite -- control by the ultimate sovereign wealth fund, the US government.  The problem, as I've discussed, is not just the politics (which are much more obvious here than with Chinese investments), but the lack of market-driven incentives.

There are, of course, those who think that it's great GM will now be the epitomy of a socially responsible (i.e., politically responsive) firm.  But let's try to remember that GM will be competing in real markets with tough global competitors.  Unless the US goes back to protecting GM from the Japanese (which would be a real disaster), GM is either going to have to learn how to sell cars people want at a reasonable cost, or our government will have to figure out how to buy us cars as well as health care, banks, etc, etc.

Sauce for the goose?

Executive compensation! Internal controls! Tell the shareholders everything!

On the other hand:

The House’s quarterly [expense] reports – which run over 3.000 pages apiece, across multiple volumes – are stored in a cupboard in a windowless office near a shoeshine stand. The Senate’s semiannual reports, which use type about half the size of the print in a daily newspaper, are in a building nearby. Expense entries for both chambers can be difficult to decipher, with entries and explanations sometimes cutting off mid-word.

The death of Wolf Block

Philly Mag reports on (HT Law Blog) what it calls the “wrongful death” of former powerhouse law firm Wolf Block. The article tries to make the point “that there was nothing inevitable about Wolf Block’s demise.” Other firms, seemingly no stronger, survived. WB’s most powerful partners tried to save it. So what happened?

The story begins with the usual lament about how law practice has turned into a “trade, akin to journalism or cooking” – and specifically about how Wolf Block changed from a “craftsman’s paradise” to a nasty business under the leadership of three hard-charging rainmakers. Then the firm’s culture was temporarily rescued by a gentler soul with wavy hair, Mark Alderman. Unfortunately, hair and avuncularity proved not to be enough. Alderman couldn’t execute a critical merger, profits sunk and the firm’s bank refused more credit without a personal guarantee, which the partners wouldn’t give. In other words, having become a business, the firm had not become a good enough business.

Ultimately the firm’s future came down to a key group of rainmaker partners, one of whom almost saved the firm by finding new bank loan that didn’t require a guarantee. But the rainmakers turned the loan down, and the firm was left with no option but to dissolve.

The article says the problem was “trust.” More precisely:

People who study human decision-making call this a “prisoner’s dilemma.” In a prisoner’s dilemma, cooperation is the choice that gets you the best outcome, but only if everyone cooperates. You don’t want to be the only one who decides to cooperate if everyone else is bolting, because then you’re screwed. Ultimately, in those final days, what Wolf Block needed to survive wasn’t a line of credit, or a merger. What it needed was some kind of larger glue to counteract the shearing logic of the prisoner’s dilemma. It needed, for lack of a better word, faith.* * *

A law firm is a strange, liquid thing. It doesn’t own anything. It’s just a group of people. It’s people and a lease and a collective sense of shared history. Nothing more. So if this is how a great and important law firm finally dies * * * there’s no reason to be shocked. It’s silly to see a law firm as a Promised Land when the true Promised Land is out there, diffuse and gleaming, beckoning to those with the courage to leave sentimental attachments behind.

A pretty good analysis, but the lesson is muddled. Although the article begins with the idea that WB didn’t have to die, in the end it says “there’s no reason to be shocked” by the death. That's correct. Because the firm “doesn’t own anything” there’s nothing to tie it together but mutual faith -- which might get you an afterlife, but not save a law firm.

Although the death of this particular firm may not have been inevitable, the death of many firms like WB may be. On the other hand, in a more general sense, it’s true that law firms don’t have to face such dismal prospects. Law practice should be a fantastic way for firms to make money in our increasingly law-saturated world.

The problem is, as the article says, that law firms don't own anything. Ownership of firm-specific property is critical to an ongoing business. Law firms theoretically could own property rights to legal products, reinforced by intellectual property laws, non-competition agreements and other contracts. Like other firms they could get outside financing based on these property rights. But as I've discussed, law firms are prohibited by ethical rules from, among other things, having non-lawyer owners and entering into strong non-competition agreements. And many legal products cannot legally exist because of rules against unlicensed practice of law.

These rules push law firms into a precarious hand-to-mouth existence. They need to squeeze profits out of their lawyers based on a failed time-based revenue model, with a significant markup purportedly based on an increasingly illusory promise of mentoring and supervision. Even worse, law firms face a mismatch between their revenues and fees and rely on bank financing to fill the gap. As the Philly Mag article says, “law firms tend to borrow at the beginning of the year, collect fees at the end of the year, and then pay the bank back.” When WB started sinking, the firm lost its bank credit and faith wasn’t enough to keep the bank or the partners in line.

As long as our absurd approach to regulating law firms persists, expect to see more "wrongful deaths" like Wolf Block’s.

Sotomayor, business and preemption

A key Sotomayor ruling in Dabit v. Merrill Lynch may become an issue in her confirmation. It’s worth discussing because the implications aren’t obvious.

Dabit involved the Securities Litigation Uniform Standards Act, in which Congress tried to close a state law end run around limits on securities class actions by preempting state actions based on "an untrue statement or omission of a material fact in connection with the purchase or sale of a covered security." The language leaves it open whether the action had to be in connection with any purchase or sale, or the plaintiff’s purchase or sale – that is, does it apply to holders of securities?

The Act says “the,” not his or her. So Judge Sotomayor interpreted it, finding that the state law survived SLUSA, and taking a cautious and narrow approach to preemption of state law. The Supreme Court reversed, based primarily on policy considerations relating to constraining abusive litigation.

In my article Dabit, Preemption, and Choice of Law, I questioned the Supreme Court’s result. I noted, among other things, that there were other relevant policy considerations, notably including federalism concerns and constraining fraud. Moreover, the class action abuse problem was not clear in this fact setting. The Second Circuit opinion sensibly allowed a class action only for those who were induced to hold, rather than letting the holders carry along the purchasers and sellers. And unlike the most problematic non-purchaser/seller cases, the plaintiffs in Dabit had clearly bought their shares, so the ruling did not pose a risk of open-ended liability. Although we can’t be sure plaintiffs were harmed by defendant’s fraud, similar concerns arise in every “fraud on the market” case.

My main problem with the Supreme Court’s decision is that it precludes a potentially large swath of state remedies, and sets the stage for more federalization of corporate law. As I said in my article:

Reduced to its essence, Dabit rests on the primacy of federal over state securities law. As Justice Stevens emphasized at the beginning of his opinion, ‘‘[t]he magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally traded securities cannot be overstated.’ Thus, Dabit gives Congress a green light to regulate under the securities laws. This power may extend even to matters like those covered in Sarbanes-Oxley that arguably relate closely to internal corporate governance. * * * In short, Dabit gives momentum to the federalization of corporate law.

To be sure, business interests will like the Supreme Court’s result in Dabit, given the counterproductive nature of securities class action remedies and because, as Fortune's Roger Parloff notes (HT PoL), “businesses usually find it cheaper to comply with one federal regulatory regimen rather than with 50 state regulatory schemes.”

But there is a broader principle of federalism, particularly as applied to corporate law, which business can ill afford to sacrifice. Competing states have advantages over a single, inflexible, federal regulator.  And as discussed in The Law Market, various constraints often keep state law from getting out of hand.

Since the Court decides securities cases only rarely, the general principles of these cases tend to outlast their specific holdings. I would rather have the case-by-case narrow-preemption principle of Sotomayor’s opinion than the Supreme Court’s policy-based result.  Parloff notes research that Sotomayor “has been a moderate in preemption cases, finding preemption in about half the cases in which she was asked to do so.” I'm ok with that.

Update: A reader points out an ambiguity in the third paragraph above.  To clarify, Judge Sotomayor effectively interpreted SLUSA to apply to "his or her" transaction and therefore did not preempt the holding claim.  

Regulating the evolving law firm

I've been discussing (see my lawyers archive) some ideas about law firms and regulating the legal profession, particularly in the financial meltdown and its effect on law firms.

This week I had a chance to discuss my ideas and learn a lot about current regulatory developments at an ABA/Georgetown conference in Chicago on Globalization and the Regulation of the Legal Profession, which brought together practitioners, academics and state supreme court justices.  Very useful conference materials are collected here. 

My paper for the conference is a preliminary take on the issues that I plan to work more on this summer. Here's a quick overview of what I said:

1. It's a mistake for professional regulation to focus exclusively on the relationship between the individual lawyer and client.  Law firms perform significant client-protection functions, including through their incentive to protect their reputations from being diluted by their lawyers' misconduct.

2. Law firms' client-protection function is being eroded by a breakdown in their viability.  Among other things, law firms are finding it harder to motivate their members to do things like mentor associates rather than devoting all efforts to polishing their own resumes and clienteles. Certainly it is getting harder for both partners and clients to give their all for the firm when their tenure is more like a millisecond than a lifetime.

3. So we need better models for the delivery of legal services to enable lawyers and law firms to better serve their clients  Yet regulation of the profession has persistently failed to accommodate these models.  Instead, the rules, among other things, restrict non-competes, thereby constraining firms' ability to protect their property rights; forbid all capital structures except traditional worker ownership; and regulate national and global firms under the law of each state where lawyers are based.

4.  Permitting non-lawyer financing, multidisciplinary practice, unlicensed sale of legal products and allowing firms to choose the jurisdiction that regulates their structure (as can other business associations), would facilitate evolution rapid of more efficient laws. 

5. This does not mean deregulation, but rather regulation that takes account of the significant evolution of the law business.  I emphasized that regulators' failure to recognize these defelopments threatens to make the regulation irrelevant and not simply unresponsive to law firms' rpoblems.

Comments are welcome!

Is naked shorting a problem?

As I've discussed, e.g., here, escalating attacks on short-selling are senseless and are threatening an important engine of market efficiency.  Even moderates on short-selling have a problem with (non-covering) short sellers.  As I discussed here, with help from Holman Jenkins, there's a question how serious or widespread this problem would be even in the absence of regulation.  But there's also a question whether even the naked shorting that occurs is a problem.

Now Boulton and Braga-Alves, Naked Short Selling and Market Returns, have some evidence:

The recent financial crisis has focused a great deal of attention on naked short sellers. However, little is known about the relation between naked short sellers and market returns. We examine market returns around naked short sale transactions to address three questions. First, are naked short sellers momentum traders who exacerbate price declines, as some claim? Second, do naked short sellers possess superior information that allows them to profit from subsequent price declines? Third, how do market participants react to information indicating increased naked short selling activity? We find that naked short sellers are contrarian investors who trade following recent positive abnormal returns. Our results provide no evidence that naked short sellers are informed traders who can accurately forecast negative returns. Instead, abnormal returns are positive in the days following increased naked short sale activity. Market participants do not view announcements that indicate increased naked short sale activity negatively, as abnormal returns are generally positive following such announcements. Overall, our results are not consistent with the recent portrayal of naked short sellers as abusive and manipulative but instead suggest that naked short sellers promote efficient markets by providing liquidity, risk-bearing, and selling stocks they view as overpriced

The authors compile data on persistent failures to deliver (FTDs) withing the three-day Regulation SHO period. The most important takeaway:  naked shorting does not drive down prices as critics have claimed.

This theory and evidence suggests that even regulation targeted at naked shorting may be unnecessary or counterproductive.  Clearly we should not be regulating all shorting as a way to get at naked shorting.

Beneficial corporations and L3Cs

Professor B has a post on "beneficial (or B) corporations," which are corporations that designate themselves as socially responsible. He cites a 2005 post by Geoffrey Manne on the UK's Community Interest Company, and my response, that  

the main effect of opting into the CIC form is that the governing statute would then limit the extent to which the firm's governance ever could be changed through a takeover or similar device to restrict the manager’s control over the cash.

I have argued at more length (in my Accountability and Responsibility in Corporate Governance) that corporate managers in fact have a lot of power under the business judgment rule to engage in what most people refer to socially responsible governance. Also, given market discipline and the agency costs of removing this discipline there isn't much demand for giving managers even more power.

The question here is, what is the best way of providing for more socially responsible governance, assuming there's a demand for it? 

Professor B writes that "[i]f US corporation law codes were more clearly understood to be enabling statutes, there is nothing the CIC buys you (other than the label) that could not be done via the articles of incorporation of a standard business corporation."  Then he gives suggestions, including dividend restrictions and stronger stronger.  But he concludes:

Unfortunately, it's not at all clear that US corporate law is sufficiently enabling to achieve this result. State law arguably does not permit corporate organic documents to redefine the directors' fiduciary duties. In general, a charter amendment may not derogate from common law rules if doing so conflicts with some settled public policy. In light of the well settled shareholder wealth maximization policy, nonmonetary factors charter amendments therefore appeared vulnerable. This problem seems especially significant for Delaware firms, as Delaware law became increasingly hostile to directorial consideration of nonshareholder interests in the takeover decisionmaking process.

Yes, the inflexibility and essentially mandatory nature of corporate law is precisely the problem.  Perhaps special B Corp statutory provisions could address this, but they'll run smack into corporate law norms in gap areas, as have special close corporation provisions.

This is one of the many ways in which uncorporations, particularly including LLCs, can be useful.  You can do what you want with an LLC in the operating agreement.  Most LLC statutes now explicitly permit non-profit LLCs.  See Ribstein & Keatinge, §4:10.

If you want more explicit authorization for socially responsible LLCs, there's now a special statutory vehicle called “low-profit” LLCs, or L3Cs.  As discussed in the above section of Ribstein & Keatinge, these entities 

are intended to signal to foundations and donor directed funds that entities formed under these provisions intend to conduct their activities in a way that would qualify as program related investments. The first such statute was adopted in Vermont. See Vt. Code, title 11, ch. 21, §3001(27) [discussed here]. . . This statute requires the L3C, among other things, not to have a “significant purpose” of producing income or property appreciation. Similar statutes have been adopted in Utah (see Utah St. § 48-2c-412) and Wyoming (see Wy. St. §17-15-102).

I add that "[i]t is not clear precisely what is accomplished by these special provisions that cannot be done under standard LLC statutes." One could say the same thing about the B Corporation.

The L3C is one of many developments of the modern uncorporation discussed in my forthcoming Rise of the Uncorporation. 

The SEC on shareholder access

The SEC is re-revisiting this area. Here’s Jay Verret's summary, more from Professor B and Harvard’s Lucian Bebchuk, and my most recent comments on shareholder rights.

As my comments indicate, I am more interested in the fundamental issue of whether this should be left to state law than in the details of the proposal.  On this issue Bebchuk says:

Opponents also argue that establishing any minimum requirements for inclusion of director candidates on the company’s proxy card departs from the SEC’s traditional role into an area best left for state corporate law. However, the SEC’s proxy rules already mandate the inclusion of some information, including certain shareholder proposals, on the corporate ballot and accompanying proxy materials. The SEC’s proposal would merely expand the current mandatory requirements, and wouldn’t enter any new territory.

This is not much of a response to my argument that the federal role here should be shrinking rather than expanding.  Indeed, it further points up the harm in an incremental increase in federal power: this not only eats away the area left by state law but, as Bebchuk shows, feeds arguments for further expansion.

Moreover, as I've often said, including in my most recent post linked above, what about the "uncorporation"?  Federal governance rules are based on corporate norms. Will expansion of these rules create a demand for alternative governance forms. Or will they reduce the possibility of using these business forms for publicly held firms?  Here's a recent summary of how these devices could be used to solve the increasingly obvious problems of corporate governance. Maybe we should think twice before enshrining these mechanisms in federal law.

Hot off the press: Partnership Governance of Large Firms

Just out, Partnership Governance of Large Firms, 76 U Chi Law Review 289 (2009). Here's the abstract:

This Article examines private-equity firms as an example of “uncorporate” structures in the governance of large firms. Other examples include master limited partnerships, real estate investment trusts, hedge funds, and venture capital funds. These firms can be seen as an alternative to the corporate form in dealing with the central problem of aligning managers’ and owners’ interests. In the standard corporate form, shareholders monitor powerful managers by voting on directors and corporate transactions, suing for breach of fiduciary duty, and selling control. These mechanisms deal with managerial agency costs by relying on other agents, including auditors, class action lawyers, judges, independent directors, and shareholder intermediaries such as mutual and pension funds. Uncorporations substitute other devices for corporate-type monitoring, including more closely tying managers’ economic wellbeing to the firm’s fortunes and greater assurance of distributions to owners. This Article also explores the implications of this analysis for the corporate tax, the enforcement of firms’ contractual arrangements, and the future of publicly held firms.

This is a shorter and more current version of my Uncorporating the Large Firm.  The subject of both papers will be covered in the context of my broader theory of the "uncorporation" in my forthcoming book, Rise of the Uncorporation.

Reflections on global legal centers

So what did I learn on my trip to Singapore and Hong Kong?

One reason for my trip was to get some background information for expanding my general theory of jurisdictional competition (see The Law Market) to more fully take account of the emergence of global legal centers – with Singapore and HK being two leading examples.

Under the general theory articulated in the book, firms seek escape from regulatory and tax burdens imposed by their home country by “unbundling” law to some extent from territory. Unbundled law becomes like a commodity traded in a market.

“Offshore” jurisdictions are key global suppliers of this law. While interest groups in “onshore” jurisdictions seek to grab benefits from firms' connections with their countries, interest groups in “offshore” jurisdictions reduce their tax and regulatory price in exchange for reaping benefits of firms’ moving some of activities and legal work to their jurisdictions.

Although it might seem that this competition externalizes costs of deregulation to the firms’ home countries, in fact onshore jurisdictions can respond simply by applying their own law to local firms. At the same time, onshores are constrained by the fact that firms can completely sever their local connections and withdraw fully not only to offshore jurisdictions, but to other onshores that are willing to recognize offshore law and tax.

This type of exit would leave behind in the onshore jurisdictions what O’Hara and I refer to in our book as “exit-affected” interest groups – those who gain economically from the escaping firms’ physical presence, including workers, lawyers and other professionals, and all those who depended on the local headquarters of a big firm. These interest groups can join with other anti-regulatory groups to oppose attempts to inefficiently tax and regulate firms. Consider what happened after SOX, when NY saw firms pull out and go to other markets, such as London. Although academics continue to debate exactly what happened and why, the fact of the pullout, and the reaction by former lead SOX supporter Chuck Schumer, among others, to seek to limit or delay SOX, are clear enough.

Offshore jurisdictions can’t win just by negating onshore tax and regulation. To begin with, they have to offer reliable law in the sense of establishing a reputation that they will stick to their tax and regulatory bargains. Firms also seek sophistication, expertise and predictability from the offshores’ adjudicators.

And given that onshores have the last word in deciding whether to recognize offshore law, offshore jurisdictions must take account of how their laws affect onshore jurisdictions. To take a recently prominent example, onshores are worried offshores will compromise their whole ability to tax or regulate by offering Swiss-type privacy or, more generally, a safe haven for wrongdoing. An offshore may be able to generate a global consensus to enforce its regulation by demonstrating that it will not compromise important offshore regulatory and tax norms. It may be difficult for an onshore to defect from this consensus, because firms can find plenty of other onshore homes.

Now let’s consider where Singapore and Hong Kong fit in all this. These jurisdictions offer unique advantages. First, they both have fairly substantial reputations as reliable and sophisticated providers of reasonable tax and regulatory rules. Both have histories as strong regional offshores, Singapore attracting wealth from Malaysia, Indonesia and India, and Hong Kong, of course, from China.

Second, both have common law English-based legal systems. Even if one doesn’t buy the law-and-finance conclusion that this is generally a developmental advantage, it is a clear advantage for a global legal center because it combines flexibility and ability to evolve in a rapidly changing world with the stability brought by the established traditions of stare decisis.

Partly because of their similarities, Hong Kong and Singapore compete for increasingly global rather than regional legal business. In my discussions I didn’t get a strong sense of each jurisdiction’s competitive strategy. That may be partly due the fast-moving nature of the global legal environment and the uncertainty of the roles to be played by various types of offshores. Moreover, the main players in each jurisdiction lack the control over their legal system that Delaware lawyers, for example, exercise. Singapore has long been dominated by Lee Kwan Yew, and is still basically operating under his vision. Hong Kong has China to contend with, subject mainly to China’s self interest and the loose constraints of HK’s SAR status and the Basic Law.

I gathered that Singapore has tended to regulate its financial institutions with a somewhat lighter hand than HK, though I’m still working on the specifics. Singapore evidently has been competing with Switzerland in offering privacy, though both have bowed recently to global demands for transparency. At the same time, Singapore may be more careful in deciding which financial institutions to admit to their zone of safety.

In theory, at least, both jurisdictions might do more in offering innovative legal structures for firms, somewhat along the Delaware model. My forthcoming book, Rise of the Uncorporation, shows the role played by coherent business organization statutory standard firms. I see little US-style experimentation elsewhere in the world, which suggests a market opportunity for global legal centers. Singapore recently adopted an LLP act, though it’s not clear precisely what types of firms the act is designed for.

The global financial meltdown poses a challenge for global legal centers. As discussed in my article, Bubble Laws (40 Houst. L. Rev. 77 (2003)), financial crashes become boom times for regulation – from the English Bubble Act, through the 1930’s securities laws, Sarbanes-Oxley, and now, what? This tendency is especially important in the context of global regulatory competition. Recall that onshores have an incentive to recognize offshore law to avoid costly exit by firms, including to other onshore jurisdictions. Offshores theoretically can be defeated by a strong regulatory cartel of onshores, perhaps effectuated through the OECD or other organization with global reach. These organizations loosely serve the role of the federal government in the US system. But without a strong constitution binding onshores, the cartel is difficult to maintain.

The difficulty of maintaining a strong onshore cartel diminishes in a global financial crisis. The risk of a complete breakdown in the financial system, made salient and perhaps exaggerated by the media, and the general tendency toward post-bubble regulation, can reinforce the cartel.  This environment might let Congress and the Obama administration significantly increase financial regulation and reduce opportunities for tax and regulatory flight without worrying about a repeat of the post-SOX-type exit of cross-listing firms if the firms have nowhere better to go.

However, this bubble mentality has a limited shelf life. Perhaps more importantly, offshores are responding, and even if they do nothing will look more attractive as the US ratchets up the tax and regulation. HK seems to be attracting hedge funds with nuanced regulation in the face of the US war on the shorts.

Significantly, HK and Singapore are not only attractive places to do business but, in their distinct ways, attractive places to live. Hong Kong taxes its residents at a much lower rate than high-income earners currently pay in the US, and the US is planning to increase that differential. Hong Kong offers more of a go-go life style and nightlife than Singapore. Based on what I saw, both places are easier to live in and offer some advantages over cities like NY, London, Chicago or LA. Among other things, they both have impressive mass transit systems and are clean and efficiently run.

So where is this going? Onshores can get more aggressive in blocking the exits. The US deals with the tax lure by taxing US non-residents on their non-US income. This has had the expectable effect on the makeup of the HK expat community, which based on the hockey-themed bars and Brit-style pubs seems to be more Canadian and Brit than US. US citizens have an incentive to just give up their costly citizenship. The US has reacted to this threat with HEART, which contains a new punitive tax on unrealized capital gains of citizens who renounce.

Onshores also can go the other way and lighten up on those who have the greatest ability to expatriate. We saw a bit of this with the post-SOX SEC exemptions for foreign firms. The danger with this “price discrimination” strategy is that the less mobile will demand equal treatment. They won’t like being “discriminated” against just because they’re more stuck in (some would say more loyal to) their home country. As I have argued in the context of SOX, exit can lead to general deregulation.

In general, the offshores are beginning to realize how to compete in a global environment. Onshores like the US seem increasingly clueless. Does it really make sense to yield to short-sighted demands for financial regulation if this causes the US to lose its edge as a global leader in finance? Does it make sense to cede access to one of the most exciting business environments in the world to other country’s citizens in order to grab a comparatively little more tax revenue?

Obviously I have to back up and flesh out a lot of the above assertions. But I’m confident in the general thrust of the above comments. Hong Kong and Singapore offer something relatively new, or at least a new stage in an evolutionary process: full-service global legal centers, which use law and legal systems to attract not only legal business and “brass plates,” but also firms themselves and their workers. HK and Singapore thus transcend other offshores like the Cayman Islands, though this type of “limited-service” offshore center also has an important role to play. Both places have shown that they can use their legal systems to attract considerable wealth. If the US tries to deal with this competition by pinning its hopes on a global cartel or withdrawing into itself, it may end up increasingly on the margins of the global financial community.

Getting mobile: Singapore and Hong Kong

Blogging may be relatively light, as I'll be in the above places for the next ten days.  Hope to have some observations from my travels.  Any insights about by destinations from the knowledgeable will be appreciated.

Skadden to Kirkland: another wheel falls off the big law model

Per the NYT (HT ATL)

David Fox and Daniel E. Wolf, two top partners at the New York law firm of Skadden, Arps, Slate, Meagher & Flom, have defected to Kirkland & Ellis in a move likely to send shockwaves through the Wall Street legal world.

* * * The loss of two noted partners, who together generated tens of millions of dollars in fees annually for Skadden, could signal a broader shift in the corporate legal landscape as lawyers at large full-service firms leave for more focused, profitable shops. Last year, Kirkland generated about $2.47 million in profit for each partner, a closely watched measurement, compared to $2.07 million in profits per partner at Skadden, according to The American Lawyer, an industry magazine.

* * *Kirkland bills itself as younger and more entrepreneurial than some of its long-established competitors, which also attracted Mr. Wolf and Mr. Fox. The firm is also more focused on specific profit-producing areas like M.& A. and bankruptcy, while bigger firms like Skadden, Jones Day, and Latham & Watkins offer a vast swath of legal services.

Yikes. What was this about Second City? A branch of a Chicago firm picking off senior partners of a premier NY firm?

I see this as another wheel falling off of the big firm model. Although Kirkland is hardly a “boutique,” the next step could be to M & A-specific shops. As I’ve said, the days when top lawyers can be adequately compensated out of the profits generated by legions of associates are ending.

This moving around from one law firm to another is just an intermediate step. The next step is to more radical versions of legal services delivery, including by firms financed with outside capital.