The Harvard Law School Program on Corporate Governance and Financial Regulation is pleased to announce the availability of positions of Post-Graduate Academic Fellows in the areas of corporate governance and law and finance. Qualified candidates who are interested in working with the Program as Post-Graduate Academic Fellows may apply at any time and the start date is flexible.
Candidates should be interested in spending two to three years at Harvard Law School (longer periods may be possible). Candidates should have a J.D., LL.M., or S.J.D. from a U.S. law school, or a Ph.D. in economics, finance, or related areas by the time they commence their fellowship. Candidates still pursuing an S.J.D. or Ph.D. are eligible so long as they will have completed their program’s coursework requirements by the time they start. During the term of their appointment, Post-Graduate Academic Fellows work on research and corporate governance activities of the Program, depending on their skills, interests, and Program needs. Fellows may also work on their own research and publishing in preparation for a career in academia or policy research. Former Fellows of the Program now teach in leading law schools in the U.S. and abroad.
Interested candidates should submit a CV, transcripts, writing sample, list of references, and cover letter to the coordinator of the Program, Ms. Jordan Figueroa, at coordinator@corpgov.law.harvard.edu. The cover letter should describe the candidate’s experience, reasons for seeking the position, career plans, and the kinds of projects and activities in which he or she would like to be involved at the Program. The position includes Harvard University benefits and a competitive fellowship salary.

 

I often use my space here to complain about courts and lawmakers being imprecise with regard to limited liability companies (LLCs).  Today, I will focus on my home state of West Virginia, which recently passed a bill to support (and provide loans for cooperatives designed to provide) much-needed broadband development in the state. I applaud the effort, but the execution was not great.  

Here’s an example from the West Virginia Code: 

12-6C-11. Legislative findings; loans for industrial development; availability of funds and interest rates.

. . . .

(f) The directors of the board shall bear no fiduciary responsibility with regard to any of the loans contemplated in this section.

This applies to a cooperative board that takes on loans for broadband projects.  But it doesn’t make sense. I think they used “fiduciary” when they meant “financial,” as I assume they meant to say that the board members of the organization would not have “financial liability.”  I am pretty sure they did not mean to remove fiduciary duties.  Then again, who knows. Maybe they are fine with the directors using loans for personal vacations.  (Just kidding. I am pretty sure they’d care.)  I know that in finance, the term fiduciary can be used to describe money (meaning some that that relies on public trust for value), but that does not make sense here, either. 

When the legislature returns for the next session, I plan to see if I can get this amended to track the LLC liability defaults. Maybe something like: 

“(f) The directors of the board are not personally liable for any of the loans contemplated in this section.”

I won’t hold my breath, but it’s worth a try.  

Last week, the Neel Corporate Governance Center at UT Knoxville hosted one of UT Knoxville’s alums, Ron Ford, as a featured speaker.  He gave a great talk on boards of directors, from his unique vantage point–that of a CFO.  In the course of his remarks, he mentioned a public company corporate gpvernance policy that I had not earlier heard of: a CEO limit or prohibition on outside board service (other than local, small nonprofit board service).  A 2017 study found that:

Only 22% of S&P 500 boards set a specific limit in their corporate governance guidelines on the CEO’s outside board service; 65% of those boards limit CEOs to two outside boards, and 32% set the limit at one outside board. One board does not allow the company CEO to serve on any outside corporate boards, and two boards allow their CEO to serve on three outside corporate boards.

This may be why I had not heard about governance policies limiting board service; it seems these policies may be relatively uncommon.  I know from experience that CEOs do serve on outside boards and often consider that service an important way to learn valuable things that can be implemented at the firm that enjoys them.

What is the ostensible purpose of a policy restricting the outside board service of a firm’s CEO?  Perhaps it is obvious.  It seems that most firms imposing this kind of restriction on CEOs desire to prevent the CEO from spending significant time on his or her service as a board member of another firm to the detriment of the firm by which he or she is employed as chief executive.  An online article succinctly captures the capacity for distraction.

. . . CEOs must weigh . . . the potential disadvantage of having to navigate a crisis. David Larcker, a professor at Stanford Law School and senior faculty at the university’s corporate governance center, says that while most CEOs would say that serving on an outside board is highly valuable, everything changes if either company comes up against a big challenge.

“Where it gets really complicated for a sitting CEO is if something happens,” Larcker says. “You’re a takeover target. You have a big restatement. You’re replacing a CEO. That’s harder to predict and takes up a lot of time.”

Are there CEOs who have experienced this kind of distraction?  Yes.  A Forbes contributor offers a well-known example in an article entitled “All Operating Executives Should Never Serve On Any Outside Boards“:

A good poster child of outside board distractions was Meg Whitman in her final 2 years at the helm of eBay (EBAY). During this time, she joined the boards of Proctor & Gamble and DreamWorks Animation. EBay flew Meg around to Cincinnati and LA board meetings on their private jet. EBay’s stock sank. Meg bought Skype. It didn’t help.

The same article also calls out two Yahoo! CEOs as further examples.  And there are others.  See also, e.g., here.

Continue Reading Preventing CEO Distraction by Restricting Outside Board Service

On Friday, Elisabeth Kempf presented her new paper, co-authored with Oliver Spalt, at Tulane’s Freeman School of Business, Taxing Successful Innovation: The Hidden Cost of Meritless Class Action Lawsuits. Here is the abstract:

Meritless securities class action lawsuits disproportionally target firms with successful innovations.  We establish this fact using data on securities class action lawsuits against U.S. corporations between 1996 and 2011 and the private economic value of a firm’s newly granted patents as a measure of innovative success. Our findings suggest that the U.S. securities class action system imposes a substantial implicit “tax” on highly innovative firms, thereby reducing incentives to innovate ex ante. Changes in investment opportunities and corporate disclosure induced by the innovation appear to make successful innovators attractive litigation targets.

Using dismissal as a proxy for meritless – a point to which I will return – Kempf and Spalt find that firms that are granted valuable patents are more likely to be targeted by a class action lawsuit than other firms in the following year, and that the difference is driven by meritless lawsuits.  The finding persists even controlling for firm size, sales growth, stock price returns, and volatility.  They also find that these lawsuits disproportionately cause a drag on the firm’s stock price performance, constituting a hidden “tax” on innovation.

In many ways, I suspect the core finding of the paper is accurate, though I do question the ultimate conclusion, and I think that in future drafts – the version on SSRN is a very early one – other relationships should be tested.

To start, obviously the definition of “meritless” is a controversial one, and speaking as a former plaintiff-side class-action attorney, I do take issue with treating all dismissed cases as meritless ex ante.  That said, the authors test using alternative measures of merit and reach the same results.  The one I find particularly convincing is the test using the nature of the lead plaintiff, institutional versus individual – it’s not pretty, but in my experience, very often a good rule of thumb for the ex ante merit of a case is the identity of the lead plaintiff.

The authors also do not distinguish between Section 11 and Section 10(b) lawsuits, or control for circuits where lawsuits are filed (though they do control for location of firm headquarters).  Section 11 lawsuits are easier to bring, and certain circuits have long had a reputation for imposing more stringent pleading standards – it is possible that a closer examination of these variables will lead to different or more nuanced conclusions.

The authors offer a number of explanations for their findings, including that innovative firms are more likely to make optimistic/forward looking statements, which they conclude attracts plaintiffs’ attorneys looking for an easy target.  On this, I both agree and disagree.  I do not agree that plaintiffs’ firms treat these statements as easy “gets” – the PSLRA and the safe harbor ensure that they are not, and every plaintiffs’ attorney knows that.  But these statements may nonetheless influence the firm’s stock price, such that the firm is more likely to experience a stock price drop when the rosy predictions do not materialize.*  And that drop is what will attract the attention of a plaintiffs’ firm, which may then latch on to the forward-looking statements and the – yes, puffery – if there’s nothing else to grasp.

Which brings me to my final observation.  Much of the discussion at Prof. Kempf’s presentation focused on whether she could prove her ultimate point, namely, that securities lawsuits constitute a type of tax on innovation that may ultimately deter firms from innovating in the first place.  Even if the paper is correct that securities fraud lawsuits do impose a tax on innovative firms, the question remains: will that tax deter innovation?  Or will it deter overclaiming by innovative firms?  Because if the latter, then – you know.  Yay.

 *The authors find that “innovative” firms are no more likely to experience a large stock price drop in reaction to a negative earnings announcement than other firms, but they have not – yet – tested to see whether these firms are more likely to experience a large stock price drop in reaction to other types of announcements.

Within the next few weeks, the Supreme Court will decide a trio of cases about class action waivers, which I wrote about here. The Court will decide whether these waivers in mandatory arbitration agreements violate the National Labor Relations Act (which also applies in the nonunion context) or are permissible under the Federal Arbitration Act. 

I wonder if the Supreme Court clerks helping to draft the Court’s opinion(s) are reading today’s report by the Economic Policy Institute about the growing use of mandatory arbitration. The author of the report reviewed survey responses from 627 private sector employers with 50 employees or more. The report explained that over fifty-six percent of private sector, nonunion employees or sixty million Americans must go to arbitration to address their workplace rights. Sixty-five percent of employers with more than one thousand employees use arbitration provisions. One-third of employers that require mandatory arbitration include the kind of class action waivers that the Court is looking at now. Significantly, women, low-wage workers, and African-Americans are more likely to work for employers that require arbitration. Businesses in Texas, North Carolina, and California (a pro-worker state) are especially fond of the provisions. In most of the highly populated states, over forty percent of the employers have mandatory arbitration policies.

 

Employers overwhelmingly win in arbitration, and the report proves that the proliferation of these provisions has significantly reduced the number of employment law claims filed. According to the author:

The number of claims being filed in employment arbitration has increased in recent years. In an earlier study, Colvin and Gough (2015) found an average of 940 mandatory employment arbitration cases per year being filed between 2003 and 2013 with the American Arbitration Association (AAA), the nation’s largest employment arbitration service provider. By 2016, the annual number of employment arbitration case filings with the AAA had increased to 2,879 (Estlund 2018). Other research indicates that about 50 percent of mandatory employment arbitration cases are administered by the AAA (Stone and Colvin 2015). This means that there are still only about 5,758 mandatory employment arbitration cases filed per year nationally. Given the finding that 60.1 million American workers are now subject to these procedures, this means that only 1 in 10,400 employees subject to these procedures actually files a claim under them each year. Professor Cynthia Estlund of New York University Law School has compared these claim filing rates to employment case filing rates in the federal and state courts. She estimates that if employees covered by mandatory arbitration were filing claims at the same rate as in court, there would be between 206,000 and 468,000 claims filed annually, i.e., 35 to 80 times the rate we currently observe (Estlund 2018). These findings indicate that employers adopting mandatory employment arbitration have been successful in coming up with a mechanism that effectively reduces their chance of being subject to any liability for employment law violations to very low levels.

This data makes the Court’s upcoming ruling even more critical for American workers- many of whom remain unaware that they are even subject to these provisions.  

 

Most Americans lack basic financial literacy.  One recent study found that about two thirds of Americans cannot correctly answer basic questions about interest rates and ordinary economic calculations.  It isn’t a surprising finding.  Put simply, most people need help when it comes to handling financial planning and investing decisions.

There are different ways to solve the problem.  One way is to focus on increasing financial literacy by doing more education and outreach.  That approach hasn’t shown great results so far.  Another mechanism for improving financial decision-making is to pair people with competent financial advisers and planners.   In theory, financial advisers can improve financial outcomes for their clients by helping them make the best decisions for their situation.  Unfortunately, the law in most states doesn’t require persons providing financial advice to act in the best interests of their clients.  Nevada is a notable, recent exception.

Many people working with financial advisers walk in with a mistaken default expectation that financial advisers must give advice in the best interests of their clients.  This perception may exist because of the constant drumbeat of trust-focused advertisements from financial services firms. With mismatched expectations and commission-compensated financial advisers, ordinary customers routinely find themselves steered into not-so-great decisions.  In many instances, if they pick a high-fee fund over a low-fee fund, this can result in missing out on thousands and thousands of dollars in future gains. The problem is entirely predictable and can be prevented.  It just requires persons to end up working with financial advisers committed to giving advice in the best interests of customers.

In the aftermath of the 1 October shooting in Las Vegas, I was asked about preparing financial literacy materials to help survivors receiving funds raised in the shootings aftermath to avoid some of the worst scams and frauds out there.  Although materials may do some good, it seemed like it would be better to get them access to financial planning assistance.   We decided to make it happen and reached out to The Institute for the Fiduciary Standard.  With their help, we put together a project bringing together the CFA Institute, the National Association of Personal Financial Advisers, and the Garret Planning Network.   They put out the call to their affiliated financial planners and dozens responded, all agreeing to the following:

I affirm the following statement regarding offering pro bono (free) financial advice to the individuals and families of the survivors of the October 1 Las Vegas tragedy.

I am a fee-only adviser registered with the state or the SEC. I have no pending or current infractions with any regulator.

I will provide at least four hours of advice free of charge. Upon completion of these four hours, I will not solicit any survivor or survivor family for my (or my firm’s) services; however, I will, if requested, offer my services to a survivor on a fee-only basis.

We put together a website to help get the word out and make it easy for survivors to get help from advisers affiliated with these organizations where all members have committed to providing advice in the best interests of their clients.  

Getting good advice to survivors is critically important.  Greg Phelps is one of the financial advisers that volunteered to help.  He has an idea of what these survivors may be going through because he was at the Route 91 festival when the shots started falling on the crowd.  He is also a fee-only financial planner that has volunteered to help other survivors.  He explained the need for assistance as critical because  “[l]ife has been hard enough on all the survivors and all the victims. I can’t tell you how many times in my 23 years that they’ve been taken advantage of or they’ve been steered the wrong way and that’s why this project is so important.” Explaining the critical need for help, he said that “[w]e can’t let that happen to these people because they’ve already been through too much.”

The good news is that we’ve got a project together to help some people get good advice in the aftermath of the shooting.  The bad news is that there are 10,000 Americans turning 65 every day.  Most are financially illiterate.  We don’t have resources in place to help them make good investment decisions before retirement or to manage their savings through retirement.  It’s an enormous, slow-moving problem that continues to play out.

Quick Update.  Financial Planning Magazine is also covering the project.

 

 

 

Keith Paul Bishop, at the California Corporate and Securities Blog, provides an example of a court that actually pays attention to entity type. As he says, “it is nice to see that some judges do recognize that LLCs are not corporations.” It sure is.  In the case he cites, D.R. Mason Constr. Co. v. GBOD, LLC, 2018 U.S. Dist. LEXIS 41236, the court gets a lot right:

[A]lthough Plaintiff’s Complaint does separately mention the term “shareholder,” [*13]  the Court will not draw the inference that this term means Plaintiff was promised traditional “stock.” This inference would not be reasonable in these circumstances because Plaintiff alleges in its Complaint that Defendant GBOD is a limited liability company, not a corporation. (Compl. ¶ 3.) Under California law, LLCs distribute “membership interests,” not shares of stock. See Cal. Corp. Code § 17704.07. Consequently, Plaintiff’s pleading indicates the financial instrument at issue is not traditional stock. Moreover, courts tasked with deciding whether LLC membership interests constitute a security under the Exchange Act generally evaluate whether such interests are “investment contracts,” not “stocks.”

It is nice to see a court that acknowledges the different entity types and frustrating that this is not the norm. As Bishop explains: 

Obviously, this case does not stand for the proposition that a membership interest never meets the definition of a “security” under the Exchange Act.  Nor does the case deal with the issue of whether a membership interest constitutes a security under state law.  It does demonstrate that some courts recognize the fact that LLCs are not corporations.

So, I sincerely hope people don’t read to much into this. But I will acknowledge that some courts are getting it right.  And thank Bishop for helping further the cause.  

This timely post comes to us from Jeremy R. McClane, Associate Professor of Law and Cornelius J. Scanlon Research Scholar at the University of Connecticut School of Law.  Jeremy can be reached at jeremy.mcclane@uconn.edu. 
__________________________________________________

Spotify, the Swedish music streaming company known for disrupting the music market might do the same thing this week to the equity capital markets. On April 3, Spotify plans to go public but in an unusual way. Instead of issuing new stock and enlisting an underwriter to build a book of orders and provide liquidity, Spotify plans to cut out the middleman and list stock held by existing shareholders directly on the New York Stock Exchange.

This will be an interesting experiment that will test some prevailing assumptions that about how firms must raise capital from the public.

The Importance of Bookbuilding. First, we will see just how important bookbuilding is to ensuring a successful IPO. When most companies go public, they hire an underwriter to market the shares in what is known as a “firm commitment” underwriting. The investment banks commit to finding buyers for all of the shares, or purchasing any unsold shares themselves if they cannot find buyers (an occurrence which never happens in practice). The process involves visiting institutional investors and building a book of orders, which are then used to gauge demand and set a price at which to float the stock. The benefit of this process is risk management – the issuing company and its underwriters try to ensure that the offering will be a success (and the price won’t plummet or experience volatile ups and downs) by setting a price at a level that they know market demand will bear, and ensuring that there are orders for all of the shares even before they are sold into the market.

Without underwriters or bookbuilding, Spotify is taking a risk that its share price will be set at the wrong level and become unstable. In Spotify’s case, however there is already relatively active trading of shares in private transactions, which gives the company some indication of what the right price should be. Nonetheless, that indication of price is volatile, in part because the securities laws limit the market for its shares by restricting the number of pre-IPO shareholders to 2,000, at least in the US. In 2017 for example, the price of Spotify’s shares traded in private transactions ranging from $37.50 to $125.00, according to the company’s Form F-1 registration statement.

Continue Reading Spotify IPO This Week May Upend How Startups Raise Capital: Guest Post