Archives For Steve Bainbridge

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!

Roberta Romano has just posted her paper, Regulating in the Dark. Here’s the abstract:

Foundational financial legislation is typically adopted in the midst or aftermath of financial crises, when an informed understanding of the causes of the crisis is not yet available. Moreover, financial institutions operate in a dynamic environment of considerable uncertainty, such that legislation enacted even under the best of circumstances can have perverse unintended consequences, and regulatory requirements correct for an initial set of conditions can become inappropriate as economic and technological circumstances change. Furthermore, the stickiness of the status quo in the U.S. political system renders it difficult to revise legislation, even though there may be a consensus to do so. This essay contends that the best means of responding to this dismal state of affairs is to include, as a matter of course, in crisis-driven financial legislation and its implementing regulation two key procedural mechanisms: (1) a requirement of automatic subsequent review and reconsideration of the legislative and regulatory decisions at some future point in time; and (2) regulatory exemptive or waiver powers, that encourage, where feasible, small scale experimentation, as well as flexibility in implementation. Both procedural devices will better inform and calibrate the regulatory apparatus, and could thereby mitigate, at least on the margin, the unintended errors which will invariably accompany financial legislation and rulemaking originating in a crisis. Given the centrality of financial institutions and markets to economic growth and societal well-being, it is exceedingly important for legislators acting in a financial crisis with the best of intentions, to not make matters worse.

It’s worth noting that Henry Butler and I, in our book about SOX (at 96-97, footnotes omitted), also suggested “sunset” provisions as an antidote to crisis-driven regulation:

[S]ignificant new financial and governance regulation like SOX that displaces and supplements prior regulatory approaches should be subject to periodic review and sunset provisions. Although Congress, of course, can always undertake such reviews, prior experience indicates that it will not. Legislation is a one-way regulatory ratchet. It arises when the conditions for reform are ripe for a regulatory panic. The conditions for a “deregulatory panic” are less likely to develop. Firms learn to live with the extra costs and may not be willing or able to bear the costs of lobbying for repeal, at least in the absence of a regulatory cataclysm. Thus, it is not surprising that SOX sponsor Michael Oxley, despite recognizing that SOX was “excessive” in some respects, and admitting that it had been rushed through Congress, suggested that Congress would not be revisiting the issue, even as to the seriously affected small companies. He said, “If I had another crack at it I would have provided a bit more flexibility for small- and medium-sized companies.” In other words, Congress normally does not have “another crack” at regulation. A sunset or review mechanism would change that.

Perhaps Congress can learn some lessons from itself. The USA Patriot Act was passed less than one year before SOX and, like SOX, was passed by an overwhelming majority. Unlike SOX, the USA Patriot Act includes sunset provisions for some of its most controversial provisions. The Patriot Act’s sunset provision forced Congress and the president to reevaluate and debate those provisions, in an atmosphere far  removed from the immediate post-9/11 panic. American investors would benefit from a sober reevaluation of SOX. Perhaps the courts will provide that opportunity. For future regulatory panics, Congress would do well to remember the lessons of the Patriot Act.

One footnote in Romano’s article particularly grabbed my attention.  Referring to Jack Coffee’s criticism of sunset provisions in a non-yet-public manuscript (“The Political Economy of Dodd-Frank: Why Financial Reform Tends to be Frustrated and Systemic Risk Perpetuated”), Romano notes:

Coffee (2011:4, 6,9) sweepingly seeks to dismiss the scholarship with which he disagrees by engaging in serial name calling, referring to the authors, Steve Bainbridge, Larry Ribstein and me, as “the ‘Tea Party Caucus’ of corporate and securities law professors” (a claim that would have been humorous had it not been said earnestly), “conservative critics of securities regulation,” (a claim, at least in my case, that would be accurate if he had dropped the adjective), and further referring to Bainbridge and Ribstein, as “[my] loyal adherents.”

 She also observes in this footnote:  

[I]n the American political tradition and academic literature, advocacy of sunsetting has historically cut across political party lines. It has had a distinguished liberal pedigree, having been advocated by, among others, President Jimmy Carter, Senator Edward Kennedy, political scientist Theodore Lowi, and Common Cause (Breyer 1982; Kysar 2005).”

Like Butler and me, she cites the Patriot Act precedent.

Well, I’m proud to be included in Romano’s and Bainbridge’s “tea party” and surprised at being there because I advocated an idea also endorsed by Carter, Kennedy, Lowi and Common Cause.  It’s sad a scholar of Coffee’s stature sees a need to resort to such rhetoric, though almost understandable since Romano’s devastating critique doesn’t leave him much of a ledge to sit on.

 As for Romano’s article, definitely do read the whole thing.  Rather than simply condemning Dodd-Frank, she argues persuasively for a way to avoid future financial over-regulation.

Update:  Matt Bodie confuses blogs and scholarly articles, statutes and people. Bainbridge sets him straight, and Leiter agrees.  But do read Bodie’s post anyway because he links to some great Gretchen posts which even I had forgotten.

Let Congress trade!

Larry Ribstein —  2 December 2011

I have previously discussed here and here the policy arguments against a broad ban on Congressional insider trading (this is apart from Steve Bainbridge’s serious problems with the proposed legislation).  

Now Todd Henderson and I have weighed in on Politico with more on why we should let Congress trade (while imposing strong disclosure duties).  It’s obviously not a popular position these OWS and politician-bashing days. But we think it’s a sensible one that deserves serious consideration.

Update:  Bainbridge responds.  He focuses on the perverse incentive problem, which Todd and I acknowledge.  Unfortunately, he ignores our argument for disclosure as a way of dealing with that issue, and the serious problems of having the SEC enforce a Congressional insider trading ban.  Consideration of these issues caused me to change my views on banning Congressional insider trading.  I think it’s inconsistent to focus on enforcement problems in banning private activity (as both Bainbridge and I do) and not do so in banning public conduct, where enforcement is even trickier.

The NYT on law teaching

Larry Ribstein —  20 November 2011

The NYT brings another David Segal story on legal education.  Today’s sermon: law schools don’t teach “lawyering.”

Boiling away the overheated journalism, here’s the indictment:  Law profs are richly paid for writing mostly useless law review articles rather than “the essential how-tos of daily practice.” Students study cases about contract law but not contracts.  Clinics get second-class status.  New lawyers need law firm training to figure out how to “draft a certificate of merger and file it with the secretary of state.” A law graduate isn’t “ready to be a provider of services.” Clients won’t pay for work by untrained associates.  Legal education is not worth its high price.

Well, yes, law schools should pay more attention to the market for lawyers and offer more value.  But as I’ve written in my article Practicing Theory, this doesn’t mean teaching what lawyers traditionally do.  Lawyers now don’t draft agreements from scratch.  There’s an app for that — software templates modified by user input.  A technological tsunami is sweeping over legal services.

Practicing Theory suggests that law schools should teach law students how to be architects and designers rather than mechanics.  The lawyers of the future will focus, more than today’s lawyers, on the building blocks of law. Computers and non-lawyers will handle the mechanical tasks. Training lawyers demands the sort of theoretical perspective that Segal disdains. 

Law students also will need business skills that law schools don’t traditionally teach.  Indeed, Segal himself notes that “graduates will need entrepreneurial skills, management ability and some expertise in landing clients” without considering the implications of this observation for legal education.

The real problem, as discussed in Practicing Theory, is not that law professors are teaching theory rather than the way to the courthouse, but that their choices of which theories to teach pay insufficient attention to the skills and knowledge today’s and tomorrow’s market demands. Segal’s article, like others in this series, ignores such nuance, preferring to string together well-worn criticisms and to eschew coherent analysis in favor of attention-getting quotes.

But, then, this is what journalists learn in journalism school.  Just as law professors swing for the law reviews, so journalists swing for the Pulitzers.  No wonder blogs are replacing the mainstream media as the source of cutting-edge information.  If you want to know what is actually ailing the legal profession and the law professoriate, you would do much better to read, e.g., Bill Henderson, Dan Katz, Brian Leiter, Brian Tamanaha, Steve Bainbridge and me.  It will save time and trees.

CBS is all hot and bothered about insider trading by Congress.  Steve Bainbridge is not so sure it’s illegal. Neither am I, and I question whether it should be on policy grounds (see here, first published here).  I suggest more disclosure, and reducing the opportunity for all kinds of corruption by having less law.

Steve Bainbridge invites my opinion of Delaware lawyer Edward McNally’s view that alternative entities “may not protect investors.” By “alternative entities” he is referring to limited liability companies and limited partnerships, despite his own recognition that they “have become the preferred form of entity for new businesses” (so why aren’t corporations “alternative entities”)? He uses as the text for his sermon VC Noble’s recent opinion in Brinckerhoff v. Enbridge Energy Co. involving the interpretation of a broad fiduciary duty waiver.

McNally says that “the lack of a uniform governance structure in these alternative entities may cause problems” when there are outside investors. He argues that broad fiduciary waivers may result in investors not being adequately paid for the risks they’re taking because “it seems doubtful that those risks can ever be adequately anticipated.” By contrast

corporate entities with much more standardized governance norms with greater investor protection have long flourished and raised capital. The corporate governance form benefits from its predictability and presumably raised capital effectively without the added risk of unpredictable governance provisions. Thus, the theoretical justification for letting alternative entities be governed loosely [that investors are paid for the risks they take] may not be valid.

Moreover, he says, the parties may not know for sure whether the waiver is effective.  He cites the following example:

Years ago, we had a case where a master limited partnership’s 60-page operating agreement attempted in great detail to spell out how to handle conflict of interest transactions involving its general partner. After consulting a national legal expert on limited partnerships, the general partner bought limited partnership interests following what it thought was the correct process. It was promptly sued, lost and paid millions of dollars in damages. The court held it followed the wrong process, and in doing so had breached its duty to the partnership. Complexity has its own risks.

He concludes that this is why “few alternative entities have been used as a vehicle to issue publicly traded securities, such as limited partnerships or membership interests.”

McNally repeatedly refers to the entity involved in Brinckerhoff as an “LLP.”  These are the initials for a “limited liability partnership,” which is a form of general partnership.  However, the entity in the case is a limited partnership, or “LP.”   He also confuses the “good faith” duty, a fiduciary duty which the agreement in Brinckerhoff added, with the “implied contractual covenant of good faith and fair dealing,” a non-waivable rule of contractual interpretation under Delaware law.

Apart from these technical glitches, I question McNally’s reasoning.  As to his claim of unpredictability, as I have discussed at some length, Delaware alternative entities are actually a way to avoid the more serious indeterminacy problem in corporate law. McNally’s illustration of uncorporate unpredictability is unpersuasive.  Maybe the general partner’s legal advisor was wrong, or the court erred.  Both can also happen in corporate practice. Anyway, he says this happened “years ago.”  Delaware uncorporate jurisprudence has developed rapidly in recent years, as the Brinckerhoff case itself illustrates.

Now let’s examine the case.  A pipeline partnership found itself mid-project at the nadir of the finaical crisis.  Its controller offered to invest.  A special committee negotiated a deal and hired legal and financial advisors to evaluate it.  They determined that it met the agreement’s “arms length” value standard for deals with affiliates. The court held this was not bad faith. The court noted (n. 39):

Although on some level the [agreement] may appear problematic for the simple reason that the controller of a limited partnership’s general partner is engaging in a transaction with the limited partnership, the LPA anticipates such transactions. Moreover, if the Court were to determine that [plaintiff] could state a claim that Enbridge [the defendant controlling party] acted in bad faith even though Enbridge negotiated the JVA with an independent special committee, then what would Enbridge have to do to be able to dispose of bad faith claims on a motion to dismiss? Would Enbridge be required, in analogy to In re John Q. Hammons Hotels Inc. S’holder Litig., 2009 WL 3165613 (Del. Ch. Oct. 2, 2009), to negotiate a transaction with an independent committee and have the transaction approved by a majority of the public unit holders? Requiring Enbridge to put in place those “robust procedural protections,” in order to be able to dispose of a bad faith claim on a motion to dismiss, would seem to rewrite the LPA when the Delaware General Assembly has explicitly stated that “[i]t is the policy of [Delaware’s Limited Partnership Act] … to give maximum effect to the principle of freedom of contract and to the enforceability of partnership agreements.” 6 Del. C. § 17–1101(c).

The court interestingly compares the determinacy of the partnership agreement with the indeterminacy the parties avoided by not being a corporation.

As I have discussed elsewhere (e.g., here and here) the parties to uncorporations may quite reasonably trade off exit and managerial incentives for control and fiduciary duties.  The courts should enforce these contracts and the Delaware courts do.  It follows that McNally’s broader point that uncorporate entities are generally unsuitable for outside investors is flat wrong.

McNally raises the separate question of why there are only a relative few publicly held alternative entities.  One reason may be that the exit tradeoff I referred to may not work in publicly held firms.  Most such firms need the corporate feature of “capital lock in” which precludes buyout and dissolution provisions.

Bottom line:  Lawyers need to understand that “alternative” entities are an important transactional tool for clients.  Protestations that uncorporate law is too new or unpredictable, which were common 20 years ago, simply don’t wash today.

UCLA’s Milken gift

Larry Ribstein —  23 August 2011

The NYT discusses a controversy at UCLA (mainly, it seems, involving objections by Lynn Stout) to the $10 million gift it just announced from Lowell Milken, Michael’s brother.  Lowell was accused many years ago in connection with his brother’s securities violations and escaped prosecution because of his brother’s plea deal. Steve Bainbridge comments in response to the NYT story, discussing this ancient history:

Some of us who were active in the field at the time–as I was–remember the story a bit differently. In our view, the government used threats to go after Lowell as one of the ways on which they coerced Michael into taking a plea deal.

I have more perspective in my paper, Imagining Wall Street.  There I note that Oliver Stone’s film Wall Street

may have helped create an environment that became increasingly unfriendly to takeovers.  In the year following the film’s release, Drexel and Milken were prosecuted, eventually culminating in the fining and jailing of Milken along with many others in the takeover game, and the demise of Drexel Burnham. Milken pleaded guilty and was sentenced to ten years in jail.68 [United States v. Milken, No. (S) 89Cr.41(KMW), 1990 WL 264699 (S.D.N.Y. Nov. 21, 1990)]  * * * It is hard to say how much of that attitude was based on actual events reported in the media, and how much on the fiction Wall Street helped create. Milken was prosecuted not for insider trading, but rather for technical violations of the Williams Act—that is, using Boesky to accumulate non-disclosed positions in target shares.69 [Id. at 4]

In short, there is a big question whether Lowell’s history is such as to taint UCLA by his gift.

But I am not unsympathetic with the idea that law schools are supposed to be teaching their students that ethics trumps money, and so should be careful about whom they take money from, and more generally the company they keep. Indeed, for that reason I wrote critically last year about Bill Lerach’s foray into law teaching.

The real question here is where you draw the line and who decides.  Is the decision to turn down a gift based on ethics or politics?  More to the point, would the same people who oppose the Milken gift also object to an association with Lerach?

And how do you balance those considerations against the institution’s needs?  Interestingly, Professor Stout has written extensively about the need to take the interests of all constituencies into account in corporate decision-making.  Where would UCLA’s students stand in the decision Professor Stout favors to reject the Milken gift?

One of the things that I hope to spend more time doing now that I have returned to the blogosphere is open-source article writing.  By that I mean blogging about an article idea and updating it as I progress.  Some say it’s a bad plan…people might steal your ideas, or maybe you expose yourself to the possibility of being wrong.  I don’t think it’s an issue, particularly if readers take my musings in the rough-and-tumble blogging spirit.  If you think I have interpreted a provision incorrectly, great. Email me and tell me why.  Better that you send me a case I missed than I learn about it after the article is published.

First some background. The National Securities Markets Improvement Act of 1996 amended The Securities Exchange Act of 1934,  the Securities Act of 1933 and the Investment Company Act of 1940 to provide the following new restrictions on SEC rule-making:

Whenever pursuant to this title the Commission is engaged in rulemaking, or in the review of a rule of a self-regulatory organization, and is required to consider or determine whether an action is necessary or appropriate in the public interest, the Commission shall also consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.

Investor protection, efficiency, competition, and capital formation.  Oh my.  In the interest of short-hand let’s call them the four guiding principles of securities regulation.  The recent proxy access case reminds us of the importance of the four principles, as the DC Circuit struck down a rule specifically authorized by Congress for failure to adequately consider the four principles.  David Zaring observes “It is worth noting that there is no explicit requirement that a cost-benefit analysis be done in the statute.”  Of course he is right.  The requirement is not explicit.  (Though, presidential executive orders have required even independent agencies to engage in cost-benefit analysis, but that’s a different question for another day).  I do however think that a natural reading of the “efficiency” principle invokes the same economic ideas on which the cost-benefit analysis branch of regulatory economics is based.

The problem I think is that despite the the importance of the four principles they are inadequately defined in the statute.  I included Apple Pie and Puppies in the title of this post because I actually think, given the uncertainty clouding the four principles, it wouldn’t really change court review to also require the Commission consider the effect of new rules on “apple pie production and puppy formation.”

I want to write an article that explores this problem and begins to think through building a comprehensive description of what is required by the four principles in SEC rule-making and review of SRO rulemaking.  Note, I don’t blame the DC Circuit for the remaining uncertainty.  Their job is to provide just enough analysis to decide the case.  It’s not their job to exhaustively resolve puzzles like these.  This is particularly true where the rule does a bad job of economic analysis.  For example, in the proxy access case the 400 page rule failed to even consider the principle objection to the rule that the conflicts posed by various institutional investors would damage share value.  So, the DC Circuit didn’t actually need to engage in much statutory interpretation of the four principles to decide the case.  I suppose untying the remaining knots is the ivory tower’s calling.

First I think you have to do some simple statutory interpretation.  I hate this exercise, and I get the feeling that appeals courts often share my malaise.  What do you do with unclear drafting?  How do you interpret operative language that uses synonyms.  What’s the difference between, for example, investor protection and capital formation?  I would think regulations that impose a net cost (benefit) on share values would both harm (help) investors and inhibit (promote) capital formation.  But the policy arguments over these terms suggest an inherent tradeoff between capital formation and investor protection, as though capital formation speaks to costs imposed solely on issuers.

My first step will be to head over to the Georgetown Law Library, which houses the entire legislative history of the ’33, ’34 and ’40 Acts.  Not as fun as going to the movies, but still a good way to escape the heatwave hitting DC.  The full transcripts of the Pecora hearings into the stock market crash of 1929 as well as legislative and committee debates over the 33′ and 34′ Acts rest on a dusty shelf in the deep dungeons of the law library.  Before the summer is over I plan to pore through the source text and try to get a better handle on what Congress had in mind when it considered the first of the four principles, investor protection, in the ’33, ’34 and ’40 Acts.  Then I think it would be worthwhile to review the Committee hearings and legislative history of the National Securities Markets Improvement Act of 1996 to understand the three relatively new constraints.

Then you have to consider what investor protection, efficiency, capital formation, and competition mean through the lens of the economic and financial literature.  For efficiency, are we talking about Kaldor-Hicks, Pareto, or something else?  Does it mean a cost-benefit analysis along the lines of what the Office of Information and Regulatory Affairs at the White House Office of Management and Budget would expect?  If so, that would incorporate a wide literature.  For example, we would need to decide what statistical value of human life the SEC would use, particularly where we start to debate capital formation in the life sciences or pharmaceutical sectors.  (And before you accuse me of being morbid, realize that most agencies have a number they use to value human life.)  The existing cases tend to show a respect for empirical literature, as where the DC Circuit focused on a lack of empirical support in both the proxy access case and its review of the independent mutual fund chairmen rule.  Does this mean stock price event studies of rule announcements?

And what about competition?  Correct me if I am wrong Josh, but I thought the FTC was the agency charged with overseeing competition.  Does this solely relate to SEC review of questions like exchange consolidation and brokerage pricing, or does it apply more broadly to disclosure rules under the 34′ Act?  Do we need more industrial economists in addition to the (relatively few) financial economists on the Commission staff?  The inclusion of competition in the four principles may have something to do with the fact that the FTC was originally intended to enforce the 33′ Act, and the 34′ Act subsequently created the SEC and gave it jurisdiction over the securities markets, so perhaps it was intended to clarify the SEC’s review of competitive effects of exchange consolidations, but it could also be read to apply much more broadly.

Then you get into complicating questions of  patchwork.  By that I mean Congress has sewn into the various Acts a complex web of permissive and mandatory authority to promulgate rules under successive amendments.  In some instances, they include mandatory rules that wouldn’t even remotely survive a review under the four guiding principles, no matter how you define them.  Then what do you do?  The proxy access case makes clear that when the SEC exercises permissive authority it is still bound by the four principles.  The SEC has taken the position that it is not bound by the four principles when it exercises mandatory authority, but as I have blogged before I think that position is misguided.  Where Congress gives a very broad stroke mandate to the SEC, as it has done under many of the Dodd-Frank authorizing provisions, the SEC effectively paints on an empty canvas.  They’re told to paint a picture of a duck, but they choose the brush, the colors and the frame.  I think to the extent that the SEC makes choices, it remains bound by the four principles.

There is an interesting twist on the four principles when it comes to the Division of Trading and Markets and SEC review of SRO rule-making designed to address speculation.  If it is true that one man’s trash is another man’s treasure, I think its safe to say that one man’s speculation is another man’s investment.  The same trading activity that some decry as speculation also can provide advantages in liquidity.  And it’s hard to know until the game is over whether a trade is speculative or truly insightful.  This has given rise to a sharp debate over regulation in this context.

As a Hayekian, I tend to believe the price system is best equipped to sort it out, but the 34′ Act doesn’t seem to agree with me.  Section 2 of the Securities Exchange Act of 1934 is titled “Necessity for Regulation” and provides a very succinct explanation of congressional intent with respect to the ’34 Act.  The word “Speculation” shows up in two paragraphs.

Paragraph 3 provides:

frequently the prices of securities on such exchanges and markets are susceptible to manipulation and control, and the dissemination of such prices gives rise to excessive speculation, resulting in sudden and unreasonable fluctuations in the prices of securities which (a) cause alternately unreasonable expansion and unreasonable contraction of the volume of credit available for trade, transportation, and industry in interstate commerce, (b) hinder the proper appraisal of the value of securities and thus prevent a fair calculation of taxes owing to the United States and to the several States by owners, buyers, and sellers of securities, and (c) prevent the fair valuation of collateral for bank loans and/or obstruct the effective operation of the national banking system and Federal Reserve System.

Paragraph 4 provides:

National emergencies, which produce widespread unemployment and the dislocation of trade, transportation, and industry, and which burden interstate commerce and adversely affect the general welfare, are precipitated, intensified, and prolonged by manipulation and sudden and unreasonable fluctuations of security prices and by excessive speculation on such exchanges and markets, and to meet such emergencies the Federal Government is put to such great expense as to burden the national credit.

Unfortunately, I think these paragraphs limit application of the four principles for rule-making in the context of exchange and broker oversight that has an anti-speculation focus.  The NSMIA doesn’t specifically amend that provision.  Perhaps one could argue that impliedly repeals these two paragraphs, but it could be a tough argument.  I know on short sales restrictions blog colleague Larry Ribstein has argued here, and blog neighbor Steve Bainbridge has argued here, that the Commission’s unreasonable suspicion of short sellers inhibits price discovery and liquidity.  These are great policy arguments that Commissioners should consider in voting on new rules, and that the Divisions should consider in drafting and interpreting rules, but I fear that Section 2 limits any potential for challenge under the APA to rules issued under the authority of the Division of Trading and Markets or in SRO review that are based on curbing what the Commission considers to be speculative activity.

If idle hands are the devil’s playground, hopefully this project will keep me busy for awhile.  Thoughts?

Bloggers have had much to say about the DC Circuit’s proxy access decision.  Of special note is our own Jay Verret and Steve Bainbridge, who adds a useful roundup.   I have a few additional comments.

First, I want to pick up on Jay’s comment that the decision shows the SEC “is an agency with too many lawyers and not enough economists.”  Indeed, the court emphasized that

the Commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters. * * *

The court condemned the SEC’s disregard of rigorous empirical evidence, noting its failure to utilize “readily available,” evidence of expenditures in proxy contests, and to appropriately weigh the Buckberg-Macey study of the negative effects of electing dissident shareholder nominees.

The court also criticized the SEC’s dismissal of the possible effect of 14a-11 in distracting management by noting that managers already need to incur such costs because of shareholders’ exercise of their state law rights.  The court said: “As we have said before, this type of reasoning, which fails to view a cost at the margin, is illogical and, in an economic analysis, unacceptable” (citation omitted).

Second, the opinion highlights the importance of comments and dissents given rising judicial distrust of the SEC (here’s more on that). This is indicated by the court’s citation of the Buckberg-Macey report noted above, and its reference to the Paredes and Casey dissents to 14a-11. Even if the Commission’s decision might seem to be a foregone conclusion, the fact that the SEC is now essentially in judicial receivership means that these expressions of views will be heard in another venue. There’s also the (possibly slim) hope that the SEC majority will get the message and start listening to such views.

Third, it is worth noting the court’s holding “that the Commission failed adequately to address whether the regulatory requirements of the ICA reduce the need for, and hence the benefit to be had from, proxy access for shareholders of investment companies, and whether the rule would impose greater costs upon investment companies by disrupting the structure of their governance.”  I have shown why it is a mistake for federal regulators to treat investment companies like ordinary state-created business associations instead of the misshapen creatures of statute that they are.

Fourth, and perhaps most important, is the court’s concluding remark that its holding striking down the rule on other grounds left it “no occasion to address the petitioners’ First Amendment challenge to the rule.”

I have previously discussed the First Amendment argument in this case. My recently published article, The First Amendment and Corporate Governance, covers the potential implications of Citizens United for regulation of corporate governance and commercial speech generally.  Suffice it to say for present purposes that regulation of speech under rules like 14a-11 is vulnerable to a First Amendment challenge.  After CU, it is no longer possible to dismiss this speech as merely “corporate” or internal corporate governance speech.  It may be, at least in some cases, part of the political debate that must be heard regardless of the identity of the speaker and the direct audience.

Indeed, I suspect that the court’s strong language about the arbitrariness of 14a-11 may have had something to do with its desire to rest its holding solely on that ground.  This court got to avoid the First Amendment can of worms, with its uncertain implications for the validity of regulation of truthful speech under securities and other laws (lawyer regulation?).  But after CU courts will not be able to avoid this argument forever.

Steve Bainbridge is offering his new book, Directors as Auctioneers: A Concise Guide to Revlon-Land, as a Kindle eBook. Here’s his discussion of the book and of his decision to go the e-book route.  I’ve bought it already and presumably will have it when I turn my Kindle on.

Steve’s reasoning is plausible:  he gets more money than for law review articles, controls the marketing and price, and keeps all the proceeds instead of just royalties. He doesn’t get any quality signal, but at his career stage doesn’t need another one. His Revlon book offers him an opportunity to “update, expand, and augment older work on Revlon and offer up a new and improved analysis in a different package” that provides analysis relevant to some recent Delaware decisions. 

I would add that the format provides a marginal incentive that could produce scholarship that might not otherwise get produced.  This is what markets are supposed to do.

Needless to say, I’m interested in how this works out for Steve.  Given rapid developments in publishing, I expect that this is just the first stage of an interesting evolutionary process.

Zillions have linked to and millions have commented on the NYT Economix blog post on the supposed lawyer surplus.  Here are some further thoughts on the “lawyer glut” and its implications for legal education.

To begin with, the NYT numbers are unreliable.  They ignore, among other things, the facts that people take multiple bars, and that NY, a big “surplus” state, is a magnet for foreign students not planning to practice in NY.  Much more importantly, they look at “annual job openings for lawyers.”  The question, which I discuss further below, is whether that really captures the full value of a law degree in a rapidly changing market. 

Brian Tamanaha adds data that should cut more deeply into the hearts of the really important group (I’m referring to law professors, of course):  falling applications, rising enrollments.  So, he says, “with tuition high and job prospects low, it seems likely that the number of law school applicants will continue to fall–although it’s hard to say how far or for how long.” This summons a scary scenario: “schools will reach deeper in the pool to fill their classes, bringing in students with lower qualifications.” He concludes that “schools would be prudent to anticipate a cumulative drop in applications of perhaps a third from their high. * * *Law schools have enjoyed flush times for more than a decade. Tough times are ahead.”

But Steve Bainbridge responds that law schools may not adjust.  He says the self-interest of university presidents and influential alums produce a “classic collective action problem” with no market (given our regulated industry) to solve it.

I have a different take in my forthcoming article Practicing Theory.  The problem isn’t that we have too many law trained people and so should train fewer.  In fact, in our increasingly regulated economy, there is probably a gross undersupply of law-trained people. 

The problem is that regulation has fixed the nature of the product so it hasn’t adequately responded to shifts in demand.  The downward demand shifts have been produced by, most importantly, technology.  But demand is increasing for new kinds of law-trained people both at the low-cost end of service to the poor and middle class and the potentially high-profit end of producing new kinds of products and services (see Law’s Information Revolution).  Yet regulation has locked law schools into models that don’t serve these new needs.

In a real market, the supply side would change. As discussed in yesterday’s WSJ, if nobody’s buying borscht, make more horseradishPracticing Theory provides some specific suggestions as to how law schools might change their product.  These include training lawyers to interact better with other disciplines and to think more globally.  In other words, the answer is to change, not necessarily to shrink.  In the long run regulation will also have to change, but there are things law schools can be doing in the meantime. 

The other side of this is that if law schools can’t figure out how to make horseradish, law professors may go the way of borscht.

Steve Bainbridge responds to my post about insider trading as compensation with a suggestion that rules against insider trading are an example of a case “where mandatory rules are appropriate.”

I was about to sputter about laws against insider trading are really about property rights, and surely property should be alienable — right?  And about how this is really about fiduciary duties, and behind that agency costs, which is the heart of corporate law.  So how much of the rest of corporate law should be made mandatory and federal?

Then I realized Steve was really talking about lawyers trading on clients’ information.  Well, that’s different. Clients rarely authorize this, so it’s usually theft and therefore bad.  But I still wonder why clients shouldn’t be allowed to authorize it.  And who knows whether that might happen as lawyers’ roles evolve?  (You knew I was going to stick that one in again, didn’t you?)

But after calming down I got riled up by the last line: “If investors have a taste for prohibiting insider trading, it thus does no good to say that the world would be a more efficient place if insider trading were allowed.”

Um, well, where does that sort of reasoning stop?  People ought to be able to indulge a lot of seemingly goofy tastes.  But that’s a long way from a normative argument that these tastes should be imposed on society.