On the June 16, 2022, episode of the Capital Record podcast, David Bahnsen and Oren Cass have a lively and stimulating conversation about the social utility of private equity. You can find the episode here. Below is a brief description.

David is joined once again by Oren Cass of American Compass, this time to discuss the state of American financial markets. The two have a congenial conversation about private equity and venture capital, what is going wrong with the two, and what the solutions may be. There is more disagreement than agreement, but there is a mutual and sincere effort to identify issues and present thoughtful remedies. Whatever your view may be on what is right or wrong in the evolution of financial markets, you’ll find this robust discussion thoughtful, provocative, and engaging.

In December 2018, in one of my earliest posts on the BLPB, I shared “although esoteric, such issues as who has access to an account at the Fed are critical social policy choices with real world implications that merit broad-based public debate.”  And I’ve continued to highlight this issue with posts such as “Master Accounts at the Fed: An Arcane But Highly Important Issue” and “Professor Hill on Bank Access to Federal Reserve Accounts and Payment Systems.”  And I’m going to continue to do so today and in the future.  It’s just that important. 

So today, I want to highlight that Custodia Bank, Inc. recently filed a lawsuit against the Federal Reserve Board of Governors and the Federal Reserve Bank of Kansas City.  Custodia alleges that the defendants have unlawfully delayed – for more than 19 months now – processing its application for a Fed master account.  A few related news stories are: here, here, and here.  Recall that TNB USA Inc. sued the Federal Reserve Bank of New York for related reasons (here), but this lawsuit was dismissed.  I’ll be sure to keep BLPB readers posted regarding what happens in Custodia’s case.            

In a post last month, I mentioned my recently published article on teaching change leadership in law schools.  That article, Change Leadership and the Law School Curriculum, 62 Santa Clara L. Rev. 43 (2022), offers some ideas about preparing our students for leading change.  The SSRN abstract follows.

Lawyers, as inherent and frequent leaders in professional, community, and personal environments, have a greater-than-average need for proficiency in change leadership. In these many settings, lawyers are charged with promoting, making, and addressing change. For example, one commentator observes that, “as stewards of the family justice system and leaders of change, family law attorneys have an ongoing responsibility to foster continuous system improvement.” Change is part of the fabric of lawyering, writ large. Change leadership, whether voluntarily assumed or involuntarily shouldered, is inherent in the lawyering task. Yet, change leadership—well known as a focus for attention in management settings and related academic literature—is rarely called out for individual or focused attention in the traditional law school curriculum. This article presents a brief argument for the intentional and instrumental teaching of change leadership to law students.

Many of our students already have been in or are assuming leadership roles.  Others are leading from where they stand.  And, as the abstract indicates, all will likely find themselves leading–in and outside the profession–at a later date.

Moreover, the world has been in, and continues to be in, a state of seemingly constant evolution.  Some of that evolution can be catalyzed or channeled by lawyers who have a compelling vision for the future.  Legal training can help foster that kind of vision.

As we all know, however, merely having a good idea is not enough.  The process of change-making can be critical to its success.  Change leadership can play an important role, and we can expose students to successful change leadership models while they are in law school.  That’s what this article advocates.  I am interested in your reactions . . . .

The battle for Spirit Airlines is fascinating.  Frontier offered to buy Spirit at a price of roughly $22 per share, payable mostly in Frontier stock.  Then JetBlue swooped in with a topping bid of $33 per share in cash.  Spirit’s board maintained its preference for Frontier’s bid, and Glass-Lewis recommended in favor of Frontier, but ISS recommended against.  ISS’s argument was, in part, that if shareholders liked the sector, they could take JetBlue’s cash and reinvest it.

Spirit’s argument was that the combination with Frontier not only stood a greater chance of surviving antitrust review, but there would be substantial operating synergies such that the combined entity would be expected to outperform the sector in the long term.

There was some interesting jousting over the reverse break fees if DoJ refused either combination – including Jet Blue’s highly unusual offer to pay part of the break fee in cash as a special dividend to Spirit shareholders as soon as they voted for a deal between Spirit and JetBlue (I mean, it’s kind of complicated given the numbers floating around, JetBlue offered $33, then lowered it to $30 when it made a tender offer for Spirit, and then added back $1.50 as a prepay on the break fee, which means one has to query whether the current JetBlue structure counts as vote-buying) – but ultimately, leaving aside antitrust risk, the fundamental question  to shareholders is whether they can reinvest the extra cash offered by JetBlue (including potentially in the Jet Blue/Spirit combination itself) more profitably than whatever long term appreciation in the stock price they could expect from a combined Frontier/Spirit entity.

Which is why this column in the Wall Street Journal stood out for me:

The bidding war over Spirit Airlines shows why “stakeholder capitalism” is a hard sell for investors.

On Wednesday, the U.S. carrier postponed a shareholder meeting scheduled for Friday that would have included a vote on the acquisition bid made by its competitor Frontier Airlines. Spirit’s board of directors retains a strong preference for this merger, which seems like a perfect cultural fit, over a rival one proposed by JetBlue Airways. But the board’s latest move betrays hesitation that shareholders might not put the same value on non-pecuniary factors.

…[S]haring DNA is precisely what could make a Spirit-Frontier combination successful. Both carriers’ networks are similar and complementary: Only in 2% of routes did they compete fiercely for market share in 2021, a data analysis shows. Conversely, JetBlue’s higher-cost model is a harder fit.

Spirit shareholders might still get their cake and eat it too if the company wrangles more concessions out of Frontier before the rescheduled June 30 vote. If not, they face a dilemma between more money in the short term and a stake in a merged company that could, speculatively, offer higher longer-term returns.

The situation illuminates two distinct ways of understanding capitalism. First is the standard “shareholder theory” popularized by Milton Friedman, which gives primacy to measurable investment returns and laments the “agency problem” of executives serving other priorities. The second, sees professional managers wresting control from shareholders—a phenomenon documented by business historian Alfred Chandler, among others, since at least the 1920s—as necessary for the survival of corporations. It links with the “stakeholder theory” in which firms should serve all involved parties.

Literally nowhere in Spirit’s pitch to investors does Spirit suggest that the Frontier transaction is anything but shareholder value-maximizing.  Nothing in Spirit’s argument has anything to do with the merger’s effect on nonshareholder interests.  In fact, Spirit’s position is not unlike the position of the Time board when it rejected Paramount’s bid in favor of a merger with Warner – and in that case, the Delaware Supreme Court famously gave the Time board leeway to pursue a long term strategic vision.  So, you know, unless you believe the Delaware courts are stakeholderists now, the mere fact that corporate directors want to reconstitute the entity rather than cash out does not a stakeholder-merger make.

What does the columnist mean by “stakeholderism,” then?  Apparently, he means something like the idea that managing for the long term is, in fact, value-maximizing for shareholders, in part because the long-term view theoretically includes building relationships with, and thereby benefitting, other constituencies.  That version of stakeholderism is often used to defend managerial control against shareholder interference (while staving off business regulation).  The irony of this concept of “stakeholderism” is that it is often opposed by other stakeholderists, including stakeholderists who share a vision of long-term value creation as benefitting all parties, because they object to giving management that much discretion.

Professor Steve Bainbridge chimed in with a different definition of stakeholderism.  He pointed out that the JetBlue flight attendants’ union opposes a merger with Spirit on the ground that it will cost jobs, while the union that represents both Frontier and Spirit favors a merger between those companies, and he concludes that a true stakeholder investor would follow the union recommendation.  He predicts that shareholders are only motivated by profit and won’t pursue the union position, which he implicitly associates with the absence of shareholder wealth-maximization.

Notice, then, that Prof. Bainbridge’s definition of stakeholderism is very different than the one offered in the Wall Street Journal.  In his view, it’s not about managerial control or long-term value maximization; it’s about whether shareholders are willing to sacrifice profits in order to benefit nonshareholder constituencies.  But whatever the unions’ position, this is not really the choice that the shareholders in this instance are being asked to confront.  I.e., this is not a salient part of the pitch to investors.

That said, it’s possible the reason the union position is not part of the pitch to investors is because no one thinks investors would find the unions’ preferences persuasive (or, worse, they think that shareholders would do the opposite of what unions want).  But that’s entirely consistent with the stakeholderism-as-profit-sacrificing theory, because profit-sacrificing stakeholderism is a movement for change; the whole point is that it functions as an objection to the way the current system operates.  In a case like this, the argument often concludes there is an actual agency problem between the institutional investors who vote the shares, and the retail shareholders who they represent.  If that’s right, the fact that the institutions who own Spirit Airlines – 70% of the stock – may vote for the JetBlue deal tells us very little.  That’s precisely why so many academics argue that institutions should determine retail preferences before voting, and why the SEC wants greater disclosure from funds that market themselves as ESG.  I mean, at this point I’d kind of be remiss if I didn’t mention that Prof. Bainbridge just recently signed a letter arguing that institutional investors do not share the preferences of their own beneficiaries, and recommended that those beneficiaries be polled as to their true preferences, so he’s familiar with this line of reasoning. 

Now, to be fair, I share Prof. Bainbridge’s view that, faced with a takeover bid at a premium that favors shareholders over everyone else, shareholders as a group are unlikely to reject it in order to benefit nonshareholder constituencies.  That dynamic is, in fact, is why we’re losing local news coverage in this country.  But to give the stakeholder argument its due, if shareholders really did force companies to operate with a view to benefitting nonshareholder constituencies, consistently and across the board, we’d also see fewer rapacious takeover bids in the first place, because the acquirer would expect that its own shareholders would refuse to let it enact its rapacious wealth-maximizing plans.  

Which means, there’s not a whole lot in the Spirit battle that sheds light on the stakeholderism debate.  This fight is more of a throwback to Paramount: as between the board and the shareholders, who gets to decide the future of the company, and the timeline for achieving it? 

There have been number of recent BLPB posts representing a diversity of viewpoints concerning the SEC’s proposed rule to “Enhance and Standardize Climate-Related Disclosures for Investors”. For example, co-blogger Joan MacLeod Heminway recently posted on a comment letter drafted by  Jill E. FIsch, George S. Georgiev, Donna Nagy, and Cynthia A. WIlliams (and signed by Joan and 24 others) that affirms the proposed rule is within the SEC’s rulemaking authority. I have offered a couple posts raising concerns about the proposed rule from the standpoint of utility and legal authority (see here and here). One of the concerns I have raised is that the SEC’s proposed disclosure regime may compel corporate speech in a manner that runs afoul of the First Amendment. SEC Commissioner Hester Pierce raised this same concern, and now Professor Sean J. Griffith has posted a new article, “What’s ‘Controversial’ About ESG? A Theory of Compelled Commercial Speech under the First Amendment”, which offers a more comprehensive treatment of this problem. Professor Griffith has also submitted a comment letter to the SEC raising this issue. Here’s the abstract for Professor Griffith’s article:

This Article uses the SEC’s recent foray into ESG to illuminate ambiguities in First Amendment doctrine. Situating mandatory disclosure regulations within the compelled commercial speech paradigm, it identifies the doctrinal hinge as “controversy.” Rules compelling commercial speech receive deferential judicial review provided they are purely factual and uncontroversial. The Article argues that this requirement operates as a pretext check, preventing regulators from exceeding the plausible limits of the consumer protection rationale.

Applied to securities regulation, the compelled commercial speech paradigm requires the SEC to justify disclosure mandates as a form of investor protection. The Article argues that investor protection must be conceived on a class basis—the interests of investors qua investors rather than focusing on the idiosyncratic preferences of individuals or groups of investors. Disclosure mandates that are uncontroversially motivated to protect investors are eligible for deferential judicial review. Disclosure mandates failing this test must survive a form of heightened scrutiny.

The SEC’s recently proposed climate disclosure rules fail to satisfy these requirements. Instead, the proposed climate rules create controversy by imposing a political viewpoint, by advancing an interest group agenda at the expense of investors generally, and by redefining concepts at the core of securities regulation. Having created controversy, the proposed rules are ineligible for deferential judicial review. Instead, a form of heightened scrutiny applies, under which they will likely be invalidated. Much of the ESG agenda would suffer the same fate, as would a small number of existing regulations, such as shareholder proposals under Rule 14a-8. However, the vast majority of the SEC’s disclosure mandates, which aim at eliciting only financially relevant information, would survive.

Prior to joining academia, I served as a compliance officer for a Fortune 500 company and I continue to consult on compliance matters today. It’s an ever changing field, which is why I’m glad so many students take my Compliance, Corporate Governance, and Sustainability course in the Fall. I tell them that if they do transactional or commercial litigation work, compliance issues will inevitably arise. Here are some examples: 

  • In M&A deals, someone must look at the target’s  bribery, money laundering, privacy, employment law, environmental, and other risks
  • Companies have to complete several disclosures. How do you navigate the rules that conflict or overlap?
  • What do institutional investors really care about? What’s material when it relates to ESG issues?
  • What training does the board need to ensure that they meet their fiduciary duties?
  • How do you deal with cyberattacks and what are the legal and ethical issues related to paying ransomware?
  • How do geopolitical factors affect the compliance program?
  • Who can be liable for a compliance failure?
  • What happens when people cut corners in a supply chain and how can that affect the company’s legal risk?
  • What does a Biden DOJ/SEC mean compared to the same offices under Trump?
  • Who is your client when representing an organization with compliance failures?
  • and so much more

I’m thrilled to be closing out the PLI Compliance and Ethics Essentials conference in New York with my co-panelist Ben Gruenstein of Cravath, Swaine, & Moore. It’s no fun being the last set of presenters, but we do have the ethics credits, so please join us either in person or online on June 28th. Our areas of focus include:

  • Risk assessment, program assessment, and attorney-client privilege
  • Ethical obligations for lawyers and compliance officers
  • Which compliance program communications can (and should) be privileged?

In addition to discussing the assigned issues, I also plan to arm the compliance officers with more information about the recent trend(?) of Caremark cases getting past the motion to dismiss stage and compliance lessons learned from the Elon Musk/Twitter/Tesla saga. 

Here’s the description of the conference, but again, even if you’re not in compliance, you’ll be a better transactional lawyer from learning this area of the law. 

Compliance and ethics programs are critically important to the success of any organization. Effective programs allow organizations to identify and mitigate legal risks. With an increasingly tough enforcement environment, and greater demands for transparency and accountability, an effective compliance program is no longer just “nice-to-have.” It’s essential. 

Whether you are new to the area or a seasoned compliance professional, PLI’s program will give you the tools you need to improve your organization’s compliance program.  We will review the principal elements of compliance programs and discuss best practices and recent developments for each.  Our distinguished faculty, drawn from major corporations, academia, law firms and the government, can help you improve your program, increase employee awareness and decrease legal risk.  Compliance and Ethics Essentials 2022 is highly interactive and includes case studies, practical tools and real-time benchmarking.

What You Will Learn 

  • Designing and conducting effective compliance risk assessments that enhance your program
  • Structuring your program for appropriate independence and authority
  • The evolving role of the board
  • ESG and your compliance program
  • Using data analytics to improve your program
  • Encouraging reporting and investigating allegations of wrongdoing
  • Best practices in compliance codes, communications, training and tools
  • Ethics for compliance professionals

Who Should Attend

If you are involved in any aspect of corporate compliance and ethics as in-house counsel, a compliance and ethics officer, human resources executive, outside counsel, or risk management consultant, this event should be on your annual calendar.

Special Feature: Special luncheon presentation with guest speaker

If you do come to the conference, I would love to grab a cup of coffee with you, so reach out.

Elisabeth Haub School of Law at Pace University invites applications for a Visiting Professor for Spring 2023 

The Elisabeth Haub School of Law at Pace University is currently seeking applicants for a Visiting Professor to teach during the Spring 2023 semester. We are particularly interested in applicants who can teach Constitutional Law, Corporations and other courses in the business law area.

All applicants should have excellent academic credentials as well as demonstrated skill and experience in teaching.  The position is a temporary, non-tenure-track appointment.

Applicants should be willing and available to teach using in-person or hybrid formats, depending on changing circumstances and the needs of the particular classes.

Applications are encouraged from people of color, individuals of varied sexual and affectional orientations, individuals who are differently-abled, veterans of the armed forces or national service, and anyone whose background and experience will contribute to the diversity of the law school.  Pace University is committed to achieving completely equal opportunity in all aspects of University life.

Please apply via https://careers.pace.edu/postings/22602. Applications will be considered on a rolling basis.

Pace University’s Elisabeth Haub School of Law offers J.D. degrees, Masters of Law degrees in both Environmental and International Law, and a series of joint degree programs including a Doctor of Juridical Science (SJD) in Environmental Law. The school, housed on the University’s campus in White Plains, NY, opened its doors in 1976 and has over 8,000 alumni around the world. The school maintains a unique philosophy and approach to legal education that strikes an important balance between practice and theory. For more information, visit http://law.pace.edu.

Please direct any questions via email to Senior Associate Dean for Academic Affairs and Law Operations, Professor Jill Gross, at jgross@law.pace.edu.

This post alerts everyone to a comment letter, drafted by Jill Fisch, George Georgiev, Donna Nagy, and Cindy Williams (signed by the four of them and 26 other securities law scholars, including yours truly and Ann Lipton), affirming that the Securities and Exchange Commission’s recent proposal related to the enhancement and standardization of climate-related disclosures for investors is within its rulemaking authority.  The letter was filed with the Commission yesterday and has been posted to SSRN.  The SSRN abstract is included below.

This Comment Letter, signed by 30 securities law scholars, responds to the SEC’s request for comment on its March 2022 proposed rules for the “Enhancement and Standardization of Climate-Related Disclosures for Investors” (the “Proposal”). The letter focuses on a single question—whether the Proposal is within the SEC’s rulemaking authority—and answers this question in the affirmative.

The SEC’s authority for the Proposal is grounded in the text, legislative history, and judicial interpretation of the federal securities laws. The letter explains the objectives of federal regulation and demonstrates that the Proposal’s requirements are properly understood as core capital markets disclosure in the service of those objectives. The statutory framework requires the SEC to adjust and update the content of the federal securities disclosure regime in response to the evolution of the economy and markets, and, in recent decades, the SEC has done so to require disclosures on a variety of subjects from Y2K readiness, to cybersecurity, to human capital management, to the effects of the Covid-19 pandemic. Rules mandating climate-related disclosure fit with this pattern of iterative modernization. Such rules do not represent a foray into new and uncharted territory, since the SEC has a long history of requiring disclosure on environmental and climate-related topics dating back more than 50 years. Finally, the federal securities laws do not impose a materiality constraint on the SEC’s authority to promulgate climate-related disclosure requirements.

The Comment Letter therefore concludes that the SEC has the statutory authority to promulgate the Proposal, and that the climate-related disclosure rules under consideration are consistent with close to nine decades of regulatory practice at the federal level and with statutory authority dating back to 1933 that has been repeatedly reaffirmed by Congress and the courts.

There is more that has been, can, and will be said about the Commission’s rulemaking proposal as a matter of process and substance.  But I will leave that for another day.  For now, we just wanted you to know about the filing of the letter and offer you an easy way to find it and review it.

I am excited to be promoting here an inventive and interesting paper, Total Return Meltdown: The Case for Treating Total Return Swaps as Disguised Secured Transactions, written by friend-of-the-BLPB Colin Marks (St. Mary’s School of Law).   The SSRN abstract follows.

Archegos Capital Management, at its height, had $20 billion in assets. But in the spring of 2021, in part through its use of total return swaps, Archegos sparked a $30 billion dollar sell-off that left many of the world’s largest banks footing the bill. Mitsubishi UFJ Group estimated a loss of $300 million; UBS, Switzerland’s biggest bank, lost $861 million; Morgan Stanley lost $911 million; Japan’s Nomura, lost $2.85 billion; but the biggest hit came to Credit Suisse Group AG which lost $5.5 billion. Archegos, itself lost $20 billion over two days. These losses were made possible due to the unique characteristics of total return swaps and Archegos’ formation as a family office, both of which permitted Archegos to skirt trading regulations and reporting requirements. Archegos essentially purchased beneficial ownership in large amounts of stocks, particularly ViacomCBS Inc. and Discovery Inc., on credit. Under Regulation T of the Federal Reserve Board, up to 50 percent of the purchase price of securities can be borrowed on margin. However, to avoid these rules, Archegos instead entered into total return swaps with the banks whereby the bank is the actual owner of the stock, but Archegos would bear the risk of loss should the price of the stock fall and reap the benefits if the stock were to go up or were to make a distribution. Archegos would still pay the transaction fees, but the device permitted Archegos to buy massive amounts of stock without having the initial margin requirements, thus making Archegos heavily leveraged. This article argues that the total return swap contracts are analogous to and should be re-characterized as what they really are – disguised secured transactions. Essentially the banks are lending money to enable the Archegoses of the world to buy stocks, and are simply retaining a security interest in the stocks. Such a re-characterization should place such transactions back into Regulation T and the margin limits. But re-characterization also offers another contract law approach that is more draconian. If the structure of the contract violates a regulation, then total return swaps could be declared void as against public policy. This raises the specter that a court could apply the doctrine of in pari delicto and leave the parties where they found them in any subsequent suits to recover outstanding debts.

I do not teach, research, or write in the secured transactions space, but this work engages corporate finance and contract law as well.  (I am grateful that Colin, among others, has encouraged my forays into contract law research over the years.)  I was privileged to have the opportunity to preview Colin’s arguments and offer some feedback during his research and writing of this paper, which is forthcoming in the Pepperdine Law Review.  I find his argument creative and intriguing.  I think you may, too.

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Recently, I published a short piece for the Nashville Institute for Faith and Work (NIFW) about Business Ethics in a Pandemic.

As mentioned there, I have found teaching Business Ethics courses extremely challenging, but important. While law can be unclear, the boundaries of business ethics are even more vague. 

Perhaps it is simply because one of my younger brothers is an English professor, but I have been increasingly drawn to using literature in the teaching of business ethics as a way to grapple with the lack of clarity.

So far, I have used the fiction and poetry of Derrick Bell, Wendell Berry, Octavia Butler, Anton Chekov, Ross Gay, Ursula Le Guin, Cormac McCarthy, Mary Oliver, Ranier Maria Rilke, May Sarton, George Saunders, and Leo Tolstoy. Admittedly, this is a bit of an odd mix, but I think each of these writers have something important to say, even if I do not use each of them every semester. 

I remain open to other suggestions, and I plan to rotate in other authors as I continue to teach our business ethics course. (I also hope to write a few longer pedagogy articles in the law & literature and ethics & literature space). 

(Photo of Bass Lake in Blowing Rock, NC, which is perhaps my favorite place to read).