The "Myth" of Glass Steagall

DealBook had a piece criticizing Elizabeth Warren and arguing against the "myth of Glass Steagall." 

Warren apparently sent an email to supporters calling for the reinstatement of Glass Steagall.  The article quoted Warren as arguing that the law “stopped investment banks from gambling away people’s life savings for decades — until Wall Street successfully lobbied to have it repealed in 1999.” 

The quote on its face is hard to criticize.  Prior to the repeal of Glass Steagall, investment banks could gamble in the stock markets all they wanted.  They would not lose deposits since they lacked the authority to accept deposits.  They were mostly gambling with shareholder equity and borrowed funds. 

Commercial banks, on the other hand, accepted deposits but, for the most part, had to stay out of the equity markets.  This effectively reduced the risk profile of commercial banks.  For a piece on the adverse consequences of repealing Glass Steagall, see The "Great Fall": The Consequences of Repealing the Glass-Steagall Act. 

But somehow the article in DealBook morphed into an allegation that some arguing that repeal of Glass Steagall caused the financial crisis of 2008.  This argument was labeled "pure historical revisionism."  The article went on to "demolish" the "myth" that Glass Steagall caused the financial crisis. 

The only myth, however, that needed demolishing was that there is any significant body of opinion arguing that the repeal of Glass Steagall singularly caused the financial crisis.  A crisis as serious and deep as the one that began in 2008 could only have multiple causes and explanations, with these causes and explanations remaining hotly contested. 

Indeed, the article itself quoted no one who said that the crisis could be traced exclusively to the repeal of Glass Steagall.  Indeed, Warren herself, when asked about the topic, indicated that she did not believe the repeal caused the financial crisis.  Instead, she noted that: 

• the repeal of the law “had a powerful impact to let the big get bigger.” She also contended that its repeal, brought about by the Gramm-Leach-Bliley Act, “mattered enormously. It is like holding up a sign to regulators to back up.”

In other words, the repeal contributed to the financial crisis in part by allowing the commercial banks to grow in size and by encouraging regulators to take a less active stance in policing the markets.  Both are likely true.

Having set up and dispatched a proverbial straw man, the article switched tact.  It used the conclusion that Glass Steagall did not singularly cause the finanial crisis to then argue that reinstatement was not the "ultimate solution" and any argument to the contrary should be met with skepticism. 

But of course it is a non sequitur to conclude that the non-causality of Glass Steagall ineluctably leads to the conclusion that it ought not to be reinstated.   The argument for reinstatement of Glass Steagall is not premised on the view that it was the singular cause of the financial crisis.  It is premised on the view that a division of functions would reduce risk, reduce size of the entities (and potentially reduce them to a size that could be allowed to fail), and facilitate regulatory oversight.  I would add that it would allow for a class of investment banking firms that were independent of commercial banks and were more dedicated to promoting active capital markets (a topic described in the article cited above). 

On this issue, Warren had the better of the analysis.

We heard it from three people, so it must be true

In yesterday’s New York Times, Joe Nocera incisively attacked the persistent falsehood that Fannie Mae and Freddie Mac were “ground zero” for the financial crisis. In “An Inconvenient Truth,” Nocera correctly observed that: “The reality is that Fannie and Freddie followed the private sector off the cliff instead of the other way around.”

In an analysis of the Financial Crisis Inquiry Commission Report, I challenged the blame-Fannie-and-Freddie for the crisis myth, here. As I wrote early in 2011:

Myth 4: The big government-sponsored companies (GSEs), Fannie Mae and Freddie Mac caused the Financial Crisis because the government pushed them to guarantee mortgage loans to poor homeowners as part of their public housing mission. Variations on this are that public housing mission drove bad underwriting by lenders who had to create risky mortgages to fulfill the demand of the GSEs who needed to buy them, as they were desperate to meet housing goals.

Reality 4:  Not exactly. Both the Report and the primary dissenting statement agree that on their own Fannie and Freddie did not cause the financial crisis. They focus blame largely on the so-called “private label” mortgage market. These are bank and non-bank,  brokers, lenders, and securitizers.  Fannie and Freddie did not originate loans; the “exotic” and dangerous loans were designed by and extended to borrowers through the private label channel. While the Report and the Thomas Dissent support the notion that Fannie and Freddie’s business model was flawed, they also agree that affordable housing goals did not either drive Fannie and Freddie to ruin or cause them create the overwhelming demand for predatory, high-risk, mortgages.

So, why is it that the distortions repeated by folks like Peter Wallison have traction with the public?

This phenomenon reminds me of an early scene in F. Scott Fitzgerald’s The Great Gatsby. At the start of the novel, upon reacquainting with her cousin Nick Carraway, Daisy Buchanan inquires whether the rumors of his engagement to a woman out West are true. Even Daisy’s husband Tom chimes in. Nick quickly denies any designs to be wed. However, Daisy brushes off his response and insists that she knows better: “We heard it from three people, so it must be true.”

The statement is funny on its face because Nick is the primary source. Surely, Daisy should recognize that he is more capable, than three gossips, of knowing whether he is or was engaged to be married.  Yet, what is also amusing is that beneath the surface, there is a kind of familiar truth to Daisy’s rejoinder. It resonates, echoing various biases to which many of us succumb. Through exposure to repetition, particularly by a seeming variety of sources, we accept a certain version of reality. Even when faced with credible contradictory evidence, we have a hard time shaking free of the various “truths” we have collected.

So what does this have to do with the financial crisis? The story of the crisis deals with very real people offering fictions, steeped in ideology.  Yet, there is a connection. There is much the falsehoods about the financial crisis, fed on ideology, politics and economic-self-interest have in common with Daisy’s triple-sourced “truth.”  The myths about the causes and responses to financial crisis are repeated by many people. Yet, notwithstanding clear evidence refuting them, even from a number of sources with better information, many of us continue to hold on to them.

[This piece first appeared on The Pareto Commons blog, December 20, 2011].

Katz v. Gerardi: Claim Splitting and the Definition of Purchasers under the Securities Act of 1933

In Katz v. Gerardi, 655 F.3d 1212 (10th Cir. 2011), the Tenth Circuit Court of Appeals affirmed the dismissal of two class action suits dismissing claims under Sections 11 and 12(a)(2) of the Securities Act of 1933 (“Securities Act”).

Jack Katz and Infinity Clark Street Operating (“Infinity”) both contributed property to a real estate investment trust operated by Ernest Gerardi and later by Archstone-Smith Trust (“Archstone”).  Archstone merged with Lehman Brothers.  The merger permitted investors in Archstone to receive cash or shares in a new investment vehicle.  Katz and Infinity filed separate class action suits against both Gerardi and Archstone alleging that they made false disclosures under Sections 11 and 12(a)(2) of the Securities Act of 1933.

Infinity’s complaint was filed in 2007 in the United States District Court for the District of Colorado.  All claims were dismissed except for one alleging breach of contract, which was stayed pending arbitration.  Katz’s complaint was filed in Illinois in 2008 and removed by Archstone to the United States District Court for the District of Colorado.

Once in Colorado, Katz amended his complaint to include Infinity as a plaintiff.  As a result, Infinity was a plaintiff in two separate actions in the same court.   The Colorado District Court subsequently dismissed Infinity from the case concluding that the plaintiff had engaged in claim splitting.

The rule against claim splitting requires a plaintiff to bring all claims against a defendant in a single suit to maximize use of judicial resources.

Infinity argued that claim splitting did not apply because there had been no final judgment in the original action.  The Tenth Circuit found the argument unpersuasive because the test for claim splitting was not whether there was finality of judgment, but whether the first suit would preclude the second suit.  As the court reasoned:

Our precedent cannot be clearer: the test for claim splitting is not whether there is finality of judgment, but whether the first suit, assuming it were final, would preclude the second suit. This makes sense, given that the claim-splitting rule exists to allow district courts to manage their docket and dispense with duplicative litigation.  If the party challenging a second suit on the basis of claim splitting had to wait until the first suit was final, the rule would be meaningless. The second, duplicative suit would forge ahead until the first suit became final, all the while wasting judicial resources.

The court also concluded that Infinity “essentially admit[ed] claim splitting” by adding the same securities claims to the other action filed in Colorado.  Moreover, at oral argument, “Infinity even conceded the securities law claims can be litigated in its other lawsuit.”

The court also affirmed the dismissal of the securities claims brought by Katz.   Section 11 provides a cause of action for false information in a registration statement.  Section 12(a)(2) provides a cause of action against parties who provide prospectuses or communications which include untrue statements of material fact.

Both sections 11 and 12(a)(2) require plaintiffs to show they were the purchaser of securities to have standing.  A seller of a security cannot, therefore, bring an action under these provisions.    The fundamental change doctrine provides an exception to this requirement.  This exists when “the shareholder is faced with the choice of either holding stock in a nonexistent corporation or exchanging his shares for value… [in] mergers.”  As the court described:  “The doctrine enables a shareholder, whose investment has been fundamentally changed, to meet the causation and reliance requirements of the securities laws even though the shareholder has not made an actual purchase or sale of securities.”

Katz received cash for his units because of the merger and, as a result, sold rather than purchased securities.   He nonetheless asserted that he had standing as a purchaser under the fundamental change doctrine.  Concluding that the doctrine applied to claims under the Securities Exchange Act of 1934, the court declined to apply it to claims under the 1933 Act.   Even were the doctrine applicable to such claims, however, the court held that it did not allow plaintiff to be transformed into a seller.

Further, even if we adopted the fundamental change doctrine and applied it to Katz's 1933 Act claims, it is still no help. In a forced sale, he is still a seller, not a purchaser. To find that Katz has standing, we would still have to assume he purchased the "new" A-1 Units, which he never did. In fact, Katz owned the same A-1 Units both before and after the merger was announced. Nothing can convert the sale of his A-1 units for cash into a purchase of shares he never acquired.

Because Infinity was improperly included in claims it did not make in its original suit and because Katz did not have standing to make a claim under the Securities Act of 1933, both cases were dismissed.

The primary materials for this case may be found on the DU Corporate Governance website.

Renfro v. Unisys Corporation: An Examination of Fiduciary Responsibility under ERISA

In Renfro v. Unisys Corp., 2011 U.S. App. LEXIS 17208 (3rd Cir. Aug. 19, 2011), members of a 401(k) defined contribution plan (“Plaintiffs”) brought this action against Unisys Corp. (“Unisys”) and Fidelity Management Trust Co. (“Fidelity”) (collectively, “Defendants”), under the Employment Retirement Income Security Act of 1974 (“ERISA”). Plaintiffs alleged that Defendants violated their fiduciary “duties of loyalty and prudence” through the “the selection and maintenance of the mix and range of investment options included in the plan.”  The trial court granted the defendants’ motion to dismiss and the Third Circuit Court of Appeals affirmed.

The Unisys Corporation Savings Plan (the “Plan”) includes a stable value fund, the Unisys Stock Fund, and seventy-one options provided by Fidelity. The seventy-one options are broken into four commingled pools and sixty-seven mutual funds. Mutual funds are subject to a number of reporting requirements and, as a result, management and administrative fees are attached.

Plaintiffs alleged that the attached fees were excessive when compared to other viable investment options. Defendants moved to dismiss the action under Fed. R. Civ. P. 12(b)(6). In considering an ERISA dismissal motion, the court must question “whether [the entity] is a fiduciary with respect to the particular activity in question.” The court evaluated each of the defendants individually.

While Fidelity was the directed trustee of the Plan under 29 U.S.C. § 1102(a)(1), the court held that it had no fiduciary duties relating to the challenged conduct because it was responsible for investing and administrative functions rather than selection of investment options. Fidelity was found not liable as a co-fiduciary, nor was it responsible for restitution.

In evaluating Plaintiffs’ claims against Unisys, the named fiduciary under 29 U.S.C. §1102(a)(1), the court adopted the analysis of other circuits in Hecker v. Deere & Co., 556 F.3d 575 (7th Cir. 2009), and Braden v. Wal-Mart Stores, Inc., 588 F.3d 585 (8th Cir. 2009). Courts “look[] first to the characteristics of the mix and range of options and then evaluate[] the plausibility of claims challenging fund selection against the backdrop of the reasonableness of the mix and range of investment options.” The court specifically assessed the available “risk profiles, investment strategies, and associated fees,” and found the Plan included “a [reasonable] variety of risk and fee profiles.” The court noted that allegations of concealed kickbacks may lead to a different analysis.

Finally, because the court affirmed the order of dismissing the action against Unisys, it refrained from evaluating Unisys’ motion for summary judgment under ERISA’s safe harbor provision, 29 U.S.C. § 1104(c).

The primary materials for this case may be found on the DU Corporate Governance website.

Bank of America, Merrill Lynch, and Salvaging the Financial Markets

Bank of America has had a tough time over the last few years.  Things arguably started in earnest when it acquired Merrill Lynch back in late 2008.  At the worst of the financial crisis, BofA went through with the acquisition despite the investment banking firm's hemorrhaging losses.  The acquisition engendered huge criticism, law suits by the SEC and NY Attorney General, and a shareholder class action.  Since then things have only gotten worse.  Law suits arising out of the mortgage business have proliferated and share prices are down. 

The NYT had a piece that to some degree revisited the Merrill Lynch acquisition, "Profits but No Joy for Merrill."  The article noted that the business at the investment bank was doing "surprisingly well" and that based upon fees is second only to JP Morgan.  In other words, it was a smart acquisition by BofA.  (This is the case despite the fact that the article states that "[i]n hindsight, many agree that Mr. Moynihan's predecessor, Kenneth D. Lewis paid too much for Merrill Lynch"). 

This piece requires a few observations.  Go back to the Fall of 2008.  The financial markets were in free fall.  Lehman shut down and the interbank market ceased to function.  Merrill Lynch was the next domino expected to fall.  In fact, as its current success shows, Merrill Lynch was not a sick company that needed to be disciplined by the market.  It was a healthy, strong investment bank that was weakened by unusual economic conditions that had not been seen since the Great Depression.  Merrill Lynch suffered from the loss of confidence that rippled through the financial markets and, unlike the commercial banks, it did not have the benefit of the Federal Reserve to bail it.  For anyone who thinks that the market is always right and government intervention is always wrong they should study these circumstances.

The second thing is that BofA was right to buy Merrill.  That seems clear now.  But its more than that.  Had Merrill not been purchased, Treasury probably would have allowed it to fail.  Had Merrill failed, along with Lehman, the depths of the financial crisis would have gotten exponentially worse.  However bad things were and however slow the recovery has been, they would have been far worse had a second investment bank collapesed.  As we noted on this Blog, the acquisition of Merrill presumably prevented its failure and presumably prevented a crises from getting far worse. 

In that regard, note the leadership that this acquisition took.  The easy thing to have done, given the growing losses at Merrill, would have been to back out.  Sure there would have been lawsuits and fallout.  But those are costs that can be managed.  Instead, the acquisition went through, the financial markets were saved a debilitating shock, and BofA got a profitable business that is today keeping it afloat.  Lewis was able to see the future in a way that, at the time of the acquisition, many could not and he was able to persevere despite enormous criticism. 

As BofA continues to suffer from low share prices and relentless law suits, it is worth keeping in mind that it probably did more than any other business to help the US recover from the financial crisis. 

OnLine Law Review Articles and the Evoluation of Legal Scholarship (Part 2)

Law reviews recognize some of these limitations and have, to some degree, fought back.  Probably all of them have a web presence.  Some, however, have gone further and sought to publish a separate Internet journal that presumably publishes articles more quickly.  These pieces presumably go through a cite checking and editing process.  Some appear in Lexis and Westlaw. 

A cursory review of a number of journals, however, reveals that the pieces sought are typically short (sometimes very short), lightly footnoted (often not footnoted at all) and frequently in the nature of an opt ed or opinion piece.  Penn (in PENNumbra) seeks pieces not to exceed 3000 words (with footnotes not to exceed 1250 words) that are either response to articles or "debates".  Michigan, in First Impressions, seeks "opt-ed length pieces".  Columbia publishes "Sidebar," which targets "responses to scholarship that appears in its print edition, and original pieces on current legal issues."  Georgetown calls its online presence Ipsa Loquitur the "blog and online companion" to the Law Journal.  The students are specifically looking for "more informal blog posts as well as formal responses to in-print scholarship, scholarly debates, and case comments."

To the extent these pieces are lightly footnoted and short, they minimize the work that already excessively busy students must do to ensure publication.  On the other hand, to the extent they are essentially extended blog posts, there would likely be numerous online places where they could be published.  The value added of appearing on a law review site (other than the status that comes with the ability to add a prominent law school name to the citation) is unclear. 

A significant exception appears to be the Yale On Line Journal.  Originally called "the Pocket Part," the On Line Journal has a more developed philosophy and seeks "scholarship on recent legal and political developments and responses to scholarship published in the printed pages of The Yale Law Journal."  The pieces seem longer (1500 to 6000 words, not including footnotes) and have more detailed footnotes.  The current piece, The Supreme Court (of Baseball), is online without footnotes but an attached PDF Has 200 of them.  The submission guidelines are here.  In other words, the pieces are more scholarly, are likely published faster, and relate to current developments in the law.

So this leads to the question, what role should online journals play?  There is in the legal community a deep need for short, focused, thoughtful pieces on current developments.  This means something more than opt eds and opinions pieces (not because they aren't valuable but because there are plenty of existing outlets for these sorts of publications) but not as lengthy as traditional law review articles. 

Morever, the need is particularly important for inchoate developments.  Judges and clerks might benefit from analysis of cases on appeal (as we have noted on this Blog, law clerks read blog posts).  Regulators might benefit from analysis as they engage in the rulemaking process.  Imagine all of the provisions in Dodd-Frank that regulators are struggling to understand and implement.  Litigators developing strategies (say on the current spate of law suits arising out of the financial crisis) might benefit from creative theories. 

As an example, the DC Circuit recently struck down the SEC's shareholder access rule, Rule 14a-11. The underlying issues of shareholder access are widely known.  The DC Circuit's opinion, however, was a hybrid.  It turned on administrative law issues, an arcane area that can be very difficult to understand.  This is in part because administrative law contains any number of black letter principles that can be taught but also can be routinely ignored by the cours (with the Supreme Court likely the worst offender). 

So I wrote a short paper on the issues contained in the case, discussing some of the complexities involved in the interrelationship between corporate governance and administrative law, Shareholder Access and the Uneconomic Analysis:  Business Roundtable v. SEC.  The piece was then very quickly published in the online law review at the University of Denver Sturm College of Law after going through a quick editing and cite checking process.  The law review version is here.  The paper was downloaded frequently on SSRN during the first month of publication. 

The piece has the potential to have some long term value.  The DC Circuit's analysis will likely be discussed in the literature for years.  Rapid publication, however, was useful to a number of ongoing developments.  The SEC had to decide whether to seek rehearing or file for certiorari (it ultimately did not).  The SEC also had to decide whether to repropose the rule struck down in the case and, if so, how to deal with the court's criticisms (no public decision there yet). 

This suggests that scholarship is not a dichotomy between blog posts and traditional law reviews.  There is a need for intermediate scholarship, something thorough but short, involving current issues and published quickly.  Such scholarship would be particularly useful to decision makers, particularly when addressing issues or concerns outside of the decision maker's traditional area of expertise.  These pieces can have high influence but short shelf lives.  

For "intermediate" scholarship to become common, there will need to be more online outlets.  The outlets will need to accept pieces that, even though short, are well footnoted.  This may mean a larger law review staff.  Most importantly, however, this type of scholarship will only become common if the academic community sees the value and provides sufficient incentive. 

OnLine Law Review Articles and the Evoluation of Legal Scholarship (Part 1)

For most of the history of law teaching, the law review article was generally considered the highest form of legal scholarship, at least among academics.  Moreover, publications in one of the top journals was synonomous with quality.  This was true despite the fact that top law reviews often had a demonstrated bias for taking articles from their own faculty.  Nonetheless, it was the system and it was influential.  Reputation, tenure, and elevation among the hierarchy of law schools often turned upon the number of law review articles and their placement in top journals. 

The digital age has, however, eroded this system, although many are not yet fully aware of this.  While placement in a top journal remains di rigueur for academics, it has become less important to those actually relying on the work.  To the extent the paper is posted on one of the online services such as SSRN, anyone with a browser can find it, whether its in the Harvard or the Alaska Law Review (published by Duke by the way).  Decision makers (judges, legislators, regulators) are less interested in the where of publication and more interested in the what of teh contents (the type and quality of the analysis).

The digital age has also raised another concern with respect to law reviews.  In a digital age, they are slow, glacially slow.  For those articles designed to be written for the ages, the delay between submission and publication is probably not very important, even in the digital age.  The works of a Karl Llewellyn or a Justice Brandeis would likely have the same influence.  But for many scholars, the work will likely have a more immediate and short lived impact.  In those circumstances, a delay in publication matters.

Blogging has provided some competition.  It represents a mechanism in the digital age that allows for rapid analysis in a place that can be easily located.  Blogging can involve extensive discussions of cases or issues that rival those in law reviews.  (This Blog, for example, often has multiple part series on the same case or development).  As a result, blog posts are frequently cited in law review articles and by courts.  Although now a bit dated, take a look at the data in Of Empires, Independents, and Captives: Law Blogging, Law Scholarship, and Law School Rankings. 

But blogs have disadvantages.  For one thing, life on the Internet is a state of nature that Thomas Hobbes would recognize.  There are fewer rules and accepted conventions.  For another, blog posts do not get the benefit of cite checking and other student provided editing services associated with law reviews.  (This Blog, however, does have a student review process for student posts).

Which brings us to what I describe as "Intermediate Scholarship," something most apparent from online journals.  We'll pick this up in the next post.

Everybody Wants to Rule the World

Possibly my two favorite things are 80s music and Goldman Sachs-related grandiosity. So, a combo is a special treat. We have them together with the BBC-broadcasted-boastings of independent trader Alessio Rastani.  Rastani proudly proclaimed today,

“This is not a time right now for wishful thinking that governments are going to sort things out . .  The governments don’t rule the world, Goldman Sachs rules the world.”

You’ve got to give this guy credit. The bar was pretty high over at Goldman, what with Blankfein doing God’s work and Tourre deeming himself the “fabulous Fab.” The interview is jam-packed with other gems, and it will probably go viral soon, so it’s worth watching.  What about the 80′s music?  Tears for Fears, of course: Everybody Wants to Rule the World.

There is a lot to mourn and to fear in the brief interview with Rastani. The context alone is disturbing — the continued financial crisis that will soon be amplified with the problems in the Eurozone. Perhaps the most troubling is the flat out admission that:

“For most traders we don’t really care about having a fixed economy, having a fixed situation, our job is to make money from it.”

I guess this guy, as an outsider, did not get the memo that the firm was trying to live down the “great vampire squid wrapped around the face of humanity” reputation. Truly, this is the kind of thing that should be wiki-leaked, not shared in the bright lights of a global news network.

This post first appeared on the ParetoCommons on September 26, 2011.

Influence in the Academy and the Internet

David Bernstein over at the Volokh Conspiracy put up a post a week or so about "advice" given by faculty at top law schools to their mentees entering the teaching market.  The advice ranged from prominently displaying ideological leanings to avoiding actual experience and going onto the job market fresh out of a judicial clerkship.  As the post rightfully noted, all of the advice is in one way or another suspect. 

But what caught our eye in particular was this piece of advice:

• Don’t bother going into the legal academy unless you can get a job at a top fifteen law school, otherwise you are better off working at a law firm; no one pays attention to what people at lower-ranked law schools have to say, so you will just get frustrated if you wind up at one of them.

David has this observation to make about the comment: "Actually, being a law professor at any law school with a good academic environment is one of the best jobs in the world; people do move up; and people do pay attention to good scholarship emanating from outside the top 15."

It has always been the case that faculty at non-top 15 (or 10 or 20) law schools have exercised important influence, contrary to the comment.  But the comment bears a bit more thought.  First, it is interesting to consider the notion of "influence."  After all, there are multiple constituencies that can be influenced by the academy. 

To the extent that they include only other academics, the top schools tend to be clustered on the coasts.  Most of the top 15 schools are on the east and west coasts.  Of the top 15 law schools, 9 are on the East Coast (Yale, Harvard, Columbia, NYU, Penn, Virginia, Duke, Cornell and Georgetown) and two (Stanford and Berkeley) are on the west cost.  Other than the University of Texas, Michigan and the two schools in Chicago (Chicago and Northwestern), no other geographic areas are represented in that cluster.  As a result, faculty interaction among these schools is relatively easy and could facilitate influence. 

But this is a cramped definition of influence.  Influence can also encompass the bar and assorted decision makers, whether those in the judiciary or those in the legislature (not to mention regulatory agencies). In that context, while a top 15 school or a top 15 journal might provide a small edge, the reality is that smart scholarship and commentary from anywhere will have the potential to influence.  All of this brings me to the Internet.   

The bar and decision makers want things that can help advance whatever process they are undertaking.  In the pre-Internet days, locating appropriate scholarship was harder and probably resulted in a number of expediencies such as an emphasis on the rank of the relevant journal. 

That has changed with the advent of the Internet.  To the extent articles are posted on SSRN, they can be found through free Google searches.  Moreover, Google, unless instructed otherwise, doesn't care whether the article is in a highly ranked or a lower ranked journal.  To the extent, therefore, that scholars can develop a significant Internet presence for their work, anyone with access to the Internet and a search engine can find it. 

In a piece I wrote several years ago (that ought to be updated if I could ever find the time), Of Empires, Independents, and Captives: Law Blogging, Law Scholarship, and Law School Rankings, I noted that, for the most part, faculty at the highest ranked schools were not active bloggers (with a few very notable exceptions).  Many of these faculty have succeeded under the traditional criteria for influence -- teaching at a top school and publishing in top journals.  Those blogging were far more likely to come from the next tier of schools.  This made sense.  Blogging amounted to a work around of the traditional criteria.  Bloggers might not appear in the top journals as often but their Internet presence made it easier to find their work.  

Moreover, there is evidence of the influence of posting on the Internet.  Bloggers are well represented in SSRN.  Blog posts are increasingly appearing in court opinions and in law reviews.  There is evidence that they are read by judicial law clerks.

In other words, the advice that influence is limited to the top 15 law schools is wrong.  But it also reflects the view of a faculty member in a top school who has not yet figured out how the Internet has altered the landscape. 

Eyes Wide Open: New York Court of Appeals Upholds Broad Release of Claims in Centro Empresarial Cempresa S.A. v America Movil, S.A.B. de C.V.

In Centro Empresarial Cempresa S.A. v America Movil, S.A.B. de C.V., 2011 NY Slip Op 4720, 1 (N.Y. June 7, 2011), the court upheld the dismissal of Plaintiffs’ complaint alleging fraud, breach of contract, and breach of fiduciary duty arising out of the sale of their interests in Telmex Wireless Ecuador (Telmex México) to defendant América Móvil, holding that the claims were barred by the broad general release signed at the time of the transaction. 

Plaintiffs, two Ecuadorian holding companies, and Telmex México, a Mexican telecommunications holding company, formed Telmex Wireless Ecuador LLC (TWE) to acquire interests in Consorcio Ecuatoriano de Telecomunicaciones S.A. Conecel (Conecel), an Ecuadorian telecommunications company.  Plaintiffs received a minority stake in TWE.

In forming TWE, the three companies signed a number of agreements, including the “Agreement Among Members,” which gave Plaintiffs the right, in the event of a rollup of TWE into another entity, to obtain reasonable financial, accounting, and legal information, and to exchange their TWE shares for shares in the new entity.  In addition, the “Put Agreement” gave Plaintiffs the right to sell their TWE shares to TelMex at a floor price during certain windows between March 2002 and March 2006.

In September 2000, Telmex México rolled TWE into a new entity, América Móvil, S.A.B. de C.V. (América Móvil).  Plaintiffs alleged that they then repeatedly requested financial information and reports in order to negotiate a share exchange under the “Agreement Among Members,” but never received this information.  Further, Plaintiffs alleged that América Móvil falsely represented Conecel’s financial position in order to avoid distributing profits.  As a result, Plaintiffs exercised their March 2002 put option and sold 50% of their TWE shares to TelMex.

In July 2003, Plaintiffs agreed to sell the remainder of their TWE shares to Telmex at the floor price.  As part of this agreement, Plaintiffs signed two releases.  The “Members Release” released Telmex from “all manner of actions…past, present, or future” arising out of the agreement or out of ownership of interests in TWE.  The “Master Release” contained similar language, but included a clause excluding releases of claims involving fraud.

In 2008, Plaintiffs brought an action against Defendants in New York Supreme Court alleging fraud, breach of fiduciary duty, and breach of contract arising from Defendants’ failure to provide financial information and negotiate a share exchange in good faith. The trial court denied Defendants’ motion to dismiss on grounds that the action was barred by release.  On appeal, Plaintiffs argued that the “Members Release” did not encompass fraud claims, and that even if it did, it was fraudulently induced.  The Court of Appeals rejected this argument, reasoning that a release may encompass unknown fraud claims and may only be challenged as fraudulently induced if the challenge identifies deception distinct from the subject of the release.  Because Plaintiffs did not allege such a distinct instance of deception, the claim of fraudulent inducement failed.  Finally, the court declined to read the fraud claim exclusion of the “Master Release” into the “Members Release,” holding that it was the latter that governed Plaintiffs’ claims.

The court also rejected Plaintiffs’ arguments that they reasonably relied upon América Móvil’s representations as a fiduciary, concluding that Plaintiffs were sophisticated principals with “eyes wide open” to Defendants’ alleged propensity for fraud, yet failed to protect themselves properly when agreeing to the “Members Release.”

Because the “Members Release” that governed Plaintiffs’ claims was broad enough to encompass fraud, and was not induced by a fraud separate from that alleged in the claims, the court affirmed the Appellate Division’s dismissal of the case under CPLR 3211 [a] [5] (“Motion to dismiss cause of action” on grounds of release) and awarded court costs to Defendants.

The primary materials for this case may be found on the DU Corporate Governance website.

CFTC v. Walsh: Fraud and the Financial Benefits of Divorce

In Commodity Futures Trading Comm. v. Walsh, No. 91, (N.Y. June 23, 2011), the court held Janet Schaberg, the ex-spouse of Stephen Walsh, was entitled to keep assets awarded during her divorce, even if those assets turned out to be  proceeds from fraud.  Stephen Walsh and his partner, Paul Greenwood, are currently defendants in a pending case brought by the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”).  The CFTC and SEC allege Walsh and Greenwood defrauded public and private investors of more than $550 million between 1996 and 2009.  There is no evidence that Schaberg had knowledge of Walsh’s activities. 

After 25 years of marriage, Schaberg and Walsh filed for divorce in 2005.  In 2006, Schaberg and Walsh entered into a Stipulation and Settlement Agreement under New York Domestic Relations Law §236(B)(3).  Under the stipulation, Schaberg received ownership of two properties in New York and Florida valued at $6.7 million and relinquished her interest in the couple’s Port Washington, New York home, valued at $7.5 million.  Schaberg also received $5 million held in bank accounts and a distributive award of $12.5 million payable by Walsh in installments through 2020. 

The CFTC and SEC filed their complaints in 2009. In the complaints, the agencies sought disgorgement of proceeds from the fraud against Walsh, Greenwood, and Schaberg.  Schaberg argued her divorce settlement was not subject to disgorgement because she became a “good faith purchaser for the value of the assets” when she entered into her divorce stipulation. 

To determine whether Schaberg’s property was subject to the agencies’ injunctions, the court first considered whether marital property included proceeds of fraud under New York law.  New York state law defined marital property as “all property acquired by either spouse during the marriage but before entering into a separation agreement.” The court concluded that property attained with the proceeds of fraud did constitute marital property and because marital property encompassed all property acquired during the marriage, marital assets could be transferred to an innocent spouse even if illegally acquired. 

The CFTC and SEC argued that the court should recognize an exception based on the public policy of returning stolen property to its rightful owner.  The court rejected this contention noting that money, though acquired through fraud, cannot be earmarked or traced.  Additionally, the court noted public policies favoring finality of business transactions and divorces, which enable ex-spouses to move forward with their lives. 

The court next considered whether Schaberg acted in good faith and paid fair consideration for the property she acquired from the divorce.  The CFTC and SEC argued that Schaberg did not give fair consideration by relinquishing her right to other marital property because it was all created by fraud thus resulting in illusory consideration.  Schaberg argued that she provided fair consideration and became a good faith purchaser.  Debtor and creditor law in New York defined a good faith purchaser as someone who has given fair consideration without knowledge of the fraud.  (Debtor and Creditor Law §278 [1])  To determine whether Schaberg paid fair consideration, the court looked at whether Schaberg relinquished rights to any untainted marital property and non-tangible assets.  The court left the question of fair consideration to the federal courts but did note that Schaberg not only relinquished her interests in the estate owned by the couple but also her right to inherit from Walsh and any claims to maintenance. 

The court concluded Schaberg’s claims to her divorce proceedings prevailed over the victims’ claims for disgorgement because she acted in good faith and had no knowledge of the fraud.  The court also noted New York’s strong public policy for finality of divorce proceedings.

The primary materials for this case may be found on the DU Corporate Governance website. 

New Jersey Court Denies Plaintiffs’ Claims for Tort Damages Arising From Contractual Obligations

In Scherillo v. Dun & Bradstreet, Inc., 2011 WL 2610134 (D. N.J. June 30, 2011), the court granted the defendant’s motion for summary judgment finding that neither plaintiff can base their claims in tort when the obligations rose out of contractual obligations. In their individual complaints, the plaintiffs claimed that Dun & Bradstreet (“D & B”) negligently misrepresented thoroughly investigating Agape World, Inc. (“Agape”) and failed to reveal that Agape’s CEO had a securities fraud conviction from 1999. Agape purportedly provided high interest bridge loans for large construction projects and claimed to offer a 10% return on investment over a two-month period.

In 2007 and 2008, individual plaintiffs John Scherillo and Richard Racioppi invested more than $1 million in Agape. Each investor was concerned about the validity of the company and sought a risk assessment report from D & B.  The report indicated that there had been no criminal action against Agape’s management.  Relying on the D&B report, each plaintiff continued to invest significant amounts of money in Agape. In 2008, Racioppi and Scherillo were unable to withdraw their investments in Agape. Agape executives informed Racioppi and Scherillo that contracts were being delayed and all funds were frozen. The plaintiffs later found that Agape’s CEO was convicted of securities fraud in 1999, information that was omitted from the D & B report.

In March of 2009, each plaintiff filed a complaint against D & B alleging gross negligence and negligent misrepresentation.  Scherillo sought $75,000 in compensatory damages and $5 million in punitive damages while Racioppi sought $1 million in compensatory damages and $5 million in punitive damages.

On June 30, 2011, the court granted the defendant’s motion for summary judgment, finding that neither plaintiff could base their claims in tort when the obligations arose out of a contractual obligation. Specifically, the court found that “a tort remedy does not arise from a contractual relationship unless the breaching party owes an independent duty imposed by law.”  New Jersey imposed an independent duty only on physicians, attorneys, insurance brokers, and manufacturers. Here, the plaintiff’s contended that D & B assumed the duty to fully and properly disclose information. The plaintiffs, however, admitted in their complaints that this duty arose out of a contractual obligation. The court found that there was no independent duty to fully and properly disclose information. Thus, D & B was not under an independent duty imposed by law and the plaintiff’s claims were actionable only under contract law.  

The primary materials for this case may be found on the DU Corporate Governance website.

Book Review: Wang & Steinberg, Insider Trading, 3d Edition

As the SEC struggles in the courts (see Business Roundtable v. SEC and Gupta v. SEC), one area where the Commission has not incurred significant difficulty has been with respect to insider trading cases. 

The Commission continues to bring these cases and win them.  Moreover, recent actions have involved exam like fact patterns.  Some included allegations of a father tipping a son, a chemist in a government agency trading on confidential information, and a husband misappropriating information from a wife.  In one instance, the Commission asserted that the defendant "exploited his romantic relationship for a financial windfall."  In addition to officers and directors, the SEC has brought actions against participants in expert networks, portfolio managers at hedge funds, attorneys, analysts and even one former baseball player.

In short, insider trading represents an active and high risk area for those involved in the capital markets.  Moreover, the law is remarkably complex and requires an understanding of such issues as the existence of a duty of trust and confidence, the need for, and violation of, a fiduciary duty, and the status of third parties as temporary insiders.  Moreover, the risk is not only to individuals.  Employers can be liable for insider trading if reckless in allowing the behavior to occur. 

All of this suggests the need for a resource that can explain these requirements in a straightforward and thorough manner.  Insider Trading 3d Edition, Oxford Press, by Professors William K. S. Wang (Hastings) and Marc I. Steinberg (SMU) does exactly that. 

The book contains 15 chapters that examine the basics of insider trading under federal law, the causes of action under state law, and everything in between.  For example, Chapter 7 comprehensively deals with government enforcement.  Chapters 9, 10, and 11 contain clear analyses of Securities Act section 17(a), Rule 14e-3, and mail/wire fraud.  Chapter 13 provides a valuable discussion of compliance programs.

The most complete analysis of the theories of insider trading takes place in Chapter 5, where the book undertakes an extensive discussion of classical insider trading (Dirks v. SEC, 463 US 646 (1983)) and misappropriation (United States v. O'Hagan, 521 US 642 (1997)).  The chapter examines the type of "relationship" necessary to trigger a prohibition on classical insider trading (including the sometimes sticky issue of independent contractors) or to implicate the misappropriation doctrine (including government employees, doctors, and attorneys). 

Chapter 5 discusses whether the personal benefit requirement mandated for classical insider trading also applies in misappropriation cases (pp. 393-94; pp. 469-476) and contains a brief but important discussion of a very difficult issue:  Whether donations of stock to charity while in possession of material non-public information amounts to insider trading (pp. 396-397). 

The book is a must for anyone who wants to avoid insider trading/tipping liability or otherwise wants to understand this  Delphic area of the law.  

Law School, Economics, and the NYT

The NYT had an article that purported to look at the economics of law school (Law School Economics: Ka Ching!).  It is a good subject that deserves debate.  The piece in the NYT, however, did not do justice to the issue.  It mostly focused on New York Law School and its dean, containing a mish mash of points that were not all well defended.  

First, the article notes that "law schools toss off so much cash they are sometimes required to hand over as much as 30 percent of their revenue to universities, to subsidize less profitable fields."  True.  But its not a secret, open or closed.  Its in the open.  It explains why law schools continue to open.  Were they unprofitable and not supportive of the university setting them up (the common model is to have law schools attached to a university), it is hard to understand why new schools would open. 

Having said that, the article starts with this point but then promptly spends most of the text describing NY Law School.  As the article describes:  NY Law School is a "PRIVATE, stand-alone institution located in the TriBeCa neighborhood of downtown Manhattan".  In other words, it is a free standing law school, not part of a larger university, and presumably does not pay the tax to anyone.  So much of what follows is unrelated to this point.

Second, the article suggests that the dean of New York Law School, Richard A. Matasar, is somehow saying one thing but in practice doing something else.  Dean Matasar is supposed to be someone who contends that law school should put students first.  Yet at the same time, he has grown the size of the law school.  The implication is that these two approaches are inconsistent.

While it is true that every student admitted by NY Law School provides an income stream, this does not mean he is working against the interests of students.  In fact, the one statistic not mentioned in the article is that there are thousands of students every year who apply to law school and do not get in, mostly because they have low test scores.  Yet a low test score does not meant that these students will make bad lawyers.  By opening the doors, Dean Matasar arguably gives more students a shot at a career in law, some of whom would probably not matriculate to any other law school. 

Third, the article suggests that there is something wrong with increasing the number of students just when the job market was imploding.  For one thing, those admitted would have at least three years before they hit the job market.  Presumably, as already appears to be the case, the job market would be on the mend. Thus, the article instead notes that, with respect to the 2009 class, "if the experience of recent N.Y.L.S. graduates is an indication, many are in for a lengthy hunt."  But those students graduated during the recession.  While the students graduating in 2012 may have difficulty, it is not likely to be as difficult as those looking for work during the recession. 

In general, articles that point to the relationship between the number of newly created legal positions and the number of graduates usually omit to discuss thos positions that while not entirely legal benefit considerably from a law degree (dean of students at a university; head of HR in a corporation; member of the police force seeking officer status).

Fourth, the article asserts that the explanation for the rise in tuition at law schools is US News.  As the article notes, the "most bizarre" explanation for the increase "comes courtesy of the highly influential US News rankings."  It is true that US News ranks law schools in part based upon the expenditures per student.  But it is something altogether different to suggest that this drives law tuition upward.  There are plenty of reasons that drive of tuition unrelated to US News. 

Take NY Law School.  Perhaps NY Law raised tuition because of US News (rather than say because it is located in a high cost area).  But if ranking in US News was such a driving force, NY Law would likely have not admitted so many additional students (736 students in 2009, a 30% increase, according to the article, something the dean attributed to unexpected yield).  The surge in additional students does not help with US News.  They pay the same tuition and at best leave the per capita expenditures unchanged.  So while they provide additional funds, it does not generally help with the rankings.     

On the other hand, additional students can very much hurt US News rankings.  Unless there is massive hiring to compensate for large increases in the number of students, they hurt the faculty student ratio, another factor in the rankings.  Larger classes also put downward pressure on the median LSAT, the median GPA, and the acceptance rate, statistics that make up 25% of the US News rankings. (I've made no attempt to look at what actually happened in the case lf NY Law). Finally, when the students hit the job market, the hiring statistics are likely to suffer. 

US News does not, therefore, benefit schools that admit large numbers of students.  Quite the reverse.  In other words, what ever upward pressure US News puts on total tuition, it does not put equal pressure on class size.    

There are serious issues to discuss in this area.  Tuition has risen; the number of students are increasing; law jobs are likely harder to obtain.  But the article in the NYT makes too many disparate and often disconnected points in the context of a single law school to really advance the discussion.  

Board Diversity and "The Hottest New Companies"

The New Yorker has an article on Sheryl Sandberg, who jumped from Google to Facebook. How is it for women on the board of "the hottest new companies" in high tech?  Not good.  According to the article:

• Among the hottest new companies— Facebook, Twitter, Zynga, Groupon, Foursquare—none, as Kara Swisher reported in the blog All Things Digital, has a female director on its board. PayPal has no women on its five-member board; Apple has one of seven; Amazon one of eight; Google two of nine. When I asked Mark Zuckerberg why his five-member board has no women, his voice, which is normally loud, lowered to a whisper: “We have a very small board.” He went on, “I’m going to find people who are helpful, and I don’t particularly care what gender they are or what company they are. I’m not filling the board with check boxes.” (He recently added a sixth member: another man.) The venture-capital firms that support new companies have even sharper imbalances; Sequoia Partners lists eighteen partners on its Web site, none of them women.

Id. at p. 3.  So the problem of board diversity isn't a matter for old line companies but extends to the most innovative or as the New Yorker puts it, the hottest, companies.  

So Long, Sheila Bair

Sheila Bair’s five-year term as Chairman of the Federal Deposit Insurance Corporation (FDIC) ends today, Friday, July 8th. During her tenure, Bair racked up an impressive list of achievements. Notably, even with the recent wave of bank failures, Bair managed to use only the industry-supplied deposit insurance fund (DIF), and not taxpayer dollars to shut down and sell off hundreds of insolvent banks.

Reflected in her vigilance over the DIF was the broader view that financial institutions, their leaders and investors (and not the public) should bear the losses from their failures. This perspective appeared to inform her other policy choices.  Indeed, her final accomplishment was the FDIC board’s unanimous approval on Wednesday of a new rule to claw back banker pay. The rule permits the FDIC acting as liquidator, to demand the return of two years of pay of senior executives and directors who were substantially responsible for the bank’s collapse.

Also, Bair was a leading voice for establishing international limits on bank borrowing, with a total-assets-to-equity leverage ratio. Supplementing the easily-gamed risk-weighted measures, this simple leverage ratio could help block bank efforts to game the system with poorly designed or misused mathematical models. Bair fought successfully to expand the FDIC’s authority through the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. As a result, instead of choosing between a taxpayer-funded-bailout and a Lehman-style-chaotic bankruptcy, there is a third choice. The FDIC has the power to bring into receivership, liquidate and shutdown failing bank holding companies and certain other systemically important nonbank financial firms.  There are legitimate questions as to whether this “orderly resolution” authority will be used effectively, if at all. However, it’s existence encourages the ongoing debate over whether we still need to break up the banks in terms of lines of business to make them no longer too big or too interconnected to fail.

Perhaps the most admirable of her accomplishments was her ability to maintain clarity and dignity amid accusations that she was not a “team player.”  When that “team” scored points at the expense of the American people, in my view, her resistance deserves a badge of honor. The so-called team players who serve in public office do us no favors when they are “just following orders” of misguided leaders.

Bair was early to see the threat of predatory lending. From a previous position as Assistant Secretary of Financial Institutions at Treasury, before departing for a short term in academia, she tried in 2002 to end those practices and met substantial resistance.  Indeed, she would later testify before the Financial Crisis Inquiry Commission (“FCIC”) of the grave consequences of Alan Greenspan’s failure as Chairman of the Fed to use its authority under the Home Ownership and Equity Protection Act (HOEPA), to ban bad underwriting practices at both banks and “nonbank” institutions. According to the FCIC report:

“This was a missed opportunity, says FDIC Chairman Sheila Bair, who described the ‘one bullet’ that might have prevented the financial crisis: ‘I absolutely would have been over at the Fed writing rules, prescribing mortgage lending standards across the board for everybody, bank and nonbank, that you cannot make a mortgage unless you have documented income that the borrower can repay the loan.’” (emphasis added).

Also, Bair advocated strenuously for loan modifications to help prevent an avalanche of foreclosures.  Bair’s performance reminds us that people matter, not just the institutions which they inhabit.

In addition to being a public servant, Bair is also a former colleague from the University of Massachusetts, Amherst. While our paths overlapped, for about eighteen months, given that we were in different departments, I had only a few occasions to converse with her. However, I benefited greatly from her presence. Bair enriched our community with her interests in corporate governance and her contacts. While a faculty member, in 2005, Bair brought Senator Paul Sarbanes to visit and address a class of MBA students and also the wider University.  And, after she rose to be listed by Forbes magazine as the second most powerful woman in the world, Bair returned, including to speak about the financial crisis and also to deliver a commencement speech.  Not an academic by trade, Bair was welcomed by Isenberg School of Management, Dean Tom O’Brien. Though he refused to take credit for his foresight, O’Brien had a knack for attracting and nurturing original thinkers and rising stars to our school. In addition to Bair, for example, he brought in Nassim Taleb who taught at UMass for a year, during which time he worked on his soon-to-be-acclaimed book, The Black Swan.

With Bair goes one of the three “New Sheriffs of Wall Street” featured on the cover of Time magazine May 13, 2010.  The cover photo mirrored one from a decade earlier. The now iconic and ironic February 15, 1999 Timecover portrayed the “Committee to Save the World.”  In that image, Alan Greenspan stood smiling assuredly front and center, flanked by a twinkle-eyed Robert Rubin and a seemingly annoyed Lawrence Summers. The subtitle of the article promised “The inside story of how the Three Marketeers have prevented a global economic meltdown – so far.”  Missing from that photo, quite unfortunately, was someone who could have actually help prevent a global economic meltdown – Brooksley Born, whom we have discussed, here. Born would resign from the CFTC a few months after the Time article.

On last year’s cover, SEC Chairman Mary Schapiro appeared in the center spot where Greenspan had posed. Professor Elizabeth Warren, then head of the Congressional Oversight Panel on the TARP and Sheila Bair took the places inhabited by Rubin and Summers. The subtitle identified the trio as “The Women Charged with Cleaning up the Mess.” Just as the Three Marketeers were not able to save the world, and indeed created quite a mess, the New Sheriffs, cannot on their own clean it all up.  And certainly not without the ongoing support of the Congress. Administration and other financial regulators.

After all, the build up and burst of the housing bubble was not a weekend-long frat party. Greenspan had more than twenty years to wreak havoc. In his own estimation, under oath last year, he volunteered that he was wrong thirty percent of the time.  Two decades of leadership with that ratio proved disastrous. And though Rubin and Summers were not each fixtures as Treasury Secretaries and other Administration roles for that long, they did manage to champion the most damaging acts of financial market deregulation in the past century. These included the gradual erosion and ultimate repeal in 1999 through Gramm-Leach-Bliley of the Glass-Steagall Act’s separation of commercial from investment banking. Also included was the passage in 2000 of the Commodity Futures Modernization Act, which fostered the explosion of credit default swaps. Both of those took place after the photo was snapped.

Sadly, one member of the sheriff-cleanup-crew is moving on. Yet, she leaves our country, the financial system, and my former University far better than she found them.

This essay was previously published on July 8, 2011 on The Pareto Commons blog.

Leadership in New York and Gay Marriage

My legal career had the distinct fortune of beginning with clerkship with the Honorable Frank M. Johnson, Jr., the judge who, in the Middle District of Alabama, provided the crucial second vote (in a 2-1 decision) in striking down segregation in the buses of Montgomery and allowed Martin Luther King to march from Selma to Montgomery.  Listen to Martin Luther King say in a megaphone that Judge Johnson had just ruled that marchers had a "legal and constitutional right" to march (at minute 3.10 of the video).  At the time I clerked he had been elevated by President Carter to the US Court of Appeals for the 11th Circuit.

In hindsight, these decisions look obvious but at the time, Judge Johnson paid a heavy price for them.  In addition to the need for protection from the US Marshals because of the constant threats, a cross was burned on his lawn and his mother's house was dynamited.  The story is that President Nixon wanted to appoint Judge Johnson to the US Supreme Court but that his civl rights decisions were so unpopular, politicians from the south intervened and convinced Nixon to do otherwise.  It was a price he was willing to pay and required considerable courage. 

Less known, however, is that Judge Johnson showed the same courage with respect to gay rights.  Judge Johnson wrote the lower court opinion in Hardwick v. Bowers, 760 F.2d 1202  (11th Cir. 1985).  He, along with his friend, Judge Tuttle, struck down the anti-gay sodomy law in Georgia.  The story I heard from one of his later clerks was that he personally turned to Judge Tuttle in conference and said that he saw nowhere in the Constitution that made this practice illegal.  Judge Tuttle agreed.  Judges Johnson and Tuttle (in an opinion written by Judge Johnson) became the first federal appellate court to strike down this type of law. 

The Supreme Court would later reverse the decision in a 5-4 decision.  See  478 U.S. 186  (1986).   Justice Powell, the deciding vote in the case would later acknowledge that he had made a mistake in voting to overturn Judge Johnson's decision. 

The US Supreme Court eventually reversed its decision in Bowers in Lawrence v. Texas, 539 U.S. 558  (2003).  Judge Johnson didn't live to see the ultimate vindication of his lower court opinion in Bowers, having died in 1999.  But Mrs. Johnson did and in a conversation with her a year or so after the decision, she would read to me the sentence in Lawrence where the Court said that "Bowers was not correct when it was decided, and it is not correct today."  For her, that sentence could just as easily have been rewritten to say that Judge Johnson was right then and was right now. 

All of this comes back with the decision over the weekend in New York to allow gay marriage.  New York has taken a mighty step forward in eliminating a government sanctioned form of discrimination.  The NYT had an insightful piece on the behind the scenes process that resulted in the action.  What the piece makes very clear is that approval as not preordained but required the extraordinary intervention from a number of people, particularly the governor, Andrew Cuomo. 

In an era where politicians are mostly criticized for their self serving behavior, Governor Cuomo showed courage and leadership.  I can't help but think that his behavior is reminiscent of what Judge Johnson would have done had he been in the same position. 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (Regulatory Alternatives) (Part 8)

We are examining the combination between NYSE Euronext and Deutsche Borse.  The transaction will need to be approved by the SEC.  One way to avoid the SEC's oversight is for the NYSE to get out of the regulatory business.  Should this be considered?

It would certainly free the NYSE from an onerous level of SEC oversight.  The NYSE for example has mandatory limits on stock ownership and voting, restrictions that can't be changed without SEC approval. See Exchange Act Release No. 62032 (May 4, 2010) (“Specifically, no person (either alone or together with its related persons) is entitled to vote . . .  more than 10% of the then outstanding votes entitled to be cast on such matter. . . . In addition, no person (either alone or together with its related persons) may at any time beneficially own shares of stock of NYSE Euronext representing in the aggregate more than 20% of the then outstanding votes entitled to be cast on any matter.”).

Likewise the NYSE can't sell its own assets, at least those associated with the SROs, without SEC approval. See Exchange Act Release No. 53382 n. 64 (Feb. 27, 2006) (“In addition, pursuant to the Operating Agreement of New York Stock Exchange LLC, NYSE Group may not transfer or assign its interest in New York Stock Exchange LLC, in whole or part, to any entity, unless such transfer or assignment is filed with and approved by the Commission under Section 19 of the Act.").

Then there is the risk of liability.  NYSE-Euronext confronts the risk of controlling, aiding and abetting, and "a cause of" liability when the regulated entities fail to perform their regulatory function.  See Exchange Act Release No. 55293 (Feb. 14, 2007) (noting that controlling person of SROs "shall be jointly and severally liable with and to the same extent that the Exchange and NYSE Arca are liable under any provision of the Exchange Act, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action" and also noting possibility of aiding and abetting liability and Commission's authority to bring cease and desist orders against those who are "a cause of" a violation).

This is more than an academic possibility.  The SEC has brought actions against the SROs for failing to adhere to their regulatory mission.  See In re New York Stock Exchange LLC, Exchange Act Release No. 60391 (July 28, 2009) (cease and desist order for "failure to properly detect, investigate and discipline widespread unlawful proprietary trading by specialists on the floor of the NYSE"). 

Removing the regulatory function from the NYSE would free the entity from these restrictions.  Moreover, this has already been occurring.  The NYSE gave up most of its control over broker-dealers in the merger with FINRA. Likewise, much of the surveillance function has been taken over by FINRA.  SeeExchange Act Release No. 56145 (July 26, 2007) (discussing combination of “member regulation operations” from NYSE Group and NASD “ into a single self-regulatory organization;” transaction involved transfer of “member firm regulation and enforcement functions and employees from NYSE Regulation” to FINRA).  See also Exchange Act Release No. 62032 (May 4, 2010) (“The Financial Industry Regulatory Authority ("FINRA") performs some of the regulatory functions contracted out to NYSER pursuant to a separate multi-party regulatory services agreement with FINRA. These regulatory contractual arrangements closely parallel the regulatory arrangements for NYSE Amex that the Commission reviewed and approved in the NYSE Amex Approval Order.").

The remaining duties are modest, with one exception.  NYSE Regulation has four groups, Listed Company Compliance, Regulatory Policy and Management, StockWatch, and Regulation Administration and, at the end of 2010, had only about 50 people.  See Form F-4, at 409.  The only significant function, therefore, is the oversight of listing standards.

Any change in the regulatory scheme would probably have to encompass one of two models.  First would be to give all regulatory responsibility to the Securities and Exchange of Commission (or FINRA).  To some degree, this process is already underway. 

In the realm of listing standards, Congress assigned to the Commission the authority to write rules governing listing requirements for audit and compensation committees of the board.  Moreover, with respect to independent directors, Congress essentially allowed the SEC to define the term with respect to compensation committees by identifying factors that must be considered by the exchange.  

Shifting complete control of listing standards to the Commission would, therefore, hasten a process already underway.  To the extent this continued, it could result in a slow, piece meal process that would gradually deprive the exchanges of the benefits of regulation (the ability to determine the standards) while leaving them with the disadvantages (the SEC's extensive regulatory oversight).

Alternatively, the regulatory function could be mostly, if not entirely, left with NYSE Regulation (and FINRA).  NYSE Regulation could, however, be made entirely independent of the NYSE.  NYSE Regulation would become self funding.  A mechanism would need to be determined for designating directors of NYSE Regulation.  One possibility, which was suggested back in 2006, was to have the SEC appoint directors.  See Exchange Act Release No. 53382 (Feb. 27, 2006) (“This model would require the Commission to appoint directly the members of the entity overseeing NYSE Regulation.”). 

Both of these shifts would probably require legislation.  Moreover, it would be unlikely to happen unless the NYSE supported the change.  It would only occur, therefore, if the NYSE viewed the costs of the regulatory role as outweighing the benefits. 

As a passing note, while the issue of regulatory responsibility has been discussed in the context of NYSE Euronext, the same analysis would apply to any stock exchange that exists as a for profit business, including Nasdaq. 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (SEC Review and German Ownership) (Part 7)

So given these circumstances, what will the SEC confront when it is asked to approve this transaction?

Foremost, it will need to examine the independence of the exchanges owned by NYSE Euronext and the independence of NYSE Regulation.  So far, the Commission has indicated that no problems have arisen with for profit companies owning entities that perform regulatory functions.  See Exchange Act Release No. 62032 (May 4, 2010) (“The Commission's experience to date with the issues raised by the ownership by a holding company of one or more SROs has not presented any concerns that have not been addressed, for example, by Commission approved measures at the holding company level that are designed to protect the independence of each SRO.”).   Nonetheless, when the system was put in place in 2006, the approach involved prognostication.  Five years of experience provide an opportunity to examine actual experience.  The SEC should do this.

Second, the SEC will have to consider the role of the new holding company, a Dutch company and the configuration of the board of directors.  The holding company, a Dutch company, will presumably stand in the place of NYSE Euronext with respect to its authority over NYSE Regulation.  Directors of the Dutch holding company will presumably sit on the board of NYSE Regulation and the SROs.  Directors of the Dutch holding company will presumably have some say in any changes to the regulatory finance agreements used to fund NYSE Regulation.

The new holding company will have a majority of directors appointed by Deutsche Borse and, presumably, have a majority of non-US Persons.  When NYSE went public in 2006, this was not an issue. When it acquired Euronext in 2007, European ownership became significant. Euronext directors were guaranteed positions on the board.  Nonetheless, it was clear that NYSE directors would be in the majority.  See Exchange Act Release No. 55293 (Feb. 14, 2007) (“The proposed NYSE Euronext Bylaws provide that in any election of directors, the nominees who shall be elected to the NYSE Euronextboard of directors shall be nominees who receive the highest number of votes such that, immediately after such election: (1) U.S. Persons as of such election shall constitute at least half of, but no more than the smallest number of directors, that will constitute a majority of the directors on the NYSE Euronext board of directors; and (2) European Persons as of such election shall constitute the remainder of the directors on the NYSE Euronext board of directors.”).

In the current combination, however, Deutsche Borse will end up with 60% of the positions on the board.  See  Press Release from NYSE, Feb. 15, 2011 ("The Company will be lead by a one-tier board with 17 members - 15 directors plus the Chairman and CEO.  Of the 15 directors, 9 shall be designated by Deutsche Borse and 6 by NYSE Euronext.").  The chairman will be the CEO of Deutsche Borse and the CEO the CEO of NYSE Euronext.  See Form F-4, at 103. 

The arrangement will apparently continued for at least three years.  See Form F-4, at 160 ("Each of the directors will be nominated by the Holdco board of directors for re-election to the Holdco board of directors pursuant to a binding nomination at each of the annual general meetings of shareholders occurring in 2012, 2013 and 2014, except that the Holdco group chairman and the Holdco group chief executive officer will each also be nominated by the board of directors pursuant to a binding nomination for re-election to the board of directors at the annual general meeting of shareholders occurring in 2015.").  The same ratio applies on committees.  See Id. at 261("Each of the committees mentioned above will consist of three Deutsche Börse directors and two NYSE Euronext directors until the date of Holdco’s annual general meeting of shareholders occurring in 2015."). 

The SEC should, therefore, consider the impact of having a holding company board with a majority of directors designated by a foreign company on the regulatory mission.  This ought to include whether such directors (and such boards) have a different regulatory philosophy than the NYSE Euronext board and what impact, if any, it could have on the regulatory mission.   Perhaps this will not be a signficiant issue.  A majority of the board of NYSE Regulation must consist of "US persons".  See NYSE Regulation Bylaws, Article III, Section I ("A 'U.S. Person' shall mean, as of the date of his or her most recent election or appointment as a director any person whose domicile as of such date is and for the immediately preceding twenty-four (24) months shall have been the United States.").  Thus, irrespective of the nationality of the board of the holding company, NYSE Regulation's board will always have a majority of US Persons.

Nonetheless, these issues ought to be considered by the SEC when asked to approve the combintation. 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (Limits of Regulatory Independence) (Part 6)

We are discussing the possible combination of NYSE Euonext and Deutsche Borse.  The other place for influence by the holding company over the regulatory mission, at least in theory, arises from control over the SROs. 

Unlike NYSE Regulation, a majority of the directors of the boards of the SROs (NYSE Exchange, NYSE Arca and NYSE Amex), come directly from the holding company.  See Exchange Act Release No. 55026 (Dec. 29, 2006) ("a majority of the directors of each of the Exchange and NYSE Market must be directors of NYSE Euronext that satisfy the independence requirements of the board of directors of NYSE Euronext;").  They must, however, mostly consist of independent and a majority must be US Persons.  See also Exchange Act Release No. 58673(Sept. 29, 2008) ("In particular, all directors on the board of NYSE Regulation (other than its CEO) are, and will be, required to be independent of management of NYSE Euronext and its subsidiaries, as well as of NYSE, NYSE Arca,and NYSE Alternext US members and listed companies.").  See also Exchange Act Release No. 55293 (Feb. 14, 2007) (“Thus, a majority of the directors of each of the Exchange and NYSE Market must be U.S. Persons who are directors of NYSE Euronext that satisfy the independence requirements of the board of directors of NYSE Euronext."). 

While the SROs have contracted or delegated authority to NYSE Regulation, there is at least some residual front line regulatory obligations not assigned to NYSE Regulation.  Thus, NYSE Arca can initiate disciplinary actions.  NYSE Market (a subsidiary of NYSE Exchange) apparently retains some authority over listing standards.  See Exchange Act Release No. 53382 (Feb. 27, 2006) (“NYSE Market will have delegated authority to, among others, oversee the operation of NYSE Market, develop and adopt listing rules and rules governing the issuance of Trading Licenses, and establish and assess listing, access, transaction, and market data fees.").

In addition, however, the SROs ultimately retain the legal obligation for any decisions made by NYSE Regulation.  See Exchange Act Release No. 53382 (Feb. 27, 2006) (“New York Stock Exchange LLC, however, expressly retains ultimate responsibility for the fulfillment of its statutory and self-regulatory obligations under the Act.").  See also  Exchange Act Release No. 62032 (May 4, 2010) (“As with NYSE Amex, and notwithstanding these regulatory agreements, the Exchange retains ultimate legal responsibility for the regulation of its permit holders and its market and has full authority to take action to assure that its regulatory responsibilities are met.").  

As a result, they retain the legal right to overturn the actions of NYSE Regulation, excepting only some disciplinary actions.  Exchange Act Release No. 53382 (Feb. 27, 2006) ("New York Stock Exchange LLC will retain ultimate responsibility for such delegated responsibilities and functions, and any actions taken pursuant to delegated authority will remain subject to review, approval, or rejection by the board of directors of New York Stock Exchange LLC in accordance with procedures established by that board of directors (provided however, that action taken upon review of disciplinary decisions by the NYSE Regulation board of directors shall be final action of the New York Stock Exchange LLC).”).  See also Exchange Act Release No. 62032 (May 4, 2010) (“In connection with the foregoing arrangements, as stated above, the Exchange retains the authority to direct NYSER and FINRA to take any action necessary to fulfill the Exchange's statutory and self-regulatory obligations, and NYSER provides a report on regulatory matters at each meeting of the Exchange board."). 

In additoin, the SROs have less independence than NYSE Regulation with respect to compensation decisons.  NYSE Regulation has its own compensation committee.  NYSE Euronext recently received permission from the Commission to eliminate the compensation committee of NYSE Arca, with the authority transferred to the holding company.  In effect, the change reflected existing practice.  See Exchange Act Release No. 62032 (May 4, 2010) (because the Exchange CEO was an executive officer of the holding company, "his/her compensation [is already] established by the Company's board of directors, in conjunction with recommendations from the NYSE Euronext Human Resources and Compensation Committee.").  See also Exchange Act Release No. 62032 (May 4, 2010) (“These committees also will perform relevant functions for NYSE Group, the Exchange, NYSE Market, NYSE Regulation, Archipelago, NYSE Arca, and NYSE Arca Equities, as well as other subsidiaries of NYSE Euronext, except that the board of directors of NYSE Regulation will continue to have its own compensation committee and nominating and governance committee.").

Thus, the holding company now (and presumably after the merger with Deutsche Borse) has some ability to influence the activities of the SROs.