Professor Caleb Griffin (University of Arkansas School of Law) offered testimony before the Senate Committee on Banking, Housing, and Urban Affairs in June of 2022 on problems associated with the fact that the “Big Three” index fund managers (Vanguard, BlackRock, and State Street) cast almost a quarter of the votes at S&P 500 companies. As a result, enormous power is concentrated in the hands of just a few index fund managers, whose interests and values may not align with those whose shares they are voting. Professor Griffin proposed two solutions to this problem: (1) “categorical” pass-through voting, and (2) vote outsourcing. Professor Griffin’s remarks were recently posted here, and here’s the abstract:

In recent years, index funds have assumed a new and unprecedented role as the most influential players in corporate governance. In particular, the “Big Three” index fund managers—Vanguard, BlackRock, and State Street—occupy a pivotal role. The Big Three currently cast nearly a quarter of the votes at S&P 500 companies, and that figure is expected to grow to 34% by 2028 and over 40% in the following decade.

The best solution to the current problem—where we have virtually powerless index investors and enormous, concentrated power in the hands of index fund management—is to transfer some of that power to individual investors.

There are two primary ways to do so. The first is to allow individual investors to set their own voting instructions with “categorical” pass-through voting, where investors are able to give semi-specific instructions on common categories of topics. The second approach is vote outsourcing, where investors could instruct management to vote their shares in alignment with a third party representative.

Pass-through voting preserves the economies of scale at the Big Three while addressing the root of the problem: concentrated voting power in the hands of a small, unaccountable group. Ultimately, index funds occupy a unique and important role in financial markets, not least because they’re disproportionately owned by smaller, middle-income investors. These investors have a valuable voice, and pass-through voting would help us hear it.

I recently came across a letter sent by Kentucky State Treasurer Allison Ball to S&P Global Ratings back in June 2022 and thought the contents might be of interest to any of our readers who missed the letter when it was originally sent.  Below is an excerpt.  You can find the full letter here.

On behalf of the Commonwealth of Kentucky and those we serve, we firmly and collectively object to S&P Global Ratings’ (S&P) new plan to include ESG credit indicators in its credit ratings for states and state subdivisions….

These ESG credit indicators inject unnecessarily subjective and political judgments into a rating system that should be solely pecuniary in nature. Earlier this year, S&P wrote, “having a social mission and strong ESG characteristics does not necessarily correlate with strong credit worthiness and vice versa,” making it abundantly clear these factors are not relevant for determining state credit calculations. We thus agree with our friends in Utah who admonished these new scoring standards and exposed them as an exercise in political subjugation when they noted the following in a recent letter signed by every Utah statewide official and their entire federal delegation:

[there are] two layers of indeterminacy that make ESG an exercise in servitude: 1) which “ESG factors” are chosen, and 2) the “correct” answer to any given factor. Whoever answers those questions has all the power in achieving a desired outcome.

Blinded by the desire to achieve politically-motivated outcomes, S&P also fails to complete a cost-benefit analysis for how this new plan will impact both individual states and the country at large. The core purpose of S&P is to provide objective insights into the financial competencies of each state. However, this new plan looks more like China’s social credit system and purposefully muddies the waters between objective financial concerns and normative political issues. It creates a dangerous framework for state borrowing mechanisms, whereby state creditworthiness will fluctuate wildly based on ever-changing political tides.

It is easy to discern the significant harm caused by placing subjective and environmental factors ahead of objective financial factors. For example, lessening American production of fossil fuels before our country has the infrastructure to support widespread reliance on green energy will only lead to a dependence on the fossil fuels produced by hostile nations and create significant national security risks.

S&P has yet to engage in a cost-benefit-analysis that weighs national security risks and the health of state economies against the need to introduce these ESG factors into its credit ratings. S&P should be forced to grapple with these realities, as subjective, leftist ESG scoring will unquestionably hurt states like Kentucky—where a reduction in coal, oil, and gas production would cause increased unemployment, higher fuel costs, and a decrease in overall tax revenue, thereby negatively impacting Kentucky’s overall creditworthiness and causing undue hardship and suffering for the people of this state. The fossil fuel industry is one of Kentucky’s signature industries, and stifling it will be harmful and costly for Kentuckians and our economy. Simply put, the emergence of these factors creates a no-win situation for our country and states like Kentucky. S&P should be forced to explain how it has weighed these factors against its decision to implement its new plan. We believe, S&P has not produced such a document because it is unable to perform a true cost-benefit-analysis without exposing itself as a political devotee instead of a leading provider of objective credit ratings.

Accordingly, we object to S&P’s new ESG credit indicators and urge S&P to only evaluate the creditworthiness of states and state subdivisions based on objective and financial factors. These ratings should not be politicized.

I posted earlier this week with a plug for my new paper on the internal affairs doctrine and an update on the Lee v. Fisher forum selection bylaw litigation in the Ninth Circuit, so I’ve just got a quick hit for today.

Unless you’ve been living in a cave, you know that Musk closed his purchase of Twitter on Thursday night; as of Friday, the stock had been delisted.  The litigation over whether Twitter lied about its business has come to a halt….

….or has it?

You may recall that in August, a Twitter whistleblower – Peiter Zatko – came forward as a whistleblower about Twitter’s internal business operations.  Elon Musk amended his complaint in Chancery to incorporate Zatko’s claims, alleging that the problems Zatko identified – such as a failure to comply with an FTC settlement – represented additional fraudulent actions on Twitter’s part that allowed Musk to terminate the deal.

What you may have missed, though, is that shortly after Zatko went public, the Rosen Law Firm filed a securities class action, Baker v. Twitter, C.D. Cal. 22-cv-06525, based on Zatko’s allegations.  The complaint names several Twitter executives – including Jack Dorsey – and Twitter itself as a defendant.  (It also, amusingly, appears to have accidentally cut-and-pasted allegations from an Activision complaint.)   

And as far as I can tell, there is no reason why that suit should not continue.  There has to be a lead plaintiff, of course, and an amended complaint, but legally, it persists against the named executives and now the Musk-owned Twitter.  Better yet, though there may be problems with loss causation depending on how Twitter’s stock moved on any given day, there’s really no reason the amended complaint couldn’t beef up allegations about spam and misleading mDAU figures, relying not only on the Zatko complaint, but also on the confidential Twitter data that Musk revealed when he filed his own complaints in Chancery.

Which means, Musk may be stuck arguing to a court that there were never any problems, let alone mDAU problems, at Twitter at all.

We all look forward to the CW allegations from any recently-fired Twitter personnel.

Two recent posts that might be related:

On Tuesday, Vivek Ramaswamy posted The ESG Fiduciary Gap on The Harvard Law School Forum on Corporate Governance.  In that post, he noted that:

BlackRock is currently under investigation for antitrust violations precisely because of its coordinated ESG activism through groups like Climate Action 100+, Net Zero Asset Managers, and Glasgow Financial Alliance for Net Zero. Vanguard and State Street are members of many of the same groups. In fact, until recently, as Arizona’s Attorney General has observed, “Wall Street banks and money managers [were] bragging about their coordinated efforts to choke off investment in energy.” U.S. antitrust statutes are broad by design. They forbid competitors from entering into any agreement with the purpose or likely effect of reducing supply in a relevant market. Here, through these groups, BlackRock is cooperating with its competitors to make concerted efforts to decrease marketwide output in fossil fuels. That is no secret; it is the very purpose of these organizations. Net Zero Asset Managers, for example, makes clear that it has an “expectation of signatories” like BlackRock to force a “rapid phase out of fossil fuel[s],” including by, for example, refusing to finance new coal projects. If the CEOs of Exxon, Chevron, and Shell decided to cut gas production and prices then spiked, the DOJ Antitrust Division would be making arrests. But when the Big Three pressure them to do the same thing, it is praised as “ESG.”

Today, DealLawyers.com linked to a Freshfields blog, which noted that:

Led by antitrust officials in the US appointed by President Biden, authorities around the world have turned a critical eye towards private equity (PE), making PE the latest target in the global trend toward increased antitrust scrutiny…. The focus on PE in the US may inspire other regulators, in particular across the Atlantic. In Germany, a draft law is being discussed which would grant the Federal Cartel Office broad powers to address perceived “disruptions” of competition. Those powers are likely to include oversight of cross-ownerships and interlocking directorates. In 2020, the European Commission requested a study on the effects of common shareholdings by institutional investors and asset managers on European markets. While no major enforcement action has been taken since the report, the headlines generated by the DOJ may inspire the European Commission to have a renewed look at these issues in Europe. And in the UK, while the Competition and Markets Authority has recognized that highly leveraged private equity acquisitions are unlikely in themselves to impact competition, it has demonstrated a willingness to follow the European Commission in pursuing private equity owners for potential antitrust violations by their portfolio companies, as demonstrated most recently in relation to its case against excessive pricing for thyroid drugs.

And one might want to add the following from Amanda Rose (which I previously quoted here):

Traditional asset managers claim their commitment to ESG is motivated by a desire to improve long-term fund performance for the benefit of investors. But agency costs offer an alternative potential explanation: embracing the ESG movement may help asset managers curry political favor, enabling them to fend off greater regulation of the industry; it may advance the personal sociopolitical commitments of those who ran them; or it may offer a way to attract investors to fund offerings without imposing any meaningful limitations on how a fund is managed.

The SEC recently released a highly specific proposal for registered investment advisers with comments open until at least December 27th.  The proposal “would require advisers to conduct due diligence prior to engaging a service provider to perform certain services or functions. It would further require advisers to periodically monitor the performance and reassess the retention of the service provider in accordance with due diligence requirements to reasonably determine that it is appropriate to continue to outsource those services or functions to that service provider.”

My immediate reaction is that I’m generally in favor of RIAs performing appropriate due diligence, but that I’m a bit skeptical about the need for specific rules in a principles-based framework.  It’s certainly true that Advisers outsource a significant amount of work today.  And it is also true that, as the proposal details, problems at third party service providers have led to broader problems. 

It’s easy to see how concentration risk can grow in such an environment.  If a huge swath of the market outsources to a particular third-party firm, a failure at the third party could paralyze the market. 

It’ll be interesting to watch to see how RIAs react to this.

 

Dear BLPB Readers:

This Friday, October 28th, at 10am ET, the Wharton Initiative on Financial Policy and Regulation is hosting an hour-long online seminar with Professor Joshua C. Macey on Market Power and Financial Risk in U.S. Payment Systems.  It should be a great event!  Registration information and a link to the whitepaper is here: Download Market Power_Financial Risk

 

“Human beings are far more complicated and enigmatic and ambiguous than languages or mathematical concepts.” – Iris Murdoch, The Sovereignty of Good Over Other Concepts (88)

During lunch yesterday, I attended a panel on “Measuring the S in ESG” at Belmont University’s Hope Summit. The presenters made plenty of thoughtful comments, but I did not leave with much hope that we will be able to accurately measure “S” (social good). (The panel also seemed to confirm that most institutional investors view ESG data primarily as a tool to assist in achieving excellent financial performance, and most are not very interested in sacrificing profits, at least not for more than a few years.)

Later that afternoon, at a celebration for our neighborhood bus driver, I began to realize why I had so little hope for numerical scores of social good. Glendra Chapman Thompson has been driving the same bus route in our neighborhood for 32 years; she is only retiring now due to serious health issues. To say she is beloved is an understatement. Her joy emanates. She is patient, kind, and always smiling. She knows the name of every child, and you can sense that she cares deeply for each one. As Iris Murdoch writes in the opening quote, languages or mathematical concepts cannot capture Mrs. Thompson’s essence.

Organizations are made up of human beings like Mrs. Thompson. While I think we could agree that Mrs. Thompson has created a massive amount of social good, we can’t capture her goodness in a number. Her love is irreducible.  

Attempting to measure social good is not only practically impossible, but the attempted measurement may also do harm. By attempting to reduce the impact of someone like Mrs. Thompson to a number, you would miss nuance and beauty. Further, by measuring and marketing social good you can cut against humility, which is often considered a cornerstone virtue.  

In the corporate context, there may be some ESG data that is helpful. (Wage data, for example, can be telling). But I think we should be honest about the many things we cannot measure. Stories and interviews may be needed, and the most significant social good may be the least flashy.  

Watch the video our school system did for Mrs. Thompson here. We often walk our children to school, but we would let them ride the bus the 800m to school on occasion simply to be in her caring presence. We will miss you Mrs. Thompson.

On Sunday, I posted a new paper to SSRN, forthcoming in the Wake Forest Law Review.  It’s called Inside Out (or, One State to Rule them All): New Challenges to the Internal Affairs Doctrine, and it covers a lot of territory I’ve touched on in blog posts, namely, litigation-limiting bylaws, the Salzberg decision, California’s board diversity law, and issues regarding the internal affairs doctrine and LLCs.  Here is the abstract:

The internal affairs doctrine provides that the law of the organizing state will apply to matters pertaining to a business entity’s internal governance, regardless of whether the entity has substantive ties to that jurisdiction. The internal affairs doctrine stands apart from other choice of law rules, which usually favor the jurisdiction with the greatest relationship to the dispute and limit parties’ ability to select another jurisdiction’s law. The doctrine is purportedly justified by business entities’ unique need for a single set of rules to apply to governance matters, and by the efficiency gains that flow from allowing investors and managers to select the law that will govern their relationship.

The contours of the internal affairs doctrine have never been defined with precision, but several recent developments have placed new pressures on the doctrine’s boundaries. These include: (1) states’ attempts to regulate the governance structures of businesses that operate within their borders in order to benefit non-investor constituencies, such as diversity requirements for corporate boards; (2) the growing prevalence of LLCs, which – because of their flexible, contractual structure – blur the lines between investment relationships and employment relationships; (3) the increasing use of shareholder agreements, which are governed by contractual rules, and not infrequently the rules of a jurisdiction other than the one in which the business entity is organized; and (4) jurisprudence permitting the charters and bylaws of Delaware corporations to include provisions that govern litigation based on non-Delaware law.

This Essay explores modern challenges to the coherence of the internal affairs doctrine, and recommends alternatives.

Of course, one of the cases I tackle in the paper is Lee v. Fisher, which I blogged about when the district court and appellate decisions issued.  Briefly, the district court enforced Gap’s forum selection bylaw that purported to move a Section 14(a) derivative claim to Delaware Chancery, which had no jurisdiction to hear it; on appeal, the Ninth Circuit affirmed.

Well, obviously reacting to the persuasive case I made in my paper, twenty-four hours after I posted, the Ninth Circuit vacated its Lee v. Fisher decision, and agreed to rehear the matter en banc.  I’ve updated my paper with a footnote to reflect the new development, which is probably all I’ll do for now, since a new decision is unlikely to issue before publication.

The Fordham Journal of Corporate & Financial Law is now accepting submissions for the Spring 2023 Issue of Volume XXVIII.  As one of the premier student-edited business law journals in the country, the Journal ranks among the top-five specialty journals in banking and financial law, and among the top-ten specialty journals in corporate and securities law.

The Journal welcomes articles and essays addressing important issues in banking, bankruptcy, corporate governance, capital markets, finance, mergers and acquisitions, securities, and tax law and practice.

Please send all submissions to either our Scholastica page or our email at jcfl@fordham.edu. For consideration in our Spring 2023 Issue, kindly send in your submissions by Friday, December 14th, 2022.

For more information regarding submissions, please visit our website. If you have any questions, please contact Brendan Finnerty, Senior Articles Editor, at bfinnerty6@fordham.edu.

In prior posts, I’ve plugged a couple of legal history articles, essentially offering different accounts of how the corporation, with its distinctive features, came to be.  In particular, I highlighted Margaret Blair’s piece on how corporate law is inextricably tied to state recognition, and Taisu Zhang’s and John Morley’s paper on how modern corporate features are tied to a developed state capable of adjudicating the rights of far flung investors with consistency.

Into this mix I’ll introduce Robert Anderson’s new paper, The Sea Corporation, forthcoming in the Cornell Law Review, demonstrating that the features we think of as defining the corporate form – limited liability, tradeable shares, entity shielding, separate personality, and centralized management selected by the equity owners – were all associated with admiralty law for centuries before the development of the modern corporation, embodied in the form of the ship’s personality.  Anderson points out that, to some extent, these were necessary given the realities of maritime commerce: when a ship docked in a foreign port, identifying and litigating against its distant owners was nearly impossible.  Therefore, creditors necessarily could only bring an in rem action against the ship itself; if the claims were less than the ship’s value, the owners could be relied upon to appear in court to collect the residual.  Otherwise, creditors would be left only to collect against the ship’s assets.  Anderson also highlights that maritime law addresses a problem that has vexed corporate scholars, namely, how to deal with limited liability and involuntary creditors (like tort victims).  Some have suggested these creditors should receive priority of payment over voluntary ones; he points out that maritime law operates in just this manner and may provide guidance in the corporate sphere.

Anyway, here’s the abstract:

Over the two centuries the corporation has become the dominant form of business organization, accounting for more productive assets than all other business forms combined. Yet the corporation is relatively young for a legal institution of such economic importance. As late as the middle of the nineteenth century, most business was still conducted through partnerships, with corporations active only in a few industries. Only in the ensuing decades did restrictions ease allowing the corporation to secure its economic dominance.

Commentators widely attribute the corporation’s success to a set of features thought to be unique to the corporation, including limited liability, transferable shares, centralized management, and entity shielding. Indeed, the consensus among economic and legal historians is that these essential corporate features created a unique economic entity that rapidly displaced the obsolete partnership.

This Article argues that these economic features were not unique to the corporation, nor did they first develop in the business corporation. Over many centuries, the maritime law developed a sophisticated system of business organization around the entity of the merchant ship, creating a framework of legal principles that operated as a proto-corporate law. Like modern corporate law, this maritime organizational law gave legal personality to the ship, limited liability, transferable shares, centralized management, and entity shielding. The resulting “sea corporations” were the closest to a modern corporation that was available continuously throughout the 17th through early 19th centuries in Europe and the United States.

The fact that maritime law developed all the most important features of corporate law offers important lessons for business organizational law itself. The parallel development of the same characteristics, with different and independent mechanisms, is strong evidence of the economic importance of the features of the modern corporation. The maritime law employed a unique device—the maritime lien—to achieve the same economic results as the nascent corporation. The key turn was the use of a property mechanism, rather than the contract mechanisms of partnership law, to implement in rem attributes. The vessel is property come to life in the eyes of the law, developing a form of legal personhood. Viewed in this broader context, the corporation is not a unique institutional solution to recurrent economic problems; it was a convenient vehicle for expanding and generalizing a set of economic solutions.

This new organizational theory of maritime law provides potentially important lessons for both maritime law and business organizations law. First, the theory provides a guiding principle for otherwise disorganized features of maritime law. It suggests that courts should explicitly interpret maritime law as a form of business entity law, keeping maritime law’s distinctive purposes, but drawing from the rich theoretical insights of law of other business associations to inform its unique institutions. At the same time, the long history of maritime law as business organization law provides hints for enduring challenges in corporate law, such as externalities of limited liability on involuntary creditors, such as tort creditors. Here, maritime law provides time-tested solutions, providing a system that provides priority for such creditors over contract creditors, solving one of corporate law’s most vexing problems.