The Law and Other Anomalies

 The ongoing saga at Market Basket focuses clearly the following question: what is the appropriate role of an American corporation in the modern age?

While the shareholders battle and squabble for control and power, various constituencies affected significantly by Market Basket as an entity are in turmoil and suffering: employees, suppliers and customers.

To what degree should the Board of Directors of Market Basket care about the well-being of these constituencies? Clearly Directors want to make decisions which do not harm the bottom line, but that focus might lead to different results from saying: “we are all one big family, what is the best solution for everybody, giving shareholders and customers and employees and suppliers and creditors an equal weight?”

This first of three blogs will touch briefly on the history of American corporations. A second blog will discuss the current mantra of maximizing “shareholder value.” A third blog will discuss a new form of entity, the so-called “public-benefit corporation.”

Corporations as an idea began as a grant by a government of a charter to a company which was charged with an obligation of doing public good. Original corporate charters were given to railroads, canal builders and the like.

In the 1970s and 1980s, there was a shift in thinking about the role of corporations. Corporations were no longer viewed as stable entities providing long term income and retirement for employees, and providing a fundamental benefit to the cities and societies where they were located. In the face of heightening economic competition and in the fear that American corporations would be left by the wayside, a new view of corporations as purely economic entities found its way from academia into corporate America. The corporation, it was so asserted, was designed only to make money for the shareholders who undertook risk. You could measure the value of a corporation, and how well it was run, by a bottom line which was easily quantifiable. CEOs were to run companies for profit. Boards were to make decisions, and select CEOs, with the same goal in mind.

The price of your share of stock became the bottom line mantra. Never mind that thereafter some academicians pointed out that actual increases in shareholder value were higher in the period prior to this new focus on economic performance.

Today, it is common wisdom that boards and CEOs are to run companies for the benefit of their shareholders. Failure to do so gets you sued in shareholder derivative actions. To the extent that corporations now undertake programs of “social responsibility” these programs, as admirable as the may be, are often seen primarily as public relations efforts. One commentator describes this development (not wholly properly) as merely a “moral defense” of capitalism.

My next blog post will discuss certain structural elements of our legal and regulatory system which support the concept that corporations cannot be understood separate and apart from their mission to maximize shareholder return.

Just a few thoughts on what the recent couple of months has brought us on the lawyering front:

First, the focus on cyber security has, if anything, intensified.  Between the news articles recounting hacks of businesses and governments and the proliferation of programs designed to educate executives and directors, it is hard to avoid getting caught up in the conversation.  A summary of appropriate board responses can be found in my June article in New England In House, which can be linked through my CV at www.DuaneMorris.com. or accessed direct at www.honiglawblog.com.    There is so much hysteria out there on the subject and so little specific “how to” information that I dared add my voice to the crowd by listing specific director steps that strike me as useful guides.

Next, the M&A surveys that now come to counsel regularly from various sources analyze not only M&A deal content but also deal pricing.  Larger companies continue to enjoy an advantage in multipes just based on size, but multiples over-all seem to be moving upwards in the middle market.  The market seems to me to be continually very choosy at least for the more traditional companies; the big stretches in price seem to be strategic tech or med-tech deals.  I am not sure that multiples for traditional mid-market companies have changed all that much. 

Banks continue to be an enigma.  In Washington, the debate continues about whether the restrictions on captial, and the Dodd-Frank reforms, are or are not valuable.   Few are shocked to see that debate break on party lines.  Meanwhile the huge settlements with banks based on any number of sins continues unabated:  money laundering for terrorists, facilitating trading with banned countries, assisting in avoidance of US taxes, lying to investors about the value of syndicated assets, inducing consumers to incur real estate debt they cannot repay, incurring trading risks for proprietary positions which are unmonitored and the results are not disclosed.  If an individual had a rap sheet like that, we would throw away the key.  No one goes to jail.   Bank stocks are not decimated.  Financial conservatives decry over-regulation nonetheless. Half the reports involve numbers beginning with a “B.”  That is a lot of money.  (Sen. Everett Dirkson famously once allowed that you take “a billion here, a billion there, and pretty soon you’re talking real money.”)

I expect to return to regular blogging in August, on return from Europe.  I look forward then to the SEC making up its mind about finally releasing crowd-funding regulations (they have been sitting on their October, 2013 proposals, and the commentary on same, for almost ten months already, they are over a year beyond their statuory deadline to act, contained in the 2012 Jobs Act, and even the States are beginning to adopt State-wide crowd funding regimes).  I look forward to Massachusetts deciding whether or not to ban non-competition agreements by statute, an issue that has raised the ire of some of the largest tech companies which (in their early days) attacked non-comps as a drag on innovation and now see non-comps as ensuring their own profitable status quo (as I write this, a weak Senate version is I believe in conference as the Session winds down). I look forward to learning that the Boston Globe was right in predicting that the revitalized Red Sox will rally and play baseball in October.

Well, it is summer; on that last point I can dream, can’t I?

At the National Association of Corporate Directors-New England breakfast on Tuesday, one guest had the temerity to suggest to the Director of SEC’s Boston Office, and to Secretary of the Commonwealth Bill Galvin (who controls the State’s Securities Division), that the government was over-reaching in its regulation of financial institutions. Much of the corporate crowd mumbled in agreement; not surprisingly, the regulators did not.

Paul Levenson has been head of the SEC Boston office since October. His list of hot regulatory topics: large-scale pyramid schemes (something not normally within the SEC bailiwick); constant pressure on public issuers to hit earning targets, resulting in liberal accounting; migration of broker/dealers into registered investment advisory functions, giving people trained in sales a fiduciary obligation which they may not be attuned to filling.

The latter point is interesting; much litigation by regulators against broker/dealers is aimed at pointing out that they already are fulfilling a fiduciary agency role with respect to customers.

Secretary Galvin focused on consumer protection; most of his cases bubble up from citizen complaints. His key areas are pyramid schemes, insider trading, and an anticipated rush of claims based upon recent SEC liberalization of the rules for private placements (new SEC Rule 506(c) permits public advertising of formerly “private” security sales to sophisticated purchasers).

There were a couple of takeaways for boards of directors:

• Cyber security is not a matter of “whether” your company will be hacked, but what your response mechanisms are. The importance of a board making sure that cyber security systems are in place varies with the company; if you are selling bumpers for automobiles you are less sensitive than if you possess consumer charge card data.
• Are banks too big and complex to actually regulate (a question from the audience based upon the billons of dollars banks already have paid in settling SEC claims)? Levenson was unremitting in this regard. For directors, you must understand that security law breaches derive from actions of your employees. Take a look at your corporate organizational chart. Can you obtain a confident feeling that high ethical standards can be policed through the organization as currently structured? Is your organizational chart so complex and over-lapping that there is no way you can conceive of a workable compliance program?

Finally the SEC, since the 2010 Dodd-Frank Act, has been relying more heavily on adjudicating securities law violations through administrative law judges appointed by the SEC itself. This avoids the troublesome task of actually going to court and having a trial where you have to convince the jury of someone else’s guilt. Levenson’s explanation: going to a jury is a waste of time and money, these are sophisticated issues which sophisticated administrative law judges can resolve more efficaciously. This trend is therefore liable to continue. Trial by jury does not seem to be high on the SEC hit parade.

All directors, whether of non-profits or for-profits, face the same problem: how to focus on the essence of board function, strategy, while besieged with the pressures of an increasingly complex world?

Some interesting perspectives surfaced at the National Association of Corporate Directors-New England Chapter meeting at the Newton Marriott yesterday.

Boards should be more proactive in identifying the information they need and the topics that should be discussed. Management must be selective, so as to prevent the sending of too much non-critical information.

Management no longer is setting board agendas. The focus should be on discussion, not “death by power point.” The discussion should be strategic, and inherent in that discussion will be a measurement of enterprise risk.

What kind of boards will we have in the future? There is growing awareness that diversity of experience is essential. As more and more companies restrict their CEOs from serving on outside boards (or limit service to a single board), more board members will be drawn from the ranks of the retired; this in turn creates an upward creep in the average age of directors and a concomitant increase in the mandatory board retirement age.

U.S. boards are slow to move to the European approach of having different stake holders represented on the board: labor, consumers, community. It was not clear to the panel whether this trend would be manifested in the United States.

More and more meetings will be handled electronically, particularly committee meetings which are increasingly important and take a lot of time. It’s almost impossible to do proper service on an active board and still hold a “day job.”

What major changes will we see on boards by the year 2018? The panel did not have an answer. Everyone agreed that maintaining “board culture,” free ability to speak with candor, will remain important. And what about participation by the digital generation? Some companies are establishing advisory boards to deal with the digital revolution. To my view, this is a mistake. Viewing digital issues as something around which a fence can be built is too narrow an approach. Digital data, digital reputation, digital marketing, digital cyber risk, everything in the future is going to be digital; the grayer heads I believe should swallow hard and blend in members of the digital generation, because their input is needed within the board itself – particularly if, as noted, the average age of board members is creeping upwards for other reasons.