Several months ago, I posted about a symposium I attended at Case Western Reserve Law School titled Fiduciary Duty, Corporate Goals, and Shareholder Activism.   The Case Western Reserve Law Review will be publishing a volume of papers from the symposium, and my contribution, What We Talk About When We Talk About Shareholder Primacy, is now available on SSRN.  The essay (well, they’re calling it an article but I think of it more as an essay) is about how shareholder primacy can be defined either as a wealth maximization norm or as obedience to shareholders, and what that means for corporate organization and theory.

In April, I attended the Corporate Accountability symposium sponsored by the Institute for Law & Economic Policy and the Vanderbilt Law Review.  The Vanderbilt Law Review will be publishing those papers, and my contribution, After Corwin: Down the Controlling Shareholder Rabbit Hole, is now available on SSRN.  The essay addresses the inconsistencies in how Delaware treats controlling shareholder transactions, and the new pressure that Corwin, as well as changes to corporate financing, have placed on the definition of what a controlling shareholder is.

(Regular readers of this blog will note that both of these essays draw heavily from my posts here.  Waste not, want not.)

Finally, I previously posted about a panel on securities litigation that I attended at George Mason.  At that time, I mentioned that my remarks drew from research that Matthew Cain, Steven Davidoff Solomon, Jill Fisch, and Randall Thomas presented at the April ILEP conference, and I promised to link to their paper when it was finally made public.  Well, that paper, Mootness Fees (also forthcoming in Vanderbilt’s ILEP symposium volume), is now available on SSRN (so hot off the presses that as of this posting, it’s still in SSRN jail).  It’s an empirical examination of mootness fees paid out in the wake of Delaware’s crackdown on merger litigation.

Enjoy!

At the 2019 Law and Society Association Annual Meeting last week, Geeyoung Min presented her paper Governance by Dividends.  In the paper, she focuses attention on stock dividends.  Near the end of her presentation, Geeyoung trod over ground on which so many of us also have trod–relating to judicial standards of review in fiduciary duty actions.  As familiar as the story was, she helped me to see something I had not seen before.  Perhaps many of you already have identified this.  If so, I am sorry to bore you with my new insight.

Essentially, what I came to realize during her talk–and develop with her and members of the audience in the ensuing discussion–was that Delaware’s judiciary may have (and I may be quoting Geeyoung or someone else who was there, since I wrote this down long-form in my contemporaneous notes) muddied the waters by seeking clarity.  What do I mean by that?  Well, by addressing relatively clearly the circumstances in which the business judgment rule, on the one hand, or entire fairness, on the other, govern the judicial review of corporate fiduciary duty allegations, the Delaware judiciary has effectively made the interstitial space between the two–intermediate tier scrutiny–less clear.

As I reflected a bit more, I realized that an analogy could be made to the development of the substantive law of corporate fiduciary duties in Delaware.  The overall story?  Judicial refinement of the fiduciary duties of care and loyalty has left the duty of good faith somewhat more indeterminate.  

I am not sure where all this goes from here, but there may be lessons in these musings for both judicial and legislative rule-makers, among others. As always, your thoughts are welcomed.

Last Thursday and Friday, I attended a truly worthwhile event: the first “Summit on the Profession of Business Law” at the University of Connecticut School of Business.  Its organizer, Robert Bird, Professor of Business Law and Eversource Energy Chair in Business Ethics Marketing, did an excellent job of assembling a diverse program of interesting and informative sessions, and described the motivating purpose of the conference as follows:

Increasingly complex and challenging regulations have pressured organizations to manage legal risk or face costly penalties. Individuals who understand how to use the law to build creative relationships and solve difficult problems add value to their organizations. Business schools are challenged to train students to demonstrate ethical values, apply critical thinking, adapt to change, and show attention to detail. As a result, there is a growing need for business schools to train future leaders who are legally educated and astute. The purpose of this summit is to exchange knowledge and encourage best practices in business law and ethics that respond to changing demands of a broad array of stakeholders.   

Although aimed at business law educators in business schools, the conference brought to my mind a number of general ideas that might resonate with readers, whether teaching business law in a business or law school (or both!), such as the importance of:

  • Having and teaching good communication skills, and that clear expectations foster this objective
  • Service for promoting a rich educational environment, and in shaping the path forward
  • The right incentives to encourage interdisciplinary collaboration
  • Openness to new opportunities, and that a myopic strategic approach can hinder this goal
  • Speaking the language of one’s audience, for example, highlighting how legal education improves “exposure management” and compliance in business organizations 
  • Leadership, including the impact of inherited leadership
  • Recognizing when change is inevitable, and proactively helping to shape it

Jeremy McClane at Illinois recently posted to SSRN a truly fascinating study of boilerplate in IPO prospectuses (okay, I gather it may have been out for a while but it was only posted to SSRN recently and that’s how I learn anything these days).  In Boilerplate and the Impact of Disclosure in Securities Dealmaking, he concludes that while the inclusion of “boilerplate” – namely, generic disclosures that copy from similar deals – contributes to lower legal fees (though not lower underwriter and audit fees), it ultimately costs firms in terms of greater IPO underpricing and greater litigation risk. (It should be noted that he does not analyze litigation outcomes – compare to the risk factor paper, described below).  Boilerplate is also associated with greater divergence in analyst opinion, and greater (upward) price revision in the pre-IPO period.  All of this, he concludes, demonstrates that boilerplate contributes to greater information asymmetry.

In a previous post, I described a working paper, Are Lengthy and Boilerplate Risk Factor Disclosures Inadequate? An Examination of Judicial and Regulatory Assessments of Risk Factor Language, that examines boilerplate in SEC risk factors.  The authors of that study concluded that – perversely – boilerplate is rewarded by judges in litigation and, crucially, by the SEC, where it is associated with fewer comment letters.

McClaine’s findings are in a similar vein.  Despite the SEC’s (purported) efforts to stamp out boilerplate, he discovers that excess levels of boilerplate are not associated with more pre-offering prospectus amendments or with more SEC commentary.  (Caveat: His study period includes post-JOBS Act filings but I’m not entirely clear how he treats draft registration statements for the purposes of this analysis).

A final note: McClane speculates on how boilerplate could impact investor assessments, given the common expectation that few investors actually, you know, read SEC filings to begin with.  He points out that professional investors and analysts do the reading, and their determinations may ultimately drive pricing.  He also notes that lawyers and underwriters draft IPO disclosures and that process may prompt them to ask questions, which ultimately generates more information.  I’d add to the mix that these days, computers do a lot of the reading (especially once trading begins), which raises the possibility that subtle variations are more detectable than they were in days’ past.  I’d love to see more analysis along these lines that divide filings by time period.

Last week, I attended the American Law Institute (ALI) Annual Meeting in Washington, DC.  (I am back in The District this week for the Law and Society Association Annual Meeting.  More on that in a later post.)  Many important project drafts and projects were vetted at the ALI meeting.  As many readers know, however, the tentative draft of the Restatement of the Law, Consumer Contracts generated some significant debate in advance of and at the conference.  The membership approved part of the draft of the project at the meeting, but much still is to come.  

I want to briefly pick up a small thread here from the portions of the proposed Restatement discussed at the meeting that relates to some of the work I have done on crowdfunding.  Crowdfunding platforms, like most web-based service businesses, use standard form “terms of use” that the service provider and customer end-user may desire to enforce under contract law.  Unsurprisingly, many of the terms of use for websites of this kind (and crowdfunding platform sites are no exception to the rule) are protective of the interests of the service provider.  These terms include, for example, mandatory arbitration provisions and waivers of jury trial and class action rights.

As many of you likely know, there has been significant litigation about the enforceability of these kinds of provisions in form agreements–and whether a valid contract has been formed at all.  See, e.g., this article from earlier this year.  As the debates on the Restatement proceeded at the meeting, I found myself thinking about whether the common law of contracts is the best way to handle legal challenges to standard form contracts.  Something inside me just kept screaming for a more tailored legislative solution . . . .

After conclusion of the ALI Annual Meeting, I found this testimony before the Senate Judiciary Committee from Myriam Gilles, Paul R. Verkuil Research Chair and Professor at Cardozo Law.  She notes in that testimony:

[W]hen pre-dispute arbitration clauses and class action bans are forced upon consumers and employees in take-it-or-leave-it, standard-form agreements, “the probability of litigation positions is highly asymmetrical: the seller is far more likely to be the defendant in any dispute, and the consumer the plaintiff.” There is no negotiation, no choice, and the resulting arbitration procedures are not, in truth, intended to provide a forum to resolve claims. The one and only objective of forced, pre-dispute, class-banning arbitration clauses is to suppress and bury claims. The whole point is that consumers and employees seeking redress for broadly distributed small- value harms cannot and will not pursue one-on-one arbitrations.

(footnotes omitted) Professor Gilles recommended a legislative solution.

I do not teach contracts.  Perhaps those of you who do have comments on this matter that negate what I have written here.  If so, please share them.  In general, as a corporate finance lawyer, I favor private ordering.  But consumer contracts are a whole other animal, distinct from merger or acquisition and other corporate finance agreements.  Perhaps we should decrease pressure on the courts by focusing some legislative attention on the appropriate form of standardized terms in consumer contracts that operate as contracts of adhesion or otherwise offend public policy.  I am not sure quite what that looks like overall, but the idea seems to bear further thought . . . .

 

The SEC recently announced it would go ahead and vote on Regulation Best Interest and a number of other provisions on June 5th.  Consumer and investor advocates have generally panned the draft regulation because it fails to meaningfully raise standards beyond the existing FINRA Suitability rule.  Although the proposal ran to 408 pages, the actual draft regulation only spans about four pages.

It’s difficult to see how the draft rule moves beyond FINRA’s suitability standard in any meaningful way.  The rule opens by saying that brokers must “act in the best interests of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the retail customer.”  This language seems to parallel FINRA’s guidance instructing brokers to make recommendations that are “consistent with” the best interest of customers.  Notably, the rule does not say that best interest means that a broker must place the customer’s interests ahead of the broker’s, which is what most people would think a best interest regulation would include.  The draft simply declares that the firm cannot put its interests ahead of the customers.

After this odd initial language, the proposal goes on to chart out how a best interest obligation may be satisfied.  It lays out three requirements, including a (i) disclosure obligation; (ii) care obligation; and (iii) conflict of interest obligation.  A loyalty obligation remains conspicuously absent.  

Disclosure Obligation

The disclosure obligation requires some written disclosure of the “material facts relating to the scope and terms of the relationship with the retail customer, including all material conflicts of interest that are associated with the recommendation.” The SEC may allow firms to satisfy this obligation with general boilerplate disclosures.  No doubt these documents will be detailed, thorough, technically accurate, and completely incomprehensible to the average financially illiterate American.

Care Obligation

FINRA’s suitability rule contains three components: (i)  reasonable basis suitability; (ii) customer-specific suitability; and (iii) quantitative suitability.  Regulation Best Interest again seems to track FINRA’s rule with a (i) reasonable basis to believe that the recommendation might be in some theoretical investor’s possible best interest; (ii) a reasonable basis to believe that the recommendation is in the best interest of a particular customer; (iii) and a reasonable basis to believe that standing together a series of transactions will be in the best interest of a retail investor.

Conflict Obligations

The third part of the rule discusses the conflict of interest obligations for brokerages.  It requires some written policies “reasonably designed to identify and at a minimum disclose, or eliminate, all material conflicts of interest that are associated with such recommendations.”  It also requires “written policies and procedures reasonably designed to identify and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with such recommendations.”

The draft rule doesn’t specify whether mitigation must be effective or what will count as mitigation.  If a brokerage wants its representatives to push its costlier proprietary products, it’ll still be able to have its brokers make those recommendations.  This leaves the door open for brokerages to create financial incentives for brokers to tilt their recommendations in ways that generate more fees for the firm and lower returns for investors.  If the firm is allowed to create financial conflicts, its unclear what meaning the mitigation requirement has.  Would a rule saying that a broker will not be terminated for not selling a particular product be enough?  This allows the firm to leave the carrot and stay the stick, generating the ability to claim it has mitigated conflicts.  There does not seem to be any limiting principle for conflicts so long as the firm could point to some yet more horrid system that it claims to have moved away from.  

Bottom Line

If this goes through as it is, retail investors should not trust their brokers.  It means that a customer cannot rely on a broker to actually act in their best interest.  The same conflicts will continue to bias investment advice.  Customers will likely receive more useless disclosures but will also be barraged with largely rhetorical claims that they should trust their brokers because they are now bound by regulation best interest.

Errata

The SEC will also vote on a number of other proposals, all unlikely to provide any material benefit to investors. 

Form CRS

The SEC will consider requiring disclosures about the nature of the relationship.  Testing revealed that the draft regulation’s sample disclosure mock up largely failed to help customers understand the nature of their relationship.

Investment Adviser Standard of Conduct

The SEC is also considering some interpretation on the investment adviser standard of conduct.  If it simply enshrines the disclosure-fetishistic position it has taken in recent enforcement cases, the interpretation may allow registered investment advisers to claim to be fiduciaries while betraying customer interests.  If an investor pays an investment adviser 1% a year, they should be able to trust the investment adviser.  In recent years, the SEC has leaned heavily on “eliminate or disclose” to address conflicts.  Allowing the “disclose” option as a solution to address conflicts means that an investor cannot trust their registered investment adviser without reading and understanding the disclosure.  

An investor considering whether to trust Wells Fargo will need to read the Form ADV specific to that particular program.  Consider this one. It’s 37 pages of small print.  It also discloses that Wells Fargo’s registered investment advisory arm has an incentive to pick the funds that kick cash to it:

Revenue sharing

Revenue sharing is paid by a mutual fund’s investment advisor, distributor, or other fund affiliate to us for providing continuing due diligence, training, operations and systems support and marketing to Financial Advisors and Clients with respect to mutual fund companies and their funds. Revenue sharing fees are usually paid as a percentage of our aggregate value of Client assets invested in the funds. Revenue sharing rates can differ depending on the fund family, and in some cases we receive different revenue sharing rates for certain funds and share classes within a particular fund family. In addition, not all mutual funds pay revenue sharing, as a result we have an incentive to include funds on our platform and recommend funds that pay revenue sharing and/or pay a higher rate. Advisory Clients are not permitted to restrict their Accounts to only mutual funds that do not pay revenue sharing. We do not collect revenue sharing payments on Program Accounts for ERISA plans, SEPs, and SIMPLE IRAs. Revenue sharing payments generated based on mutual fund assets under management in Participating Accounts are considered Platform Support and included in the Advisory Account Credit.

Allowing this sort of conflict to be solved through “disclosure” means that investors cannot trust their advisers.  Anyone who would read and fully understand the Wells Fargo disclosures probably has no need for Wells Fargo’s asset allocation assistance.

Solely Incidental

The SEC may also issue an interpretation as to what “solely incidental” means.  The Investment Advisers Act does not apply to brokers as long as the “advice” they provide is “solely incidental” to their execution services.  For decades the term has had practically no meaning or restraining effect.  Brokers have long identified themselves as “financial advisers,” putting it on the business cards, websites, and email signatures.  If they only gave incidental advice, they wouldn’t be holding themselves out as advisers. With the horse so far out of the barn, SEC seems unlikely do much on this front.

 

 

 

 

Joey Elsakr, a PHD/MD student at Vanderbilt University, has teamed up with his roommate for a blog called Money & Megabytes. The blog covers personal finance and technology topics, which I think may be of interest to many of our readers and their students.

Last year, convinced that students need more guidance on personal finance, I gave a talk at Belmont University on the topic. Given the very limited advertising of the talk, I was surprised by the strong turnout. The students were quite engaged, and some simple personal finance topics seemed to be news to many of them. I plan on asking Joey to join me in giving a similar talk next year.

One post that I would like to draw our readers’ attention to is Joey’s recent post on his monthly income/expenses. You can read the entire post here, but here are a few takeaways: 

  • Know Where Your Money Goes. How many students (or professors!) actually have a firm grasp on where they are spending money? While creating a spreadsheet like Joey’s could be time consuming, the information gained can be really helpful (and just recording the information — down to your nail clippers purchase! — probably makes you more careful). Bank of America users can create something similar, very quickly, using their free My Portfolio tab. 
  • Power of Roommates: Many of my students complain of the high rent prices in Nashville. Some have even said “it is impossible to find a decent place for under $1000/mo.” Joey pays $600/mo, in a prime location near Vanderbilt, in a nice building, because he has two roommates. Also, because he has roommates, Joey only pays a third of the typical utilities. Now, if you have the wrong roommates, this could be problematic, but having roommates not only helps save you money but also helps work those dispute resolution skills. 
  • Charitable Giving. I am inspired that Joey, a grad student, devotes a sizable portion of his income to charitable giving. Great example for all of us. 
  • Multiple Forms of Income. Even though Joey is a dual-degree graduate student at Vanderbilt and training to make the Olympic Trials in the Marathon — he ran collegiately at Duke University — Joey has at least four different streams of income. Other than his graduate stipend, his other three streams of income appear to be very flexible, which is probably necessary given his schedule. This income may seem pretty minor, but it adds up over the year, and it gives him less time to spend money. 
  • Food Budget. This is an area where I think a lot of students and professors could save a good bit of money. My wife and I have started tracking our expenses more closely and the food category is the one where we have made the most savings — thank you ALDI’s. A lot of the food expenses are mindless purchases—for me, coffee and snacks from the Corner Court near my office—and those expenses add up quickly over the month. 

Follow Joey’s blog. Even though I consider myself fairly well-versed on personal finance topics, Joey recently convinced me that a savings account is the wrong place to house my emergency fund. And I agree with Joey’s post here — paying attention to personal finance can actually be a fun challenge. Joey’s blog also introduced me to The Frugal Professor, though I am not sure I am ready to take the cell phone plunge quite yet.   

I’ll start with the exciting news that my Business Organizations students were 48 for 48 in recognizing that LLCs are not corporations.  In fact, a number of my students specifically referred to “LLCs (NOT corporations) …” in their exams. It’s nice to be heard.  I believe that’s at least three years in a row without such a mistake, and maybe longer. I have evidence, at least on this issue, repetition is effective.  

As for this summer, it is going to be an interesting one.  I have now finished grading my last classes as a part of West Virginia Univerity College of Law. As some readers may know, I have accepted the opportunity to join Creighton University School of Law as the next dean.  (For those wondering, my wife Kendra will be joining the Creighton Law faculty, as well, where, as was true at WVU, she will teach family law as a full professor.) After Kendra’s run for Congress ended, she told me it was “my turn,” and that I should pursue my goals.  I don’t think either of us expected such a big change so quickly.  

Long before all of this became a reality, and after the campaign, we planned a family vacation to Europe for a month, so we’ll be doing that with the kids — Bulgaria, Germany, Italy, and Greece.  Buying and selling a house, moving across the country, and starting new jobs (and new schools for the kids) will all be part of the mix, too, but hey, what’s life without some adventure?  

The fact that we’re willing to leave should tell people just how much we believe in this opportunity. We have an absolutely incredible life already, with dear friends, amazing students, and a community of supportive and caring people.  (Not to mention an absolutely gorgeous location.) And yet we’re moving.  I have high hopes and high expectations — both for me and for my new institution.  It’s worth stating clearly that we have loved West Virginia and we have had incredible opportunities to grow both personally and professionally. I want people to know that we are not so much leaving West Virginia as we are going to Creighton, a possibility I wouldn’t have without my time here at WVU.

I very much appreciate that, and because of all we have learned and experienced, new adventures await.