Ideoblog

Business and the Supreme Court

Jeffrey Rosen has an interesting article in the NYT magazine about the Supreme Court's pro-business tilt. Gordon Smith gives some highlights, noting the interesting agreement on business issues between liberal and conservative justices:

With their pro-business jurisprudence, the justices may be capturing an emerging spirit of agreement among liberal and conservative elites about the value of free markets. Among the professional classes, many Democrats and Republicans, whatever their other disagreements, have come to share a relatively laissez-faire, technocratic vision of the economy and are suspicious of excessive regulation and reflexive efforts to vilify big business. Judges, lawyers and law professors (such as myself) drilled in cost-benefit analysis over the past three decades, are no exception. It should come as little surprise that John Roberts and Stephen Breyer, both of whom studied the economic analysis of law at Harvard, have similar instincts in business cases.

Rosen notes the influence of Lewis Powell, Rex Lee and the litigation coordinating efforts of the Chamber of Commerce. I wonder how much of this development can be attributed to Henry Manne, whose writings and judicial and law professor seminars had a profound influence on US law and policy, as I have recently written.

For me the most interesting part of Rosen's article was about the clash of two strains of conservatism:

Ever since the Reagan administration, there had been a divide on the right wing of the court between pragmatic free-market conservatives, who tended to favor business interests, and ideological states-rights conservatives. In some business cases, these two strands of conservatism diverged, leading the most staunch states-rights conservatives on the court, Antonin Scalia and Clarence Thomas, to rule against business interests. Scalia and Thomas were reluctant to second-guess large punitive-damage verdicts by state juries, for example, or to hold that federally regulated cigarette manufacturers could not be sued in state court. As a result . . . the chamber began a vigorous campaign to urge the Bush administration to appoint pro-business conservatives.

When it came time to replace Chief Justice William Rehnquist and Justice Sandra Day O’Connor, the candidate most enthusiastically supported by states-rights conservatives, Judge Michael Luttig, had a record on the Court of Appeals for the Fourth Circuit that some corporate interests feared might make him unpredictable in business cases. (“One of my constant refrains is that being conservative doesn’t necessarily mean being pro-business,” Conrad [of the Chamber of Commerce] told me.) The chamber and other business groups enthusiastically supported John Roberts, who had been hired by the chamber to write briefs in two Supreme Court cases in 2001 and 2002. . . . . The business community was also enthusiastic about Samuel Alito, whose 15-year record as an appellate judge showed a consistent skepticism of claims against large corporations. Ted Frank of the American Enterprise Institute predicted at the time of the nomination that if Alito replaced O’Connor, he and Roberts would bring about a rise in business cases before the Supreme Court. Frank’s prediction was soon vindicated.

I certainly sympathize with the Court's pro-business move. [With respect to Alito, I take some credit for being among the first to highlight his business record when he was nominated –see here, and the follow-up Forbes column.]  But while I don't consider myself a "conservative," I think the Court's rejection of what Rosen calls "state's rights" [in NYT-speak] in favor of a broad view of federal power is not entirely a good thing, even for a pro-business type. See, for example, my article on preemption in the securities law area (which got some push-back when I presented it at Cato).

Yes, the states have overreached, particularly in empowering the trial bar, and we've seen, particularly recently, the corruption underlying this overreaching. But we must remember that federal law is not without its flaws, and its flaws are compounded by the high costs of exiting a federal regime.

As I've often argued, including in the article noted above, there is a way out of this dilemma, a business-friendly alternative to broad federal preemption: enhancing parties' power to contract for the applicable state law. Erin O'Hara and I have a forthcoming book on that, The Law Market, which I'll be writing about in coming months. You can get tastes of the analysis in, among other places, our Corporations and the Market for Law, just out in the Illinois Law Review, and our recent paper on European and American choice of law.

The market for law offers a way to get competition and evolution of legal rules while enabling firms to avoid the Mississippi swamps and duplicative and costly state regulation.  I think business will come to see the attractions of this approach, particularly when it realizes in coming years that Congress may not be entirely pro-business.

What is Iraq?

As Iraq engages in the task of nation-building, it has to face what sort of nation it is, if any sort. Part of the inherent problem of Iraq is that it did not arise from indigenous forces, but was rather carved willy-nilly by western powers. Now that this territory doesn't have Saddam's strong arm holding it together, there's a question of what sort of entity it is or eventually will be – a unitary nation, a federal union like the US, a trade group of distinct political entities like Europe or a bunch of autonomous countries?

These questions are raised by the recent deal between Hunt Oil Co. and Kurdistan, discussed in today's WSJ. Hunt entered into the deal as it got tired of waiting for Baghdad to pass a national oil law, and Kurdistan went ahead and passed one of its own. According to the WSJ:

The deal shows the new Kurdish law "has created a supportive and transparent business environment" for international oil companies, said Ashti Hawrami, Kurdish minister for natural resources, in a statement. Mr. Hawrami said that any eventual revenue from the deal will be shared with other Iraqi regions. * * * Ray Hunt, chief executive of Hunt and the patriarch of the family's business interests -- which span energy, real estate, private investment and ranching -- said in a statement that he was pleased to be "participating in the establishment of the petroleum industry in the Kurdistan region of Iraq." * * * [A] spokeswoman said Hunt determined that conditions were right to sign the deal, after the regional law was passed. "They have a new petroleum law which is transparent and which calls for immediate work in the region[.]" * * * The Kurdish regional government "provided all of the necessary processes to begin work and we were ready to go."

A federal judge has a good time in a backdating case

WSJ Law Blog commends the humor of U.S. district court Judge James Rosenbaum in denying a motion to dismiss in the United Health backdating case. According to the judge, plaintiff’s theory has won several academy awards. And, he might have added, a Pulitzer Prize.

But all these awards don’t substitute for actual judicial reasoning, which was sadly absent from the opinion except for this remark:

In The Sting, the bad guy is ultimately brought down by utterly charming con men, played by Paul Newman and Robert Redford. The Sting (Universal Pictures, 1973). They gain their revenge through a scheme involving “past-posting,” or betting on horse races after the results are known. The Court expresses not the slightest opinion as to whether such shenanigans occurred here, but such is the essence of plaintiffs’ theory.

It is a poker axiom that if a player has his knees under the table and cannot tell who the sucker is, he’s it. In this game, according to plaintiffs, the patsy was either the hapless corporation, which in varying ways defendants controlled, or the corporation’s shareholders, whose equity provided the game’s antes and bloated pot.

The problem with the judge’s reasoning is that there’s nothing per se wrong with “past-posting” in the form of backdating. The question is whether it was properly approved and disclosed. I’m not saying it was in the United Health case. But the defendants had some arguments that they deserved to have the court seriously address, particularly given the importance of judicial guidance on this issue.

If you want an example of a judge who did believe it necessary to seriously address arguments in backdating and springloading cases, see my discussion of Delaware Chancellor Chandler’s opinions in the Ryan and Tyson cases. A comparison of the federal and state cases provides a pretty good anecdote in support of state corporation law.

Pick your poison: class actions or corporate criminal prosecutions?

Stanford's Joe Grundfest writes in today's WSJ that securities class actions are declining. One reason? He suggests maybe it's because there's less fraud.  And that might be because

there is a new, tougher and superior enforcement mechanism in place. The SEC and the Department of Justice now insist that any corporation suspected of a sufficiently serious fraud conduct an internal investigation that will finger the executives responsible. The corporation must also cooperate in prosecuting these executives. This enforcement technique is stunningly effective, if often overbearing. It eliminates the government's need to conduct expensive and lengthy investigations and provides the authorities with extraordinary leverage over every executive suspected of wrongdoing. Private litigation doesn't have an equivalent deterrent effect because it can't threaten executives with jail and because damages are almost always paid by corporations and insurers, not the executives who cause the fraud. As long as the government's enforcement activities remain sufficiently vigorous, the private class-action securities fraud lawsuit can be viewed as an expensive, wasteful and unnecessary sideshow that generates little deterrence and offers questionable levels of compensation. The question then is not why these lawsuits have been shrinking so rapidly in recent months, but when and whether they should exist at all.

Grundfest's explanation of the decline in private securities litigation may be correct, but his suggestion that this is a good thing is deeply troubling. As I've often suggested (see my Corporate Crime archive) there are serious problems with criminalizing the sorts of corporate misconduct that are the subject of private action.

Does the dip in securities litigation suggest that the corporate criminal prosecutions have been worth these costs?  I'd demand more evidence that we don't just have an up-market litigation cycle. Moreover, even if we do have less fraud to litigate, I'd wonder whether it's been worth the price.  Do we have less risk-taking?  A zero fraud world is not necessarily paradise.

The question here is not who one's favorite bad guy is (federal prosecutors or class action lawyers) but what system achieves the maximum deterrence at the minimum costs. (Compensation really doesn't enter into any of these approaches).

As I said in my Dabit, Preemption and Choice of Law, "the efficiency of private litigation can be assessed only in the context of all of the tools for fighting fraud." But I also noted that there's a lot we don't know about the optimal mix of approaches to deal with fraud, and that a one-size-fits all federal regime, with its lurches from one "solution" to another, is not necessarily the way to go.

Update:  In the post above I refered to "maximum deterrence at the minimum costs."  That was careless phrasing.  I meant "most cost-effective deterrence." 

While I'm at it I should note that, generally consistent with Grundfest, Karpoff, Lee and Martin, in their recent Legal Penalties for Financial Misrepresentation, find that "a recent increase in regulatory penalties has coincided with a decrease in private penalties."  But, for the reasons discussed in my post, this doesn't either establish a causal relationship between the two phenomena or justify the current mix of sanctions.

Abortion and choice of law

Will Baude writes in the NY Times (linked by Dan Markel, blogged here) that repealing Roe would open the country to choice of law chaos:

--States might use child custody laws to “place unborn children into protective custody, forbidding their mothers to take them across state lines.”

--“Anti-abortion states could forbid their residents to obtain or perform abortions, even while out of state.”

--“Just as Utah could make it a crime for a resident to go to Rhode Island for an abortion, Rhode Island could forbid Utah's law-enforcement officials from interfering with her decision to get one.”

Would states act this way? In my article with Frank Buckley, Calling a Truce in the Marriage Wars, 2001 University of Illinois Law Review 561, draft here, we discuss an interstate political dynamic for same sex marriage, similar to the one for abortion laws, that cuts the other way.

How many of the more outrageous scenarios Baude describes, assuming they are practical and politically realistic, would be constitutionally permissible? No the law is not crystal clear, and the constitutional constraints on choice of law are very light. But I suspect, for example, that changing residency to the pro-abortion state would be enough to constitutionally stop the anti-abortion state of origin from acting against the relocating mother.

Most importantly, Congress has the power to act under the Full Faith and Credit clause to stop the mayhem Baude describes. As divided as we are on abortion, it doesn't follow that a majority can't be found on a choice-of-law solution that would allow the two sides to live in harmony. 

Baude says, “If Roe is reversed, the ensuing chaos will demand a federal resolution to the abortion battle – again.” Maybe, but it doesn’t have to be another single answer up or down on abortion.

The Economics of Federalism

Have you ever wanted a brief summary of the law and economics of federalism? One that concisely brings together all of the many strands of this extensive subject, with citations to the major works? 

Well the answer to your prayers is now available: Bruce Kobayashi and my paper on the Economics of Federalism. Here’s the abstract:

This is the introductory essay for the Economics of Federalism, a book edited by the authors and forthcoming in Edward Elgar Publishing's ECONOMIC APPROACHES TO LAW series. This essay discusses the major issues and theories concerning federal political systems, which we define as systems that have a hierarchy of at least two distinct "state" and "central" levels, each with a well-defined scope of authority. The essay discusses two branches the economics literature. The first branch, on competitive federalism, stems from Tiebout's 1956 article. It focuses on the horizontal structure of federalism and examines jurisdictional competition between state governments for mobile individuals and resources. The second branch of the literature, on fiscal federalism, examines the vertical structure of federalism, or the division of public services and taxing power between the central and state governments. The essay also examines applications of the economic analysis of federalism to specific areas of the law, including corporate law, antitrust law, environmental law, choice of law rules, contractual choice of law, and public choice theory.

New dimensions in state competition

Abraham Bell & Gideon Parchomovsky, Of Property and Federalism, Yale L.J., Oct. 2005 is now out through the Yale Law Journal’s innovative blog-like “Pocket Part,”  with a link to the pdf of the article and comments by Bob Ellickson and Judge Stephen Williams.  Here’s the abstract:

This Essay proposes a mechanism for expanding competition in state property law, while sketching out the limitations necessary to protect third parties. The fact that property law is produced by the states creates a unique opportunity for experimentation with such property and property-related topics as same-sex marriages, community property, adverse possession, and easements. The Essay begins by demonstrating the salutary effects of federalism on the evolution of property law. Specifically, it shows that competition among states has created a dynamic property system in which new property institutions replace obsolete ones. The Essay then contemplates the possibility of increasing innovation and individual choice in property law by inducing state competition over property regimes. Drawing on the scholarly literature examining state competition for corporate law and competition over the provision of local public goods, the Essay constructs an open property system that creates an adequate incentive for the states to offer new property regimes and allows individuals to adopt them without relocating to the offering state. This Essay also has important implications for the burgeoning literature on the numerus clausus principle, under which the list of legally permissible property regimes is closed. The Essay argues that in a federal system, it is socially desirable to expand the list of property forms to include certain out-of-state forms.

This is a very interesting paper that deserves to be read widely.  But there’s one aspect of the proposal that interests me particularly:  the creation of a system of corporate-like fees to provide incentives for states to compete to develop property forms. I have argued that such fees may not, in fact, provide adequate incentives.  Rather, we need to look to the incentives of private parties who participate in the lawmaking process, particularly including lawyers.

I discussed this issue in connection with another interesting paper by Rob Sitkoff and Max Schanzenback on jurisdictional competition for trust funds, also forthcoming in Yale. This paper shows, consistent with my theory, evidence of non-state-revenue based competition, specifically to eliminate the rule against perpetuities. 

I find even more interesting Rob Sitkoff’s current project, presented at the Midwest Law & Economics Association meeting, which shows evidence of non-fee-based, lawyer-driven state competition to provide statutory trust laws. Here’s a link to the abstract of this work-in-progress.

In general, these are exciting times to be thinking about federalism issues.

Update:  Yale's innovation has generated a lot of buzz.  Here's a roundup.

What time is it in Indiana?

The W$J reports on Indiana’s time woes.  Indiana’s counties are on all kinds of time – est all year, some est and edt, some cst or cdt.  Starting in April 2006, the whole state will be on daylight savings, but counties have the option of being on central or eastern time. I know the hardship.  Indianapolis has the nearest big airport to Champaign, and catching or scheduling a flight there still challenges my senile mind.

Sounds like a case for a federal law, right?   Indiana and its counties impose costs on the rest of us just so that the sun can rise and set when they want it to.  Congress should make things simple.

But wait: the costs of the law are largely internalized in Indiana.  If it’s a massive inconvenience for non-Hoosiers to deal with Indiana businesses, Hoosier firms will lose customers and have an incentive to lobby their state or counties to join the uniform standard.  But they may not have a strong incentive to lobby simply because it’s not such a big inconvenience.  If you deal regularly with a Hoosier or Hoosier firm, you learn.  If not, you don’t really care.

Also, if Congress is going to settle it, what should be the rule?  In other words, should Indiana be eastern, central, or a mix? The WSJ article discusses a statistician's efforts to get Indiana on central. His arguments are largely astronomical.  How do we know he’s right in terms of all relevant costs and benefits?  If we don’t know, why not a decentralized solution to the problem?

Come to think of it, why do we even need time zones?  We could have a market for time.  Maybe uniform time zones could be a default rule. Everybody could decide to live in his own time zone.  A Californian could be on Tibet time (some of them are anyway). Except for his interactions with others, this is just a matter of how he sets his watch.  When he interacts with people or firms, the default rule applies unless the contract provides otherwise. Meet you for dinner at 6, Tibet time?

This might even have something to do with a few other topics, such as: same-sex marriage (A Standard Form Approach to Same-Sex Marriage, 38 Creighton Law Review 309 (2005) (draft), Calling a Truce in the Marriage Wars (with Buckley), 2001 University of Illinois Law Review 561 (draft)); contractual choice of law generally (From Efficiency to Politics in Contractual Choice of Law, 37 Ga. L. Rev. 363 (2003)); internet law (State Regulation of Electronic Commerce (with Kobayashi), 51 Emory L.J. 1 (2002) (draft)), attorney ethical rules (Ethical Rules, Law Firm Structure and Choice of Law, 69 U. Cin. L. Rev. 1161 (2001) (draft)).

Update: One of the great things about blogs is how they're able to specialize, as well as attract information like a powerful magnet.  So as a result of the above post, I learned about an Indiana blog that has lots of information and links about the Indiana time issue, such as here.

The Cuno decision

The Supreme Court has granted cert in Cuno v. DaimlerChrysler, which held that Ohio’s investment tax credit encouraging firms to stay in Ohio violated the Commerce Clause. Here’s the TaxProf discussion, with links to previous posts.

As I argue in my Accountability and Responsibility in Corporate Governance (section II.F), locality competition is one of many markets that encourage even profit-maximizing firms to be socially responsible:

Firms have economic incentives to be on good terms with the communities in which they have main offices and factories.  Undesirable firms can face annoying local taxes and regulations and irresponsible firms may find it difficult to recruit and retain loyal workers.  Communities may be willing to reduce taxes to attract “cleaner” firms.   Localities that can offer significant amenities may have the leverage in the location market to bind firms to agreements regarding their activities in the community, and firms may compete for good locations. Firms accordingly have entered into “good neighbor” agreements with local communities to ensure friendly relations with local government and employees.  While depressed communities may have little market power and may seek to offer firms a lax zoning and environmental controls, even firms in these areas need to consider their long-term standing with local government and workers.  Economic conditions and government officials may change, and a firm that seeks to exploit its home community will have no reserve of goodwill, or “social license,” with workers and local officials that can help it through difficult situations.

As I point out in a footnote, which will now have to be updated:

Relationships between firms and their home communities might be threatened by a recent ruling that a state investment tax credit and local property tax exemption to encourage local investment violated the commerce clause. See Cuno v. DaimlerChrysler, Inc., 386 F.3d 738 (6th Cir. 2004).

It follows from this analysis that the preferential tax credit the 6th Circuit overturned is an example of state competition.  It is the diametric opposite of, say, state constraints on wine exports, which frustrate state competition.  This is, of course, relevant to the constitutional analysis.

The policy argument against the tax credit is that such Tieboutian competition erodes tax revenues.  The glass-full perspective is that it constrains states' ability to over-tax. 

For my previous discussion of the subsidies (which the Cuno decision doesn't touch)/tax breaks issue, see my post on Wal-Mart, reponding to this Bainbridge essay.  Of course, arguing on policy grounds, as Prof B does, that preferential treatment and subsidies are bad is not the same as arguing that they are unconstitutional.  I believe that permitting this competition is both good policy and constitutional, and hope the Supreme Court agrees, at least with the latter.

Update: Vic has another take on Cuno:

The easiest way for me to see [the 6th circuit decision] was to think about two corporations, both selling products in Ohio, both needing to build a new distribution center.  One builds the new distribution center in Cleveland, the other in Erie PA.  The former gets better treatment under Ohio law, as it has a lower Ohio tax liability.  Following the logic of last term's dormant commerce clause case dealing with restrictions on out of state wineries, it's hard to see how state tax incentives would survive.

This suggests that it’s unconstitutional to impose a lower local tax than some other state.  That’s obviously not right. 

The problem in Cuno was that a company currently taxed in Ohio could reduce its tax by investing in Ohio but not elsewhere.  That’s a little different, but only a little, because it’s hard to see the big distinction from a company that is not in Ohio but comes there to pay a lower tax.  And that’s without even considering whether subsidies can be distinguished. 

The cases the 6th circuit relied on dealt with differential local tax treatment based on interstate shipment of goods. That is more like the wine case. 

Having said this, I’m not going to go further and claim that I have worked through all of the distinctions. At some point, the state tax so clearly exports costs that it can lead to balkanization rather than competition.  The wine case, which barred certain imports, seems to be in that category. Ohio’s welcome mat does not. 

It may be difficult to distinguish all these cases on economic grounds.  But the fact that the investment tax credit does not clearly fit within the prior cases the court cited should have been enough to validate the tax, particularly given the social benefits of such contract-like relationships discussed in my initial post.

Some thoughts on the Ellison settlement

As Christine Hurt notes, the story of Larry Ellison’s $100 million payment to settle his California derivative insider trading suit hasn't gotten the attention it deserves.

The bottom line is that Ellison, having won dismissal of a Delaware derivative suit based on the same alleged insider trading incident, decided to settle in California, obviously to avoid the risk of higher damages there.  Rather than pay the money to the corporation, to the ultimate benefit of shareholders, obviously including Ellison, the money will go to charity.

There are several interesting issues here.  I’m not going to rehash the basic insider trading charge.  And since I haven’t seen the California complaint, I could be getting basic things wrong about the case.  But here goes:

1. The case raises an interesting issue about who is damaged, and how much, by insider trading. What's wrong, if anything, with insider trading, is that it can be a theft of corporate property. It follows that the damage would be to the corporate entity, just as with any corporate opportunity or similar theory.  See my article, Federalism and Insider Trading, 6 Supreme Court Economic Review, 123 (1998). This suggests that a derivative remedy is not only appropriate, but is the only appropriate remedy.  But it's hard to see how damage to the corporation gets close to 100 mil on a non-fanciful theory. So the money may as well go to charity.

2.  What law applies in a case like Ellison's?  I find this especially interesting.  Oracle is a Delaware corporation, so it probably should be Delaware law. The Delaware Supreme Court recently reaffirmed this "internal affairs" choice of law rule, as I have discussed. In that case the court held that Delaware rather than California law applied to a suit involving a Delaware corporation.

3.  But what if California disagrees with me and Delaware and applies its own law?  Then it might, for example, apply a looser test of liability than in Delaware – e.g., not requiring that plaintiff prove that Ellison traded because of the information he had. The Delaware court said California wouldn’t apply California law, which may be wishful thinking, and that it constitutionally couldn’t, which may be wrong, as I discuss in my earlier post.    Ellison apparently didn't want to stick around to find out what would happen.

4.  How does federal insider trading law fit with all this?  There is a federal Oracle case still pending.  The Securities Litigation Uniform Standards Act preempts most shareholder class actions, exempting certain actions against issuers in the so-called “Delaware carve-out.”  But SLUSA doesn’t apply to derivative suits like the ones in the Oracle case. 

5. The innovative settlement here, and the fact that Ellison faces real consequences under state law, raise the issue of whether state law can effectively supplement federal law.  I discuss this issue as applied to the fraud on the market theory in my Fraud on a Noisy Market article noted yesterday.  There I suggest a significant shrinkage of federal liability, but also amending SLUSA to give plaintiffs the option to sue under state business association laws that apply to firms organized under those laws. 

6.  The attraction of a state law approach is that there is a lot of uncertainty about the appropriate rule in many kinds of cases, including insider trading (should we require proof of what motivated the insider trade?) and fraud on the market. This suggests that it might be a good idea to work these ideas out in the "laboratory" of state law. But note that the key to this working is that only one state’s law can apply – no plaintiff shopping for the most litigation-friendly forum. In other words, my suggestion hinges on accepting the internal affairs rule that seems to have been up for graps in the Oracle situation.