Category: Corporate Law

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Better Bankers Symposium, June Carbone

Thanks to everyone who participated in the Better Bankers Symposium.

My two cents worth it that the current system does not just reward “greed,” it create a Gresham’s dynamic where those most motivated not just by self-interest, but a preference for short term financial rewards, drive out others who see their self-interest defined in other ways.  Market discipline may produce boom and bust cycles that put firms like Lehman Brothers out of existence, but the corrections of the market often either overcorrect (Akerlof’s references to lemons’ markets) or do so at very high cost (the financial crisis).  This is because greedy individuals (those motivated by short term gains) have managed to create an opaque system in which market responses kick in only after individuals have a chance to leave the companies they undermined, with their outsized individual bonuses intact.

Better Bankers thinks more creatively about how self-interest can be marshalled to police such activities before they get out of control.  It seeks to restore the identity of interests between bankers and banks.  It thus seeks to create a system in which self-interest includes interests broader than short term financial incentives, and in which private market mechanisms can become more effective.  The old joke is “how many economists does it take to change a lightbulb?  None, the market will do it if it needs to be done.”  Hill and Painter’s answer is that it requires a design and it requires the will to create the conditions where the more intelligent design is likely to be adopted because it advances the common good at the expense of individuals who would like to be able to continue to game the system.  Let’s hope their proposal finds fertile ground.
JUNE CARBONE
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The Arc of Covenant Banking: Hill & Painter’s Better Bankers, Better Banks

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University of Minnesota law professors Claire Hill and Richard Painter do a great service in their new book, Better Bankers, Better Banks, by focusing concretely on an issue that many have discussed but few have offered to change: how to align the incentives of bankers and banks.

They argue that “bankers [should] be personally liable from their own assets for some of their banks’ debts” for money owed due to insolvency, fines, or fraud-based liability. Thus, they propose formal, liability-creating contracts—which they call “covenants”—between banks and bankers: “Covenant banking operates directly on bankers’ monetary rewards” because, under their proposal, “highly paid bankers would bear some personal liability if their banks become insolvent, are fined by regulators, or are found liable in civil cases involving fraud. The liability would not be unlimited, but should potentially adversely affect the banker’s standard of living.”

The Hill/Painter proposal is valuable and interesting both in its own right, and for the harder questions that it raises.

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Better Bankers Book Symposium – a Perspective from Across the Pond

“Better Bankers, Better Banks” is an intriguing account of all the scandals and problems in banking that we appear to have become accustomed to. Professors Hill and Painter offer a fascinating new proposal on how to address these problems, which is as topical in the US as it is in Europe. In short, what their proposal amounts to is to rebalance the upside and the downside participation of bank managers in the profits and losses of their bank. Whereas before the crisis, regulatory efforts have long sought to align bankers’ incentives with the upside (by offering variable pay, bonuses, etc), there was very little attention on how to account for the downside risk. The idea of “covenant banking”, i.e. a form of self-commitment in the firm’s losses, is an important contribution to the current debate on how to improve banking culture post-crisis.

Inevitably, as soon as a proposal is on the table, market participants will want to know how it works in practice. In the following, I offer a few thoughts and questions that may broaden the debate towards its effects and implications.

First, how strongly would we encourage banks (or bankers) to make use of covenant banking. I am a little sceptical on whether they might adopt covenants deliberately. Some form of a government nudge would certainly be required. Different nuances in the regulatory toolkit are available. It seems to me that offering a best practice recommendation or a legislative menu with different options could be a sensible step to take. Findings from behavioural science support the effectiveness of such soft law standards.

Secondly, how will the market respond? Will clients and customers appreciate the stronger commitment that an individual banker’s “covenant” involves? Will they be able to digest the additional information appropriately? I would argue that a certain standardization of the covenant might help. If a small number of different covenants were “on offer”, endorsed by legislature or best practice code, the public would be much better placed to appreciate them. By contrast, if you leave firms to develop a million different tailor-made types – with exceptions, limitations and exclusions – creditors will not be able to price in their value correctly. This even more when you add an international perspective – jurisdictions will differ in their prescriptions and make it difficult to appreciate them in cross-border cases.

My final point is a little provocative: do we really get “better” bankers by making them liable for the firm’s debts? My pessimistic view of human nature is that bankers will still have strong incentives to work around their covenants – and possibly even use them as a commitment signal but do the opposite. Monitoring by creditors is therefore essential. This is another reason for why the rules should be clear, transparent, and somewhat standardized.

Hill and Painter have started a captivating journey, and I congratulate them on designing a stimulating new conceptual framework to address evil banking behaviour. I am convinced that their book will be the starting point for a long and fruitful discussion.

 

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Delaware’s Latest Show of Corporate Savvy

corp_logo_180x175Delaware continues to be the savviest seller in the world of corporate charters and related services, thanks to a combination of judicial vision and legislative elegance supported by all the state’s leadership and citizens alike.  The most recent example appears in the intersection of two technical corners–strike suit merger litigation and forum selection bylaws.

As detailed in this Wall Street Journal article of Wednesday, Delaware’s Chancery Court, led by Vice Chancellor Travis Laster, has been cracking down on frivolous shareholder suits challenging mergers.  The cases tend to be settled quickly based on corporate governance promises. Most of the cash that changes hands goes to plaintiffs’ lawyers while defense lawyers and boards seem to accept paying this “merger tax” as an investment in the certainty that that there will be no future litigation.

The WSJ piece suggests that the Chancellors’ crackdown may simply lead plaintiffs’ lawyers to file such suits in other forums.  But this overlooks one of the most important developments in recent Delaware corporate law, with which the savvy Delaware judges are keenly attuned.  If plaintiffs’ lawyers start filing increasing numbers of suits outside the Chancery Court,  more and more boards would unilaterally adopt bylaws barring such cases from any forum but Delaware.

The Delaware legislature recently authorized boards to do just that and courts elsewhere are bound to respect such arrangements and transfer any filed cases over to Delaware (as the Oregon Supreme Court did at year end in Roberts v. Triquint Semiconductor, Inc.).

True, in the past, Delaware boards and defense lawyers settle the frivolous cases and may find value in the finality. To that extent, the Chancellors’ crackdown on settlements may lead them to prefer litigating in courts more willing to give a rubber stamp, perhaps states eager to compete with Delaware in the corporate chartering and services business.

Except the Delaware judges are signaling a new world where boards need not fear these suits and crave their settlement as much as in the past.  If so, that makes Delaware more attractive and favors its selection for forum.  That increases board incentives to adopt Delaware forum bylaws.

A clearly virtuous effect of this combination of legislative, judicial, and directorial innovation is to make the merits matter more.  For Delaware, it is yet another way to cement the state’s deserved reputation as an attractive place to be incorporated.  And it does so primarily in the name of quality corporate law administration, rather than being either pro-management or pro-shareholder.

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Five Reasons to Cheer for Starr v. United States (AIG Nationalization Case)

AIG coverYesterday, the US Federal Court of Claims ruled that the US government and its leaders acted illegally in nationalizing AIG during the 2008 financial crisis, in a shareholder suit led by Hank Greenberg, the man who built AIG until his departure in 2005. But the judge (Wheeler) also ruled against awarding any damages, saying AIG shareholders were not harmed.

A top journalist at a major financial magazine asked me the following five questions, and I gave the answers indicated–being five reasons you should celebrate the ruling. Please note that I wrote the book, The AIG Story (Wiley 2013), with Greenberg, where we laid out the legal basis for Wheeler’s ruling on illegality.

1) Is this a moral victory for Hank Greenberg? Do you think he sees it that way? 
Yes, it is a moral victory for Greenberg and for everyone else who cares about the rule of law.  I can’t speak for Hank other than to say he cares deeply about the rule of law.

2) Andrew Ross Sorkin calls this a split decision in today’s New York Times. Is that true and if not who won?
It is a Solomonic split decision but designed to invite an appeal by Greenberg and not by the government, so Hank gets a second bite at the apple on appeal.

3) Given the collateral calls that were pending and the certainty of an AIG bankruptcy, did Greenberg ever have a real chance to recover $40 billion?
No, but given the possibility of hiving off the insurance companies outside of bankruptcy, Judge Wheeler’s conclusion on no damages is vulnerable to reversal on appeal.

4) What will this ruling mean for government intervention in future financial crises? Is that good or bad?
No more violating the law or the rule of law by government officials, whatever they may think at the time. Very good–a win for justice and true American legal values.

5) The judge says that government broke the law in taking over AIG. Do you agree with that assessment?
Yes. Virtually every major figure in the takeover violated the law, certainly fiscal authorities such as Bernanke and Geithner, and maybe cabinet secretaries such as Paulson, and many of their bankers and lawyers, including those from Davis Polk, Goldman Sachs and Sullivan & Cromwell. They should all feel disgraced.

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A Berkshire Opportunity Cost: Listed Family Firms

aaaaaThe following is adapted from “Berkshire’s Blemishes,” a working paper delineating the costs, rather than the vaunted benefits, of Warren Buffett’s Berkshire Hathaway as a management model.  

Warren Buffett loves family businesses whose owner-managers care more about their constituents than about profits, recognizing instead that customer care tends to translate into economic gain. Those entrepreneurs, in turn, love Berkshire Hathaway, Buffett’s company, because it offers intangible benefits such as managerial autonomy and a permanent home. When family businesses sell to Berkshire, they know they can still run them as they see fit and will not be sold if prospects falter: Berkshire has not sold a subsidiary in forty years and promises not to.

Buffett hates using Berkshire stock to pay for acquisitions, however, since few companies can match the time-tested premium currency Berkshire has come to represent. In fact, Berkshire’s worst acquisition was paid for in stock and Buffett still translates the cost into current values: $443 million paid in 1993, equivalent to more than $5 billion in Berkshire stock now. Preferring to pay cash, Berkshire is often able to acquire family businesses at a discount because selling shareholders value Berkshire culture. Buffett also hates auctions, plagued by frightful dangers like the winner’s curse, which can push bids well above value, rationally calculated.

Sensible as these tenets are, there is always an opportunity cost, in this case forsaking listed family firms–publicly traded companies controlled by a family. Unlike those owned solely by close-knit groups who all wish to sell to Berkshire, directors of listed family businesses owe duties to non-family shareholders when selling control. In most states, led by Delaware, they are duty-bound to get the best value for shareholders.  (The doctrine is known by famous cases illustrating it, including Revlon and Paramount v. QVC.)

In a stock deal where all holders share gains in future business value, directors could consider Berkshire’s special culture in valuing the transaction. But with cash, all such future value goes to Berkshire’s shareholders, not selling public stockholders, who would also gain nothing from the autonomy or permanence that family members prize in a sale to Berkshire. So directors resist an all cash sale at a discount and seek rival suitors at higher prices, even stimulating an auction to drive price up—repelling Berkshire’s interest.

An example can be drawn from Berkshire’s 2003 acquisition of Clayton Homes, a publicly traded family business bought for a modest (seven percent) premium to market. Many Clayton shareholders objected; one, Cerberus Capital Management, told Clayton it wanted the chance to make a competing bid; another sued. The result was a six-month delay in getting to a shareholder vote, which narrowly approved the Berkshire deal. Many Clayton shareholders were disappointed, but Cerberus opted not to outbid Berkshire, and the court dismissed the lawsuit.

The scenario remains unattractive to Berkshire, however, given the risk of litigation, delay and rival bids. After all, courts might require directors to take affirmative steps, presenting the risk of an auction, which in itself suffices to deter Berkshire from bidding in the first place. The upshot: the publicly traded family business is outside Berkshire’s acquisition model, amounting to an opportunity cost for what would otherwise be a sweet spot. On balance, it is probably a price worth paying, but it’s useful to know the price.

Lawrence A. Cunningham, a professor at George Washington University,  has written numerous books on a wide range of subjects relating to business and law. 

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Berkshire’s Disintermediation

aaaaaDisintermediation” is the business phenomenon of the technology era, when consumers go straight to the source for everything from accommodations to crowdfunding. Yet the greatest exemplar of the practice is the era’s least technologically savvy company, Berkshire Hathaway. Berkshire, 50 years old as a conglomerate and now one of America’s largest public companies, almost never uses intermediaries — brokers, lenders, advisers, consultants and other staples of today’s corporate bureaucracies. There are lessons in the model for the rest of corporate America, as well as investors, and it is an honor to be including a full length piece on the broad topic of disintermediation in the Wake Forest U. symposium on the subject hosted by Alan Palmiter and Andrew Verstein.

While American companies borrow heavily, Berkshire shuns debt as costly and constraining, preferring to rely on itself and to use its own money. It generates abundant earnings and retains 100 percent, having not paid a dividend in nearly 50 years. In 2014, Berkshire earned $20 billion — all available for reinvestment.  In addition, thanks to its longtime horizon, Berkshire holds many assets acquired decades ago, resulting in deferred taxes now totaling $60 billion. These amount to interest-free government loans without conditions. The principal leverage at Berkshire is insurance float. This refers to funds that arise because Berkshire receives premiums up front but need not pay claims until later, if it all. Provided insurance is underwritten with discipline, float is akin to borrowed money but cheaper. At Berkshire, float now totals $72 billion, which it uses to buy businesses that continue to multiply Berkshire’s value.

American corporations tend to design acquisition programs using strategic plans administrated by an acquisitions department. They rely heavily on intermediaries such as business brokers and investment bankers, who charge fees and have incentives to get deals done; firms also use consultants, accountants and lawyers to conduct due diligence before closing. erkshire has never had any such plans or departments, rarely uses bankers or brokers, and does limited due diligence. In the early days, Berkshire took out a newspaper ad announcing its interest in acquisitions and stating its criteria — which it has reprinted in every annual report. Berkshire now relies on a network of relationships, including previous sellers of businesses.

Today, corporate America’s boards are intermediaries between shareholders and management. Directors are monitors involved in specific strategic decision-making. They meet monthly, using many committees, which in turn hire consultants, accountants and lawyers. American directors are well-paid — averaging $250,000 annually — including considerable stock compensation plus company-purchased liability insurance.  Berkshire’s board, in contrast, follows the old-fashioned advisory model. Composed of friends and family, they are directors because they are interested in Berkshire. They do not oversee management but provide support and advice. There are few committees, no hired advisers, and only two or three meetings a year. Berkshire pays its directors essentially nothing and provides no insurance. Berkshire’s directors are significant shareholders and bought the stock with their own cash — which is why they are there.

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FAN 53.1 (First Amendment News) U. Maryland Law to Host Conference: “The Impact of the First Amendment on American Business”

e5eb96fc377fcf9f7e18eb56d245dca1The 2015 Symposium (March 27th), “The Impact of the First Amendment on American Businesses,” will facilitate a discussion on the effects and consequences of First Amendment jurisprudence on businesses. The symposium will specifically cover the areas of commercial speech, religious exemptions for businesses, and rights of businesses to use technology appropriately. This event will be located at University of Maryland Francis King Carey School of Law, and is open to anyone interested in attending, including students, lawyers, and scholars.

Welcome and Introductory Remarks
Dean Donald TobinUniversity of Maryland Francis King Carey School of Law

Keynote Speaker 1
Travis LeBlanc, Federal Communications Commission

Panel 1: First Amendment and Commercial Speech Relating to Health

Jane Bambauer, University of Arizona School of Law
Adam Candeub, Michigan State University College of Law
Stephanie Greene, Boston College & Greene LLP
Kathleen Hoke, University of Maryland Francis King Carey School of Law
Wendy Wagner, University of Texas at Austin School of Law

Panel 2: First Amendment and Technology

Hillary Greene,  University of Connecticut School of Law
James Grimmelmann, University of Maryland Francis King Carey School of Law
Glenn Kaleta, Microsoft Corporation
Renee Knake, Michigan State University College of Law
Neil Richards, Washington University School of Law
Felix Wu, Yeshiva University Benjamin N. Cardozo School of Law

Panel 3: Religious Exemptions for Corporations

Caroline Corbin, University of Miami School of Law
Michelle Harner, University of Maryland Francis King Carey School of Law
Louise Melling, American Civil Liberties Union
Jennifer Taub, Vermont Law School
Nelson Tebbe, Brooklyn Law School

Keynote Speaker 2

Tamara PietyUniversity of Tulsa School of Law

Closing Remarks

Danielle CitronUniversity of Maryland Francis King Carey School of Law

For additional information, please contact Joella Roland, Executive Symposium & Manuscripts Editor, via email at JoellaRoland@UMaryland.edu.

ht: Neil Richards 

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Fed Officials Accused of Perjury in AIG Bailout Trial

In the financial trial of the century, the most important document is missing. The document is the term sheet that the government says it gave AIG’s board right before taking the company over in Sept. 2008.  The government says the AIG board thus approved the Draconian terms that benefited Goldman Sachs and other rivals. But other evidence, including  AIG’s contemporaneous securities filings, suggests the board was agreeing only to sell the government warrants not transfer 80% of the common stock to it for a song.  The missing document would prove which side is telling the truth.

That’s one of many amazing points of contention noted by Yves Smith of Naked Capitalism in her relentless digging into what government really did during the financial crisis. Most recently, she alleges and documents perjury and obstruction of justice by top federal officials in the pending case of former AIG shareholders against the US. The case alleges that the government trampled on corporate law rights and that the Fed exceeded its authority—allegations that I document in my book, The AIG Story, written with Hank Greenberg, lead plaintiff in the case.

Smith lays out her claims in an extensive blog post at Naked Capitalism, accompanied by reams of additional documents and examples. For those looking for a skinny version, here is an abridged adaptation. Most examples concern Scott Alvarez, general counsel of the Board of Governors of the Federal Reserve; there is one with with Tom Baxter, general counsel of the New York Fed, who worked with Tim Geithner. The shareholders are represented by the noted trial lawyer, David Boies. The point about the term sheet is at the end.

Example 1

Boies: Would you agree as a general proposition that the market generally considers investment-grade debt securities safer than non-investment-grade debt securities?

Alvarez: I don’t know.

 

Example 2

Boies: [Presents a copy of the Financial Crisis Inquiry Commission report stating that the Fed had lowered the standards it applied for the quality of collateral for its loans under two programs then devised to support lending and asks] Do you see that?

Alvarez: I see that. . .

Boies: . . . [W]ould you agree that the Federal Reserve had lowered its standards regarding the quality of the collateral that investment banks and other primary dealers could use while borrowing. . . ?

Alvarez: No.

Boies: You would not agree with that?

Alvarez: Right.

 

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Buffett on Family Business: Beat the Third Generation Curse

warren buffettWarren Buffett is very good at spotting great family businesses. What does he look for? How can his filters help family businesses prosper?

For one, they can mitigate one of the greatest dangers: the third generation “curse.” This refers to how few family businesses survive beyond the third generation, let alone prosper.

An under-appreciated fact about Berkshire Hathaway, the conglomerate Buffett built: virtually all its family businesses boast second or third generation descendants who rival or outshine previous generations. That is rare among family businesses.

So while every family and business situation differs, Berkshire’s two dozen family companies are a good place to look for insight about multi-generational prosperity in the family business.

Studying Berkshire’s family businesses, I found that they are united by the following values. These values are important factors in their success, in the founding generation and subsequent ones.

Family business members, and their professional advisors, whether in law, accounting, or other fields, would do well to ponder these points.

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