Corporate Law


Should a Parent Company Be Liable for the Misdeeds of Its Subsidiary? Agency Theories Under the Foreign Corrupt Practices Act

Marcela E. Schaefer

In an effort to increase accountability and compliance with the Foreign Corrupt Practices Act (FCPA), in recent years both the Securities and Exchange Commission (SEC) and Department of Justice (DOJ) have held parent companies liable for the anti-bribery violations of their subsidiaries. Scholars and practitioners have argued that the two government agencies are applying an aggressive enforcement policy based on an overly expansive understanding of agency principles. However, because most investigations settle with deferred or non-prosecution agreements, a paucity of FCPA case law prevents corporations, prosecutors, and even judges from clearly understanding what the correct standards are for determining when a parent company is liable for the actions of its subsidiaries—especially under a principal-agent theory of liability. This Note is the first to challenge the narrative that the DOJ and SEC are improperly enforcing the FCPA anti- bribery provisions. It delineates the ways in which a parent can be liable for the misconduct of its subsidiaries before analyzing liability predicated on a principal-agent relationship and the amount of control required to establish such a relationship. It then provides a novel formulation of the correct standard to use in assessing whether an agency relationship exists, based on the Third Restatement of Agency and corporate case law. This Note then assesses DOJ and SEC cases before concluding that while the agencies are correct in holding parent companies liable for the misconduct of their subsidiaries, they are applying agency theories inconsistently, exacerbating the existing confusion as to what the correct standards are for parent companies. 

Engineered Credit Default Swaps: Innovative or Manipulative?

Gina-Gail S. Fletcher

Credit default swaps (CDS) are, once again, making waves. Maligned for their role in the 2008 financial crisis and condemned by the Vatican, investors are once more utilizing CDS to achieve results of questionable market benefit. A CDS is a financial contract that allows investors to “bet” on whether a borrower will default on its loan. However, rather than waiting to see how their bets pan out, some CDS counterparties are collaborating with financially distressed borrowers to guarantee the profitability of their CDS positions—“engineering” the CDS’ outcome. Under the CDS contract, these collaborations are not prohibited, yet they have roiled the CDS market, leading some market participants to view the collaborations as a sign that CDS are little more than a rigged game. Conversely, some view “engineered CDS transactions” as an innovative form of financing for distressed companies. As engineered CDS transactions proliferate in the market, it becomes increasingly prudent to look beyond their contractual acceptability to assess whether, from a legal point of view, these transactions are permissible. 

Engineered CDS transactions demonstrate the challenges that the existing legal and non-legal framework face in effectively responding to new forms of market distortion. This Article examines the costs and benefits of engineered CDS transactions on the market as a precursor to determining whether legal intervention is needed. Assessment of the relative costs and benefits of engineered transactions indicates that despite their innovativeness, engineered CDS transactions are largely detrimental to the markets because they impose costs on actors unaffiliated with the CDS market and, more broadly, destroy public trust in the financial markets. Yet, despite their associated harms, legally, engineered transactions exist in a gray space. This Article analyzes the phenomenon of engineered CDS transactions, assessing the capacity of applicable legal frameworks, private standards, and market discipline to address these transactions, and finds each to be lacking. Consequently, this Article proposes a range of responses, including modernization of the existing anti- manipulation framework, to mitigate the harm and collateral consequences that stem from engineered CDS transactions. 

The Case for Do-Over Derivative Shareholder Suits in Delaware Chancery Court

Alice Hong

Most of the literature addressing shareholder derivative litigation has emphasized the perils of excessive multi-forum shareholder litigation, proposing various solutions to sidestep the problems encountered in cases like California State Teachers’ Retirement System v. Alvarez (Wal-Mart II). This Note addresses a separate and distinct problem—a long overlooked inquiry into the due process implications of using nonparty issue preclusion to curb what is seen as an overgrowth of shareholder derivative litigation. 

The Delaware Chancery Court’s recent decision in Wal-Mart II illustrates a conceptual puzzle in the application of issue preclusion rules in the context of derivative shareholder suits. In Wal-Mart II, a separate federal suit was dismissed on the grounds that the plaintiffs had failed to satisfy the demand requirement, a crucial step for establishing the plaintiffs’ authority to bring a derivative suit on behalf of the corporation. The Delaware courts gave preclusive effect to the federal court’s ruling in barring a derivative action by different shareholders. But how can such a judgment—finding that a shareholder plaintiff seeking to bring a derivative action lacks authority to bring suit on behalf of the corporation—be given preclusive effect to bar a future suit by other shareholders? A rule that would resolve this inconsistency was proposed by Chancellor Bouchard’s decision for the Chancery Court late in 2017, In re Wal-Mart Stores Delaware Derivative Litigation (Wal- Mart I). While the Delaware Supreme Court declined to adopt the proposal, an analysis of the Delaware Supreme Court’s decision suggests that Chancellor Bouchard’s proposal may have been the right rule at the wrong time. This Note proposes adoption of the rule proposed in Wal-Mart I as Delaware’s preclusion law, arguing that the current treatment of nonparty preclusion in derivative share- holder suits is incompatible with the strong presumption against nonparty preclusion and inconsistent with the treatment of a related mechanism: the class action. In doing so, this Note advocates for an approach to nonparty issue preclusion that would deny preclusive effect to putative derivative suits dismissed prior to satisfaction of the demand requirement. 

The Death of Corporate Law

Zohar Goshen, Sharon Hannes

For decades, corporate law played a pivotal role in regulating corporations across the United States. Consequently, Delaware, the leading state of incorporation, and its courts came to occupy a central and influential position in corporate law and governance. This, however, is no longer the case: The compositional shift in equity markets from retail to institutional ownership has relocated regulatory power over corporations from courts to markets. Corporate law has, as a result, and as illustrated by the declined role of the Delaware courts, lost its pride of place and is now eclipsed by shareholder activism.

What explains the connection between the rise of institutional ownership and the death of corporate law? We answer this question by unpacking the relationship between market dynamics and the role of corporate law. Our analysis uncovers a critical, yet hitherto unnoticed, insight: The more competent shareholders become, the less important corporate law will be. Increases in shareholder competence reduce management agency costs, intensify market actors’ preference for private ordering outside of courts, and, ultimately, drive corporate law into the shadow.

The Infrastructure Ratchet Effect

Shlomit Azgad-Tromer

This article identifies a profound and previously overlooked incentive for excessive risk- taking by infrastructure providers. The magnitude and critical nature of infrastructure implies that negative externalities potentially far exceed the net assets of the infrastructure provider. The nonconsensual relationship of infrastructure providers with their stakeholders implies that excessive risks cannot be contracted for and incorporated into price. Shareholders of infrastructure providers thus develop asymmetric preferences towards excessive risk-taking: They could gain from risks if things go well but are shielded by limited liability rules if things do not. The article identifies this moral hazard and terms it “The Infrastructure Ratchet Effect.”

This Article shows that normal market forces and legal mechanisms fail to counter these distorted incentives in infrastructure providers: Regulation, reputation, litigation, and debt pricing all fail to deter excessive risk-taking in infrastructure. Project finance, leverage, executive compensation, and behavioral tendencies exacerbate the problem.

To illustrate the infrastructure ratchet effect, this Article presents the 2017 data breach at Equifax as a case study, arguing that Equifax is a data public utility and should be considered an infrastructure provider. It surveys the events leading to the massive Equifax data breach and shows that despite cataclysmic implications, Equifax eschewed adequate controls to ensure the security of its data. This Article proposes the infrastructure ratchet effect as a possible explanation for this series of events.

In addition to shedding new light on the infrastructure ratchet effect as a potential source of cataclysmic risks caused by infrastructure providers, this Article considers possible tools to tackle these distorted incentives. Insight is drawn from literature surrounding banking-risk regulation, where a similar moral hazard is well understood.

Agency Costs of Venture Capitalist Control in Startups

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.

Deterring Fraud: Mandatory Disclosure and the FDA Drug Approval Process

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.

Finding a Reasonable Approach to the Extension of the Protective Sweep Doctrine in Non-Arrest Situations

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.

New Demands, Better Boards: Rethinking Director Compensation in an Era of Heightened Corporate Governance

Katherine M. Brown

Sarbanes-Oxley and the accompanying era of heightened corporate governance dramatically changed the composition, role, and responsibilities of corporate boards. As a result of these changes, many of the justifications for traditional director compensation plans no longer apply. As directors struggle with their new responsibilities as independent corporate monitors, the manner in which they are compensated must reflect these changes. A director compensation plan in which directors receive compensation primarily in the form of cash, coupled with finely tailored equityholding requirements, strikes the right balance of director independence and director accountability. It also facilitates the creation of corporate boards drawn from a more diverse pool of talent.

Layovers and Cargo Ships: The Prohibition of Internet Gambling and a Proposed System of Regulation

Ryan S. Landes

Since its emergence in the 1990s, Internet gambling has grown into a $12-billion-per-year industry. In October 2006 Congress passed the Security and Accountability for Every Port Act, which includes a provision that prohibits domestic financial institutions from moving funds to and from online casinos, all of which are located overseas. While the new law has certainly caused a major stir in the Internet gambling community, users and overseas companies are continuing to find new ways to circumvent it. In this Note, the author first gives an overview of the gambling industry and the problems it poses to gamblers and communities. The author then reviews the tactics Congress attempted to use over the last decade in fighting Internet gambling—criminalizing the operation of a gambling website, criminalizing individual gambling, and criminalizing funds transfers to and from casinos—and explains why each method fails to address, and often exacerbates, the very problems the legislation seeks to resolve. The author then proposes a new method of regulation and explores how that system could significantly reduce the problems of Internet gambling.