Corporate Law

Dan Awrey

These are not your parents’ financial markets. A generation ago, the image of Wall Street was one of floor traders and stockbrokers, of opening bells and ticker symbols, of titans of industry and barbarians at the gate. These images reflected the prevailing view in which stock markets stood at the center of the financial universe. The high point of this equity-centric view coincided with the development of a significant body of empirical literature examining the efficient market hypothesis (EMH): the prediction that prices within an efficient stock market will fully incorporate all available information. Over time, this equity-centric view became conflated with these empirical findings, transforming the EMH in the eyes of many observers from a testable prediction about how rapidly new information is incorporated into stock prices into a more general—and generally unexamined—statement about the efficiency of financial markets.

In their seminal 1984 article The Mechanisms of Market Efficiency, Ron Gilson and Reinier Kraakman advanced a causal framework for understanding how new information becomes incorporated into stock prices. Gilson and Kraakman’s framework provided an institutional explanation for the empirical findings supporting the EMH. It has also played an influential role in public policy debates surrounding securities fraud litigation, mandatory disclosure requirements, and insider trading restrictions. Yet despite its enduring influence, there have been few serious attempts to extend Gilson and Kraakman’s framework beyond the relatively narrow confines in which it was originally developed: the highly regulated, order-driven, and extremely liquid markets for publicly traded stocks.

This Article examines the mechanisms of derivatives market efficiency. These mechanisms respond to information and other problems not generally encountered within conventional stock markets. These problems reflect important differences in the nature of derivatives contracts, the structure of the markets in which they trade, and the sources of market liquidity. Predictably, these problems have led to the emergence of very different mechanisms of market efficiency. This Article describes these problems and evaluates the likely effectiveness of the mechanisms of derivatives market efficiency. It then explores the implications of this evaluation in terms of the current policy debates around derivatives trade reporting and disclosure, the macroprudential surveillance of derivatives markets, the push toward mandatory central clearing of derivatives, the prudential regulation of derivatives dealers, and the optimal balance between public and private ordering.

Daniel Michaeli

A federal law known as the Jones Act imposes citizen ownership and control requirements on owners and operators of ships that transport goods between U.S. ports. Scholars have consistently presumed that these requirements are enforceable. This Note demonstrates, however, that limiting foreign ownership in companies with widely dispersed shareholders has become legally and practically infeasible in modern U.S. securities markets. It sheds light for the first time on the Seg-100 program of the Depository Trust Company, which aims to resolve this problem but would ultimately, even with substantial changes, be unable to discern the citizenship of entities that are not natural persons—a vast majority of shareholders. After considering the Jones Act’s ownership and control restrictions in the context of U.S. national security and economic interests, the Note finds that both practical considerations and U.S. interests support elimination of the citizen ownership and control requirements. Recognizing that Congress may be unwilling to invite unrestricted foreign investment in coastwise shipping, it also proposes more limited reforms to foreign ownership limitations and administrative actions that could reduce, but not eliminate, unnecessary costs of the current system.

Arin H. Smith

In 2010, the economy was reeling from an economic recession that particularly affected low-income consumers. One law, known as the Durbin Amendment, sought to protect consumers by regulating the fees that financial institutions charge merchants each time a customer uses a debit card. This Note examines the amendment’s effects, arguing that it has ultimately raised the costs of banking for low-income consumers. Due to complex banking disclosures and the structure of the regulations, these increased costs have not been offset by increased transparency or lower retail prices. This Note recommends specific changes to the Durbin Amendment that will better support its stated goals. However, because these changes cannot entirely mitigate the negative effects, this Note recommends that Congress also pass legislation to improve access to banking for low-income consumers.

Trang (Mae) Nguyen

International indicators are widely used as diagnostic tools for global governance. For the developing world, with scarce resources and complex social problems, indicators can help businesses, donors, and policymakers identify issues, tailor solutions, and measure impacts. This Note studies the dynamics between global and domestic indicators in Vietnam, particularly the ways they influence Vietnam’s policy processes. It finds that while global indicators have advanced the notion of competitiveness and made it a priority of the national government, sub-national indicators—here, a ranking of Vietnam’s provinces—play a significant role as a more tailored and focused tool to motivate internal competition for pro-business reforms. This Note therefore confirms the dominant viewpoint that global indicators influence a country’s development agenda, but concludes that this effect is even more pronounced in the presence of robust local indicators.

Jesse M. Fried & Mira Ganor

Venture capitalists investing in U.S. startups typically receive preferred stock and extensive control rights. Various explanations for each of these arrangements have been offered. However, scholars have failed to notice that these arrangements, when combined, often lead to a highly unusual corporate governance structure: one where preferred shareholders, rather than common shareholders, control the board and therefore the firm itself The purpose of this Article is threefold: (1) to highlight the unusual governance structure of these VC-backed startups; (2) to show that preferred shareholder control can give rise to potentially large agency costs; and (3) to suggest legal reforms that may help VCs and entrepreneurs reduce these agency costs and improve corporate governance in startups.

Liora Sukhatme

The valuation of a pharmaceutical company often depends on its ability to bring a drug to market, making information about the likelihood of Food and Drug Administration (FDA) approval critical to investors and a highly sensitive issue for the company. Since the FDA drug approval process is not public, investors must rely on company disclosures to evaluate the likelihood of FDA approval. Currently, the FDA will not disclose the content of action letters sent to sponsor companies, giving company executives dangerous discretion over whether to disclose the information and how to present it. This discretion, coupled with a lack of oversight over the content of the disclosures, has resulted in several recent cases of fraud among pharmaceutical companies. As a way to curb such company discretion and prevent future fraud, this Note proposes mandatory public disclosure of action letters sent by the FDA to sponsor companies. 

Lee Harris

Economic theory that suggests underperforming boards of directors should be
fearful of an ouster vote by shareholders underappreciates the complexity of shareholder
voting decisions. Skill at enhancing firm value has less to do with whether
directors win votes and stay at the helm of public companies than previous commentators
have presumed. Instead, like incumbent politicians, managers of some of
the largest U.S. firms tend to stay in charge of firms because they understand—and
take advantage of—the political dynamics of corporate voting. This Article presents
a competing theory of shareholder voting decisions, one that suggests that shareholder
voting in corporate elections is not dissimilar from citizen voting in political
elections. Next, the Article presents the evidence. Using a hand-collected dataset
from recent board elections, the Article compares the explanatory power of a standard
economic variable (long-term stock price returns) and a political variable
(money budgeted for campaigning) on election outcomes. Based on the data, directors’
ability to enhance firm value (as measured by stock price returns) is not significantly
related to whether they win reelection. Rather, the likelihood of being
returned to office appears to be a function of typical election politics—how much
was spent by challengers to persuade shareholder voters. These findings have at
least two implications. First, the theory that shareholder voting may be politicized
helps point the way to how the SEC ought to craft reforms—and, just as important,
how not to craft them. Recent SEC reform efforts have the laudable goals of creating
new conduits for shareholders to participate in firm affairs, increasing
shareholder-nominated candidate success, and disciplining incumbent managers.
The results of this study suggest that these reforms will not achieve the stated goals.
Even with these reforms, the board continues to have an important political advantage,
which likely translates into real votes. As the research here shows, the outcome
of elections depends on persuasion and, not simply, as the SEC contends, on shareholders’
director nominees being presented alongside those of management.
Second, the evidence and theory about shareholder voting presented here has significant
implications for understanding mergers and acquisitions, particularly hostile
acquisitions. The theory is that acquirers have steep incentives to target firms
with poor performance. In most cases, however, such acquisitions depend on winning
a vote from shareholders. Thus, if there is any disciplinary effect created by the
prospect of takeovers, it depends crucially on understanding what motivates shareholder
voting behavior. If voting shareholders respond to political motivations, not
economic ones, then the performance of target board members might not be as
relevant as takeover theorists had previously surmised.

Alec Orenstein

The recent collapse of the world financial system exposed excessive risk taking at
many of the largest financial services firms. However, when shareholders of
Citigroup sued the board of directors alleging that the board failed to adequately
monitor the firm’s risk exposure, the Delaware Chancery Court dismissed the suit
under the famous Caremark case. Caremark held that a board’s failure to monitor
will not result in liability unless there was a failure to implement a monitoring
system or a “sustained or systematic” failure to use that monitoring system. This
deferential standard is premised on an assumption that managers are risk averse
and the law should encourage risk taking. However, certain characteristics of financial
firms make such firms more prone to risk taking and more susceptible to catastrophic
losses resulting from that risk taking than other firms. In this Note, I argue
that Caremark should be reworked in cases involving managers of financial firms
in order to deter the excessive risk taking that caused such massive losses to shareholders
of these firms recently. This standard should take the form of a gross negligence
standard that allows the court to take a close look at whether management
took the necessary steps to prevent their firm from being exposed to excessive risk.

Matthew R. Shahabian

In the wake of the fall of Lehman Brothers and the surrounding financial instability, Congress passed the Emergency Economic Stabilization Act of 2008, giving the Treasury Department unprecedented power to intervene directly in the financial markets and the economy at large. Though the original intention of the bill was for Treasury to purchase “toxic” assets from financial institutions in order to bring immediate relief to the financial sector, the Treasury Department instead purchased equity from such institutions and became the largest shareholder of corporations like Citigroup, A.I.G., and Bank of America. As a shareholder, the government possessed great informal influence over corporate policy—influence that it did not hesitate to exercise. This influence, paired with the lack of judicial review in the bailout bill, created a new kind of political risk for investors uncertain of whether the government would use its shareholder position to advance its own political goals. This Note analyzes and evaluates this political risk created by government control and explains why neither administrative law nor corporate law constrained the government as shareholder in the financial crisis following Lehman’s failure. Given that the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act fails to address what the government should do in the event of a future financial crisis, this Note suggests a clearer outline for the government’s role in corporate management when it acts as a shareholder and argues for judicialreview to provide procedural protections to shareholders, thereby reducing political risk.

Leslie A. O'Brien

Under the Supreme Court’s current protective sweep doctrine, it is constitutional for law enforcement officers to conduct a cursory sweep of a home incident to arrest where they have reasonable suspicion to believe the home may harbor a dangerous third party. The Supreme Court, however, has not clarified whether the protective sweep doctrine applies where there is no arrest. While at least one federal circuit court currently holds the view that protective sweeps are invalid absent an arrest, most circuits have indicated that protective sweeps may be valid even when they are not incident to an arrest. This Note argues that neither side of this circuit split has struck the right balance. By focusing too much attention on the “incident to arrest” language in Maryland v. Buie and not enough attention on the Court’s express concern for officer safety, the decisions refusing to extend the protective sweep doctrine to any non-arrest situations prohibit protective sweeps in cases where they would be reasonable and, thus, constitutional. In contrast, by failing to respect the Court’s repeated affirmations that exceptions to the warrant and probable cause requirements should be limited, and by brushing aside the importance of the arrest in Buie, the decisions extending the protective sweep doctrine to non-arrest situations either sanction unconstitutional searches or provide insufficient guidance to lower courts and the police, leaving Fourth Amendment privacy rights vulnerable. This Note argues that, to strike the right balance between protecting government interests and Fourth Amendment privacy rights, courts must incorporate a proper inquiry into the “need to search” into their reasonableness analysis. Specifically, they should require a compelling need for officers’ initial lawful entry into a home for protective sweeps to be valid. In applying this standard, courts should draw a bright line according to the type of entry involved, extending the protective sweep doctrine to situations where officers have entered a home pursuant to exigent circumstances or a court order, but not where officers have entered a home pursuant to consent. Such an approach will maintain the limited nature of this exception to the warrant and probable cause requirements while allowing officers to protect themselves when the public interest so requires. It will also provide lower courts and officers with clear guidelines on how to apply the law. As an ancillary benefit, this approach will also minimize the risk of pretextual searches.

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