This may be obsolete by the time you read this post, but here are my thoughts on Corporate Governance, Compliance, Social Responsibility, and Enterprise Risk Management in the Trump/Pence Era. Thank you, Joan Heminway and the wonderful law review editors of Transactions: The Tennessee Journal of Business Law. The abstract is below:

With Republicans controlling Congress, a Republican CEO as President, a “czar” appointed to oversee deregulation, and billionaires leading key Cabinet posts, corporate America had reason for optimism following President Trump’s unexpected election in 2016. However, the first year of the Trump Administration has not yielded the kinds of results that many business people had originally anticipated. This Essay will thus outline how general counsel, boards, compliance officers, and institutional investors should think about risk during this increasingly volatile administration. 

Specifically, I will discuss key corporate governance, compliance, and social responsibility issues facing U.S. public companies, although some of the remarks will also apply to the smaller companies that serve as their vendors, suppliers, and customers. In Part I, I will discuss the importance of enterprise risk management and some of the prevailing standards that govern it. In Part II, I will focus on the changing role of counsel and compliance officers as risk managers and will discuss recent surveys on the key risk factors that companies face under any political administration, but particularly under President Trump. Part III will outline some of the substantive issues related to compliance, specifically the enforcement priorities of various regulatory agencies. Part IV will discuss an issue that may pose a dilemma for companies under Trump— environmental issues, and specifically shareholder proposals and climate change disclosures in light of the conflict between the current EPA’s position regarding climate change, the U.S. withdrawal from the Paris Climate Accord, and corporate commitments to sustainability. Part V will conclude by posing questions and proposing recommendations using the COSO ERM framework and adopting a stakeholder rather than a shareholder maximization perspective. I submit that companies that choose to pull back on CSR or sustainability programs in response to the President’s purported pro-business agenda will actually hurt both shareholders and stakeholders.

Earlier today, the Enforcement Section of the Massachusetts Securities Division filed an administrative complaint against Scottrade.  The complaint alleges that Scottrade “knowingly violated its own internal policies designed to ensure compliance with the United States Department of Labor (“DOL”) Fiduciary Rule by running a series of sales contests involving retirement accounts.”  It may be the first state enforcement action seeking to force brokerages to comply with the DOL Fiduciary Rule.

More specifically, Massachusetts took issue with Scottrade’s sales contests because the DOL’s Fiduciary Rule requires that “advice to retirement account customers must be based on the best interest of customers, not the best interests of the firm.” On paper, Scottrade had enacted impartial conduct standards for its customers’ retirement accounts.  The brokerage’s compliance manual includes a subsection on incentives, saying:

The firm does not use or rely upon quotas, appraisals, performance, or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended to reasonably expected to cause associates to make recommendations that are not in the best interest of Retirement Account clients or prospective Retirement Account clients.

Despite this provision and the DOL Fiduciary Rule, Scottrade allegedly ran national sales contests and offered rewards for selling customers and causing them to move their assets to Scottrade.  How much of an impact the sales contests had on employee behavior may be difficult to know.  An internal email from a Scottrade Divisional Vice President seems to indicate that the contest had an impact on employee behavior:

The first week of the Q3 “RUN-THE-BASSES” contest is done, and we have a few regions off to a SCREAMING start [] You certainly knocked the cover off the ball!  Some would say you knocked it out of the park!  Very soon, we will get an official count on how we did, and more exciting, a chance to see where we stack-up against our peers on our official scoreboard! [. . .]  Happy Selling!

In contrast to the intense internal focus on these sales contests, Scottrade’s retirement customers were not always aware of the incentives that might be shaping the financial advice they received.  One representative told the Massachusetts enforcement section that the prizes and sales contests were not disclosed to clients during the conversations.

The Massachusetts complaint also contains troubling allegations that Scottrade trained its staff to identify customers’ emotional needs and then use them to gather new assets, including a focus on emotional needs that “are not rational or logical.”  The complaint alleges that “Scottrade’s own internal-use materials instructed agents to target a client’s ‘pain point’ and emotional vulnerability,” with training sessions lauding “the use of emotion over logic in getting a client to bring additional assets to the firm.”  It’s difficult to square using customers emotional needs to manipulate them into using Scottrade with giving advice in the best interest of customers.  The Massachusetts complaint does not reveal whether the Scottrade compliance manual contains any provision about the appropriate level of emotional manipulation for retirement customers.

Now that Massachusetts has filed this administrative complaint, it opens up questions about what happens next.  Other states may follow after Massachusetts and file their own enforcement actions.  It’s also possible that FINRA will bring its own enforcement proceeding.  FINRA Rule 3110 requires firms to “establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations.”  FINRA might also consider whether Scottrade violated FINRA Rule 2010, requiring its member firms to “observe high standards of commercial honor and just and equitable principles of trade.”

 

 

Recent (overdue) additions to my SSRN page:

A New Social Contract: Corporate Personality Theory and the Death of the Firm, 101 Minnesota Law Review Headnotes 363 (2017). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3123349

Socio-Economics: Challenging Mainstream Economic Models and Policies, 49 Akron Law Review 539 (2016). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3123817

The Role of Corporate Personality Theory in Opting Out of Shareholder Wealth Maximization, 19 Transactions: The Tennessee Journal of Business Law 415 (2017). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3123795

The Inclusive Capitalism Shareholder Proposal, 17 UC Davis Business Law Journal 147 (2017). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3123823

I suspect click-bait headline tactics don’t work for business law topics, but I guess now we will see. This post is really just to announce that I have a new paper out in Transactions: The Tennessee Journal of Business Law related to our First Annual (I hope) Business Law Prof Blog Conference co-blogger Joan Heminway discussed here. The paper, The End of Responsible Growth and Governance?: The Risks Posed by Social Enterprise Enabling Statutes and the Demise of Director Primacy, is now available here.

To be clear, my argument is not that I don’t like social enterprise. My argument is that as well-intentioned as social enterprise entity types are, they are not likely to facilitate social enterprise, and they may actually get in the way of social-enterprise goals.  I have been blogging about this specifically since at least 2014 (and more generally before that), and last year I made this very argument on a much smaller scale.  Anyway, I hope you’ll forgive the self-promotion and give the paper a look.  Here’s the abstract: 

Social benefit entities, such as benefit corporations and low-profit limited liability companies (or L3Cs) were designed to support and encourage socially responsible business. Unfortunately, instead of helping, the emergence of social enterprise enabling statutes and the demise of director primacy run the risk of derailing large-scale socially responsible business decisions. This could have the parallel impacts of limiting business leader creativity and risk taking. In addition to reducing socially responsible business activities, this could also serve to limit economic growth. Now that many states have alternative social enterprise entity structures, there is an increased risk that traditional entities will be viewed (by both courts and directors) as pure profit vehicles, eliminating directors’ ability to make choices with the public benefit in mind, even where the public benefit is also good for business (at least in the long term). Narrowing directors’ decision making in this way limits the options for innovation, building goodwill, and maintaining an engaged workforce, all to the detriment of employees, society, and, yes, shareholders.

The potential harm from social benefit entities and eroding director primacy is not inevitable, and the challenges are not insurmountable. This essay is designed to highlight and explain these risks with the hope that identifying and explaining the risks will help courts avoid them. This essay first discusses the role and purpose of limited liability entities and explains the foundational concept of director primacy and the risks associated with eroding that norm. Next, the essay describes the emergence of social benefit entities and describes how the mere existence of such entities can serve to further erode director primacy and limit business leader discretion, leading to lost social benefit and reduced profit making. Finally, the essay makes a recommendation about how courts can help avoid these harms.

Just a quick post today about a teaching technique I have been using that offers significant opportunities for exploration, especially in small class environments.

I am again teaching Advanced Business Associations this semester.  The course allows students to review and expand their knowledge of business firm management and control issues in various contexts (public corporations, closely held corporations, benefit corporations, and unincorporated business entities), mergers and acquisitions, and corporate and securities litigation.  I have reported on this course in the past, including in this post and this one.

At the conclusion of each unit, I have students locate (go off on a treasure hunt, of sorts) and post on the course management website (I use TWEN) a practice document related to the matters covered in that unit.  Today we concluded our unit on benefit corporations.  Each student (I only have five this semester) was required to, among other things, post the actual corporate charter (not a template or form) of a benefit corporation.  Although the Advanced Business Associations course features training presentations by representatives of Lexis/Nexis, Westlaw, and Bloomberg that include locating precedent documents of various kinds, the students have not yet had this training.

In our discussions about this part of today’s assignment, we learned a number of things.  Here are a few:

  • New articles, blog posts, and other secondary materials can be a good starting place in locating firms with particular attributes.
  • The word “charter” can mean different things to different people.
  • Journalists do not understand the difference between a benefit corporation and a B corporation.
  • In research geared toward locating precedents for planning and drafting, googling descriptive terms is likely to yield fewer targeted results than googling the terms used an actual exemplar document.
  • Corporate charters for privately held firms can be difficult to find–especially in certain specific jurisdictions, even when you know the firm’s name and other identifying attributes.
  • “If at first you don’t succeed, try, try, again.” Three of the five students posted more than one document before they found an appropriate example.
  • The corporate charters the students posted include exculpation and indemnification.
  • Patagonia’s charter is pretty cool.  It has a detailed, specific benefit purpose, a prohibition on redemptions, and a right of first offer.  It also requires a unanimous vote on certain fundamental/basic corporate changes, redemptions, and bylaw amendments.
  • There is a law firm in California that is a professional corporation organized as a benefit corporation “to pursue the specific public benefit of promoting the principles and practices of conscious capitalism through the practice of law.”  Also pretty cool.

The discussion was rich.  The students accomplished the required task and reflected responsibly and valuably on their individual search experiences during our class meeting.  They learned from each other as well as from me; benefit corporations seemed to come alive for them as we spoke.  We accomplished a lot in 75 minutes!

Do any of you use a similar teaching technique?  Have you adapted it for use in a large-class (over 50 students) environment?  If so, let me know.  I would like to evolve my “treasure hunt” for business law drafting precedents for use in a larger class setting.

Socially responsible investing is all in the news these days, as several large asset managers and advisors have publicly declared commitments, of one kind or another, to pressuring portfolio companies to act in socially responsible ways.

Commenters debate whether these managers genuinely believe social responsibility will improve value at portfolio companies, or whether they are trying to appeal to the preferences of clients who themselves favor socially responsible investing, either as a mechanism for improving value, or, more probably, as a matter of, essentially, “taste.”  If you’re going to invest an index fund, for example, you may as well invest in the one where you believe your dollars will also be used to push for your preferred agenda – even if little is actually being done in that direction.

The reason it’s so difficult to suss out anyone’s exact motive, of course, is that it’s tough to admit – as an asset manager or any kind of institutional investor – that you’re interested in anything other than financial returns.  Not simply because of the publicity you’ll generate, but because it’s not clear how far fiduciary obligations allow fund managers to go in pursuing social goals. 

(This is, of course, one of the ways in which reductionistic fiduciary duties strips out the real concerns of the ultimate humans the duties are designed to benefit).

Which is why I found the letter by Jana Partners announcing its new social activism fund – and targeting Apple – so intriguing.  In a partnership with the California State Teachers Retirement System (who is not, at least yet, an investor in the fund), Jana is urging Apple to institute stronger parental controls on the iPhone.  Now, there’s been a lot of commentary about Jana’s motivations – is Jana truly trying to profit via social activism? Or is this a loss leader so that it can cultivate relationships with kinds of institutions it needs to support its more traditional activist campaigns?– but what intrigues me are the interests of CalSTRS.

Because the letter spends most of its time talking about how better controls will ultimately prove profitable for Apple and thus Apple’s shareholders, but concludes by pointing out that the issue is “of particular concern for CalSTRS’ beneficiaries, the teachers of California, who care deeply about the health and welfare of the children in their classrooms.”

In other words, the subtext is that CalSTRS’ interest is for teachers as teachers – not necessarily for teachers as shareholders.

This is hardly the first time a pension fund has shown its hand in this way, but it does highlight how funds are even more constrained than businesses in terms of openly pursuing socially responsible goals, and the delicate tapdance they sometimes do around that fact.

As I watch the opening ceremonies of the 2018 Winter Olympic Games, I am struck by all of the design work that goes into the ceremony and the games.  Who designs the vast opening and closing ceremony productions?  Does the host country hire some or all the people who appear in the productions or are some or all volunteers?  Who holds the intellectual property rights to the program elements and the recording of the program?  The International Olympic Committee, I guess . . . .  It strikes me that the Olympic Games have become big business, and intellectual property rights have become important to the value of that business.  The World Intellectual Property Oganization notes that “[t]he Games are as much a celebration of innovation and creativity as they are of humanity, fair play and sporting excellence.”

Perhaps most amusing to me in the run-up to the 2018 Winter Olympic Games has been the coverage of the U.S. opening ceremony outfits, designed by Ralph Lauren.  Even for those of you who purport to know nothing about fashion design, you may recall that Ralph Lauren designs those shirts and shorts and sweaters with the little embroidered polo horse on the chest . . . .  But trust me, he’s an iconic American designer.  Anyway, here is a critique of the American ensembles, ranking each item.  The jacket is heated (!).  But the large fringe suede gloves appear to be a particularly controversial fashion choice.  As one critic noted:

These outfits have come in for a lot of criticism, particularly because they require the athlete to wear ludicrously large gloves that look as though they were designed for grilling by some sadist who then wants the grillers to go up in flames because the fringe of their large gloves has caught on fire.

She goes on to say the following:

The gloves have also come in for criticism because they have a Southwestern, Native American–meets–Route 66 truck stop, tchotchke vibe to them. The Olympic rings and the American flag are beaded. Between the fringe and the beading, there have been some claims and concerns about appropriation. I hear those. However, I do think that, in the long view, we want the American Olympic team outfits to be referencing a broader set of cultural influences on American life.

Wow.  Who knew the business of deigning for the Olympic Games was so complex and fraught with peril?

In truth, the relationship between the U.S. Olympic Committee and Ralph Lauren is just one example of a designer collaboration seen frequently in fashion design in recent years.  Target, H&M, and many others have entered into successful collaborations with major designers.  See, e.g., here, here and here.  These collaborations involve contracts addressing the fusion of the applicable intellectual property rights, among other legal and business issues.  See, e.g., here and here.  This is undoubtedly an interesting aspect of fashion law.

But back to the Olympic outfits . . . .  Bustle is running a series of articles on the team uniforms and their designers.  Here is the first installment.  And if you want to know how much it will cost you to buy parts of the Team U.S.A. opening ceremony outfits, you can read about that here.  They’re pricey; be prepared . . . .

The Yale Law School Center for Private Law is now accepting applications for the 2018-19 Fellow in Private Law. The Fellowship in Private Law is a full-time, one-year residential appointment, with the possibility of reappointment. The Fellowship is designed for graduates of law or related Ph.D. programs who are interested in pursuing an academic career and whose research is related to any of the Center for Private Law’s research areas, which include contracts (including commercial law, corporate finance, bankruptcy, and dispute resolution), property (including intellectual property), and torts. More information is available here.

 

About a week ago, FINRA released a Special Notice detailing a new portal for stakeholders to signal their willingness to serve on FINRA’s board and other important committees.  The new portal creates a way for FINRA to increase engagement from key stakeholders, specifically including retail investors, consumer groups, and institutional investors.  Persons with an interest in serving on FINRA’s committees, advisory boards, or Board of Governors can use this new portal to get their information to FINRA.

FINRA has drawn criticism in the past for bypassing investor and consumer advocates in favor of appointing persons with deep industry ties to serve as “Public Governors” on its governing Board.  In a recent op-ed, Andrew Stoltmann and I pointed out that credibly signalling commitment to FINRA’s stated investor protection mission means that it should have investor advocates on its board.  In a report issued by the Public Investors Arbitration Bar Association (PIABA), we discussed our governance concerns in more detail and suggested that the FINRA Board consider a number of investor advocates with knowledge of the securities industry for future Public Governor seats.  FINRA has now created a process for bringing a broad array of candidates into its nominating process.

Some of these changes may be attributable to the FINRA 360 process led by Robert Cook, FINRA’s new CEO.  This organizational review process has already resulted in substantial increases in transparency.  We praised some of these changes in the PIABA governance report:

FINRA recently announced its FINRA360 organizational improvement initiative. The initiative offers an opportunity for FINRA to build upon existing strengths and become a more effective force for investor protection. FINRA’s successes generate widespread public benefits by giving investors the confidence to invest for their futures. Investor protection also plays a vital role in business capital formation—keeping bad actors out of the market increases investor confidence and willingness to invest. Because FINRA’s policies and enforcement affect far more than its member firms, the public has a strong interest in its regulatory performance.

Transparency of FINRA’s governance structure has received some attention as part of its 360 process. In response to comments received through this process, FINRA disclosed additional information about its Board of Governors on its website for the first time. We encourage FINRA to maintain these disclosures and increase the availability of information about FINRA’s governance. This increased transparency decreases the odds that material conflicts will go undetected and potentially taint FINRA’s vital governance processes.

For this new portal to successfully engage stakeholder communities, FINRA should do some outreach to consumer and investor groups to ensure that awareness spreads quickly.  Unlike a new Beyoncé album, it might take some time for everyone to realize that something new and wonderful has arrived.  Consumer and investor groups should respond to this opening and outreach.