Category: Corporate Law


Corporate Internal Affairs and the Constitution

Many thanks to Dan and the others at Co-Op for inviting me to visit for a few weeks.

Along with most everyone else, I have been waiting for months to see which cases the Supreme Court would review. One I have been watching is Moores v. Friese, No. 05-1590, a matter that has intrigued others, including Christine Hurt and Larry Ribstein.

Well, today the new term begins and . . . petition denied. Fair enough, but there is still a story here.

The case is a suit by a litigation trustee of Peregrine Systems, a Delaware corporation based in California, against various insiders under a California insider trading statute that allows the issuer to sue insiders and potentially recover treble damages. A central issue is whether the California provision applies because, under the “internal affairs doctrine,” the law of the state of incorporation normally governs internal conflicts among a corporation’s shareholders, directors, and officers. The California Court of Appeals, 36 Cal. Rptr. 3d 558 (Ct. App. 2005), reinstated these claims after concluding that this provision does not address internal affairs because it is more akin to blue sky (securities market) regulation. The California Supreme Court denied review.

The contours of the internal affairs doctrine under California law is fascinating stuff, but this is no reason for the U.S. Supreme Court to get involved. That is, of course, unless (1) this insider trading provision necessarily falls within the doctrine, and (2) California’s adherence to it is constitutionally mandated under the dormant commerce clause or due process clause. The cert petition presented this theory, and it was endorsed in an amici curiae brief filed by the U.S. Chamber of Commerce and others.

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The “Academic Business Judgment Rule”

Larry Ribstein is ruminating on recent flack he’s taken for his posts [here and here] on Ken Lay’s accountability. I think (or hope) that he is referring to posts like mine when he says:

I’m dubious about the use of criminal law for the sort of non-Vesco crimes Lay was convicted of, and think that a life sentence for such crimes belongs in the “foolish” category. But this sort of thinking is protected by what one might call the academic business judgment rule, and it’s not the pathology I’m discussing here.

He also suggests that some anti-capitalist sentiment is “ingrained.” Overall, Larry’s post is well worth a read. I very much endorse the idea that the aspect of academic freedom most worth defending is the freedom to be apparently wrong!


18th Century Venture Capitalists

dismal.jpgAs I posted earlier, of late I have been reading Virginia history. I have one title to suggest: Charles Royster, The Fabulous History of the Dismal Swamp Company. It is an tremendously detailed history of one of the great 18th century land speculations, the attempt to drain and sell the Great Dismal Swamp on the Virginia-North Carolina border. George Washington was one of the movers and shakers in the company, but other characters in the story include names like George Wythe, Richard Henry Lee, Patrick Henry, and a host of other luminaries from the American Revolution, as well as lesser known names like Christopher Gist, a Virginia merchant who helped to found Lloyd’s maritime insurance business.

Royster is a good writer and — for me at least — the narrative works nicely. The research represented by the book is awe-inspiring and the result is an enormous wealth of detail about everything from family politics (everyone who was anyone is colonial Virginia was related to everyone else) to imperial politics. At the center of the story, however, is what amounts to a venture capital deal.

To me one of the most fascinating parts of the story is the role that the events of the American Revolution play in it. The Dismal Swamp Company was founded as the Seven Years War (aka the French and Indian War) was coming to an end and its story twists through the years leading up to independence. Furthermore, given the vast scale of the project it inevitably became entangled in colonial and ultimately metropolitan politics. Hence, the events of the Revolution play out in the story, but in a new angle. They are not at center stage. Rather, the Stamp Act and Patrick Henry’s fiery speeches in the House of Burgesses are secondary characters who come on and off stage only as they impact the unfolding drama of the deal.

If one sees history in legal terms, the plots are often structured around public law stories in general and constitutional ones in particular. Royster’s book is, in a sense, the private law story of the American Revolution. He is not a legal historian, but the law is hardly a bit player in his story. The drama, however, centers less around constitutional arguments about rights and representation than around bills of exchange, maritime insurance contracts, mortgages, debts, collection actions, wrangles over title to land, corporate governance, and the like, all of which propel the characters in the story via various complicated paths to ruin or fortune.

Definitely worth reading.


Wild KPMG Fees Decision

Barely one day old, and Gonzalez-Lopez is already making waves in corporate law. To see the connection, however, you’ll have to bear with me for a bit of brush-clearing.

Judge Lewis A. Kaplan (S.D.N.Y.) today ruled on certain individual defendants’ motions to dismiss an indictment arising from the KPMG tax shelter investigation. (Large pdf here.) According to the defendants, their due process rights were violated when the U.S. Attorney pressured their former employer (KPMG) not to advance and reimburse legal fees incurred as individuals defendants. Judge Kaplan found a due process violation, scolded the government, and suggested a new lawsuit against KPMG to recover those legal fees, in which today’s decision would have collateral effect and make the proceedings summary. In short: the decision seems to constitutionalize the right to receive indemnification from your employer.

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The Disney Opinion and “Not in Good Faith”

As I noted earlier today, I thought, upon first read, that the Delaware Supreme Court’s Disney opinion from yesterday dealt a fatal blow to my “not in good faith” director liability argument. For those who missed it the first dozen times, I maintain that a complaining shareholder who is suing her directors, alleging that the directors failed to act in good faith, does not *have* to go so far as to prove “bad faith” acts by her directors, but, rather, she can point to the absence of good faith acts on which to pin liability. The phrase “not in good faith,” I maintain, does not mean (only) “bad faith.” Under my “not in good faith” theory of liability, directors who basically abdicate their duty or bury their heads – which are acts arguably short of bad faith acts – have violated their fiduciary obligation to act “in good faith.” And I thought that when I read the Disney opinion yesterday that the Delaware Supreme Court was boxing me in by maintaining narrowly that “not in good faith” only meant “bad faith.” Not so, it seems.

I had forgotten, when I first read yesterday’s opinion, that sometimes Delaware opinions take a second or third read before one can glean their full import. Such was the case with Disney. While I *thought* that the Disney opinion supported the position that my broad “not in good faith” category had no place in Delaware fiduciary jurisprudence, I was very wrong. More clearly, despite frequently invoking the phrase “bad faith” in the actual holding of the case, the Delaware Supreme Court in Disney did not say that a plaintiff shareholder who was trying to establish that a director acted without good faith in violation of her fiduciary obligations must prove “bad faith.” Quite the opposite: when the court discusses (in what I would call “dicta”) three categories of troublesome director behavior, the third category discussed appears to be almost exactly the same as the Nowicki Not-In-Good-Faith category! And that third category is (a) a category distinct from the court’s “bad faith” category (see below) and (b) a category that deals with liability-meriting behavior!

Allow me to explain in more detail:

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The Nowicki “Not In Good Faith” Manifesto LIVES ON!

I first read and posted about the Disney opinion last night. At that time, I all but agreed with Gordon Smith that the Delaware Supreme Court had shut down my “not in good faith” argument. (For those of you who somehow missed the first several recitations of my theory, my view is that the phrase “not in good faith” (as it pertains to the business judgment rule presumption and DGCL 102(b)(7)) means something DIFFERENT than “bad faith.” My view is that acts “not in good faith” INCLUDE bad faith acts, but there is also a narrower additional category reached by “not in good faith.” Essentially, Caremark-esque cases would fit into the “not in good faith” category.)

What I had forgotten, however, was that Delaware jurists are crafty. (I discussed this recently on the wonderful Truthonthemarket blog.) So, while it SEEMED to Gordon that the Nowicki “Not in Good Faith” theory could not live on, and I agreed with his pronouncement because I was weak with illness and I only had the strength to read the 89 page opinion *one* time instead of the requisite three, I now find, on my third read of the Disney opinion, that my “not in good faith” theory, much like a cockroach, has largely survived the Disney fall-out.

More on this later.


Disney, Bob Iger, and Michael Eisner

Bob Iger has been in the driver’s seat at Disney for over half of a year, and I am excited about what Iger’s Disney is starting to and will, ultimately, look like. Disney announced yesterday a new promotion – “Where Dreams Come True” – which the WSJ reports as being a “new global campaign to draw more guests to Disney’s theme parks.” The promotion, to start in October, involves a million giveaways to Disney visitors, including things like an overnight stay in Cinderella’s castle or the *entire* Magic Kingdom park to oneself for a day. I get giddy just thinking about it, in large part because I *love* the Magic Kingdom, and I like what I view to be the start of a return to the business concepts underlying Walt Disney’s ideas from decades past. I sincerely hope that Iger ends up delivering to the degree that we hard-core Disney fans expect.

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Whistleblowers and Stereotyped Cultural Norms

I’m a little slow to weigh in on this issue, but I just received the latest edition of the ABA Journal. This month, they have a story, “Culture Clash,” by John Gibeaut describing how Sarbanes-Oxley’s whistleblower provisions are causing trouble for foreign cross-listed companies. Ideoblog and Conglomerate have already provided some commentary about the article, which begins as follows:

Americans like to elevate whistleblowers to near folk-hero status, from Daniel Ellsberg, who leaked the Pentagon Papers to Sherron Watkins, who exposed the Enron Corp. financial scandal that in 2002 moved Congress to pass the fraud-busting Sarbanes-Oxley Act. Indeed, Watkins shared Time magazine’s Person of the Year honors in 2002 with World Com Inc. whistleblower Cynthia Cooper and FBI agent Collen Rowley, who accused the bureau of mishandling information on suspected hijacking plotter Zacarias Moussaoui before the Sept. 11 terrorist attacks.

Say whistleblower in Germany, however, and the term most likely conjures up memories of the Gestapo, Adolf Hitler’s secret police. In France, the term evokes images of the Vichy regime’s collaboration with the Nazis and of neighbors ratting out one another.

I think that the beginning of the article relies on some flawed cultural stereotypes of both Europeans and Americans. Be that as it may, I would question the author’s proposition that American whistleblowers enjoy some sort of elevated status. About a year and a half ago, I wrote an article about (American) whistleblowers and the Sarbanes-Oxley Act. In the article, I argue that whistleblowers are not being given enough protection. Not under state employment law, and not under Sarbanes-Oxley either. Studies – cited in my article – show in graphic detail that American whistleblowers end up unemployed, broke, divorced, and depressed.


Skilling And Lay Off To The Pokey

It appears that a Houston jury was not particularly sympathetic to these gentlemen, convicting them of most charges. Of course, business criminals get time to get their lives together before heading to prison. They’ll be sentenced in September and remain free until then.


On the Milberg Indictment

MW.gifI’ve been mulling over the Milberg indictment. Since I waited a weekend to post, I have the advantage of having read lots of other folks’ views. Quick summaries follow:

  • Michael Dorf: Kickback payments slaved the named plaintiffs to MW, bloating agency costs.
  • Steve Bainbridge:Kickbacks encourage “nuisance claims.” We may need criminal sanctions to crank the Hand formula to optimal levels, but only against individual lawyers.
  • Walter Olson:”[MW was] taking no chances on the watchdogs staying pacified: It threw regular chunks of raw liver into their cages.”
  • Larry Ribstein: Who cares? Lawyers are fungible.
  • Ed Morrissey: Bad for Democrats and ambulance chasers.
  • Christine Hurt: It’s high noon, and MW can’t blink.
  • And let’s not forget MW itself: It was just a referral! And the theory is overreaching! And our interests remained aligned!

Wow. Lots of words. So here is what I think.

First, I still don’t particularly understand the economics of outrage here. I’ve seen two arguments about why kickbacks are bad (apart from their being unlawful, which we’ll put aside briefly). First, I’ve heard the argument that they “capture” the lead plaintiff, making that person less able to monitor the lawyer’s work. As Dorf points out, however, plaintiffs in securities class actions are sort of like shareholders stockholders: they have deputized oversight and management to lawyers, in return for fiduciary duties. Some folks seem to have in mind a more active role for lead plaintiffs – something like a controlling stockholder(?) – but given the relatively low bonuses awarded in settlements for lead plaintiffs, why would anyone want to play that role? That is, you can’t have distributed, small-stakes, high-impact, governance by private actions and have plaintiff management at the same time. The capture argument is another way of saying that these types of claims are not in the public interest. But we don’t criminalize inefficient lawyering. Not usually.

The second argument I’ve seen is related to the first – it is Bainbridge’s – and it suggests that kickbacks encourage securities actions that are (on the merits) weaker. Yup, that sounds right. But that isn’t an argument against kickbacks, it is an argument that judges aren’t doing enough to raise hurdles to weak actions at early stages, as the PSLRA was designed to accomplish. To the contrary, I have found that judges are quite hostile to securities claims.

The argument that I haven’t seen on the blogs, but which is larded through the indictment, suggests that MW was, in effect, selling out the rest of the class to benefit the folks at the head of the line. And in a way, this is (for me) the strongest argument against the practice. If MW really did countenance paying referrals-as-kickbacks to named class members out of their portion of the settlement, then we know that dollars were being taken out of the mouths of the rest of the class pretty directly. On the other hand, one might argue that MW had to pay off the named plaintiffs to bring the cases in the first place – that it is a an expense like overhead.

Two additional aspects of the case trouble me. Obviously, indicting the entire firm feels excessive. I don’t agree with Larry R. that reputational effects won’t follow MW’s innocent lawyers. I know lots of counsel at MW – I litigated against them – and I thought they were incredibly hard working, tough, honest, passionate adversaries. One of my worst days as a lawyer came across a deposition table from an experienced Milberg partner: he taught me a great lesson on how to get one’s opponent to hang himself on the record. And I’d be shocked if more than a handful of lawyers at the firm had any knowledge of the activities charged. If the USAO is really indicting out of pique for failure to roll over as most corporations would do in response to a patently unreasonable discovery demand, well, many folks who think of themselves as white knights are going to be tarnished unfairly.

Second, I have some problems with the continued federalization of state practice ethical rules. Although the indictment doesn’t come out and say this, some of the illegality is premised on state fiduciary duty and referral laws. (Some, granted, is based on Rule 23.) Shouldn’t this type of prosecution be the job of Elliot Spitzer and his imitators? Which raises a question: why didn’t Spitzer get here first?