Peter Turchin recently posted an interesting piece on Bloomberg entitled, “Blame Rich, Overeducated Elites as Our Society Frays.”  Here is an excerpt:

The “great divergence” between the fortunes of the top 1 percent and the other 99 percent is much discussed, yet its implications for long-term political disorder are underappreciated…. Increasing inequality leads not only to the growth of top fortunes; it also results in greater numbers of wealth-holders…. There are many more millionaires, multimillionaires and billionaires today compared with 30 years ago, as a proportion of the population…. Rich Americans tend to be more politically active than the rest of the population. They support candidates who share their views and values; they sometimes run for office themselves. Yet the supply of political offices has stayed flat …. In technical terms, such a situation is known as “elite overproduction.” … [Another example:] Economic Modeling Specialists Intl. recently estimated that twice as many law graduates pass the bar exam as there are job openings for them…. Past waves of political instability, such as the civil wars of the late Roman Republic, the French Wars of Religion and the American Civil War, had many interlinking causes and circumstances unique to their age. But a common thread in the eras we studied was elite overproduction. The other two important elements were stagnating and declining living standards of the general population and increasing indebtedness of the state…. Elite overproduction generally leads to more intra-elite competition that gradually undermines the spirit of cooperation, which is followed by ideological polarization and fragmentation of the political class. This happens because the more contenders there are, the more of them end up on the losing side. A large class of disgruntled elite-wannabes, often well-educated and highly capable, has been denied access to elite positions…. History shows a real indeterminacy about the routes societies follow out of [such] instability waves. Some end with social revolutions, in which the rich and powerful are overthrown…. In other cases, recurrent civil wars result in a permanent fragmentation of the state and society…. In some cases, however, societies come through relatively unscathed, by adopting a series of judicious reforms, initiated by elites who understand that we are all in this boat together. This is precisely what happened in the U.S. in the early 20th century. Several legislative initiatives, which created the framework for cooperative relations among labor, employers and the government, were introduced during the Progressive Era and cemented in the New Deal. By introducing the Great Compression, these policies benefited society as a whole.

When teaching on entity formation, my students often ask why so many companies choose Delaware.  Numerous academics have attempted to answer that question, and now the Official Website of the First State [Delaware] lists reasons why it thinks businesses choose Delaware.

The listed reasons are:

  1. The statute
  2. The courts
  3. The case law
  4. The legal tradition
  5. The Delaware Secretary of State

No new claims here, but interesting to see how the state sees (or promotes) its advantages. 

The webpage also includes a blog, entitled “Delaware Corporate and Legal Services Blog,” which only has a few posts so far, but may be worth tracking. 

H/T: Francis Pileggi

Federal district court judge Jed Rakoff is no stranger to controversy.  He has admonished the SEC for failing to obtain admissions in two settlements and other judges have since followed suit (see here for example). This likely played some part in SEC Chair Mary Jo White’s decision in June to start seeking admissions during settlements.  White announced a few days ago that her lawyers are ready for more trials, and that in her view, trials facilitate public accountability.

Judge Rakoff has now set his sights on the Department of Justice, and his recent speech entitled “Why Have No High Level Executives Been Prosecuted in Connection with the Financial Crisis,” has made headlines around the world.  I heavily excerpt the speech below, but I recommend that you read it in full.  In his remarks, he sharply criticizes the DOJ for failing to prosecute individuals, a topic I discussed last week here. He also offers his own theories to rebut what the DOJ’s explanations. His remarks remind us that the 5-year statute of limitations on many crimes will run shortly and therefore many people may never face prosecution.

Judge Rakoff first acknowledged in his speech that prosecutors had other priorities including focusing on post-9/11 and insider trading cases.  He then minces no words in spreading the blame around. Some of his most biting censure is below:

 “…what I am suggesting is that the Government was deeply involved, from beginning to end, in helping create the conditions that could lead to such fraud, and that this would give a prudent prosecutor pause in deciding whether to indict a C.E.O. who might, with some justice, claim that he was only doing what he fairly believed the Government wanted him to do… [i]n recent decades, however, prosecutors have been increasingly attracted to prosecuting companies, often even without indicting a single individual. This shift has often been rationalized as part of an attempt to transform “corporate cultures,” so as to prevent future such crimes; and, as a result, it has taken the form of “deferred prosecution agreements” or even “non-prosecution agreements,” in which the company, under threat of criminal prosecution, agrees to take various prophylactic measures to prevent future wrongdoing. But in practice, I suggest, it has led to some lax and dubious behavior on the part of prosecutors, with deleterious results… [The prosecutor is] happy because [he] believe[s] that [he has] helped prevent future crimes; the company is happy because it has avoided a devastating indictment; and perhaps the happiest of all are the executives, or former executives, who actually committed the underlying misconduct, for they are left untouched… I suggest that the future deterrent value of successfully prosecuting individuals far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window-dressing. Just going after the company is also both technically and morally suspect.”

I am sure that general counsels, ethics officers and board members don’t think that their compliance programs are cosmetic, check-the-box initiatives, but they should take heed of Judge Rakoff’s words. Clearly the SEC has made a significant policy shift and perhaps the DOJ will as well.  In the meantime, companies and their counsel should prepare for the new paradigm in which settlements may require more than shareholder dollars.

I was recently asked to evaluate a corporation’s obligation to indemnify a director named in a derivative suit initiated by the corporation alleging that the director usurped corporate opportunities. The MBCA establishes a standard framework for optional and mandatory indemnification of directors and officers, sets the appropriate boundary of indemnification obligations (i.e,. no reimbursement of derivative suit settlements or intentional misconduct), establishes the procedures for indemnification and advancement of expenses, and provides mechanisms for directors to enforce their indemnification rights through court orders.  The standard procedures for indemnification require the corporation to authorize the indemnification and make a determination that the conduct at issue qualifies for indemnification.

MBCA § 8.55 Determination and Authorization of Indemnification

(a) A corporation may not indemnify a director ….[until after] a determination has been made that indemnification is permissible ..[and].. director has met the relevant standard of conduct ….

(b) The determination shall be made:

(1)…. a majority vote of all the qualified directors…., or by a majority of the members of a committee;

(2) by special legal counsel ….or

(3) by the shareholders, but shares owned by or voted under the control of a director who at the time is not a qualified director may not be voted on the determination.

(c) Authorization of indemnification shall be made in the same manner as the determination that indemnification is permissible…..

 The determination is tricky for advanced expenses because the determination is made before the adjudication and with limited facts.  Yet, as the comments to the MBCA reflect, access to advance funds is often necessary to provide directors/officers with full protection because few individuals have personal resources to finance potentially complex and protracted litigation.  Some states, like Georgia OCGA § 14-2-856 and Delaware § 145, broaden the indemnification provisions established in the MBCA by providing procedures for shareholder agreements to expand the scope of corporate indemnification obligations and avoid the “determination” of complying conduct required under the MBCA.  A writing mandating an advance of expenses creates a vested right that cannot be unilaterally terminated. More importantly, statutes that recognize a vested right to advanced expenses avoids the requirement of a determination regarding the advance, which will often constitute a self-dealing transaction (director named in suit and seeking advance, also votes on determination of conduct qualification for indemnification) and therefore requires the entire fairness evaluation.

The expanded indemnification statutes raise all sorts of interesting questions about the scope of indemnification (the Georgia statute for example is intended to expand the scope to possibly include derivative suit settlements and fines), the process required for the mandatory advances (i.e., whether a shareholder vote approving the obligation can later be attacked because a defendant, who is now conflicted, voted shares in favor of the obligation), and whether these provisions violate public policy.  If you know of cases addressing these issues or litigating these expanded indemnification statutes in other jurisdictions, please respond in the comments.

Anne Tucker 

Given my interest in social enterprise, many friends and colleagues e-mailed me Professor Steven Davidoff’s recent article in the New York Times DealBook about Make a Stand,  a company founded by then eight-year old Vivienne Harr that sells “all-natural, certified organic, U.S. grown/Fair-Trade, GMO-free” lemonade and donates 5% of gross revenue to organizations focused on ending child slavery. 

As Professor Davidoff mentions, Make a Stand is organized as a social purpose corporation in Washington state.  Social purpose corporations are one of the many “social enterprise” legal forms that have arisen in the U.S. over the past five years, along with benefit corporations, benefit LLCs, flexible purpose corporations, L3Cs, public benefit corporations, and sustainable business corporations. 

While these new legal forms have been grouped under the term “social enterprise,” the term “social enterprise” is not well defined in the literature. 

The Social Enterprise Alliance (the “SEA”) defines “social enterprise” through a tripartite test:

  1. Directly addresses social need;
  2. Commercial activity [not donations] drives revenue; and
  3. Common good is the primary purpose.

The recent “social enterprise” statutes, however, do not expressly require products or services of social enterprises to directly address social need in the way described by the SEA.   Most of the social enterprise statutes are also unclear on whether shareholder or other stakeholder interests take priority.  The benefit corporation statutes do require a “general public benefit purpose” but simply list shareholder interests alongside other stakeholder interests that the directors must consider in every decision (and shareholders are the only listed stakeholders that the statutes give standing to sue derivatively ).

Professor Christine Hurt (Illinois Law) describes one of the differences between corporate social responsibility (“CSR”) and social entrepreneurship (often used interchangeably with “social enterprise”) as: 

CSR focuses on companies that make widgets, but who do so in an enlightened way; Social entrepreneurship envisions companies that make a completely different kind of widget. . . .most of the companies who are heralded for “good CSR” make products for rich people or at least premium products that are a splurge for the average person: Ben & Jerry’s ice cream; Burt’s Bees; Toms shoes. In making these products, which are more expensive than their competitors, they brand themselves as “giving back” or being enlightened to employees, communities or the environment. These companies don’t seem to be losing money by “doing well and doing good,” though their profit margins arguably might be lower than otherwise.

 

Social entrepreneurs start for-profit companies in a sphere usually inhabited only by not-for-profits and try to do something that can’t be done by NGOs because of capital scarcity or knowhow scarcity. Social E’s make a different kind of widget that isn’t needed by rich people, but by the needy: affordable clean water, light sources, hygiene products, sanitation, etc.

However, most of the companies that have chosen the social enterprise legal forms, including Make a Stand, look more like companies engaging in CSR than social enterprises as defined by Professor Hurt.  Make a Stand’s lemonade may be made in an “enlightened way” and a percentage of revenue is given away, but the lemonade itself appear to be made for sale to relatively wealthy consumers. 

Some legal scholars have given “social enterprise” a much broader definition, a definition that looks much more like Professor Hurt’s description of CSR – essentially, companies that use commercial activity to drive revenue with at least one significant social or “common good” purpose. 

Part of the confusion stems from people using the term “social enterprise” to describe at least three different types of enterprises, which I have listed below.  Some companies will, of course, fall in more than one category. 

Generous Enterprise.  What (and how much) the company gives away.  Examples include Make a Stand’s 5% of revenue giving pledge, Patagonia’s 1% of revenue for the planet commitment, and TOMs Shoes’ and Warby Parker’s buy one, give one model.     

Responsible Enterprise.  How (and under what conditions) the product is made.  Examples include companies committed to fair trade, organic, recycled materials, LEED certified buildings, good corporate governance practices, fair treatment of employees, and the like.  Some companies that spring to mind as attempting to be “responsible” are Ben & Jerry’s, Method, Plum Organics, and Seventh Generation.  On the smaller side, someone I went to high school is a co-founder of a company that falls into this category; Recover Brands makes clothing from recycled plastic bottles and recycled cotton.

Justice Enterprise.  Who makes and who purchases the product.  These companies exist to provide employment to disenfranchised and/or create products for purchase by disenfranchised.  Greyston Bakery, Spring Back Recycling (a company that began as a project by the Belmont University Enactus team), Thistle Farms, and others, exist, in large part, to hire, train, and support the disenfranchised (especially those transitioning from homelessness and prison).  Companies like Grameen Danone Foods, Cure2Children, and Power Africa develop products or services targeted at underserved communities with the goal of improving their lives; each of these three organizations is providing and developing, as Professor Hurt put it, “a different kind of widget that isn’t needed by rich people, but by the needy.”  Steven Buhrman at Wannado Local inspired the naming of this category.  As mentioned to me by Professor Hurt, this category could be broken into two.  I agree.  Perhaps, “reintegration enterprises” for the first, and  “social innovation enterprises” for the second.

Social enterprises could also be divided by whether they make and distribute profits.  Originally, the term social enterprise was used primarily in the non-profit context and primarily in articles originating in business schools.  Law professors, however, have generally and increasingly used the term in the for-profit context.

Academics, managers, investors, consumers, customers, and governments are all using the term “social enterprise,” but more precise terminology may be helpful.  Clarity is important when governments offer incentives to “social enterprises” and investors decide to invest in “social enterprises” so that both groups identify the type of social return they are seeking.  Also, clarity within the three groups is needed.  How much giving is sufficient?  What are the standards for responsible operation?  What types of products and services are appropriate for a justice enterprise?  Right now there are more questions than answers in the social enterprise space, but there are an increasing number of people working on answers, including those at B Lab, academics and practitioners (including those who blog at SocEntLaw.com), and the Sustainability Accounting Standards Board (“SASB”).

Cross-posted at SocEntLaw.

Last week, I had the pleasure of being part of the Second Annual Searle Center Conference on Federalism and Energy in the United States.  (I had the good fortune to be part of the first one, too.)  The conference covered a wide range of energy issues from electricity transmission siting to hydraulic fracturing to natural gas markets.  One paper/presentation struck me as particularly interesting for markets generally (I am told an update version will be available soon at the same site: “The Evolution of the Market for Wholesale Power” by Daniel F. Spulber, Kellogg School of Management, Elinor Hobbs Distinguished Professor of International Business and Professor of Management Strategy & R. Andrew Butters, Kellogg School of Management, Northwestern University.

Here is the conclusion: 

A national market for wholesale electric power in the US has emerged following industry restructuring in 2000. Tests for correlation and Granger Causality between trading hubs support the presence of a national market. Going beyond pairwise analysis, we introduce an array of multivariate techniques capable of addressing the national market hypothesis, including the common trend test. Although there is strong evidence of integration between the series, the analysis suggests a division between the eastern and western parts of the market. We also find border connects of 300 miles between the three interconnects.

The absence of transmission between the interconnects and significant border effects suggests that the national market is not yet fully integrated, even within the one-month horizon. Construction of transmission facilities between the interconnects would complete the development of the US wholesale market for electric power. Our analysis suggests that transmission facilities connecting the three regions would result in substantial gains from trade.

This conclusion – that “[a] national market for wholesale electric power in the US has emerged following industry restructuring in 2000 – could have a profound effect for how we view (and FERC views) wholesale electricity markets.  The study notably does not control for or otherwise address the price of renewable energy credits (RECs), which are required for compliance with renewable portfolio standards in a majority of states. This may not change the conclusion, but it would be interesting to see how if the RECs have any influence on the market operations.

In addition, it’s possible that more than just the 2000 market restructuring is at play here.  Since that time, electricity generation from natural gas has grown dramatically, and there is every reason to believe that will continue.  According to the Energy Information Administration, “Nearly 237 GW of natural gas-fired generation capacity was added between 2000 and 2010, representing 81% of total generation capacity additions over that period.”  If natural gas really is a major driver in facilitating this market, it would mean that that recent shale gas boom is even broader reaching than some may have expected. 

There’s more work to be done here to be certain a national market for electricity really is emerging and if more can be done to facilitate that market. If true, such a market could bode well for the consumers, especially those in higher cost regions.  It could also be an indicator that the regulatory structure of the market, even if not ideal, it working efficiently.  If so (as I am inclined to believe), it suggests that the Congress and FERC should leave the market-related regulations alone, and focus efforts on things that will further develop the market, such as the study’s finding “that transmission facilities connecting the three regions would result in substantial gains from trade.”

A student who completed one of my computer-assisted legal exercises pointed out that one of his answers was partially correct, and asked me why he didn’t receive partial credit. The short answer is a technical one–the software doesn’t allow for partial credit on questions. But the student’s inquiry made me think about the deeper issue of giving credit for partially correct answers.

All of the law professors I know give partial credit for exam essay answers that contain errors or reach erroneous conclusions. In the context of a single end-of-semester exam, where there’s significant time pressure and no opportunity for students to redo their answers, that philosophy probably makes sense. But does it teach our students the wrong lesson?

One doesn’t get credit for partially correct answers in law practice. Answers are either right or wrong. If the lawyer tells the client yes and the correct answer is no, it doesn’t matter that most of the lawyer’s analysis was correct. Overlooking a crucial fact or missing an important step in the analysis is not excusable in practice. The client is unlikely to congratulate the lawyer for being 80% correct.

Of course, lawyers get lucky. The lawyer’s answer may be right even though the analysis is completely wrong. A poorly drafted clause in a contract may never be triggered. But lawyers don’t survive for long on luck. Eventually, poor or incomplete analysis will bite the lawyer.

A partially correct answer is bad lawyering. It may make sense to give credit for a partially correct answer on law exams, but we should make it clear to our students that partially correct isn’t acceptable in real life.

A quick review of the top 10 Papers for Corporate, Securities & Finance Law eJournals on SSRN for the period of September 18, 2013 to November 17, 2013 (here), led me to Utpal Bhattacharya’s paper “Insider Trading Controversies: A Literature Review.”  Here is the abstract:

Using the artifice of a hypothetical trial, this paper presents the case for and against insider trading. Both sides in the trial produce as evidence the salient points made in more than 100 years of literature on insider trading. The early days of the trial focus on the issues raised in the law literature like fiduciary responsibility, the misappropriation theory and the fairness and integrity of markets, but the trial soon focuses on issues like Pareto-optimality, efficient contracting, market efficiency, and predictability raised in the financial economics literature. Open issues are brought up. A jury finally hands out its verdict.

Congratulations to Eric Chaffee, former BLPB contributing editor & friend of the blog, for taking over the Securities Law Prof Blog reins from Barbara Black.  Barbara has left some big shoes for Eric to fill, having single-handedly built the Securities Law Prof Blog into one of the staple blogs for business law folks, but if anyone is up to the task it’s Eric.  Make sure you add the Securities Law Prof Blog to your personal blogroll.

I have posted an updated draft of my latest paper Rehabilitating Concession Theory, which is forthcoming in the Oklahoma Law Review, on SSRN.  I have made only minor changes to the the prior draft, but I thought I’d post the abstract and link to the paper here in case any blog readers haven’t seen the paper before and might be interested in the content.

In Citizens United v. FEC, a 5-4 majority of the Supreme Court ruled that, “the Government cannot restrict political speech based on the speaker’s corporate identity.” The decision remains controversial, with many arguing that the Court effectively overturned over 100 years of precedent. I have previously argued that this decision turned on competing conceptions of the corporation, with the majority adopting a contractarian view while the dissent advanced a state concession view. However, the majority was silent on the issue of corporate theory, and the dissent went so far as to expressly disavow any role for corporate theory at all. At least as far as the dissent is concerned, this avoidance of corporate theory may have been motivated at least in part by the fact that concession theory has been marginalized to the point where anyone advancing it as a serious theory risks mockery at the hands of some of the most esteemed experts in corporate law. For example, one highly-regarded commentator criticized the dissent by saying: “It has been over half-a-century since corporate legal theory, of any political or economic stripe, took the concession theory seriously.” In this Essay I consider whether this marginalization of concession theory is justified. I conclude that the reports of concession theory’s demise have been greatly exaggerated, and that there remains a serious role for the theory in discussions concerning the place of corporations in society. This is important because without a vibrant concession theory we are primarily left with aggregate theory and real entity theory, two theories of the corporation that both defer to private ordering over government regulation.