Tagged: Current Events


So Young, So Cynical

As I mentioned in a previous post, I teach (and really enjoy teaching) Legal Profession. In my prior post, I noted my sense that students resist ethics courses because they view themselves as moral, ethical people who will be moral, ethical lawyers. That trend has continued this semester, but I am also hearing more cynicism about the profession than in the past.

Now, it may be that I am teaching 1Ls this semester, as opposed to 3Ls who simply want to graduate and do not want to stir the pot. (And I have to say that I have a very thoughtful and engaged group of 1Ls.) It may be that law students are questioning their decision to enter the profession in different ways and on different levels than in the past because of the current environment. Indeed, given the amount of money these students invest in their legal education, they must cringe when they read the newspapers—or more likely the Internet—these days. (For recent stories regarding downsizing in the profession, see here, here and here.) Regardless of the reason, the sentiment is striking. I should note, however, that I am not surprised by it given the generally negative public perception of lawyers.

So what type of cynicism am I hearing? We recently were discussing what constitutes lawyer misconduct, a lawyer’s obligation to report the misconduct of colleagues and a lawyer’s obligation to disclose her own misconduct to the client. That last duty always gets them, and we typically discuss in detail the origins of this duty (see here, here and here) and the circumstances that might give rise to the duty basically to tell your client that you made a mistake. In several discussions with my students both in- and outside class, the common questions have been along the lines of: “Well Prof. Harner, this all sounds great in theory, but who actually reports misconduct in the real world? And why would you ever report your own misconduct?” These are very honest and sobering questions.

I do my best to instill in my students the importance of the self-reporting nature of the profession and the value (both personal and professional) to being an ethical, honest lawyer. We discuss the trust and integrity that underscore the lawyer-client relationship and what happens to legal process when that trust is breached. And I think they get all of that. But I also think they are sensitive to life in the real world, and the pressures they will be facing—assuming they can actually get jobs—as associates subject in many respects to the whims and behaviors of more senior lawyers and clients. As one of my students told me in discussing ABC’s new series, The Deep End (see also here), “You know Prof. Harner, the associates always find a happy resolution to ethical dilemmas on television, but I doubt it is really that easy in practice; being ethical and calling a colleague on her misconduct could end your career.”

I think my students are raising valid concerns; these certainly are not new concerns but perhaps they have renewed importance as students are more and more concerned about getting and then keeping jobs. I find that shock therapy helps drive the point home for some students, so I give them many examples of lawyers being disbarred and note the junior associate who now faces sanctions and discipline in connection with the Qualcomm discovery litigation (see here and here). And I hope that when they face that hard decision in practice, they will make the right one.


Conflicts and Competitive Advantage

This week, Toyota announced a massive recall of some of its most popular models, including Highlander, Corolla, Venza, Matrix and Pontiac Vibe. Specifically, “Toyota has recalled 2.3 million vehicles for sticky accelerator pedals . . . and has shut down sales and production of eight models while it works on a fix.” (See here.) Notably, “[t]he Obama administration said it pressed Toyota to protect consumers who own vehicles under recall and to stop building new cars with the problem.” (See here.) Although I understand and appreciate the administration’s concern for consumer safety, I cannot help also seeing a glaring conflict of interest in the administration’s conduct.

As you might recall, the government owns stock in General Motors and Chrysler—key competitors of Toyota. And consider the following: “GM announced today it will offer interest-free loans and other incentives. In and of itself, this is no big deal, but GM is making the offer exclusively to Toyota owners who may now want to get rid of their vehicles because of the recall involving faulty gas pedals.”  (See here.)

GM’s decision might be good business; companies often seek to capitalize on a competitor’s misfortunes. And I suspect that the administration’s involvement in the Toyota recall was unrelated to GM’s business decision regarding the Toyota incentive plan. But it just does not look good, and it highlights the significant issues with the government intervening in and owning private businesses. (For a more detailed discussion of these issues, see here and here.)

Also, as a follow up on my prior post regarding the General Motors and Chrysler bankruptcies and the government’s decision to grant arbitration rights to dealers who are party to rejected franchise agreements, recent reports suggest that over 1,400 dealers are pursuing their arbitration rights. Chrysler also has agreed to participate in the arbitration program.


Making Money in a Down Economy

For the past few years, many businesses have struggled to meet payroll and keep the doors open. But such challenges are not bad news for everyone. At least one group of investors (a/k/a distressed debt investors) has found a way to capitalize on the financial troubles of businesses. In fact, recent reports (see here and here) suggest significant above-market returns for hedge funds that utilize a distressed debt investment strategy (e.g., Avenue Capital Group, Third Avenue Funds, Third Point Funds).

A distressed debt investor basically buys the debt of a troubled company and then flips the debt for a quick profit or seeks returns through a longer investment horizon. Investors that fall in the latter category may simply wait for the debt to be refinanced or cashed out, or they may seek to utilize the leverage associated with the debt instrument upon a default or potential default by the company. In fact, “activist” distressed debt investors may use their distressed debt holdings to influence management decisions (think of Carl Icahn’s letter to CIT bondholders) or gain control of the company through a debt-for-equity exchange or credit bid at an asset sale (think of Carl Icahn’s recent acquisition of Tropicana Entertainment and bid for Trump Entertainment).

The existence of an activist investor in a company’s debt holdings can swiftly change the dynamics of the company’s restructuring negotiations. These investors typically want to achieve their objective at the lowest cost (thereby maximizing their upside), which often conflicts with the objectives of other stakeholders. Conflict can lead to delay, expense, litigation and even liquidation. Many companies, such as Adelphia, Aleris, Foamex, Fairpoint, Lyondell and Tropicana Entertainment, have experienced this type of conflict firsthand.

That being said, hedge funds and private equity firms that typically invest in distressed debt may be a good (or the only) source of funding for troubled companies. And their investment objective (maximizing their upside) is understandable given their obligations to their own fund investors and, let’s be honest, the typical fund fee structure.  So the question then becomes who is or should be protecting the interests of other stakeholders to mitigate conflict and obtain a fair deal for the company? Is management, particularly in a distressed situation, up to the task? Even if it is, management typically does not learn about the presence of a distressed debt investor in the company’s capital structure until it is too late. Notably, this issue is beyond the scope of the proposed Hedge Fund Transparency Act of 2009 and the Financial Regulatory Reform: A New Foundation proposal submitted by the Group of 30. Moreover, proposed revisions to Bankruptcy Rule 2019 (requiring some disclosure of holdings) may help some companies and other stakeholders in the bankruptcy context, but again the information may come too late and only for bankrupt companies. And whether you focus on disclosure, representation or accountability in considering the creditor control issue, you certainly need to target more players than just hedge funds and private equity firms.


Time’s Cover Jinx?

Sports fans are probably familiar with Sports Illustrated’s cover jinx. As SI itself explains, “Millions of superstitious readers — and many athletes — believe that an appearance on Sports Illustrated’s cover is the kiss of death.” (The SI jinx timeline really is remarkable, see here.)

So, is the same type of jinx emerging with Time’s “Person of the Year” cover? Richard Nixon receives the honor (for a second time) in 1972, and the Watergate scandal breaks in 1973. Ronald Reagan, Bill Clinton and Barack Obama all receive the honor in the year they are elected President of the United States, and their approval ratings drop dramatically in the following, first year of their presidential terms. “You” receive the honor in 2006, and we all know what happens to the bank accounts of many of those honorees in 2007 and 2008. And now just a month after being named Time’s Person of the Year for 2009, Federal Reserve Chairman Ben Bernanke’s confirmation is in question. (See here and here.)

Admittedly, Chairman Bernanke is controversial. Some believe that he pulled the global economy back from the brink, sparing us from further devastation in another depression. Others believe that he leans too closely towards Wall Street and did not do enough to prevent the economic crisis. But what would a “no” vote at this time mean for the economy? Markets like certainty, and at least Chairman Bernanke is a known quantity, particularly when there is no known “Plan B.” In the end, I suspect that all of the political anxiety about the confirmation will fall into the category of being “much ado about nothing,” (see here) and the political rhetoric of the past week will simply be another example of politicians governing with an eye towards the next election, rather than the long-term interests of the country.


Are Hedge Funds and Private Equity Firms Next?

As widely reported, President Obama came out swinging yesterday against large financial institutions. Under the administration’s proposal, commercial banks no longer could invest in or sponsor hedge funds or private equity firms, and the banks would be subject to new leverage caps. This proposal is the most recent step by the administration to try to regulate risk. According to President Obama, “We simply cannot accept a system in which hedge funds or private equity firms inside banks can place huge, risky bets that are subsidized by taxpayers and that could pose a conflict of interest.”  (Full text of speech here.)

As you might imagine, the financial sector is highly critical of the proposal (for example, see here) and some commentators are questioning whether it is feasible given the structure of firms like Goldman Sachs (for example, see here) and the global nature of the economy (and mixed reactions from the U.K. and Europe so far, see here and here). You also have to wonder what is next. Given Tuesday’s election results (for a discussion of resulting policy shifts, see here) and the reappearance of Paul Volcker on the scene, those aspects of the Group of 30 report, Financial Regulatory Reform:  A New Foundation, previously not pushed by the administration might be back on the table. Indeed, the administration previously downplayed the need to restrict the size or activities of large financial institutions:  “We have created them [i.e., large financial institutions], and we’re sort of past that point, and I think that in some sense, the genie’s out of the bottle and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that we’re unlikely to ever come back to or want to come back to.” (Comments of Diana Farrell, Deputy Director of the National Economic Counsel.)

If that is the case, will we see a renewed focus on hedge funds and private equity firms? They were among the initial targets of public anger and Congressional inquiry, but little has been done with The Hedge Fund Transparency Act of 2009 or the more aggressive oversight proposed by the Group of 30 report. And will any of these efforts really mitigate financial risk in the market? Even if you believe that some government intervention is necessary, is the government really equipped to perform a meaningful oversight role?