The Election and Impact on Business

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This is the first of a series of posts based upon an extensive program sponsored by the National Association of Corporate Directors on November 20.  The focus was on what the results of the election meant for different kinds of business, for capital and investment markets and for the economy in general.  Each section will have specific focus as indicated by the titles.

I start here with  general observations that apply to all businesses and markets.  Stability and predictability are essential for good business, and for companies and their boards making decisions that have some likelihood of being accurate.  Did the expert panel believe that the new administration would provide such predictability?  The answer was mixed; it depended on what sector you were looking at.  Those sectors will be explored in future posts.  BUT there were a couple of general themes:

First, business generally has been optimistic about a Republican administration and in some sectors that will be justified.

Second, the left wing of the Democratic party was described as arming itself for many fights.  This was characterized as the wrong posture.  The basic posture of the Democratic Party, based on its sweeping loss, is going to be reconsidered based on the new reality, and the liberal wing will not call those shots and should not because continued internal war based on historical causes neither works (the election itself being proof) nor addresses the needs of the country.  The country needs engaged counterbalance to what may well be new directions, and influence will come only by engaging the issues rather than drawing battle lines.  There will be many matters where the benefit of new directions clearly will be positive.  To fight all the time impedes progress, upsets businesses and spooks the stock market, the investment climate and the M&A process. It was noted that in some areas, the people being proposed for governance roles are centrists (putting aside the flack about the character flaws of others which are not ultimately central to the business of America).

Finally, be ready for material change.  Putting aside the promise to punish the enemy within, which by the way the panel thought would occur to some degree in the early stages of the new administration because Trump said it, believes in it and will be compelled to act upon it, the broader economic picture will be very disruptive.  Both Trump and Musk are masterful disrupters and they will act true to form.  After a passing reference to issues of Musk’s personality, the panel thought that this new duo would have positive material impact on many aspects of US business: scientific advances including in climate and medicine, and  AI (much more about AI later as the panel thought this the key to both near term and long term business health and also the US’s position in the business and geo-political world arenas as well as fundamental to national defense concerns).

Future posts will address: immigration and the sensitivity that Trump will have as to economic impact; how governance will proceed and the roles of Congress, personnel appointed and use of Executive Orders; the role of China in geo-politics and the impact of Chinese inroads vs domestic problems, and possible impact on world peace; the consideration of the EU given that all big business in the US is involved there; the interplay of interest rates, the bond market, inflation and CapX; how directors need to conduct their business in the new environment; how the administration ought to deal with Mexico and particularly Canada (our governments may be at odds but Canada is our biggest trading partner and the most logical source of the massive power we need to keep data centers alive 24-7 as that is the key to the vital task of winning the AI war); the future of ESG; how all this impacts the Middle East and Ukraine.

AI and Antitrust

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My prior post set forth in broad strokes the current Federal focus on bringing antitrust actions against major American tech companies based on alleged monopoly power derived from sheer size.  Commentators warn that, with the incredible potential power of AI, government must address the growing AI marketplace with the same jaundiced view– or perhaps, with the same great care for American commerce and politics.

Google monopolizes search engines, Amazon monopolizes retail, Meta monopolizes social media, Apple monopolizes the devices which disseminate the output of these companies.   If AI is used improperly, whether consciously or not, all affected markets will be misled, manipulated, corrupted.

Timothy Wu, former presidential adviser and author of “The Curse of Bigness: Antitrust in the New Gilded Age,” claims that today’s actions against big tech and search engine platform dominance will be seen in the future as “all about who’s going to control artificial intelligence.”  Microsoft CEO Satya Nadella testified at trial that her company used its powerful search engines to obtain consumer data to train their AI to make their search engines dominant.

FTC Chair Lina Khan has noted that  the AI field is “fast-moving” and that the FTC wants to assure “that the opportunity for competition and the potential for disruption are preserved, rather than this moment being co-opted by some of the existing dominant firms to double down on their dominance.”  Given the head-start of the giants, it is feared that all small AI companies of merit will be crushed, or will be sucked up into the giants to obtain their technology or to “capture and kill” competition.

The future here is unclear but, remember, the Government won the Google case and now we are awaiting what action will occur as remedy.  We are headed for interesting times, with impact not only on society and its commercial and political market-places but also with respect to your investment portfolio, the way in which new capital is deployed to tech companies, and how the next Administration will process all this– it is noted that during all the political battles this year, with all the hot-point political issues being debated, neither Presidential candidate has taken any specific position on tech antitrust.

The New/Old Antitrust Initiatives

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Today, the United States Department of Justice is litigating against the largest tech companies, claiming they constitute illegal monopolies.  This also is not just a Democratic-party aggressive liberal effort at control: in 2019 the Trump DOJ launched investigations of Google, Meta, Apple and Amazon.  This new intensity follows a couple of decades of antitrust apathy.  Today, there are antitrust suits pending against Amazon, Apple,  Meta (owns Facebook) and Google.  Why this new wave?

First, understand that this is a revival of classic antitrust activity and not a reinterpretation of the underling laws  (1890 and 1914 Federal legislation).  In the “old days” companies were sued and indeed broken up based on sheer size which had the effect of creating, well, large and hence dominant enterprises in particular markets– recall that Standard Oil and AT&T and American Tobacco were chopped up in the good old days.  It is not very hard to look at sheer size, creating substantial market control, and conclude that there is societal risk.  And it is not very hard to see how size begat more size and to then  track the steps to get there, and fairly conclude that such growth involved absorbing competitors, blocking competitors, tying up customers and generally acting like, well, monopolies.

In 2020, the House Committee on the Judiciary investigated  the state of the digital economy and warned that this vital aspect of commercial life and social and political discourse was becoming highly concentrated.  And since classic practice was to identify monopoly by size and to find steps taken to build that monopoly that excluded competitors which were of course smaller enterprises–voila, litigation.  (I do not even address the active European antitrust efforts to similar effect.)

This Fall’s issue of Harvard Law (the school’s alumni publication) quotes Timothy Wu, special assistant to the president for technology and competition policy, as he set down the philosophical basis of current thinking: antitrust law is seen as “almost a companion to the Constitution.  In the sense that the Constitution is a check on public power, the antirust laws are a backstop or limit on corporate and private power.” The article goes on to cite, among other proofs of massive private power to big tech, that “Google controls 80% of the internet search business in the U.S.  In a survey of 2,000 consumers last year, 75% of respondents indicated they check prices and product review on Amazon before making a purchase.” While in the short term this may in fact be benign, one can imagine that in the long run that power can be used to wholly control pricing of whatever is sold and content of whatever is believed.

Mr. Wu should be taken with a grain of salt.  No doubt there is social risk here, but when he argues (in his book “The Curse of Bigness: Antitrust in the New Gilded Age”) that the rise of political strongmen can be traced to increased corporate power and wealth disparities, one can only suspect that there are a lot of other factors contributing to whatever the political landscape looks like.

With this a backdrop, and with the shape of our future allegedly hanging on the promise/risk of AI, we will in a following post consider how the government is perceiving the growth of AI in this time of  alleged tech monopolies.

Harvard, Free Speech and Academic Freedom

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After a summer spent on the law practice and some time on the Cape, it is time to pick up the cudgel of posting on the law and, as the name of this site suggests, also about anomalies.

Which brings me to our societal battle over policy of universities, where much criticism (and student rioting) has grown from the cauldron of foreign affairs and the interface between academic freedom for faculty and students and its occasional constriction of  what is perceived as a right of free speech.

A major effort at clarification appears in the current issue (September-October) of Harvard Magazine by eminent professor  Robert Post, whose central thesis is that the Constitutional protection of free speech relates to the public marketplace of ideas, where all ideas except those causing overt evil are to be protected, no matter how odious or illogical.  But the university is not a public forum for political society.  The university is a location for the search of truth within the confines of academic discourse.  A professor can say in society whatever he wants; a professor (and all students) within the academy need to be accurate as to facts, making supportable points within academic rigor.  Thus, “tenured scholars have the authority to veto the ideas and speech of untenured scholars and students if the do not meet  those standards.  In this institutional sense, all that speech in search of truth is not equal.”  [italics in original]

Post charges universities with making sure that, in public discourse, academics can say what they wish but that in the theoretical geography of academia they cannot. He accuses us of conflating the two different sets of freedom and in effect getting it wrong: punishing professors for public statements but also allowing inaccurate political speech within the teaching context.   Schools cannot purge faculty just because they are communists but faculty cannot seemingly misrepresent communism, reflecting political bias,  in teaching it.  In rough summary, “academic freedom does not rest principally on the First Amendment rights of individual faculty….”

The articulated theory is facially logical but, even accepting it as correct, there are fine lines to be drawn.  I doubt that student occupiers of campuses are attuned to that analysis.

In the September 6 New York Times, another eminent Harvard professor (Cass Sunstein) took a long, subtle look at the proposed distinction and attempted to illustrate it in action.  The effort is granular but not easy to parse; I must recommend to you that you do your own reading of this legal/political commentary.  But to give you some flavor: First Amendment does not apply to private colleges, only to public officials and institutions; colleges would do well to emulate the First Amendment; students and professors are allowed however to say “the United States is a racist country” or “Israel is committing genocide” or Abortion is Murder;” the Constitution  may impose restrictions not permissible elsewhere; religious schools and military academies have distinctive missions which might justify special rules.

Got it?  Of course not. You will be more edified but still unsure if you read the two articles.  If you cannot obtain access, email me at [email protected] and I will help.

 

 

The AI Role of Boards of Directors

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Last week, an expert panel under the auspices of the National Association of Corporate Directors–New England, presented on what a Board should know about use of AI within their own corporation.  To this observer, perhaps by reason of awaiting specific guidance to be passed on to Boards, the session was fascinating but somewhat frustrating.

Consultants and investors agreed that at this point most entities were at a very early stage, experimenting and not going “all-in” on any function wholly dependent on AI beyond very basic data analysis (for which the less sophisticated AI was wholly adequate)..  Many experiments were often “fails” on a learning curve.  It was estimated that no more than 5% of companies were deep into AI implementation for a variety of reasons, including fear of the biases or hallucinations  that might arise from AI relying on large language models, and fear that one’s own AI might find its way into the hands of competitors.

It also seems that the key at this stage is for a Board to identify “use cases” in which to experiment with an AI solution.  Little guidance was given as to how a Board is best able to identify its own optimal use cases.

While no one on the panel stated this, it seemed clear to me that a board member without specific application expertise would be at a loss to have an inkling as to initial direction.  This observation leads to the use of expert consultants, or larger enterprises hiring a group of AI experts; it was not clear where a group of AI experts might be found, given the lack of industry experience noted above indicating a good direction.  Indeed, the panel itself seemed to possess substantial insight into possible approaches, but the panel was culled from elite experts not likely to be found on the average (albeit highly competent) Board.

It should be noted that in the past couple of weeks Economist magazine also noted, in a major cover story, that actual business use of AI in almost all significant use  cases was quite unusual; there seemed in the coverage some ROI hesitancy in the level of investment capital today going into the AI side of the economy.

While I have generally not been a fan of adding a Board member for each vertical function, favoring general board experience or domain experience in the enterprise business space, I confess to having concluded that AI at this point may well be a spot for one AI-expert director given the risk and the size of the spend involved.   (Until now, I was of the view that skill-specialized directors beyond the specific business involved were highly desirable only for financial control/accounting functions in certain kinds of enterprises.)

One thing was quite clear: all on the NACD panel were quite sure that at some point AI would be integral in a major way in all business, with continuing  huge investments coming into the AI space.  In AI, the best is yet to come– with the caveat the worst to come may be the next step.

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Changes to Delaware Corporate Law Protect VCs, Fund Investors

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A new Delaware law effective August 1 but applying retrospectively, overturning a contrary court decision, makes it clear that when investors in a Delaware-formed company obtain contractual rights which limit what that corporation  can do, those “negative covenants” are in fact enforceable.

Professional investors typically want some sort of control over how a company will be operated, before they make a significant investment.  The practice has grown to include a set of so-called negative covenants, which specifically would prevent a board from taking actions without agreement of certain shareholders, or a certain percentage of shareholders, or of a director representing a particular class of shareholders.  The earlier, now-over-ruled Delaware court decision struck down an  agreement vesting stockholders with a veto right over taking certain corporate actions, since the Delaware corporate law specified that the business of a corporation was subject to the control of the directors unless set forth in the Certificate of Incorporation (charter).  Such agreements also may contain not a veto right but rather compel future action without board vote provided a certain trigger event occurs.

While there can be a wide variety of negative covenants on virtually any subject, and often reflects the maturity of the company involved, generally the list of prohibited transactions includes charter amendments affecting the voting or financial rights of shares, the incurrence of debt or guarantees, transactions that suggest self-dealing by management, changes in business conducted, and changes in key personnel.

This site, in a  July 3 post, noted the pendency of the above change in the Delaware corporation law, as it awaited signature by the Governor (now obtained).

Other, technical changes affecting M&A and investment practice also have been adopted, for which I respectfully refer you to the July 18 alert at https://duanemorris.com/alerts/2024

 

College Athletes Can Be Paid

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That college athletes can be paid has become common knowledge and widely reported.  What has escaped careful analysis is the May settlement by the NCAA of three antitrust law suits claiming damages for prior failure to compensate college athletes.

First, the lawsuit did not relate to nonpayment for playing. It related to: compensating college athletes when their name, image and likeness (in the trade, “NIL”) was used for commercial gain prior to 2021 (when NCAA first granted permission for such payments); and, income paid to NCAA for deals with TV markets (which practice also prevented athletes from profiting on their true market value).

I omit here the likely reasoning behind NCAA’s decision to pay about $2.8 Billion (yes, BILLION) to settle cases brought under an 1890 Federal statute passed to break the 19th century Trusts over a century ago, a time when the NCAA and the idea that money could be made from college athletic contests was many decades in the future.

I note that the Federal court has yet to agree that such payment will be adequate in amount, nor as to the other terms of the settlement.

Payment will be effected by the NCAA in large measure, from its cash reserves and insurance payments (did you think the NCAA was a charitable institution?), while major schools each may be hit with as much as $30Million per year for the next ten years, which may well distort present athletic programs (and reduce direct scholarships or rosters sizes of major programs).  Feel free to think about your donation to your alma mater if it has a big-time athletic program, although it may be that your school will actually need your donation even more in the future….

It is unclear how proceeds will be split among athletes historically, how current payments will be made for future events, the split between male and female athletic programs– so no doubt more (confusing) developments will appear.  Newspaper reportage could be confused; not sure sports writers are best suited for this kind of stuff.  Forgive this shameless plug for my law firm, which  follows this matter closely, and which has a fuller report on the foregoing available now; http://www.duanemorris.com and go to “alerts.”

Major Change in Delaware Law?

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Delaware law is known to be friendly to management and to boards of directors.  Company founders and investors long have favored Delaware corporate law as being best for establishing good governance, predictability of result, and freedom from strike suits by disgruntled minorities.  Recent criticism of some seemingly contrary Delaware court cases, criticism by Elon Musk (whose ox was gored by a recent decision striking down his multi-billion dollar employment agreement) and the movement of some corporations out of Delaware, has for the first time created concern that pro-management corporate governance is under attack.

A couple of weeks ago Delaware’s legislature adopted a new statute, which the Governor has indicated he will sign, that further alleviates this concern that Delaware no longer will enforce board control with rigor.  Effective August 1, Delaware will make expressly legal a contract between investors and a company which will contractually compel boards of directors to undertake or refrain from specified corporate actions.  Last February, one such agreement was struck down by one Delaware Chancery Court member, although such contracts are not unusual as between corporations and major shareholders (typically PE or VC funds).  The new statute would make such typical agreements expressly permissible.

Frankly, the outcry against this new law, alleging that it restricts board action that should be absolute, while perhaps “correct’ in some abstract sense, seems foolish.  That horse ran out of the barn long ago.

First, general use of such agreements has long been an important element of capital formation and is reflective of established market logic, none of which previously  has in fact been judged to limit board primacy.  The new law merely reinstitutes the market status quo.  Second, it is clearly proper to place restrictions on what a corporation can do if contained within the charter (Certificate of Incorporation) of a Delaware corporation, and such charter provisions by their nature restrict  board action; thus, a contract is simply a different route to a fundamentally acceptable end.

The passage of this new statute is not bad news for Delaware governance, it is just a correction of a judicial blip.

 

 

Not Reporting the Law

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You may have noticed a paucity of recent posts of late, even though legal issues have dominated much of the news.  The Supreme Court has a near-monopoly on legal developments, but of course there are the legal battles of Donald Trump, the Boston drama of a weeks-long televised criminal trial, and numerous court determinations about abortion, curtailment of the powers of various Federal agencies such as the SEC and FTC, and restrictions on the President forgiving student debt, just to mention a few.

My view has been that  major themes are well-covered in the general or business press, and do not need my repetitive posts as an echo chamber; those people with an interest in such things will find sufficient information to satisfy their needs.  I try to post about important things that might not get either full coverage elsewhere or with respect to which the coverage is not crystal-clear as to major take-aways.

I did want to comment generally, however, about what is a clearly emerging legal trend in American case law, and its overall impact.  This impact is sometimes seen as a swing towards  conservative viewpoints, or as a swing to traditional law, or as a political or socio-political movement, and each such analysis bears consideration.  But from a technocratic standpoint, the trend is best seen, I suggest, as the dismantling of the liberal administrative state.

On the operational level, as relates to the conduct of American business, this is a process of substantial deregulation.  Until recently, government regulation was seen either as pro-active for the protection of people or, alternatively, as meddling with individual freedoms, with the pro-active viewpoint often reflected in growing governmental policy both at the federal and state levels.  However, many courts recently are consistently cutting back on the exercise of power by  governments to impede business practices.  The activism of the current federal administration is very robust, but against this back-drop the decisions of many courts stand highlighted in contrast.

While the upcoming election  season will define which approach will control the White House, the Congress and state governments, the composition of the courts (appointed at all levels and with an  increased  anti-regulatory streak in many cases) will remain relatively constant (most judges don’t get re-elected every few years), and those courts will continue to exercise power towards less governmental regulation.

Each side of the argument proceeds from a desire to provide the greatest good for the population at large.  But the manner of establishing that “greatest good” is radically different: government protection vs individual freedom to decide for oneself. The popular and business press is highly attuned to reporting this ongoing battle, and you will be spared much regurgitation of such matters   in this blog site.  But one last thought: you will see much impassioned rhetoric on both sides, a growing number of court cases trying  to negative governmental activism, and a set of business opportunities  which may well alter our understanding of  the social compact.

Stay tuned….

ESG vs WOKE: Politics vs Corporate Practice

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ESG is the buzz-acronym for investing based on equity, sustainability and governance practices of a company.  WOKE is the buzz-acronym for a political movement reflecting one side of a cultural war.  Anti-WOKE legislation of varied sorts has been adopted in nineteen States, and is heavily lobbied against by vocal groups including climate change deniers, fossil fuel groups and the Republican governments of several important and growing States (think Florida and Texas for starters).  ESG has become a toxic phrase in some parts of the marketplace.

What does all these mean for the conduct of corporations?  The Spring issue of Directorship, the official publication of the National Association of Corporate Directors, attempts to get underneath the rhetoric on both sides to measure the actual impact of the WOKE movement on the ESG agendas adopted by a large majority of America’s biggest corporations.

The conclusions need a caveat.  The NACD article relies on anecdotal input from admittedly senior people, but the interviewees are few in number, and the survey jointly conducted by NACD and Wall Street Pro was pretty limited in content.

The conclusions generally are: corporations are committed to ESG values; 75% of S&P 500 companies factor ESG into CEO compensation; companies may scale back the rhetoric and stop using ESG as a catch-all, but remain committed to its values and for the most part will not alter substance; over time, companies likely  will  break apart the elements of ESG  and start pursuing and reporting them as separate issues to avoid political pressure.

The corporate mind-set is reported as of the view that ESG attentiveness is related to better economic performance.  By adhering to this view, corporations can end-run most of the anti-WOKE legislation, which tries to tie permitted corporate policy to economic factors only.  People may stop trumpeting ESG efforts (Blackrock itself, an earlier investor supporter, is reputed to have already done so) but they will continue to pursue them.

Finally, seems to me that adherence to the substance of ESG as related to profit, putting aside positive social impact for purposes of this narrow analysis, needs to be founded on actual economic success for the bottom line which justifies ESG for the entity and its investors.  I have not seen recently any robust studies of the correlation of ESG focus to corporate profits, but a year or two ago I did see (and post about) the majority (albeit not 100%) view that such correlation existed.  It does seem, at this point, that ESG is here to stay as an operational element if not a PR focus; the substantial infrastructure supporting ESG in  many corporations will remain in place.  No doubt some smaller number of corporations will declare themselves ESG-free, but not with the present assent of the world of corporate advisors (including NACD).

[Disclosure: I am on the Emeritus Board of NACD-New England.]