Professor Bainbridge...on law, politics, religion, culture & food

More Martha

With respect to my post the other day about Martha Stewart's indictment, an astute reader emails to ask whether I'm talking about the "infamous Count 9 of the criminal complaint instead of to the overall obstruction charges that form the basis for the rest of the complaint"? I'm only talking about count 9. I agree with the reader's assessment of that count. He writes:

If you were thinking only of Count 9's charge that by publicly proclaiming her innocence, she was engaging in criminal securities fraud, I agree with you. In fact, even if she is, indeed, guilty, something bothers me if the government is allowed to publicly make allegations against her but she is not allowed to publicly deny them.

Meanwhile, Tung Yin of the Yin Blog has a very interesting post providing a good deal of detail on the legal merits of the obstruction of justice charge. I don't dispute his assessment that what Martha did could be criminal (in a hyper-technical sense, IMHO), but I still don't get why it is criminal as a matter of sound public policy or, especially, why as a prudential matter a prosectutor should have brought Count 9. I agree entirely with the first reader's assessment that it is unfair to let the government fling allegations, which they end up deciding not to charge somebody with, and then let the government prosecute that person for having denied the allegations the government decided it couldn't prove. Why isn't that just whacked?

Turning to the obstruction counts, however, I'm also skeptical of them as a prudential matter. It also seems to me that aggressive prosecutorial use of 18 U.S.C. sec. 1001 undercuts the requirement that the government prove guilt beyond a reasonable doubt. Granted the 5th amendment only gives you a right to remain silent, but shouldn't you be allowed to tell the cops "I didn't do it" without getting hauled up on charges later -- especially if they end up deciding not to charge you with the underlying crime? I mean, I can't tell you the number of times I've told a cop I didn't see the stop sign. [Ed: After reading Prof. Yin's helpful follow-up post, I added the underlined sentence for further clarification.]

I should note that Prof. Yin, to say the least, seems receptive to the prudential component of my argument:

Now, all that's left is to wonder, should the alleged lie in the actual case with the actual circumstances be a crime? And if so, is it really worth prosecuting? That's a totally different question, and certainly I can see arguments to be made that Stewart's alleged false statement really isn't worth the government's attention and time -- but for her celebrity status.

Exactly, if the defendant wasn't Martha Stewart (and if we hadn't already had Enron and so on), this case never happens. My friend Tom Smith makes this point quite pithily:

Steve Bainbridge is right on about Martha Stewart. He is perhaps too polite to add, however, that the ill-defined insider trading laws are perfect tools for ambitious prosecutors who want to go on scalp-hunting expeditions. Is Martha the most egregious insider trader in Manhattan these days? Hardly. But she is a high profile celeb with a reportedly obnoxious personality that the press would love to see fall. The Bonfire of the Vanities with the feds roasting their marshmellows on the flames.

Harsh, but true. (Download my overview of insider trading law here.)

Corp Law Blog on the SEC’s shareholder access proposals

As I've already written, Mike O'Sulluivan of the Corp Law Blog has been blawgging steadily on the SEC's action today in putting forward the shareholder access proposal for comments. In his main post, he raises many good questions about the proposal, but makes one point on which I'm inclined to disagree:

5. Legal Authority. I think this is going to be a big issue; several commissioners asked about it and I was not wholly satisifed with SEC General Counsel Giovanni Prezioso's answers. At one point, in discussing the issue with Commissioner Goldschmid, Prezioso said that the new rule was, like Rule 14a-8, just mandating that certain material appear in a proxy. As Commissioner Atkins later stated, the proposed rule is decidedly not a mere disclosure rule. Atkins also expressed a concern that the rule preempted state law, and cautioned the SEC staff that the rule would be challenged and that these concerns were not mere technicalities.

I've blawgged the authority issue before, of course. My take on that issue remains that the SEC has authority to do most, if not all, of what it's proposing. The key point is that the SEC's authority under Section 14(a) is not limited to disclosure. The SEC has authority to do more than just mandate "that certain material appear in a proxy" statement. Business Roundtable v. SEC, 905 F.2d 406 (DC Cir. 1990), indicated (albeit in dicta) that the SEC's powers under 14(a) include sufficient control over the process of shareholder voting to ensure the Congressional goal of "fair corporate suffrage." I discussed the meaning of that phrase from Section 14(a)'s legislative history in my article The Short Life and Resurrection of SEC Rule 19c-4, where I concluded that:

The proper interpretation of “fair corporate suffrage” now becomes evident. In using that term, Congress did not mean to address the substantive question of how many votes per share to which a stockholder is entitled. Instead, as the D.C. Circuit recognized, Congress was talking about an entirely different concern: the need for full disclosure and fair solicitation procedures. (610)

I further concluded that the Exchange Act gave the SEC power to ensure that shareholders are able "to make effective use of whatever voting rights they possess by virtue of state law." In dicta, the Business Roundtable opinion likewise concludes that the SEC has authority to adopt rules creating "a control over management’s power to set the voting agenda, or, slightly more broadly, voting procedures.” (905 F.2d at 411.) Why doesn't shareholder access to the proxy statement to nominate directors likewise constitute "a control over management’s power to set the voting agenda"? None of which is to say, of course, that the proposal is a good idea on the merits!

As for preempting state law, I'm as much of a competitive federalist as the next guy. (See my article The Creeping Federalization of Corporate Law.) These days, however, preemption is mostly a prudential matter. If Section 14(a) gives the SEC authority to adopt this rule, any resulting preemption of state corporate law -- however unfortunate -- will not be a barrier to the rule's validity.

SEC puts shareholder access rule out for comment

Reuters is reporting that:

U.S. regulators, moving to boost the power of investors in the boardroom, gave initial approval on Wednesday to a plan that would let shareholders nominate board directors using official company ballots. The Securities and Exchange Commission's decision drew criticism from big business and praise from investor activists who want to wrest control from CEOs of weak boards like those that slept through the scandals at Enron Corp. and elsewhere.

Well, that's sound and objective journalism, isn't it?

As you might expect, Mike O'Sullivan of Corp Law Blog is all over it, with 3 very detailed posts. The main substantive post is here; scroll down for the next two. My own take is that this is still a bad idea, for the reasons I've set forth before. The relevant posts are:
Shareholder Access (Again): NYT Reports: "Big Pension Funds Object to Proposal on Proxy Rules"
Shareholder access again -- updated
Corp Law Blog on shareholder activism and shareholder proposals
Donaldson tells Congress action on shareholder access to proxy coming soon

Faculty retreats

Some academic bloggers have been discussing the merits of faculty routs retreats. Miami law prof Michael Froomkin seems to have started it with a mildly skeptical post about a forthcoming retreat by his faculty:

[My colleagues] tend to be fun to be around—when taken one or two at a time. But perhaps because academia tends to attract the lone wolf personality type, most of us are not necessarily at our best when working collaboratively in large groups.

UNC law prof Eric Muller responded with a degree of enthusiasm that I found surprising:

I think most people, like Michael, simply take the "lone wolf" phenomenon as unalterable, and then get increasingly dispirited and frustrated when the faculty as a whole seems to be going in circles or riven by discord. If a retreat can either (a) help a few important people at the "center" of a faculty gather a critical number of allies, and thereby break a logjam, or (b) smoke out the people whose intransigence is holding back the group as a whole, then I say that's worth the effort, even if it makes people intermittently uncomfortable.

He also opines that the folks most likely to object to "a well-planned and facilitated retreat" (a mythical beast, IMHO) are "either the lonest and loudest of the lone wolves ... or the 'backroom politics' people." (What about the wolves who just want to be left alone to work on their teaching, books, and articles?)

Meanwhile, Chicago poli sci prof Daniel Drezner is very much in the skeptic's camp:

The idea of a faculty retreat sounded good the first time I heard it -- probably because I thought it would be held at some secluded lake somewhere with generous coffee breaks. In actuality, the retreats I've attended (all before I was at the U of C) were day-long marathons of bad pizza, bad flourescent lighting, and bad pontificating.

In the comments section, Jeff Cooper opines: "How anyone could think that a faculty retreat is a good idea after attending a faculty meeting is beyond me." Yep. Larry Levin chimes in with: "During my academic day my experience of faculty retreats ran the gamut from the second or third rung of Hell to the ninth." Ditto.

I am very much in the latter camp. Indeed, I couldn't agree more with the last comment. I've attended one faculty retreat (back when I was at Illinois) and I expect it cut at least two millenia off my stint in Purgatory. Bad coffee, bad food, uncomfortable folding chairs, bad PowerPoint shows. It was just a day long faculty meeting, which gave the usual suspects even opportunity to hold forth. And then there was all the time we spent trying to come up with a "mission statement" and a "vision for the institution." My take was: We're a law school. We teach students and write scholarship. But no. Instead, we spent what seemed like hours on it. Put bluntly, mission statements are bunk. They are a late 80s Deming/TQM-inspired management fad. You write them up, using all the latest buzz words, and then ignore them. "Vision statements" are even worse, because sometimes people actually try to implement them. I'm reminded here of the last two of Russell Kirk's canons of conservtaism: (5) Beware "of 'sophisters, calculators, and economists' who would reconstruct society upon abstract designs." (6) Recognize "that change may not be salutary reform: hasty innovation may be a devouring conflagration, rather than a torch of progress." The whole experience reminded me of a Dilbert cartoon.

UPDATE: Prof. Froomkin reports on the retreat; doesn;t sound too bad.

Defending Martha Stewart

The WSJ (sub. req'd) is reporting that Martha Stewart is trying to get some of the counts of her indictment dismissed. Here's the part that caught my eye:

Ms. Stewart wasn't indicted on insider trading charges but was charged with interfering with the inquiry that sought to determine if she sold the stock based on a tip that ImClone founder Sam Waksal and his family were unloading their holdings. ... Prosecutors say Ms. Stewart defrauded investors in her own company through a series of false statements that they allege were designed to curb the losses in her company's stock. ... The charge "seeks to criminalize Ms. Stewart's public declarations that she had not engaged in insider trading in making a personal stock sale," her lawyers said in the summary.

I've come to think that's exactly right. Granted, back in June 2003, I wrote an op-ed for the LA Times, in which I suggested:

Stewart apparently didn't pay much attention to the Watergate scandal. It wasn't the break-in that brought down Nixon's presidency; it was the cover-up. It won't be insider trading that brings down Martha Stewart. It will be the cover-up.

To the extent the obstruction charges are based on Stewart's denials, as opposed to the alleged alteration of documents, however, I've concluded that the alleged cover-up shouldn't bring Stewart down.

Stewart's indictment does not allege insider trading. Only the SEC's civil complaint contains insider trading allegations. In my June op-ed, I explained that the SEC's charges were so outlandish that "the Justice Department did not charge Stewart with insider trading. ... Instead, the Justice Department went after Stewart for conspiring to obstruct justice by engaging in the great American pastime of lying to the cops."

The SEC’s charges against Stewart are based on a bizzare interpretation of insider trading law. Suppose Jane is the CEO of a big mining corporation. Jane learns the company has struck gold. Before the discovery is announced, Jane buys some more stock. That is classic insider trading. Now suppose Jane tells her friend Don the good news. Don buys stock, also pre-announcement. That is known as tipping. According to the U.S. Supreme Court, the tip will be illegal if Jane got a personal benefit from making the tip and Don knew (or should have known) that Jane’s tip violated her fiduciary duty to the company. A third kind of insider trading is called misappropriation. Suppose Jane’s company plans a hostile takeover of a second company. She tells her attorney Anne about the plan. Anne then buys stock in the target company. Anne has committed illegal insider trading based on misappropriated information. If Anne tips her friend Dave, that would be illegal too. The charges against Stewart don’t look anything like these examples. It is as though Jane’s broker thought her trade was unusual and told another client about it. (Doubtless you'll want to read all about insider trading in my book.)

Martha Stewart pretty clearly didn’t know about the FDA’s Erbitux action. In fact, according to the SEC itself, after selling her ImClone stock, Stewart called Waksal and left the following message: “Martha Stewart—something is going on with ImClone and she wants to know what….” Although the SEC’s complaint makes much of the Stewart-Waksal friendship, the SEC nowhere alleges that Stewart had any advance knowledge of the problem with Erbitux.

In other words, Martha Stewart got a hot tip and she acted on it. So what? As a society, we care about insider trading because it is a form of theft. Information about the gold discovery belonged to Jane’s company, not to Jane. Information about the takeover bid belonged to the company, not to Anna. They stole that information from its owner and used it for personal gain. If the information leaked as a result, the company would be injured. But what information did Stewart steal and from whom? The SEC tells us she stole it not from ImClone but from Merrill Lynch, but does this look like theft as you know it? To be sure, the SEC may be able to make out the requisite theft in some hyper-technical sense but Stewart’s misconduct has very little to do with the historic reasons for policing insider trading.

According to published reports, the U.S. Attorney decided going after Stewart would be an “unprecedented” expansion of insider trading law. Instead, the Feds indicted her, inter alia, over her denials that she committed insider trading. At worst, however, Martha lied about doing something that isn't illegal. I still don't get why that should be criminal.

For more Martha Stewart news, see my earlier post on the dismissal of the Delaware shareholder litigation. Stewart's official defense web site is www.marthatalks.com. Interestingly, while Stewart's website has a section collecting favorable op-eds, mine is not listed there. Maybe it was this line in my op-ed that got me excluded: "I don't particularly like Martha Stewart's public persona." Anyway, for a very funny parody of Stewart's site, check out www.marthastewarttalks.com. (Interestingly, Google ranks the parody site higher than the official site.)

Villanova conference wrap-up

I tend to think that wanting to be a law school dean is a character flaw. There are exceptions, however. My friend Mark Sargent of Villanova is definitely one of the exceptions. The CST conference he sponsored this past weekend was a great success. Lots of interesting papers and a very smooth operation all around.

Never say never. A while back, I blegged re blogging during conferences. The response was mostly positive, so I had no qualms about blogging during sessions this weekend. (Not that I did all that much. See My Remarks on CST re Corporations and Solidarity's Debt to Burke) But I also did something I swore in that post not to do: I pulled out my laptop while on the dais and started typing. In my defense, I wasn’t blogging – I was revising my remarks to include some comments on the prior speakers. Even so, I felt rather uncomfortable, as though I causing a distraction.

Speaking of blogging during conferences, John Dvorak has a column touching on that topic in the latest PC Magazine. He calls it “an unwanted trend” that reduces “the speaker into background noise—like a TV show.” Ouch.

What do Catholic law professors have against PowerPoint? I only saw one PowerPoint presentation the whole weekend.

Villanova Conference: My Remarks on Catholic Social Thought and the Corporation

Saturday morning I spoke at Villanova University School of Law’s symposium on Catholic Social Thought and Law. My panel was entitled “The Corporation through the Lens of Catholic Social Thought.” My remarks focused on the need to preserve the economic liberty of corporate actors as a means of preserving the freedom of the men and women who make up the corporation.

If a concern for human freedom is not at the center of Catholic social teaching, human freedom is at least very near it. As the current Pope has observed, “the good of the individual [cannot] be realized without reference to his free choice, to the unique and exclusive responsibility which he exercises in the face of good or evil.” (Centesimus Annus, 13) Hence, Catholic social thought purports to reject socialism or other forms of command economies.

At the same time, however, Catholic social teaching scarcely can be described as rabidly pro-capitalism. John Paul, for example, describes corporate profits as a mere “indicator that a business is functioning well.” (Centesimus Annus, 43) As the Catechism explains, moreover: “Those responsible for business enterprises are responsible to society for the economic and ecological effects of their operations. They have an obligation to consider the good of persons and not only the increase of profits.” (Catechism, 2432)

Contrast that conception of the corporation’s profit-making function with the Michigan supreme court’s famous command in Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919), that: “A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end.” (684) Or, as Milton Friedman (1970) even more famously put it, “the social responsibility of business is to increase its profits.”

How then do those us who are vocationally concerned with the governance of U.S. corporations reconcile the laws of Man and God? At the outset, it is critical to remember that the Church especially encourages lay initiative “when the matter involves discovering or inventing the means for permeating social, political, and economic realities with the demands of Christian doctrine and life.” (Catechism, 899) Indeed, at least insofar as prudential judgments are concerned, John Paul has emphasized that the “church has no models to present.” (Centesimus Annus, 43) In pondering the implications of Catholic social teaching for corporate governance, I therefore think it especially appropriate to draw not only on the primary documents but also on certain lay thinkers. Hence, my interest in this project.

CEO certification requirements

Mike O' Sullivan at Corp Law Blog has a very good recent post entitled Strapping the CEO to the Front Bumper. He notes that last Wednesday "the Senate Finance Committee approved changes to the JOBS Act (S. 1637) that would require CEOs to personally certify corporate tax returns." Mike is pretty critical of this provision, albeit in a nuanced way:

I'm not, in general, a fan of regulation-by-personal-certification. ... How many CEOs are qualified to even begin second-guessing what's on their corporate tax returns? Do we even want our CEOs taking time from other pursuits -- such as running a business -- to delve into the intricacies of the Internal Revenue Code? Has anyone asked Scott McNealy what he thinks of this?

All this leaves me wondering what purpose this new CEO certificate really serves, other than to paint another set of concentric circles on a CEO's back.

Both the current post and the linked Scott McNealy post are worth reading. My initial reaction to both was agreement, as it usually is when I read Mike's excellent blog, but maybe there is something to be said in favor of CEO certification requirements.

In regulating corporations, the state has two basic choices. It can either regulate the entity itself or it can regulate the managers who act on behalf of the entity. (Gordon Smith raised this issue in an interesting post over at his Venturpreneur blog a couple of weeks ago.) In many areas of the law, we focus much more on entity rather than personal liability. Query, however, whether that makes sense.

Edward, First Baron Thurlow, famously asked: “Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?” The corporation is neither a person nor even a thing capable of being owned; it is just a label -- a legal fiction -- for a nexus of contracts between people. When we talk about the corporation as an entity -- or punish it as an entity -- we reify the corporation. Reification is useful because it permits us to utilize a form of shorthand. It is easier to say “General Motors ought to do so and so” than to describe the complex process that is actually necessary for General Motors to do something. Indeed, it is very difficult to think about large firms without reifying them. Reification, however, can be dangerous. Reification makes it easy to lose sight of the fact that firms do not do things; people do things. The proper focus is thus not on the corporation’s obligations, but on the moral obligations and legal duties of the actors who make corporate decisions.

Corporations don't do bad things; people acting on behalf of corporations do bad things. When we punish the corporation instead of the people, we commit two errors. First, the innocent suffer. When the corporation pays a fine, that money didn't grow on a tree. Instead, it comes out of the pockets of the shareholders. The shareholders own a residual claim on the corporation's assets and earnings -- they get whatever is left over after everybody else has been paid (its more complicated than that because shareholders can take assets out pre-liquidation, but the simplification is valid for our purposes). If the corporation pays a fine, that reduces the value of the residual claim. It is therefore the shareholders who suffer the loss when the company is fined. Second, because the bad actors go unpunished, there is no deterrent effect. Why should managers care about the costs of breaking the law when the shareholders will pay the fine? (Again, its more complicated than that because there may be reputational costs.)

Sound public policy therefore should focus on liability for human rather than corporate actors (there may be prudential exceptions in the private context, such as in the mass tort setting, where individual actors might not be able to compensate those injured by corporate conduct). Doing so is consistent both with notions of retributive justice and deterrence.

CEO cerification requirements admittedly differ from criminal sanctions. The latter are partially retributive, looking back to punish past misconduct, as well as having a deterrent effect. In contrast, the former are solely intended as a deterrent. But so what? The goal of both criminal sanctions and CEO certifications is to provide incentives. The Sarbanes-Oxley certification requirements give CEOs an incentive to make darn sure that the corporation's financial statements are complete and accurate. Granted, the CEO will neither personally draft those statement nor even audit them. But that is not the point. The point is to give the CEO an incentive to hire good people and to incentivize those people to do their jobs right. In other words, they give CEOs an incentive to create and monitor systems of internal control.

Hence, I am not inclined to oppose all certification requirements. (In fairness, neither is Mike. He is merely not, "in general, a fan ....") Instead, the right question is whether, as a prudential matter, the particular certification requirement makes sense. Part of that analysis, of course, also must include the cumulative burdens that certification requirements impose on CEOs.

As to the specific certification requirement at issue here, which you will recall is one that the CEO certify the firm's tax returns, I think Mike has a good point:

How, you may wonder, can a CEO who doesn't understand taxes ensure that the corporation's tax professionals act with the appropriate level of care? How many CEOs are qualified to even begin second-guessing what's on their corporate tax returns?

I would add to those rhetorical questions the observation that tax returns and financial statements differ in an important way. The government has all the resources of the modern regulatory state at its disposal to verify the validity of corporate tax returns. Individual investors (and even institutions) lack the resources -- and, indeed, the access -- to verify corporate financials. From an agency cost perspective, it thus makes sense to require CEOs to certify the financials: the certification provides a bond that makes those financials more credible, which allows investors to rely on them.

UPDATE: Scheherazade of the enjoyable Civil Procedure blog asks a good question about this post:

I need to think about this a little more -- CEO certification would seem to strip the corporation of the limited liability that is one of the basic reasons for the corporate form, yes?

Not really. In a small, closely held corporation where the CEO is also the dominant stockholder, this would be a concern. In the large publicly held corporations to which most CEO certification requirements seem to be limited, however, it is only shareholders -- not officers and directors qua officers and directors -- who get the benefit of limited liability. Scheherazade's instinct that CEO certifications do strip officers and directors of a protection they formerly enjoyed, however, is correct. These requirements effectively preempt the state corporate law business judgment rule, as I argued in my article The Creeping Federalization of Corporate Law. While you're visiting Scheherazade's site, you can surf over to this post and offer her some advice on changing her blog's name. For what its worth, longtime readers of this blog (all three of you) know that I changed its name fairly early on, for reasons I explained here.

REFERENCES: For an extended discussion of corporate criminal liability by (the controversial) John Lott, see here. See also this paper by Reinier Kraakman on vicarious corporate liability.