Volume 13

Volume 13.1

Cracking the Preemption Code: The New Model for OTC Derivatives

Barry Taylor-Brill

Salvador Dali's famous painting, "Gala Contemplating the Mediterranean Sea which at Twenty Meters Becomes the Portrait of Abraham Lincoln (Homage to Rothko)," is prominently displayed in the main hall of the Teatre-Museu Dali in Dali's hometown of Figueres, Spain. Up close, it is a painting of Dali's wife, Gala. At a distance, the viewer sees it transform into a portrait of Abraham Lincoln. Dali's masterpiece is a perfect metaphor for how, under Title VII of the Dodd-Frank Act, a well-designed preemption model for derivatives comes into view when one steps back far enough to see the bigger picture.

Merit Management Group, LP v. FTI Consulting, Inc.: Narrowing the §546(e) Safe Harbor

Katie Drell Grissel

From Compulsion to Compensation: How Selective Waiver Compensates Corporations for Involuntary Disclosures

Keyawna Griffith

Selective waiver is necessary to prevent corporations from losing their attorney-client privilege and work product doctrine as a result of government compulsion. The majority of circuit courts reject selective waiver in some form. They believe selective waiver stems from voluntarily disclosing confidential or privileged information to the government, distorts the purposes of the attorney-client privilege and work product doctrine, and constitutes a tactical advantage for the corporation. However, this Note will argue that selective waiver can be exercised under current legislation and doctrine. It is an extension of the attorney-client privilege and can be enforced under Federal Rule of Evidence 502. Contrary to what almost all of the circuit courts that have addressed selective waiver have said, this Note asserts that a corporation's decision to disclose to the government while under pressure is an involuntary disclosure. This is a key reason why selective waiver is fair and deserves to be recognized.

Volume 13.2

Fiduciary Duties in Activist Situations

Hon. J. Travis Laster

Dual-Class Index Exclusion

Andrew Winden & Andrew Baker

One of the most contentious and long-standing debates in corporate governance is whether company founders and other insiders should be permitted to use multi-class stock structures with unequal votes to control their companies while seeking capital through a public listing. Stymied by the permissive attitudes of legislatures and regulators, institutional investors opposed to multi-class arrangements recently turned to a new potential source of regulation: benchmark equity index providers. At the behest of institutional investors, the three largest index providers recently changed the eligibility requirements for their benchmark equity indexes to exclude, limit or underweight companies with multi-class stock structures. Investors expected the prospect of exclusion from such indexes to discourage founders and directors from adopting dual-class stock structures in connection with their initial public offerings.

While there is a voluminous financial literature on the effects of index inclusion and exclusion on stock prices, and legal scholars have recently explored the corporate governance implications of the exponential growth of passive index investing, focusing primarily on the incentives of index fund asset managers, neither the financial nor the legal literature have considered the corporate governance role and influence of the parties who write the rules for index investing: the index providers. We begin to fill this gap in the literature by assessing the efficacy of index providers as corporate governance arbiters through the rubric of their dual-class index exclusion decisions.

We start with the premise that the index exclusion sanction will not discourage dual-class listings unless it is sufficiently costly to outweigh the perceived benefits of founder control through a multi-class stock structure. We expect the index exclusion sanction will not be sufficiently costly for several reasons. First, it is difficult, if not impossible, to implement a sanction through the public capital markets. Second, the index inclusion effect on which the anticipated sanction is premised has effectively disappeared in recent years and may never have been a long-term source of lower capital costs. Third, despite the explosive growth of index investing in recent years, funds following stock indexes still hold a relatively modest percentage of the market capitalization of U.S. equities—around 12% according to BlackRock. Finally, the proliferation of index investing opportunities has weakened the market-moving influence of any one benchmark index.

To test the efficacy of the sanction, we conduct an event study of the S&P announcement that dual-class companies would henceforth be excluded from the S&P 1500 Composite Index and its components—the S&P 500, S&P 400 mid-cap and S&P 600 small-cap indices. Because S&P grandfathered dual-class companies currently in the index, we are able to compare movements in the stock prices of dual-class companies currently in the index with movements in the stock prices of dual-class companies not yet included in the index at the time of announcement. We do not observe any statistically significant abnormal returns in the stock prices of either included or excluded firms as a result of the S&P announcement, suggesting that exclusion is not expected to have a significant adverse cost of capital effect on firms that elect to list with a dual-class stock structure in the future and that the sanction is ineffective. In the absence of an effective sanction, the exclusion of dual-class shares from benchmark equity indexes will not affect corporate governance choices. It may, however, have material adverse consequences for index investors and the index providers themselves.

From Dodge to eBay: The Elusive Corporate Purpose

Dalia T. Mitchell

This article examines the history of the law of corporate purpose. I argue that the seemingly conflicting visions of corporate social responsibility and shareholder wealth maximization, which characterize contemporary debates about the subject, are grounded in two different paradigms for corporate law—a socio-political paradigm and an economic-financial one. Advocates of the socio-political paradigm have historically focused on the power that corporations could exercise in society, while those embracing the economic-financial paradigm expressed concerns about the power that the control group could exercise over the corporation’s shareholders. Over the course of the twentieth century, scholars have debated the merits of each of these paradigms and the concerns associated with them, while judges drew upon the academic and, more importantly, the managerial sentiments and concerns of the era to attach a purpose to corporate law’s doctrine, that is, the ultra vires doctrine in the early twentieth century, the enabling business judgment rule by midcentury, and the laws applicable to evaluating managerial responses to hostile takeovers at the century’s end. Ultimately, the cases seemingly addressing corporate purpose did not endorse wealth maximization or social responsibility as objectives. Rather, they empowered corporate managers to set corporate goals without interference from shareholders or the courts.

The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms

Thomas A. Lambert & Michael E. Sykuta

Recent empirical research purports to demonstrate that institutional investors’ “common ownership” of small stakes in competing firms causes those firms to compete less aggressively, injuring consumers. A number of prominent antitrust scholars have cited this research as grounds for limiting the degree to which institutional investors may hold stakes in multiple firms that compete in any concentrated market. This Article contends that the purported competitive problem is overblown and that the proposed solutions would reduce overall social welfare.

With respect to the purported problem, we show that the theory of anticompetitive harm from institutional investors’ common ownership is implausible and that the empirical studies supporting the theory are methodologically unsound. The theory fails to account for the fact that intra-industry diversified institutional investors are also inter-industry diversified, and it rests upon unrealistic assumptions about managerial decision-making. The empirical studies purporting to demonstrate anticompetitive harm from common ownership are deficient because they inaccurately assess institutional investors’ economic interests and employ an endogenous measure that precludes causal inferences.

Even if institutional investors’ common ownership of competing firms did soften market competition somewhat, the proposed policy solutions would themselves create welfare losses that would overwhelm any social benefits they secured. The proposed policy solutions would create tremendous new decision costs for business planners and adjudicators and would raise error costs by eliminating welfare-enhancing investment options and/or exacerbating corporate agency costs.

In light of these problems with the purported problem and shortcomings of the proposed solutions, the optimal regulatory approach—at least, on the current empirical record—is to do nothing about institutional investors’ common ownership of small stakes in competing firms.

The Woeful Inadequacy of Section 13(d): Time for a Paradigm Shift?

Maria Lucia Passador

Undoing a Deal with the Devil: Some Challenges for Congress’s Proposed Reform of Insider Trading Plans

John P. Anderson

The Unfulfilled Promise of Hedge Fund Activism

J.B. Heaton

Hedge fund activism has mostly disappointed. While hedge fund activists are good at motivating sales of companies to potentially-overpaying acquirers, hedge fund activism is neither the threat to corporate strength that hostile commentators have claimed nor a meaningful force for better corporate performance. Instead, more than a decade of research shows hedge fund activism to be economically unimportant to corporate performance one way or the other. Hedge fund activists have disappointed their investors as well, generating unimpressive returns. I explore three reasons why hedge fund activism has mostly disappointed. First, hedge fund activists have no comparative advantage in generating ideas for meaningful competitive advantage at target firms. Second, hedge fund activists likely suffer from a form of winner’s curse where the hedge fund activist is too pessimistic about the firm it targets. Third, hedge fund activists often target declining firms, the equity in which is often unsalvageable by the time the activist has taken notice. In the end—and in the spirit of Edison’s famous comment about his failures on his way to inventing the light bulb—we have learned little more from a decade of research on hedge fund activism than one additional way that shareholder activism does not work.

The Seller’s Curse and the Underwriter’s Pricing Pivot: A Behavioral Theory of IPO Pricing

Patrick M. Corrigan

Canonical theories of law and economics predict that issuing firms in initial public offerings (IPOs) demand—and that competitive markets produce—a transaction structure that maximizes value to issuers. Yet, since 1980, corporate America has left approximately 19 cents of foregone proceeds on the table for every dollar it has raised in IPOs. Moreover, the standard IPO contract appears designed to exacerbate rather than resolve agency costs, information asymmetries, and other foreseeable causes of IPO underpricing. This Article studies a new puzzle: why don’t issuers anticipate their transactional vulnerability and bargain for a sale of stock contract that protects them against foreseeable causes of underpricing?

To explain this puzzle, I model issuer heterogeneity in a novel way. Some fraction of issuers have managers that—when they engage an underwriter months before the IPO—fail to anticipate their underwriters’ incentives or capacity to impose underpricing when the IPO is priced. The interaction between market forces and managerial psychology at these naïve issuers explains the structure of the standard IPO contract. Conditional on using the standard IPO contract, underwriters pivot between two strategies. In the IPOs of naïve issuers, underwriters hold up and underprice IPOs. In the IPOs of sophisticated issuers, underwriters short sell the issuing firm’s stock and overprice IPOs.

The model predicts efficiency losses and wealth transfers from naïve issuers and one-shot investors to underwriters, repeat investors, and sophisticated issuers in IPO markets. The behavioral theory I present provides a more comprehensive explanation for IPO pricing and practices than existing accounts, and supports arguments for substantive reforms to federal broker-dealer regulation.