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Shanker Singham of the Babson Global Institute (formerly a leading international trade lawyer and author of the most comprehensive one-volume work on the interplay between competition and international trade policy) has published a short article introducing the concept of “enterprise cities.”  This article, which outlines an incentives-based, market-oriented approach to spurring economic development, is well worth reading.  A short summary follows.

Singham points out that the transition away from socialist command-and-control economies, accompanied by international trade liberalization, too often failed to create competitive markets within developing countries.  Anticompetitive market distortions imposed by government and generated by politically-connected domestic rent-seekers continue to thrive – measures such as entry barriers that favor entrenched incumbent firms, and other regulatory provisions that artificially favor specific powerful domestic business interests (“crony capitalists”).  Such widespread distortions reduce competition and discourage inward investment, thereby retarding innovation and economic growth and reducing consumer welfare.  Political influence exercised by the elite beneficiaries of the distortions may prevent legal reforms that would remove these regulatory obstacles to economic development.  What, then, can be done to disturb this welfare-inimical state of affairs, when sweeping, nationwide legal reforms are politically impossible?

One incremental approach, advanced by Professor Paul Romer and others, is the establishment of “charter cities” – geographic zones within a country that operate under government-approved free market-oriented charters, rather than under restrictive national laws.  Building on this concept, Babson Global Institute has established a “Competitiveness and Enterprise Development Project” (CEDP) designed to promote the notion of “Enterprise Cities” (ECs) – geographically demarcated zones of regulatory autonomy within countries, governed by a Board.  ECs would be created through negotiations between a national government and a third party group, such as CEDP.  The negotiations would establish “Regulatory Framework Agreements” embodying legal rules (implemented through statutory or constitutional amendments by the host country) that would apply solely within the EC.  Although EC legal regimes would differ with respect to minor details (reflecting local differences that would affect negotiations), they would be consistent in stressing freedom of contract, flexible labor markets, and robust property rights, and in prohibiting special regulatory/legal favoritism (so as to avoid anticompetitive market distortions).  Protecting foreign investment through third party arbitration and related guarantees would be key to garnering foreign investor interest in ECs.   The goal would be to foster a business climate favorable to investment, job creation, innovation, and economic growth.  The EC Board would ensure that agreed-to rules would be honored and enforced by EC-specific legal institutions, such as courts.

Because market-oriented EC rules will not affect market-distortive laws elsewhere within the host country, well-organized rent-seeking elites may not have as strong an incentive to oppose creating ECs.  Indeed, to the extent that a share of EC revenues is transferred to the host country government (depending upon the nature of the EC’s charter), elites might directly benefit, using their political connections to share in the profits.  In short, although setting up viable ECs is no easy matter, their establishment need not be politically unfeasible.  Indeed, the continued success of Hong Kong as a free market island within China (Hong Kong places first in the Heritage Foundation’s Index of Economic Freedom), operating under the Basic Law of Hong Kong, suggests the potential for ECs to thrive, despite having very different rules than the parent state’s legal regime.  (Moreover, the success of Hong Kong may have proven contagious, as China is now promoting a new Shanghai Free Trade Zone thaw would compete with Hong Kong and Singapore.)

The CEDP is currently negotiating the establishment of ECs with a number of governments.  As Singham explains, successful launch of an EC requires:  (1) a committed developer; (2) land that can be used for a project; (3) a good external infrastructure connecting the EC with the rest of the country; and (4) “a government that recognizes the benefits to its reform agenda and to its own economic plan of such a designation of regulatory autonomy and is willing to confront its own challenges by thinking outside the box.”  While the fourth prerequisite may be the most difficult to achieve, internal pressures for faster economic growth and increased investment may lead jurisdictions with burdensome regulatory regimes to consider ECs.

Furthermore, as Singham stresses, by promoting competition on the merits, free from favoritism, a successful EC could stimulate successful entrepreneurship.  Scholarly work points to the importance of entrepreneurship to economic development.

Finally, the beneficial economic effects of ECs could give additional ammunition to national competition authorities as they advocate for less restrictive regulatory frameworks within their jurisdictions.  It could thereby render more effective the efforts of the many new national competition authorities, whose success in enhancing competitive conditions within their jurisdictions has been limited at best.

ECs are no panacea – they will not directly affect restrictive national regulatory laws that benefit privileged special interests but harm the overall economy.  However, to the extent they prove financial successes, over time they could play a crucial indirect role in enhancing competition, reducing inefficiency, and spurring economic growth within their host countries.

PayPal co-founder Peter Thiel has a terrific essay in the Review section of today’s Wall Street Journal.  The essay, Competition Is for Losers, is adapted from Mr. Thiel’s soon-to-be-released book, Zero to One: Notes on Startups, or How to Build the Future.  Based on the title of the book, I assume it is primarily a how-to guide for entrepreneurs.  But if the rest of the book is anything like the essay in today’s Journal, it will also offer lots of guidance to policy makers–antitrust officials in particular.

We antitrusters usually begin with the assumption that monopoly is bad and perfect competition is good. That’s the starting point for most antitrust courses: the professor lays out the model of perfect competition, points to all the wealth it creates and how that wealth is distributed (more to consumers than to producers), and contrasts it to the monopoly pricing model, with its steep marginal revenue curve, hideous “deadweight loss” triangle, and unseemly redistribution of surplus from consumers to producers. Which is better, kids?  Why, perfect competition, of course!

Mr. Thiel makes the excellent and oft-neglected point that monopoly power is not necessarily a bad thing. First, monopolists can do certain good things that perfect competitors can’t do:

A monopoly like Google is different. Since it doesn’t have to worry about competing with anyone, it has wider latitude to care about its workers, its products and its impact on the wider world. Google’s motto–“Don’t be evil”–is in part a branding ploy, but it is also characteristic of a kind of business that is successful enough to take ethics seriously without jeopardizing its own existence.  In business, money is either an important thing or it is everything. Monopolists can think about things other than making money; non-monopolists can’t. In perfect competition, a business is so focused on today’s margins that it can’t possibly plan for a long-term future. Only one thing can allow a business to transcend the daily brute struggle for survival: monopoly profits.

Fair enough, Thiel. But what about consumers? That model we learned shows us that they’re worse off under monopoly.  And what about the deadweight loss triangle–don’t forget about that ugly thing! 

So a monopoly is good for everyone on the inside, but what about everyone on the outside? Do outsize profits come at the expense of the rest of society? Actually, yes: Profits come out of customers’ wallets, and monopolies deserve their bad reputations–but only in a world where nothing changes.

Wait a minute, Thiel. Why do you think things are different when we inject “change” into the analysis?

In a static world, a monopolist is just a rent collector. If you corner the market for something, you can jack up the price; others will have no choice but to buy from you. Think of the famous board game: Deeds are shuffled around from player to player, but the board never changes. There is no way to win by inventing a better kind of real estate development. The relative values of the properties are fixed for all time, so all you can do is try to buy them up.

But the world we live in is dynamic: We can invent new and better things. Creative monopolists give customers more choices by adding entirely new categories of abundance to the world. Creative monopolies aren’t just good for the rest of society; they’re powerful engines for making it better.

Even the government knows this: That is why one of the departments works hard to create monopolies (by granting patents to new inventions) even though another part hunts them down (by prosecuting antitrust cases). It is possible to question whether anyone should really be rewarded a monopoly simply for having been the first to think of something like a mobile software design. But something like Apple’s monopoly profits from designing, producing and marketing the iPhone were clearly the reward for creating greater abundance, not artificial scarcity: Customers were happy to finally have the choice of paying high prices to get a smartphone that actually works. The dynamism of new monopolies itself explains why old monopolies don’t strangle innovation. With Apple’s iOS at the forefront, the rise of mobile computing has dramatically reduced Microsoft’s decadeslong operating system dominance.

…If the tendency of monopoly businesses was to hold back progress, they would be dangerous, and we’d be right to oppose them. But the history of progress is a history of better monopoly businesses replacing incumbents. Monopolies drive progress because the promise of years or even decades of monopoly profits provides a powerful incentive to innovate. Then monopolies can keep innovating because profits enable them to make the long-term plans and finance the ambitious research projects that firms locked in competition can’t dream of.

Geez, Thiel.  You know who you sound like?  Justice Scalia. Here’s how he once explained your idea (to shrieks and howls from many in the antitrust establishment!):

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices–at least for a short period–is what attracts “business acumen” in the first place. It induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.

Sounds like you and Scalia are calling for us antitrusters to update our models.  Is that it?

So why are economists obsessed with competition as an ideal state? It is a relic of history. Economists copied their mathematics from the work of 19th-century physicists: They see individuals and businesses as interchangeable atoms, not as unique creators. Their theories describe an equilibrium state of perfect competition because that is what’s easy to model, not because it represents the best of business.

C’mon now, Thiel. Surely you don’t expect us antitrusters to defer to you over all these learned economists when it comes to business.

The Religious Freedom Restoration Act (RFRA) subjects government-imposed burdens on religious exercise to strict scrutiny.  In particular, the Act provides that “[g]overnment shall not substantially burden a person’s exercise of religion even if the burden results from a rule of general applicability” unless the government can establish that doing so is the least restrictive means of furthering a “compelling government interest.”

So suppose a for-profit corporation’s stock is owned entirely by evangelical Christians with deeply held religious objections to abortion.  May our federal government force the company to provide abortifacients to its employees?  That’s the central issue in Sebelius v. Hobby Lobby Stores, which the Supreme Court will soon decide.  As is so often the case, resolution of the issue turns on a seemingly mundane matter:  Is a for-profit corporation a “person” for purposes of RFRA?

In an amicus brief filed in the case, a group of forty-four corporate and criminal law professors argued that treating corporations as RFRA persons would contradict basic principles of corporate law.  Specifically, they asserted that corporations are distinct legal entities from their shareholders, who enjoy limited liability behind a corporate veil and cannot infect the corporation with their own personal religious views.  The very nature of a corporation, the scholars argued, precludes shareholders from exercising their religion in corporate form.  Thus, for-profit corporations can’t be “persons” for purposes of RFRA.

In what amounts to an epic takedown of the law professor amici, William & Mary law professors Alan Meese and Nathan Oman have published an article explaining why for-profit corporations are, in fact, RFRA persons.  Their piece in the Harvard Law Review Forum responds methodically to the key points made by the law professor amici and to a few other arguments against granting corporations free exercise rights.

Among the arguments that Meese and Oman ably rebut are:

  • Religious freedom applies only to natural persons.

Corporations are simply instrumentalities by which people act in the world, Meese and Oman observe.  Indeed, they are nothing more than nexuses of contracts, provided in standard form but highly tailorable by those utilizing them.  “When individuals act religiously using corporations they are engaged in religious exercise.  When we regulate corporations, we in fact burden the individuals who use the corporate form to pursue their goals.”

  • Given the essence of a corporation, which separates ownership and control, for-profit corporations can’t exercise religion in accordance with the views of their stockholders.

This claim is simply false.  First, it is possible — pretty easy, in fact — to unite ownership and control in a corporation.  Business planners regularly do so using shareholder agreements, and many states, including Delaware, explicitly allow for shareholder management of close corporations.  Second, scads of for-profit corporations engage in religiously motivated behavior — i.e., religious exercise.  Meese and Oman provide a nice litany of examples (with citations omitted here):

A kosher supermarket owned by Orthodox Jews challenged Massachusetts’ Sunday closing laws in 1960.  For seventy years, the Ukrops Supermarket chain in Virginia closed on Sundays, declined to sell alcohol, and encouraged employees to worship weekly.  A small grocery store in Minneapolis with a Muslim owner prepares halal meat and avoids taking loans that require payment of interest prohibited by Islamic law.  Chick-fil-A, whose mission statement promises to “glorify God,” is closed on Sundays.  A deli that complied with the kosher standards of its Conservative Jewish owners challenged the Orthodox definition of kosher found in New York’s kosher food law, echoing a previous challenge by a different corporation of a similar New Jersey law.  Tyson Foods employs more than 120 chaplains as part of its effort to maintain a “faith-friendly” culture.  New York City is home to many Kosher supermarkets that close two hours before sundown on Friday and do not reopen until Sunday.  A fast-food chain prints citations of biblical verses on its packaging and cups.  A Jewish entrepreneur in Brooklyn runs a gas station and coffee shop that serves only Kosher food.  Hobby Lobby closes on Sundays and plays Christian music in its stores.  The company provides employees with free access to chaplains, spiritual counseling, and religiously themed financial advice.  Moreover, the company does not sell shot glasses, refuses to allow its trucks to “backhaul” beer, and lost $3.3 million after declining to lease an empty building to a liquor store.

As these examples illustrate, the assertion by lower courts that “for-profit, secular corporations cannot engage in religious exercise” is just empirically false.

  • Allowing for-profit corporations to have religious beliefs would create intracorporate conflicts that would reduce the social value of the corporate form of business.

The corporate and criminal law professor amici described a parade of horribles that would occur if corporations were deemed RFRA persons.  They insisted, for example, that RFRA protection would inject religion into a corporation in a way that “could make the raising of capital more challenging, recruitment of employees more difficult, and entrepreneurial energy less likely to flourish.”  In addition, they said, RFRA protection “would invite contentious shareholder meetings, disruptive proxy contests, and expensive litigation regarding whether the corporations should adopt a religion and, if so, which one.”

But actual experience suggests there’s no reason to worry about such speculative harms.  As Meese and Oman observe, we’ve had lots of experience with this sort of thing:  Federal and state laws already allow for-profit corporations to decline to perform or pay for certain medical procedures if they have religious or moral objections.  From the Supreme Court’s 1963 Sherbert decision to its 1990 Smith decision, strict scrutiny applied to governmental infringements on corporations’ religious exercise.  A number of states have enacted their own versions of RFRA, most of which apply to corporations.   Thus, “[f]or over half a century, … there has been no per se bar to free exercise claims by for-profit corporations, and the parade of horribles envisioned by the [law professor amici] has simply not materialized.”  Indeed, “the scholars do not cite a single example of a corporate governance dispute connected to [corporate] decisions [related to religious exercise].”

  • Permitting for-profit corporations to claim protection under RFRA will lead to all sorts of false claims of religious belief in an attempt to evade government regulation.

The law professor amici suggest that affording RFRA protection to for-profit corporations may allow such companies to evade regulatory requirements by manufacturing a religious identity.  They argue that “[c]ompanies suffering a competitive disadvantage [because of a government regulation] will simply claim a ‘Road to Damascus’ conversion.  A company will adopt a board resolution asserting a religious belief inconsistent with whatever regulation they find obnoxious . . . .”

As Meese and Oman explain, however, this problem is not unique to for-profit corporations.  Natural persons may also assert insincere religious claims, and courts may need to assess sincerity to determine if free exercise rights are being violated.  The law professor amici contend that it would be unprecedented for courts to assess whether religious beliefs are asserted in “good faith.”  But the Supreme Court decision the amici cite in support of that proposition, Meese and Oman note, held only that courts lack competence to evaluate the truth of theological assertions or the accuracy of a particular litigant’s interpretation of his faith.  “This task is entirely separate … from the question of whether a litigant’s asserted religious beliefs are sincerely held.  Courts applying RFRA have not infrequently evaluated such sincerity.”

***

In addition to rebutting the foregoing arguments (and several others) against treating for-profit corporations as RFRA persons, Meese and Oman set forth a convincing affirmative argument based on the plain text of the statute and the Dictionary Act.  I’ll let you read that one on your own.

I’ll also point interested readers to Steve Bainbridge’s fantastic work on this issue.  Here is his critique of the corporate and criminal law professors’  amicus brief.  Here is his proposal for using the corporate law doctrine of reverse veil piercing to assess a for-profit corporation’s religious beliefs.

Read it all before SCOTUS rules!

On Wednesday, the U.S. Supreme Court heard oral argument in Halliburton v. Erica P. John Fund, a case that could drastically alter the securities fraud landscape.  Here are a few thoughts on the issues at stake in the case and a cautious prediction about how the Court will rule.

First, some quick background for the uninitiated.  The broadest anti-fraud provision of the securities laws, Section 10(b) of the 1934 Securities Exchange Act, forbids the use of “any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe….”  The Commission’s Rule 10b-5, then, makes it illegal “to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”

Although Section 10(b) doesn’t expressly entitle victims of securities fraud to sue for damages, the Supreme Court long ago inferred a private right of action to enforce the provision.  The elements of that judicially created private right of action are: (1) a material misrepresentation or omission by the defendant, (2) scienter (i.e., mental culpability worse than mere negligence) on the part of the defendant, (3) a connection between the misrepresentation or omission and the purchase or sale of a security, (4) the plaintiff’s reliance upon the misrepresentation or omission, (5) economic loss by the plaintiff, and (6) loss causation (i.e., the fraud, followed by revelation of the truth, was the proximate cause of the plaintiff’s investment loss).

For most individual investors, the economic loss resulting from any instance of securities fraud (and, thus, the potential recovery) is not enough to justify the costs of bringing a lawsuit.  Accordingly, 10b-5 suits seem like an appropriate context for class actions.  The elements of the judicially created cause of action, however, make class certification difficult.  That is because most securities fraud class actions would proceed under Federal Rule of Civil Procedure 23(b)(3), which requires that common issues of law or fact in all the plaintiffs’ cases predominate over plaintiff-specific issues.  Because the degree to which any individual investor relied upon a misrepresentation (element 4) requires proof of lots of investor-specific facts (How did you learn of the misrepresentation?, How did it influence your investment decision?, etc.), the reliance element would seem to preclude Rule 10b-5 class actions.

In Basic v. Levinson, a 1988 Supreme Court decision from which three justices were recused, a four-justice majority endorsed a doctrine that has permitted Rule 10b-5 class actions to proceed, despite the reliance element.  The so-called “fraud on the market” doctrine creates a rebuttable presumption that an investor who traded in an efficient stock market following a fraudulent disclosure (but before the truth was revealed) “relied” on that disclosure, even if she didn’t see or hear about it.  The theoretical basis for the fraud on the market doctrine is the semi-strong version of the Efficient Capital Markets Hypothesis (ECMH), which posits that securities prices almost instantly incorporate all publicly available information about the underlying company, making it impossible to earn above-normal returns by engaging in “fundamental analysis” (i.e., study of publicly available information about a listed company).  The logic of the fraud on the market doctrine is that publicly available misinformation affects a security’s price, upon which an investor normally relies when she makes her investment decision.  Thus, any investor who makes her investment decision on the basis of the stock’s price “relies” on the “ingredients” of that price, including the misinformation at issue.

In light of this logic, the Basic Court reasoned that a defendant could rebut the presumption of reliance by severing either the link between the misinformation and the stock’s price or the link between the stock’s price and the investor’s decision.  To sever the former link, the defendant would need to show that key market makers were privy to the truth, so that the complained of lie could not have affected the market price of the stock (in other words, there was “truth on the market”…great name for a blog, no?).  To sever the latter link, the defendant would need to show that the plaintiff investor made her investment decision for some reason unrelated to the stock’s price—say, because she needed to divest herself of the stock for political reasons.

Basic thus set up a scheme in which the class plaintiff bears the burden of establishing that the stock at issue traded in an efficient market.  If she does so, her (and similarly situated class members’) reliance on the misinformation at issue is presumed.  The defendant then bears the burden of rebutting the presumption by showing either that the misrepresentation did not give rise to a price distortion (probably because the truth was on the market) or that the individual investor would have traded even if she knew the statement was false (i.e., her decision was not based on the stock’s price).

The Halliburton appeal presents two questions.  First, should the Court overrule Basic and jettison the rebuttable presumption of reliance when the stock at issue is traded in an efficient market.  Second, at the class certification stage, should the defendant be permitted to prevent the reliance presumption from arising by presenting evidence that the alleged misrepresentation failed to distort the market price of the stock at issue.

With respect to the first question, the Court could go three ways.  First, it could maintain the status quo rule that 10b-5 plaintiffs, in order to obtain the reliance presumption, must establish only that the stock at issue was traded in an efficient market.  Second, it could overrule Basic wholesale and hold that a 10b-5 plaintiff must establish actual, individualized reliance (i.e., show that she knew of the misrepresentation and that it influenced her investment decision).  Third, the Court could tweak Basic by holding that plaintiffs may avail themselves of the presumption of reliance only if they establish, at the class certification stage, that the complained of
misrepresentation actually distorted the market price of the stock at issue.

My guess, which I held before oral argument and seems consistent with the justices’ questioning on Wednesday, is that the Court will take the third route.  There are serious problems with the status quo.  First, it rests squarely upon the semi-strong version of the ECMH, which has come under fire in recent years.  While no one doubts that securities prices generally incorporate publicly available information, and very quickly, a number of studies purporting to document the existence of arbitrage opportunities have challenged the empirical claim that every bit of publicly available information is immediately incorporated into the price of every security traded in an efficient market.  Indeed, the winners of this year’s Nobel Prize in Economics split on this very question.   I doubt this Supreme Court will want to be perceived as endorsing a controversial economic theory, especially when doing so isn’t necessary to maintain some sort of reliance presumption (given the third possible holding discussed above).

A second problem with the status quo is that it places an unreasonable burden on courts deciding whether to certify a class.  The threshold question for the fraud on the market presumption—is the security traded in an efficient market?—is just too difficult for non-specialist courts.  How does one identify an “efficient market”?  One court said the relevant factors are:  “(1) the stock’s average weekly trading volume; (2) the number of securities analysts that followed and reported on the stock; (3) the presence of market makers and arbitrageurs; (4) the company’s eligibility to file a Form S-3 Registration Statement; and (5) a cause-and-effect relationship, over time, between unexpected corporate events or financial releases and an immediate response in stock price.”  Others have supplemented these so-called “Cammer factors” with a few others: market capitalization, the bid/ask spread, float, and analyses of autocorrelation.  No one can say, though, how each factor should be assessed (e.g., How many securities analysts must follow the stock? How much autocorrelation is permissible?  How large may the bid-ask spread be?).  Nor is there guidance on how to balance factors when some weigh in favor of efficiency and others don’t.  It’s a crapshoot.

The status quo approach of presuming investor reliance if the plaintiff establishes an efficient market for the company’s stock is also troubling because the notion of a “market” for any single company’s stock is theoretically unsound.  An economic market consist of all products that are, from a buyer’s perspective, reasonably interchangeable.  For example, Evian bottled water (spring water from the Alps) is a very close substitute for Fiji water (spring water from the Fiji Islands) and is probably in the same product market.  From an investor’s perspective, there are scores of close substitutes for the stock of any particular company.  Such substitutes would include all other stocks that offer the same package of financial attributes (risk, expected return, etc.).  It makes little sense, then, to speak of a “market” consisting of a single company’s stock, and basing the presumption of reliance on establishment of an “efficient market” in one company’s stock is somewhat nonsensical.

With respect to the second possible route for the Halliburton Court—overturning Basic in its entirety and requiring individualized proof of actual reliance—proponents emphasize that the private right of action to enforce Section 10(b) and Rule 10b-5 is judicially created.  The Supreme Court now disfavors implied rights of action and, to avoid stepping on Congress’s turf, requires that they stick close to the statute at issue.  In particular, the Court has said that determining the elements of a private right of action requires “historical reconstruction.”  With respect to the Rule 10b-5 action, the Court tries “to infer how the 1934 Congress would have addressed the issue had the 10b-5 action been included as an express provision of the 1934 Act,” and to do that, it consults “the express causes of action” in the Act and borrows from the “most analogous” one.  In this case, that provision is Section 18(a), which is the only provision in the Exchange Act authorizing damages actions for misrepresentations affecting secondary, aftermarket trading (i.e., trading after a public offering of the stock at issue).  Section 18(a) requires a plaintiff to establish actual “eyeball” reliance—i.e., that she bought the security with knowledge of the false statement and relied upon it in making her investment decision.  There is thus a powerful legal argument in favor of a full-scale overturning of Basic.

As much as I’d like for the Court to take that route (because I believe Rule 10b-5 class actions create far greater social cost than benefit), I don’t think the Court will go there.  Overruling Basic to require eyeball reliance in Rule 10b-5 actions would be perceived as an activist, “pro-business” decision:  activist because Congress has enacted significant legislation addressing Rule 10b-5 actions and has left the fraud on the market doctrine untouched, and pro-business because it would insulate corporate managers from 10b-5 class actions.

Now, both of those characterizations are wrong.  The chief post-Basic legislation involving Rule 10b-5, the 1995 Private Securities Litigation Reform Act, specifically stated (in Section 203) that “[n]othing in this Act shall be deemed to … ratify any implied private right of action.”  As Justices Alito and Scalia emphasized at oral argument, the PSLRA expressly declined to put a congressional imprimatur on the judicially created Rule 10b-5 cause of action, so a Court decision modifying Rule 10b-5’s elements would hardly be “activist.” Nor would the decision be “pro-business” and “anti-investor.”  The fact is, the vast majority of Rule 10b-5 class actions are settled on terms where the corporation pays the bulk of the settlement, which largely goes to class counsel.  The corporation, of course, is spending investors’ money.  All told, then, investors as a class pay a lot for, and get very little from, Rule 10b-5 class actions.  A ruling eviscerating such actions would better be characterized as pro-investor.

Sadly, our financially illiterate news media cannot be expected to understand all this and would, if Basic were overturned, fill the newsstands and airwaves with familiar stories of how the Roberts Court continues on its activist, pro-business rampage.  And even more sadly, at least one key justice whose vote would be needed for a Basic overruling, has proven himself to be exceedingly concerned with avoiding the appearance of “activism.”  A wholesale overruling of Basic, then, is unlikely.

That leaves the third route, modifying Basic to require that class plaintiffs first establish a price distortion resulting from the complained of misrepresentation.  I have long suspected that this is where the Court will go, and the justices’ questioning on Wednesday suggests this is how many (especially Chief Justice Roberts and Justice Kennedy) are leaning.  From the Court’s perspective, there are several benefits to this approach.

First, it would allow the Court to avoid passing judgment on the semi-strong ECMH.  The status quo approach—prove an efficient market and we’ll presume reliance because of an inevitable price effect—really seems to endorse the semi-strong ECMH.  An approach requiring proof of price distortion, by contrast, doesn’t.  It may implicitly assume that most pieces of public information are instantly incorporated into securities prices, but no one really doubts that.

Second, the third route would substitute a fairly manageable inquiry (Did the misrepresentation occasion a price effect?) for one that is both difficult and theoretically problematic (Is the market for the company’s stock efficient?).

Third, the approach would allow the Court to eliminate a number of the most meritless securities fraud class actions without appearing overly “activist” and “pro-business.”  If class plaintiffs can’t show a price effect from a complained of misrepresentation or omission, then their claim is really frivolous and ought to go away immediately.  The status quo would permit certification of the class, despite the absence of a price effect, as long as class counsel could demonstrate an efficient market using the amorphous and unreliable factors set forth above.  And once the class is certified, the plaintiffs have tons of settlement leverage, even when they don’t have much of a claim.  In short, the price distortion criterion is a far better screen than the market efficiency screen courts currently utilize.  For all these reasons, I suspect the Court will decide not to overrule Basic but to tweak it to require a threshold showing of price distortion.

If it does so, then the second question at issue in Halliburton—may the defendant, at the class certification stage, present evidence of an absence of price distortion?—goes away.  If the plaintiff must establish price distortion to attain class certification, then due process would require that the defendant be allowed to poke holes in the plaintiff’s certification case.

So that’s my prediction on Halliburton.  We shall see.  Whatever the outcome, we’ll have lots to discuss in June.

Like most libertarians I’m concerned about government abuse of power. Certainly the secrecy and seeming reach of the NSA’s information gathering programs is worrying. But we can’t and shouldn’t pretend like there are no countervailing concerns (as Gordon Crovitz points out). And we certainly shouldn’t allow the fervent ire of the most radical voices — those who view the issue solely from one side — to impel technology companies to take matters into their own hands. At least not yet.

Rather, the issue is inherently political. And while the political process is far from perfect, I’m almost as uncomfortable with the radical voices calling for corporations to “do something,” without evincing any nuanced understanding of the issues involved.

Frankly, I see this as of a piece with much of the privacy debate that points the finger at corporations for collecting data (and ignores the value of their collection of data) while identifying government use of the data they collect as the actual problem. Typically most of my cyber-libertarian friends are with me on this: If the problem is the government’s use of data, then attack that problem; don’t hamstring corporations and the benefits they confer on consumers for the sake of a problem that is not of their making and without regard to the enormous costs such a solution imposes.

Verizon, unlike just about every other technology company, seems to get this. In a recent speech, John Stratton, head of Verizon’s Enterprise Solutions unit, had this to say:

“This is not a question that will be answered by a telecom executive, this is not a question that will be answered by an IT executive. This is a question that must be answered by societies themselves.”

“I believe this is a bigger issue, and press releases and fizzy statements don’t get at the issue; it needs to be solved by society.

Stratton said that as a company, Verizon follows the law, and those laws are set by governments.

“The laws are not set by Verizon, they are set by the governments in which we operate. I think its important for us to recognise that we participate in debate, as citizens, but as a company I have obligations that I am going to follow.

I completely agree. There may be a problem, but before we deputize corporations in the service of even well-meaning activism, shouldn’t we address this as the political issue it is first?

I’ve been making a version of this point for a long time. As I said back in 2006:

I find it interesting that the “blame” for privacy incursions by the government is being laid at Google’s feet. Google isn’t doing the . . . incursioning, and we wouldn’t have to saddle Google with any costs of protection (perhaps even lessening functionality) if we just nipped the problem in the bud. Importantly, the implication here is that government should not have access to the information in question–a decision that sounds inherently political to me. I’m just a little surprised to hear anyone (other than me) saying that corporations should take it upon themselves to “fix” government policy by, in effect, destroying records.

But at the same time, it makes some sense to look to Google to ameliorate these costs. Google is, after all, responsive to market forces, and (once in a while) I’m sure markets respond to consumer preferences more quickly and effectively than politicians do. And if Google perceives that offering more protection for its customers can be more cheaply done by restraining the government than by curtailing its own practices, then Dan [Solove]’s suggestion that Google take the lead in lobbying for greater legislative protections of personal information may come to pass. Of course we’re still left with the problem of Google and not the politicians bearing the cost of their folly (if it is folly).

As I said then, there may be a role for tech companies to take the lead in lobbying for changes. And perhaps that’s what’s happening. But the impetus behind it — the implicit threats from civil liberties groups, the position that there can be no countervailing benefits from the government’s use of this data, the consistent view that corporations should be forced to deal with these political problems, and the predictable capitulation (and subsequent grandstanding, as Stratton calls it) by these companies is not the right way to go.

I applaud Verizon’s stance here. Perhaps as a society we should come out against some or all of the NSA’s programs. But ideological moralizing and corporate bludgeoning aren’t the way to get there.

[The following is a guest post by Thomas McCarthy on the Supreme Court’s recent Amex v. Italian Colors Restaurant decision. Tom is a partner at Wiley Rein, LLP and a George Mason Law grad. He is/was also counsel for, among others,

So he’s had a busy week….]

The Supreme Court’s recent opinion in American Express Co. v. Italian Colors Restaurant (June 20, 2013) (“Amex”) is a resounding victory for freedom-of-contract principles.  As it has done repeatedly in recent terms (see AT&T Mobility LLC v. Concepcion (2011); Marmet Health Care Center, Inc. v. Brown (2012)), the Supreme Court reaffirmed that the Federal Arbitration Act (FAA) makes arbitration “a matter of contract,” requiring courts to “rigorously enforce arbitration agreements according to their terms.”  Amex at 3.  In so doing, it rejected the theory that class procedures must remain available to claimants in order to ensure that they have sufficient financial incentive to prosecute federal statutory claims of relatively low value.  Consistent with the freedom-of-contract principles enshrined in the FAA, an arbitration agreement must be enforced—even if the manner in which the parties agreed to arbitrate leaves would-be claimants with low-value claims that are not worth pursuing.

In Amex, merchants who accept American Express cards filed a class action against Amex, asserting that Amex violated Section 1 of the Sherman Act by “us[ing] its monopoly power in the market for charge cards to force merchants to accept credit cards at rates approximately 30% higher than the fees for competing credit cards.”  Amex at 1-2.  And, of course, the merchants sought treble damages for the class under Section 4 of the Clayton Act.  Under the terms of their agreement with American Express, the merchants had agreed to resolve all disputes via individual arbitration, that is, without the availability of class procedures.  Consistent with that agreement, American Express moved to compel individual arbitration, but the merchants countered that the costs of expert analysis necessary to prove their antitrust claims would greatly exceed the maximum recovery for any individual plaintiff, thereby precluding them from effectively vindicating their federal statutory rights under the Sherman Act.  The Second Circuit sided with the merchants, holding that the prohibitive costs the merchants would face if they had to arbitrate on an individual basis rendered the class-action waiver in the arbitration agreement unenforceable.

In a 5-3 majority (per Justice Scalia), the Supreme Court reversed.  The Court began by highlighting the Federal Arbitration Act’s freedom-of-contract mandate—that “courts must rigorously enforce arbitration agreements according to their terms, including terms that specify with whom [the parties] choose to arbitrate their disputes, and the rules under which that arbitration will be conducted.”  Amex at 2-3 (internal quotations and citations omitted).  It emphasized that this mandate applies even to federal statutory claims, “unless the FAA’s mandate has been overridden by a contrary congressional command.”  Amex at 3 (internal quotations and citations omitted).  The Court then briefly explained that no contrary congressional command exists in either the federal antitrust laws or Rule 23 of the Federal Rules of Civil Procedure (which allows for class actions in certain circumstances).

Next, the Court turned to the merchants’ principal argument—that the arbitration agreement should not be enforced because enforcing it (including its class waiver provision) would preclude plaintiffs from effectively vindicating their federal statutory rights.  The Court noted that this “effective vindication” exception “originated as dictum” in prior cases and that the Court has only “asserted [its] existence” without ever having applied it in any particular case.  Amex at 6.  The Court added that this exception grew out of a desire to prevent a “prospec­tive waiver of a party’s right to pursue statutory reme­dies,” explaining that it “would certainly cover a provision in an arbitration agreement forbidding the assertion of certain statutory rights.”  The Court added that this exception might “perhaps cover filing and administrative fees attached to arbitration that are so high as to make access to the forum impracticable,” Amex at 6, but emphasized that, whatever the scope of this exception, the fact that the manner of arbitration the parties contracted for might make it “not worth the expense” to pursue a statutory remedy “does not constitute the elimination of the right to pursue that remedy.”  Amex at 7.

The Court closed by noting that its previous decision in AT&T Mobility v. Concepcion “all but resolves this case.”  Amex at 8.  In Concepcion, the Court had invalidated a state law “conditioning enforcement of arbitration on the availability of class procedures because that law ‘interfere[d] with fundamental attributes of arbitration.’”   As the Court explained, Concepcion specifically rejected the argument “that class arbitration was necessary to prosecute claims ‘that might otherwise slip through the legal system’” thus establishing “that the FAA’s command to enforce arbitration agreements trumps any interest in ensuring the prosecution of low value claims.”  Amex at 9 (quoting Concepcion).  The Court made clear that, under the FAA, courts are to hold parties to the deal they struck—arbitration pursuant to the terms of their arbitration agreements, even if that means that certain claims may go unprosecuted.  Responding to a dissent penned by Justice Kagan, who complained that the Court’s decision would lead to “[l]ess arbitration,” contrary to the pro-arbitration policies of the FAA, Amex dissent at 5, the Court doubled down on this point, emphasizing that the FAA “favor[s] the absence of litigation when that is the consequence of a class-action waiver, since its ‘principal purpose’ is the enforcement of arbitration agreements according to their terms.”  Amex at 9 n.5 (emphasis added).

By holding parties to the deal they struck regarding the resolution of their disputes, the Court properly vindicates the FAA’s freedom-of-contract mandates.  And even assuming the dissenters are correct that there will be less arbitration in individual instances, the opposite is true on a macro level.  For where there is certainty in contract enforcement, parties will enter into contracts.  Amex thus should promote arbitration by eliminating uncertainty in contracting and thereby removing a barrier to swift and efficient resolution of disputes.

By Geoffrey Manne & Berin Szoka

As Democrats insist that income taxes on the 1% must go up in the name of fairness, one Democratic Senator wants to make sure that the 1% of heaviest Internet users pay the same price as the rest of us. It’s ironic how confused social justice gets when the Internet’s involved.

Senator Ron Wyden is beloved by defenders of Internet freedom, most notably for blocking the Protect IP bill—sister to the more infamous SOPA—in the Senate. He’s widely celebrated as one of the most tech-savvy members of Congress. But his latest bill, the “Data Cap Integrity Act,” is a bizarre, reverse-Robin Hood form of price control for broadband. It should offend those who defend Internet freedom just as much as SOPA did.

Wyden worries that “data caps” will discourage Internet use and allow “Internet providers to extract monopoly rents,” quoting a New York Times editorial from July that stirred up a tempest in a teapot. But his fears are straw men, based on four false premises.

First, US ISPs aren’t “capping” anyone’s broadband; they’re experimenting with usage-based pricing—service tiers. If you want more than the basic tier, your usage isn’t capped: you can always pay more for more bandwidth. But few users will actually exceed that basic tier. For example, Comcast’s basic tier, 300 GB/month, is so generous that 98.5% of users will not exceed it. That’s enough for 130 hours of HD video each month (two full-length movies a day) or between 300 and 1000 hours of standard (compressed) video streaming. Continue Reading…

Free Uber

Josh Wright —  6 September 2012

From the NY Times:

Uber, a company based in San Francisco, is introducing a smartphone app to New York that allows available taxi drivers and cab-seeking riders to find one another. The company said the service would begin operating on Wednesday in 105 cabs — a bit less than 1 percent of the city’s more than 13,000 yellow cabs. Uber added that it hoped to recruit 100 new drivers each week.

But the program may have a significant problem: Taxi officials say that Uber’s service may not be legal since city rules do not allow for prearranged rides in yellow taxis. They also forbid cabbies from using electronic devices while driving and prohibit any unjustified refusal of fares. (Under Uber’s policy, once a driver accepts a ride through the app, no other passenger can be picked up.)

So, who else might be interested in fighting the rise of Uber and similar services?

The influx of apps appears to have created a moment of unity among yellow-taxi, livery and black-car operators, all of whom have raised concerns about the apps’ legality. Some industry officials said the commission was not acting forcefully enough; the result, said Avik Kabessa, the chief executive of Carmel Car and Limousine Service and a member of the board of the Livery Roundtable, a group representing livery drivers, is a New York City version of “the Wild West.”  An analysis conducted by the Metropolitan Taxicab Board of Trade, which represents yellow-taxi operators, identified what it deemed to be 11 potential violations of taxi guidelines in Uber’s model. These included charging a tip automatically, not allowing for cash payments and turning away passengers while being on duty.

Uber and similar services face similar threats in other cities, including here in DC, where Uber faced the “Uber Amendments” which would require Uber to charge five times the price of a cab!  At least the DC Commission was incredibly clear about the role of the regulation: to suppress competition and harm consumers:

Explanation and Rationale
· This section would clarify how sedan services operate.

· Sedans would be required to charge a minimum fare of 5 times the drop rate for taxicabs.

· Sedans would be required to charge time and distance rates that are greater as those for taxicabs.

· These requirements would ensure that sedan service is a premium class of service with a substantially higher cost that does not directly compete with or undercut taxicab service.

Here is Uber’s response to the DC Council:

The Council’s intention is to prevent Uber from being a viable alternative to taxis by enacting a price floor to set Uber’s minimum fare at today’s rates and no less than 5 times a taxi’s minimum fare. Consequently they are handicapping a reliable, high quality transportation alternative so that Uber cannot offer a high quality service at the best possible price. It was hard for us to believe that an elected body would choose to keep prices of a transportation service artificially high – but the goal is essentially to protect a taxi industry that has significantexperience in influencing local politicians. They want to make sure there is no viable alternative to a taxi in Washington DC, and so on Tuesday (tomorrow!), the DC City Council is going to formalize that principle into law.

There appears to be subsequent history, including a temporary shelving of the Amendment with the potential to bring it back on its own in the future.  Councilwoman and George Washington Law Prof Mary Cheh is a force behind the Uber Amendment and complained that a settlement could not be reached with Uber that would shed the requirement of having prices 5 times higher, but retain a price differential in the name of shielding taxi cabs from competition (emphasis my own):

Establishing a minimum fare is important to distinguish premium sedan service from traditional taxicab service and to prevent sedans from directly competing with or undercuting taxicabs.  Taxi companies want minimum fares that are much higher than what I am proposing in my amendment.  However, I believe that simply preserving the status quo is appropriate and reasonable.

I am deeply disappointed that Uber has decided that it no longer supports this amendment that we negotiated in good faith.  The taxi industry is one that has been regulated for a very long time.  If Uber wishes to operate taxis, then it is free to do so, but it should then be subject to the same regulations and requirements of taxis.

As I frequently point out on the blog, local barriers to entry cause substantially greater dissipation of consumer surplus than is conventionally acknowledged (e.g., here, here, and here).

HT: Hal Singer.

Our greatly lamented colleague Lary Ribstein was a movie buff. Some time ago he wrote an encyclopedic article on business in the movies, “Wall Street and Vine: Hollywood’s View of
Business.”  At the time of his death, he and I were in discussions about publishing this article in the journal I edit, Managerial and Decison Economics.  After his tragic death, I contacted his widow, Ann, and received permission to publish the article.  It is now published in the June issue of MDE.  (If your library does not subscribe to MDE, the article is still available on SSRN.)  Anyone with any interest in the movies and their perception of business must read this article. Given the volume of Larry’s scholarship, it is amazing that he had time to see as many movies as he discusses in this article.

Richard Epstein replies to Judge Posner’s Apple v. Motorola opinion and follow-up article in The Atlantic.

The anti-patent sentiment has just been fueled by a remarkable opinion by Judge Richard Posner, my long-time colleague at the University of Chicago, sitting as a trial judge in the major case, Apple v. Motorola. The high-profile case concerns five patents—four by Apple and one by Motorola—that are involved in mobile phone technology, and it has drawn more than its fair share of attention. Judge Posner took the extraordinary step of dismissing the claims of both sides with prejudice—meaning, the case cannot be filed again elsewhere—on the grounds that neither side could make good on its argument for either damages or injunctions.

Thus, when the dust settled, there was no reason at all to have a trial on whether either side had infringed the patents of the other. In a subsequent piece written for The Atlantic, grandly entitled “Why There are Too Many Patents in America,” Posner delivered a general critique of the patent system, discussing the broader issues involved in his judicial decision.

There is much of interest, as always, in Epstein’s column.  But the closing section on damages and injunctions is where the action is:

What is so striking about Posner’s relentless dissection of the imprecision in these claims was that he could apply it with equal conviction in any patent software dispute. The estimates of damages under the law are not confined to a single standard, but often involve an uncertain choice between reasonable royalties for licensing the patent and actual damages that were incurred because the patents were not licensed. The injunctive relief is (or at least should be) awarded precisely because it is so difficult to figure out what those damages really ought to be.

But Posner said that he would not allow an injunction if the best that the plaintiffs could garner was $1 in nominal damages. That surely seems over the top, because if there is infringement, the one number that is manifestly wrong is $1. A more sensible approach here, therefore, is to mix and marry the two remedies, so that the injunction does not pull the past product off the market, but awards some damages for past losses, while giving the infringer some period of time—say three to six months—to invent around the patent for future output. This then sets the stage for a negotiated license if that is cheaper.

By putting the remedial cart before the liability horse, we have the odd situation that no one can find out anything about the strength of the patent or the potential range of damages. If that is done on a common basis, then we will have knocked out the entire patent system for software, without having the slightest idea of the relative strength of the Apple and Motorola contentions.

The Posner decision looks doubly worrisome against the backdrop of his ominous Atlantic column, which shows his ill-concealed disdain for a complex industry with which he has had no direct engagement. It is an odd way to make patent policy. Right now, a similar Apple-Samsung dispute is before Judge Lucy Koh, which will involve a real trial. The Posner opinion is already on the fast track to appeal before the Federal Circuit, which will give us more information as to whether these submarine assaults on the patent system will take hold. Let us hope that Posner’s mysterious patent adventurism dies a quick and deserved death.

Do go read the whole thing.  For interested readers, here is Posner’s Atlantic column.