Professor Dan Kleinberger and I have recently published a short article in the Business Law Today entitled “The Limited Effect of ‘Maximum Effect.'” The executive summary of the piece is that more than 20 jurisdictions have followed Delaware rather than the Uniform Law Commission in giving “maximum effect” to the principle of freedom of contract in LLC arrangements.  You may wonder, “Exactly how effective has the construct of ‘maximum effect’ been?”  Our answer is “not very.”

If you’re interested in reading beyond the executive summary, you can find the article here:  https://businesslawtoday.org/2020/08/limited-effect-maximum-effect/

 

It’s hard to believe that the US will have an election in less than two weeks. Three years ago, a month after President Trump took office, I posted about CEOs commenting on his executive order barring people from certain countries from entering the United States. Some branded the executive order a “Muslim travel ban” and others questioned whether the CEOs should have entered into the political fray at all. Some opined that speaking out on these issues detracted from the CEOs’ mission of maximizing shareholder value. But I saw it as a business decision – – these CEOs, particularly in the tech sector, depended on the skills and expertise of foreign workers.

That was 2017. In 2018, Larry Fink, CEO of BlackRock, told the largest companies in the world that “to prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society…Without a sense of purpose, no company, either public or private, can achieve its full potential. It will ultimately lose the license to operate from key stakeholders.” Fink’s annual letter to CEOs carries weight; BlackRock had almost six trillion dollars in assets under management in 2018, and when Fink talks, Wall Street listens. Perhaps emboldened by the BlackRock letter, one year later, 181 CEOs signed on to the Business Roundtable’s Statement on the Purpose of a Corporation, which “modernized” its position on the shareholder maximization norm. The BRT CEOs promised to invest in employees, deal ethically and fairly with suppliers, and embrace sustainable business practices. Many observers, however, believed that the Business Roundtable statement was all talk and no action. To see how some of the signatories have done on their commitments as of last week, see here.

Then came 2020, a year like no other. The United States is now facing a global pandemic, mass unemployment, a climate change crisis, social unrest, and of course an election. During the Summer of 2020, several CEOs made public statements on behalf of themselves and their companies about racial unrest, with some going as far as to proclaim, “Black Lives Matter.” I questioned these motives in a post I called ““Wokewashing and the Board.” While I admired companies that made a sincere public statement about racial justice and had a real commitment to look inward, I was skeptical about firms that merely made statements for publicity points. I wondered, in that post, about companies rushing to implement diversity training, retain consultants, and appoint board members to either curry favor with the public or avoid the shareholder derivative suits facing Oracle, Facebook, and Qualcomm. How well had they thought it out? Meanwhile, I noted that my colleagues who have conducted diversity training and employee engagement projects for years were so busy that they were farming out work to each other. Now the phones aren’t ringing as much, and when they are ringing, it’s often to cancel or postpone training.

Why? Last month, President Trump issued the Executive Order on Combatting Race and Sex Stereotyping. As the President explained:

today . . .  many people are pushing a different vision of America that is grounded in hierarchies based on collective social and political identities rather than in the inherent and equal dignity of every person as an individual. This ideology is rooted in the pernicious and false belief that America is an irredeemably racist and sexist country; that some people, simply on account of their race or sex, are oppressors; and that racial and sexual identities are more important than our common status as human beings and Americans … Therefore, it shall be the policy of the United States not to promote race or sex stereotyping or scapegoating in the Federal workforce or in the Uniformed Services, and not to allow grant funds to be used for these purposes. In addition, Federal contractors will not be permitted to inculcate such views in their employees.

The Order then provides a hotline process for employees to raise concerns about their training. Whether you agree with the statements in the Order or not — and I recommend that you read it — it had a huge and immediate effect. The federal government is the largest procurer of goods and services in the world. This Order applies to federal contractors and subcontractors. Some of those same companies have mandates from state law to actually conduct training on sexual harassment. Often companies need to show proof of policies and training to mount an affirmative defense to discrimination claims. More important, while reasonable people can disagree about the types and content of diversity training, there is no doubt that employees often need training on how to deal with each other respectfully in the workplace. (For a thought-provoking take on a board’s duty to monitor diversity  training by co-blogger Stefan Padfield, click here.)

Perhaps because of the federal government’s buying power, the U.S. Chamber of Commerce felt compelled to act. On October 15th, the Chamber and 150 organizations wrote a letter to the President stating:

As currently written, we believe the E.O. will create confusion and uncertainty, lead to non-meritorious investigations, and hinder the ability of employers to implement critical programs to promote diversity and combat discrimination in the workplace. We urge you to withdraw the Executive Order and work with the business and nonprofit communities on an approach that would support appropriate workplace training programs …  there is a great deal of subjectivity around how certain content would be perceived by different individuals. For example, the definition of “divisive concepts” creates many gray areas and will likely result in multiple different interpretations. Because the ultimate threat of debarment is a possible consequence, we have heard from some companies that they are suspending all D&I training.  This outcome is contrary to the E.O.’s stated purpose, but an understandable reaction given companies’ lack of clear guidance. Thus, the E.O. is already having a broadly chilling effect on legitimate and valuable D&I training companies use to foster inclusive workplaces, help with talent recruitment, and remain competitive in a country with a wide range of different cultures. … Such an approach effectively creates two sets of rules, one for those companies that do business with the government and another for those that do not. Federal contractors should be left to manage their workforces and workplaces with a minimum amount of interference so long as they are compliant with the law.

It’s rare for the Chamber to make such a statement, but it was bold and appropriate. Many of the Business Roundtable signatories are also members of the U.S. Chamber, and on the same day, the BRT issued its own statement committing to programs to advance racial equity and justice. BRT Chair and WalMart CEO Doug McMillon observed,  “the racial inequities that exist for many Black Americans and people of color are real and deeply rooted . .  These longstanding systemic challenges have too often prevented access to the benefits of economic growth and mobility for too many, and a broad and diverse group of Americans is demanding change. It is our employees, customers and communities who are calling for change, and we are listening – and most importantly – we are taking action.” Now that’s a stakeholder maximization statement if I ever heard one.

Those who thought that some CEOs went too far in protesting the Muslim ban, may be even more shocked by the BRT’s statements about the police. The BRT also has a subcommittee to address racial justice issues and noted that “For Business Roundtable CEOs, this agenda is an important step in addressing barriers to equity and justice . . . This summer we took on the urgent need for policing reform. We called on Congress to adopt higher federal standards for policing, to track whether police departments and officers have histories of misconduct, and to adopt measures to hold abusive officers accountable. Now, with announcement of this broader agenda, CEOs are supporting policies and undertaking initiatives to address several other systems that contribute to large and growing disparities.”

Now that stakeholders have seen so many of these social statements, they have asked for more. Last week, a group of executives from the Leadership Now Project issued a statement supporting free and fair elections. However, as Bennett Freeman, former Calvert executive and Clinton cabinet member noted, no Fortune 500 CEOs have signed on to that statement. Yesterday, the Interfaith Center on Corporate Responsibility (ICCR) sent a letter to 200 CEOs, including some members of the BRT asking for their support. ICCR asked that they endorse:

  1. Active support for free and fair elections
  2. A call for a thorough and complete counting of all ballots
  3. A call for all states to ensure a fair election
  4. A condemnation of any tactics that could be construed as voter intimidation
  5. Assurance that, should the incumbent Administration lose the election, there will be a peaceful transfer of power
  6. Ensure that lobbying activities and political donations support the above

Is this a pipe dream? Do CEOs really want to stick their necks out in a tacit criticism of the current president’s equivocal statements about his post-election plans? Now that JPMorgan Chase CEO Jamie Dimon has spoken about the importance of respect for the democratic process and the peaceful transfer of power, perhaps more executives will make public statements. But should they? On the one hand, the markets need stability. Perhaps Dimon was actually really focused on shareholder maximization after all. Nonetheless, Freeman and others have called for a Twitter campaign to urge more CEOs to speak out. My next post will be up on the Friday after the election and I’ll report back about the success of the hashtag activism effort. In the meantime, stay tuned and stay safe.

With the comment period closing today, the SEC will consider a FINRA proposal to make some relatively minor changes to how the current process for expunging public records works.  In my comment letter, I explained that changes simply don’t do anywhere near enough to address the core problem underlying the current, fundamentally broken expungement process. In essence, the Proposal’s expungement process improperly relies on an adversarial system to surface information relevant to whether customer dispute information should be expunged.  This adversarial system fails to function in any reliable way because expungement hearings generally proceed as one-sided affairs which are functionally ex parte proceedings.  In these functionally ex parte proceedings, arguments and evidence submitted by brokers seeking expungement never receive any real scrutiny by anyone well-situated to carefully consider these expungement requests.  When arbitrators recommend expungement, courts—which are generally precluded from closely reviewing the underlying arbitration absent the rarest of circumstances—then confirm the arbitration awards.  Judicial review under these circumstances provides no meaningful check on this process and only serves as a dubious veneer. 

To help the Commission see that these expungement hearings often have little resemblance to the sort of adversarial proceeding one would expect in arbitration, I pointed out that in expungement-only arbitrations, law firms often sue their own clients to obtain expungements for brokers employed by their brokerage firm clients.  State ethics rules generally prohibit lawyers from suing their own clients unless all clients involved specifically consent to the conflict.  And even then, the ethics rules prohibit a lawyer from representing both the claimant and the respondent at the same time in an adversarial proceeding.  (But that hasn’t prevented it from happening within the FINRA arbitration forum.  One arbitration award reveals that a lawyer represented both the claimant and the respondent in the same proceeding.) As a practical matter, clients are only likely consent to being sued by their own lawyers when lawsuit somehow benefits them.

Expungement-only or “straight-in” arbitrations deviate from how we ordinarily expect adversarial proceedings to go.  Consider a typical fact pattern.  A customer loses a large amount of money after following a broker’s investment advice.   The customer, believing that the commission-compensated broker gave unsuitable advice, complains about it or files an arbitration claim against the brokerage firm.  The brokerage firm may even settle the suit for a significant amount of money.  The rough allegations in the complaint and any settlement amount or arbitration outcome go into a public database so that other investors and regulators can know that another investor complained and whether any settlement ensued.

Later, the broker decides to seek an expungement.  The broker will file an arbitration claim against the brokerage and allege that the customer’s claim was “false,” that the broker had nothing to do with the complaint, or that the complaint was simply factually impossible.  In essence, the broker files an arbitration calling the customer a liar and names the brokerage employer as the respondent.  Together, the broker and the brokerage will select the arbitrator who will hear the case.  Each of them may strike up to four arbitrators off the ten arbitrator list FINRA provides and rank the remaining arbitrators.  If they cooperate, they can effectively control which arbitrator will be selected to hear the case.  (Surprise, arbitrators who grant expungements hear many, many expungement cases.). 

Under current FINRA guidance, the parties will send the customer some kind of notice about the expungement proceeding and letting the customer know that the customer can participate if they want, but that they have no obligation at all to participate.  This will be the first time the customer might learn that his former financial adviser has called him or her a liar.  My review of some of these letters left me with the distinct impression that the lawyers drafting these notice letters would prefer it if customers didn’t participate.  (Surprise, customers only participate in about 1 out of 7 expungement hearings).  The letter often does not plainly state that the broker plans to convince an arbitrator that the customer is a liar.  It doesn’t say anything outright false, but figuring out that the broker will call the customer a liar generally takes some reading.  After all, most people would not know that they were being called liars if they received a letter saying that “a broker has filed an arbitration proceeding under the industry arbitration code and now seeks to modify or remove certain information from the Central Registration Depository pursuant to FINRA Rule 2080.”

The new changes will make some difference, but it’s mostly just nibbling around the edges.  FINRA won’t allow the parties to strike and rank arbitrators for expungement hearings any more.  It will require the broker to actually show the arbitrator the letter it used to notify the customer.  It’ll require a majority vote by a three-arbitrator panel.  It’ll put some time limits in place so that brokers can’t wait years and years before seeking an expungement.  It’ll make some other changes.

But there are many things the proposal won’t do.  It won’t address common customer barriers to participation.  It won’t provide a lengthy notice period so customers can figure out what is going on and get legal help. It won’t even guarantee customers can receive all of the documents filed in these arbitrations.  It won’t make it clear that these proceedings are really ex-parte proceedings and that all advocates must be held to higher standards in them.  It won’t change the system in any truly significant way.  It burdens the customer with protecting the public record at the customer’s expense.

Ultimately, what this does is simply continue the problem.  It will likely allow FINRA to politely kick the can down the road for another five years and say that it has made changes in response to criticism and that it will continue to monitor the process and make further changes if they become necessary.  Fixing this problem has not been an urgent priority.  FINRA’s proposals were filed about a month ago after taking a lengthy period to digest the comments FINRA received after putting out a notice in 2017.

As it stands, we know that the current expungement system is not set up in a way that is likely to surface information necessary for an arbitrator to make an informed recommendation on expungement.  These changes do not significantly alter that reality.  You should not trust BrokerCheck alone when looking up a financial professional.  You’ll need to also check the arbitration award database to see if there have been expungements.  Even then, you won’t learn everything you should have been able to see.  But at least you’ll know that you should be more cautious.  After all, one study found that brokers receiving expungements were more than three times as likely to engage in future misconduct as the average broker.

Yesterday, the CFTC and the Bank of England signed a Memorandum of Understanding on the Cooperation and the Exchange of Information Related to the Supervision of Cross-Border Clearing Organizations. Heath Tarbert, the Chairman of the CFTC, and Jon Cunliffe, deputy governor for financial stability at the Bank of England, also authored an opinion piece published in Risk.  It notes that the UK is “the single largest investor in the US,” and that the US “is the largest investor in the UK.”  The two jurisdictions account for about 80% of the global market activity for interest rate derivatives. 

The global clearing mandates that followed the financial crisis of 2007-09 have increased the importance of cross-border financial market infrastructures such as clearinghouses and also the potential for these infrastructures to propagate risks throughout global financial markets.  The opinion notes that “The long-lasting significance of these reforms was seen when the Covid-19 pandemic sent shockwaves through the world’s financial markets earlier this year.  The largest dollar moves in history were recorded for the S&P 500, Dow Industrial Average and Nasdaq-100.  The FTSE All-Share index fell more than 10% on March 12.  Despite this market turmoil and a transition to a work-from-home model, the central counterparties at the heart of this activity remained resilient.” 

That’s great news.  Ideally, this will be indicative of the future performance of these global, cross-border infrastructures.  However, should a clearinghouse become distressed or insolvent in either jurisdiction and taxpayer funds required, I think it would be helpful to have a better understanding of how any taxpayer losses would be shared not only between the U.S. and the U.K., but also with any other relevant jurisdictions.  Recall that “[t]he largest recipients of AIG bailout funds were European banks, Wall Street firms and, to a lesser degree, municipal governments,” and it was AIG’s near collapse that largely motivated the clearinghouse mandates.               

I was today years old when I learned that the California courts have a group of cases captioned the “Franchise Tax Board Limited Liability Corporation Tax Refund Cases.”  This is distressing.  

In that case, the court explains: “This coordinated litigation involves the remedies available to certain limited liability companies (LLCs) that paid a levy pursuant to section 17942 of the Revenue and Taxation Code which was later determined by this District to be unconstitutional.”  Fran. Tax Bd. Ltd. Liab. Corp. Tax Refund Cases, 235 Cal. Rptr. 3d 692, 697 (Cal. App. 1st Dist. 2018), reh’g denied (Aug. 6, 2018), review denied (Oct. 31, 2018) (emphasis added).  We can see clearly that rhe courts knows these are limited liability companies, and not limited liability corporations. Nonetheless, for eternity, when citied, these cases will refer to limited liability corporations. See, e..g, Union Band Wage & Hour Case v. Union Bank, B295835, 2020 WL 6018545, at *18 (Cal. App. 2d Dist. Oct. 9, 2020) (“Their reliance on Franchise Tax Board Limited Liability Corp. Tax Refund Cases (2018) 25 Cal.App.5th 369, 395-396 does not support their position.”). 

Another recent case makes a similar mistake, thought it seems to have gotten a lot of other things right.  A Louisiana court explained: 

Robinson argues that, pursuant to La. R.S. 12:1320(B), as the manager of HLN, a limited liability corporation, Robinson is not liable, in solido, with HLN. Moreover, Robinson argues that Appellant mischaracterized the claim in an attempt to “resurrect” a prescribed tort claim. This Court, in Streiffer v. Deltatech Constr., LLC, explained that “[a] limited liability company is a business entity separate from its members and its members’ liability is governed solely and exclusively by the law of limited liability companies. ‘The fact that a person is the managing member of a limited liability company and/or has a significant ownership interest therein does not in itself make that person liable for its debts.’ ” 2018-0155, pp. 7-8 (La. App. 4 Cir. 10/10/18), ––– So.3d ––––, 2018 WL 4923559, writ denied, 2018-2107 (La. 2/18/19), 263 So.3d 1154 (internal citations omitted). Pursuant to La. C.C. Art. 24, limited liability companies, such as HLN, and its members, such as Robinson, are considered wholly separate entities. Ogea v. Merritt, 2013-1085, p. 6 (La. 12/10/13), 130 So.3d 888, 894-95. Further, pursuant to La. R.S. 12:1320(B), “no **11 member, manager, employee, or agent of a limited liability company is liable in such capacity for a debt, obligation, or liability of the limited liability company.” Further, pursuant to La. R.S. 12:1320(C), “[a] member, manager, employee, or agent of a limited liability company is not a proper party to a proceeding by or against a limited liability company, except when the object is to enforce such a person’s rights against or liability to the limited liability company.” Based on the record before us, Robinson, as a manager of the limited liability company, cannot be liable, in solido; Appellant offered no evidence to rebut the general rule of limited liability.

Thomas v. Hous. Louisiana Now, L.L.C., 2020-0183 (La. App. 4 Cir. 9/30/20) (emphasis added). Other than the limited liability corporation thing, this is about right.  An individual who is a member of an LLC may have some independent liability (respondent inferior) by his or her actions in tort or through veil piercing, but they are not liable for the torts of the entity merely by being a member or manager.  Here the court notes that no evidence was offered to suggest otherwise.  Thus, the rest of the assessment is spot on.  

One other interesting note for those not familiar with Louisiana’s civil law origins: the reference to a “prescribed tort claim” is a reference to an attempt to a cause of action for which the statute of limitations had run.  My first job as a law clerk was with a New Orleans law firm, and while I had went to Tulane, I took the common law curriculum. My first assignment was related to a “prescription issue,” which sounded like a property law claim to me. Fortunately, the assigning attorney quickly clarified that for me. 
 
 I figured I’d add a little some extra — lagniappe — beyond a mere rant about people not accurately describing LLCs. 

Lots of virtual events that should be of interest to our readers, including the “Showcase Discussion” on Thursday 11/12 from 11:00 a.m. – 12:15 p.m.: A Discussion with Professors Robert George and Cornel West on Freedom of Speech, Freedom of Thought, the Black Lives Matter Movement, and the Cancel Culture. You can find the full schedule and register here.

Professor Jeremy McClane’s paper, Reconsidering Creditor Governance in a Time of Financial Alchemy, was just published by the Columbia Business Law Review and it’s a doozy.  His thesis is that lenders play an important role in corporate governance by imposing a degree of fiscal discipline on firms’ decisionmaking.  But when loans are securitized, lenders have fewer incentives to exercise control.  By analyzing SEC filings, he finds evidence to suggest that after firms violate financial covenants with lenders, the ones with nonsecuritized loans improve their performance and operate more conservatively, but the ones with securitized loans do not, implying that lenders intervened to force changes in the former category but not the latter.

The upshot: Lenders play an important role in corporate governance, with a view toward curbing the kind of short-term behavior that is often criticized from a stakeholder perspective (i.e., quick payouts that can make the firm more unstable and ultimately harm employees).  Securitization has therefore removed an important constraint on predatory behavior.

I recently had the pleasure of hearing my OU colleague Professor Megan Shaner present her interesting and timely new article, Back to the Future? Reclaiming Shareholder Democracy Through Virtual Annual Meetings (with Professor Yaron Nili).  What an important topic, especially in these unusual times!  An abstract is below:

From demanding greater executive accountability to lobbying for social and environmental policies, shareholders today influence how managers run American corporations. In theory, shareholders exert that influence through the annual meeting: a forum where any shareholder, large or small, can speak their mind, engage with the corporation’s directors and managers, and influence each other. But today’s annual meetings, where a widely diffused group of owners often vote by proxy, are largely pro forma: only handful of shareholders attend the meeting and voting results are largely determined prior to the meeting. In many cases, this leaves Main Street investors’ voice unspoken for.

But modern technology has the potential to resurrect the annual meeting as the deliberative convocation and touchstone of shareholder democracy it once was. COVID-19 has forced most American corporations to hold their annual meetings virtually. Virtual meetings allow shareholders to attend meetings at a low cost, holding the promise of re-engaging retail shareholders in corporate governance. If structured properly, virtual meetings can reinvigorate the annual meeting, reviving shareholder democracy while maintaining the efficiency benefits of proxy voting.

The Article makes three key contributions to the existing literature. First, using a comprehensive hand collected dataset of state reactions to COVID-19 and of all annual meetings held between March 11 and June 30, 2020, it offers a detailed empirical account of the impact that COVID-19 and the move to virtual annual meetings had on shareholder voting. Second, it uses the context of COVID-19 to show how modern-day annual meetings have drifted away from its democratic function. Finally, the Article argues that technology can revive the shareholder democracy goals of annual meetings, and underscores how virtual meetings can meet that important goal.

Mark Roe & Roy Shapira have posted The Power of the Narrative in Corporate Lawmaking on SSRN (here).  Here is the abstract:

The notion of stock-market-driven short-termism relentlessly whittling away at the American economy’s foundations is widely accepted and highly salient. Presidential candidates state as much. Senators introduce bills assuming as much. Corporate interests argue as much to the Securities and Exchange Commission and the corporate law courts. Yet the academic evidence as to the problem’s severity is no more than mixed. What explains this gap between widespread belief and weak evidence?

This Article explores the role of narrative power. Some ideas are better at being popular than others. The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: (1) connotation — the words themselves tell us what is good (reliable long-term commitment) and what is not (unreliable short-termism); (2) category confusion — disparate types of corporate misbehavior, such as environmental degradation and employee mistreatment, are mislabeled as being truly and primarily short-termism phenomena emanating from truncated corporate time horizons (when they in fact emanate from other misalignments), thereby making us view short-termism as even more rampant and pernicious than it is; and (3) confirmation — the idea is regularly repeated, because it is easy to communicate, and often boosted by powerful agenda-setters who benefit from its repetition.

The Article then highlights the real-world implications of narrative power — powerful narratives can be more certain than the underlying evidence, thereby leading policymakers astray. For example, a favorite remedy for stock-market-driven short-termism is to insulate executives from stock market pressure. If lawmakers believe that short-termism is a primary cause of environmental degradation, anemic research and development, employee mistreatment, and financial crises — as many do — then they are likely to focus on further insulating corporate executives from stock-market accountability. Doing so may, however, do little to alleviate the underlying problems, which would be better handled by, say, stronger environmental regulation and more astute financial regulation. Powerful narratives can drive out good policymaking.