The Law and Other Anomalies

The other day at UMass Boston, MassMEDIC (the trade organization of Massachusetts medical device companies) held its 16^th Annual Conference.  It was well attended, and my prior blog post reported Covidien CEO Jose Almeida’s comments for the advancement of the United States medical device industry.

Another speaker, Yair Holtzman, is a director at WTP Advisers of White Plains, New York, where he focuses on business advisory services to the life science industry.  A CPA and MBA, Yair ambitiously traced the current and future states of R&D in device development.  Let me take a stab at summarizing the high points.

In the past, the United States has been dominant in the medical device market through a combination of its head start with a large number people working within the field, deep expertise, entrepreneurial investment, a robust middle class that drove medical device advances, and a group of patients who could afford to be price-insensitive when it came to buying medical services.  A large number of hospitals, and the leadership of the FDA in device safety, didn’t hurt.

International R&D, as many have noted, is greatly increasing.  Reimbursement has become an issue in the United States, creating concern for ROI that can be derived from R&D efforts.  Added pressure was placed on U.S. ROI for many other reasons, as outlined by Covidien’s Almeida (see the May 1^st post).  China and India have growing middle classes and growing expertise; they may well develop medical device products and not even bother to have them cleared in the United States.  Approval of devices in Europe takes half the time of FDA review; Brazil, India and China are becoming very entrepreneurial and are attracting substantial investment.  Germany and Israel have substantial medical device expertise.

For these reasons the United States, historically a leader in the production and consumption of medical device advances, may find itself left behind the rest of the world.

Joining the cacophony in criticizing the Affordable Care Act, which in 2013 will assess a 2.3% excise on the gross income of medical device companies regardless of whether or not a profit has been made, Holtzman anticipated that the effect would be “devastating” and urged that the excise be repealed.  Also in order is a reinstatement of the R&D tax credit, which expired at the end of 2011.

What else must be done in the future?  First, greater speed and predictability must become part of the FDA approval process.  Second, a continuation in the trend to reduce R&D costs through joint ventures and through “farming out” R&D functions must continue.  Third, the industry must recognize certain trends in healthcare: mobile health, personalized medicine, economic efficiency demanded by patients and their reimbursers, and the need for disruptive technologies which will create a paradigm shift in costs and outcomes.  Analytics to demonstrate both health and financial outcomes must become part of device development.

Holtzman observed a trend in the United States to develop incremental products, as opposed to developing disruptive technologies through R&D expenditure, with the “disruptive” perhaps more likely to be generated offshore.  This development is not beneficial to U.S. industry, to say the least.

Holtzman also noted that many VCs are establishing offshore presences, including in Israel and Singapore.  Hopefully some of his recommended changes (at the FDA and in tax policy) will again make domestic United States venture investment in medical device companies attractive, but Holtzman added that his firm has success in identifying grants, state credits and local incentives, as well as joint venturing approaches, in order to drive down R&D costs, speed development and thereby improve ROI.

Interestingly, Holtzman’s remarks also reflected an anomaly which was apparent upon analysis of several recent life science conferences (not just medical devices).  On the one hand, the FDA is praised as setting the standard for review of medical technology which is emulated around the world, and which is one basis for historical American primacy in these markets; on the other hand, the FDA now also is criticized as one of the primary causes of the United States slipping behind the rest of the world.

Jeffrey Toobin’s lead article in the April 9 New Yorker is a clear and convincing argument for the liberal viewpoint on the Supreme Court’s role in evaluating Romneycare – whoops, I mean Obamacare.  As befits a graduate of THE Law School, Toobin applies the power of court precedent to the debate, finds that the law should be sustained, and excoriates Court conservatives for replacing judicial process with personal bias and a lack or respect for the elected representatives of the people.

We should pause to note that Toobin, for about twenty years the legal guru at New Yorker and more recently at CNN, writes with convincing clarity and hits from the left side of the plate.  Neither of these facts make him wrong —  but neither guarantees that he is correct, either.

Toobin notes extrinsic pressures on the Court deliberations: politics.  It is hard to know the degree to which the Justices will internalize political realities in their judgments.  His analogy to the Roosevelt Supreme Court reversing in 1937 its conservative bias (most importantly expressed by the Court striking down the NRA in the 1935 “sick chicken case”), thereby reflecting an appropriate appreciation for the presumed validity of Congressional Acts passed by elected officials, seems misguided; likely, fear of Roosevelt packing the Court was a greater driver of the Supreme Court changing direction.

What is not discussed by Toobin is the role of social values underlying the debate.  The article’s suggestion that the conservatives on the Court are applying not only unprecedented standards but also their own sense of our Social Compact to the detriment of “THE LAW,” is implicit and not stated but, I suspect, can be found one layer deeper in the Toobin onion.

For example, his moral outrage over this same Court declaring corporations to be people in Citizens United is echoed in Toobin’s clear moral contempt for questions directed from conservative Justices to the Solicitor General that suggest sympathy for the insurance companies which are subject to Romney/Obamacare.

Every branch of our government reflects the sense of the electorate (that part which votes) as to the current nature of our Social Compact.  We, or some of us, elect two branches and one branch names the third; to say that Justices are not elected is true only in the technical sense.  And to suggest as does Toobin that conservative social thinking is polluting the judgment of conservative Justices is just another way of saying that people are messing with the liberal social thinking that for several decades of the 20^th Century in fact dominated the content of our legal precedent.  It is not that improper social thoughts are taking over our Courts; rather, it is that social thoughts that liberals do not share are taking over our Courts.

Enter another way to think about the debate; it is a way that is not Constitutionally premised, but rather is reflective of what underlies our governance and what is (imperfectly) reflected in our voting.  What would Jeremy Bentham and John Stewart Mill, the utilitarian philosophers, do if they were on the Court?

Likely they would be blind to the Constitutional arguments although that would be a shame; the primacy of the rule of precedential law is pretty important and not often shared outside the legal profession.  I am sure they would ignore the pressure of the election.  But they would, as all people must, bring their understanding of our society’s “Deal” with itself to the deliberations.  And their understanding is neither conservative nor liberal, it is utilitarian.

Now there are various schools of utilitarianism and I am going to do disservice to all of them (and reveal no doubt a lack of deep knowledge) by reducing the whole lot to a simple proposition: best governmental decisions provide the greatest good and happiness to the greatest number.  Put another way – my way  —  we should look to weight benefit and burden.  That mathematics multiples the number of benefited by the amount of benefit, and balances it against the number of burdened multiplied by the amount of burden.  The best answer is told by the way in which the balance tips.

So who is benefited by Romney/Obamacare?  Arguably most people.  Those without current coverage?  Yes.  Those with existing coverage?  Likely so; I know that when I pay my horrendous premiums I am already paying for many who are not covered; it is implicit in the costs of the care I receive that I am covering the uninsured who by and large are being treated anyway at hospitals and by doctors that I, and others like me, do already pay for. The insurance companies?  As regulated entities, which particularly under Romney/Obamacare cannot be allowed to fail, they will get funded by premiums and governments.

Who is burdened?  Everyone who pays taxes certainly.  But query if they are paying in the long run more than they are paying now by reason of presently paying for their own care and (in an inefficient way) the care of the “uninsured.”  Individuals whose freedom is infringed by being forced to buy a product they do not want?  I find that a facially logical proposition that plays to our legitimate sense of freedom but is unconvincing.  We already are forced to “buy” an infinity of things that we may not want.  How about certain military adventures?  Farm subsidies? Pork barrel? Pick your pet peeve that your tax dollars go to.  Would Bentham much care about the argument that the government could fund universal health care by tax but cannot do so by Romney/Obamacare, when the functional result and economic costs seem roughly the same?

Our “freedoms” are impinged mightily every single day by government, and that is a wholly separate and legitimate discussion, but is not significantly addressed by saying that Romney/Obamacare should be stricken because government is forcing us to buy a commercial product.

None of the above of course reflects an independent moral judgment, which is the degree to which our society should afford medical care to people not receiving it.  There are two flavors of what is now happening in medical care: many receive it free and we are paying for it anyway and inefficiently to boot; or, some do not receive it at all, which ought to present a moral conundrum to many.   (Indeed, some people from whom I hear the argument against the law apply the moral standard privately in their charity but do not see the government as the mechanism to bring moral judgment to medical care, although our government does and must bring moral judgment to almost anything it does do, and by definition).

We will have our answers by the end of June when the Court concludes its current session and must report out its decisions on all cases it has heard.  The Court spent three days hearing arguments that I submit will not drive the decision.  The decision will be decided by preconceived notions of the Social Compact on the part of eight Justices, and some unknowable tortured process undertaken by Justice Kennedy, who so often is the “swingman” between the entrenched personal philosophies of the others.

We as observers are so politicized in the way we see things that we may miss the real battle here, but that battle also may not be express in what is expected to be multiple written decisions of the Court, as it is not express in Toobin’s New Yorker article.

And the Justices will decide,  based on whatever has happened to each of them beforehand, and which brought them to the legal, intellectual and emotional place which each now occupies.  Perhaps, as in Bob Dylan’s words, “A man hears what he wants to hear and disregards the rest.”

Jeffrey Toobin’s lead article in the April 9 New Yorker is a clear and convincing argument for the liberal viewpoint on the Supreme Court’s role in evaluating Romneycare – whoops, I mean Obamacare.  As befits a graduate of THE Law School, Toobin applies the power of court precedent to the debate, finds that the law should be sustained, and excoriates Court conservatives for replacing judicial process with personal bias and a lack or respect for the elected representatives of the people.

We should pause to note that Toobin, for about twenty years the legal guru at New Yorker and more recently at CNN, writes with convincing clarity and hits from the left side of the plate.  Neither of these facts make him wrong —  but neither guarantees that he is correct, either.

Toobin notes extrinsic pressures on the Court deliberations: politics.  It is hard to know the degree to which the Justices will internalize political realities in their judgments.  His analogy to the Roosevelt Supreme Court reversing in 1937 its conservative bias (most importantly expressed by the Court striking down the NRA in the 1935 “sick chicken case”), thereby reflecting an appropriate appreciation for the presumed validity of Congressional Acts passed by elected officials, seems misguided; likely, fear of Roosevelt packing the Court was a greater driver of the Supreme Court changing direction.

What is not discussed by Toobin is the role of social values underlying the debate.  The article’s suggestion that the conservatives on the Court are applying not only unprecedented standards but also their own sense of our Social Compact to the detriment of “THE LAW,” is implicit and not stated but, I suspect, can be found one layer deeper in the Toobin onion.

For example, his moral outrage over this same Court declaring corporations to be people in Citizens United is echoed in Toobin’s clear moral contempt for questions directed from conservative Justices to the Solicitor General that suggest sympathy for the insurance companies which are subject to Romney/Obamacare.

Every branch of our government reflects the sense of the electorate (that part which votes) as to the current nature of our Social Compact.  We, or some of us, elect two branches and one branch names the third; to say that Justices are not elected is true only in the technical sense.  And to suggest as does Toobin that conservative social thinking is polluting the judgment of conservative Justices is just another way of saying that people are messing with the liberal social thinking that for several decades of the 20^th Century in fact dominated the content of our legal precedent.  It is not that improper social thoughts are taking over our Courts; rather, it is that social thoughts that liberals do not share are taking over our Courts.

Enter another way to think about the debate; it is a way that is not Constitutionally premised, but rather is reflective of what underlies our governance and what is (imperfectly) reflected in our voting.  What would Jeremy Bentham and John Stewart Mill, the utilitarian philosophers, do if they were on the Court?

Likely they would be blind to the Constitutional arguments although that would be a shame; the primacy of the rule of precedential law is pretty important and not often shared outside the legal profession.  I am sure they would ignore the pressure of the election.  But they would, as all people must, bring their understanding of our society’s “Deal” with itself to the deliberations.  And their understanding is neither conservative nor liberal, it is utilitarian.

Now there are various schools of utilitarianism and I am going to do disservice to all of them (and reveal no doubt a lack of deep knowledge) by reducing the whole lot to a simple proposition: best governmental decisions provide the greatest good and happiness to the greatest number.  Put another way – my way  —  we should look to weight benefit and burden.  That mathematics multiples the number of benefited by the amount of benefit, and balances it against the number of burdened multiplied by the amount of burden.  The best answer is told by the way in which the balance tips.

So who is benefited by Romney/Obamacare?  Arguably most people.  Those without current coverage?  Yes.  Those with existing coverage?  Likely so; I know that when I pay my horrendous premiums I am already paying for many who are not covered; it is implicit in the costs of the care I receive that I am covering the uninsured who by and large are being treated anyway at hospitals and by doctors that I, and others like me, do already pay for. The insurance companies?  As regulated entities, which particularly under Romney/Obamacare cannot be allowed to fail, they will get funded by premiums and governments.

Who is burdened?  Everyone who pays taxes certainly.  But query if they are paying in the long run more than they are paying now by reason of presently paying for their own care and (in an inefficient way) the care of the “uninsured.”  Individuals whose freedom is infringed by being forced to buy a product they do not want?  I find that a facially logical proposition that plays to our legitimate sense of freedom but is unconvincing.  We already are forced to “buy” an infinity of things that we may not want.  How about certain military adventures?  Farm subsidies? Pork barrel? Pick your pet peeve that your tax dollars go to.  Would Bentham much care about the argument that the government could fund universal health care by tax but cannot do so by Romney/Obamacare, when the functional result and economic costs seem roughly the same?

Our “freedoms” are impinged mightily every single day by government, and that is a wholly separate and legitimate discussion, but is not significantly addressed by saying that Romney/Obamacare should be stricken because government is forcing us to buy a commercial product.

None of the above of course reflects an independent moral judgment, which is the degree to which our society should afford medical care to people not receiving it.  There are two flavors of what is now happening in medical care: many receive it free and we are paying for it anyway and inefficiently to boot; or, some do not receive it at all, which ought to present a moral conundrum to many.   (Indeed, some people from whom I hear the argument against the law apply the moral standard privately in their charity but do not see the government as the mechanism to bring moral judgment to medical care, although our government does and must bring moral judgment to almost anything it does do, and by definition).

We will have our answers by the end of June when the Court concludes its current session and must report out its decisions on all cases it has heard.  The Court spent three days hearing arguments that I submit will not drive the decision.  The decision will be decided by preconceived notions of the Social Compact on the part of eight Justices, and some unknowable tortured process undertaken by Justice Kennedy, who so often is the “swingman” between the entrenched personal philosophies of the others.

We as observers are so politicized in the way we see things that we may miss the real battle here, but that battle also may not be express in what is expected to be multiple written decisions of the Court, as it is not express in Toobin’s New Yorker article.

And the Justices will decide,  based on whatever has happened to each of them beforehand, and which brought them to the legal, intellectual and emotional place which each now occupies.  Perhaps, as in Bob Dylan’s words, “A man hears what he wants to hear and disregards the rest.”

Ernie Godshalk is a professional director currently sitting on two public boards; a director of the National Association of Corporate Directors/New England, Ernie is well known to the local director community as a thoughtful commentator on board service.

His current view of the world economy is that it is recovering slowly but subject to substantial risks, and heading the list are the precarious nature of the Euro (I parenthetically note today’s report of further weakening in the Euro countries’ employment) and the international risks created by Iran and perhaps Pakistan.  In light of this view, I asked how a board should go about enterprise risk management.

Godshalk’s view is that, while his boards discuss risk virtually every meeting and care is given to identifying who is responsible for watching which risks, there are indeed some existential exposures which cannot be controlled by the company and consequently cannot really be monitored.

Ernie expressed concern as to the impact of any Euro failure on the highly leveraged Deutsche Bank, and rejected the view that a Euro failure in the long run would not represent a substantial risk for United States businesses.  Certainly, identifying non-European markets for the purchase of parts or the sale of goods, and the shortening of lead times, can mediate the Euro risk to some extent, but substantial risk will remain given the international nature of United States business.

What are the problems most plaguing our economy, aside from major geopolitical risks?  We discussed excessive US regulation; we further debated whether over-regulation was an annoyance and a marginal expense but not an ultimate depressor of United States business.  Godshalk noted two factors in the American environment that he thought were significant: first, our high tax rate and, second, our immigration policy.

Noting the internationalization of business in general, even domestic United States companies have substantial opportunity to relocate operations and profits overseas.  Higher United States tax rates drive that flight abroad.

Immigration is an oft-cited problem, as it has become difficult to obtain visa approval for persons with requisite skills to drive technology businesses.  Even more anomalously, I suggested that we are now bringing foreign students to the United States and transferring our own sophisticated technology to them and, then, refusing to allow them to stay; it is the forced exportation of our technological advantage.

Asked about the biggest problems in serving as a director these days, Godshalk noted two: first, failure of boards properly to address CEO succession; and, second, the inordinate time which boards must apply to risk assessment, say-on-pay, proxy solicitation and the like, which diverts the board from its strategic mission of “adding value” and making the company business better.

Finally, I asked Ernie about the current state of the M&A market.  From a strategic acquisition standpoint, he believes that good deals are available.  The strategic advantage should be in either technology or in sales (for example, efficiency in marketing multiple lines).  In response to the suggestion that an improving M&A market has caused an increase in EBITDA multiples, particularly for strategic acquirors, Ernie noted that there are many companies that are for sale, there is pent up sales demand, and many enterprises with VC and PE money remain well “behind plan” by reason of the recent business recession, and consequently are favorably priced.

The issue of over-regulation of United States business is and will remain a significant discussion.  Two days before our meeting, the Congress passed and sent to the President the JOBS Act, which rolls back some of the Dodd-Frank regulatory requirements at least for businesses that are now going public with sales less than $1,000,000,000 (which is not all of them, but surely most of them).  Now that the Federal Administration identifies relationship between regulation and employment, it is possible that bi-partisan efforts (so hard to achieve in so many areas) will nonetheless continue to address these issues of over-regulation which Godshalk believes drive companies abroad and waste director time in boardrooms.

This morning’s mail has upset a part of my world view.

Universities long have been accused of being bastions of populist, liberal thought; Northeastern elite universities (along with anomalous Berkeley, the Harvard of the West) have borne the brunt of this accusation.

Such was not my experience at Harvard Law School; during my attendance (decades ago) it was the bastion of pro-corporate thinking.  Corporations should be minimally regulated so as to return greatest profit to their sole relevant constituency: the shareholders.

My 7:44 AM email today from The Harvard Law School Shareholder Rights Project reports that that group, “a clinical program through which Harvard Law School faculty, staff and students assist public pension funds and charitable organizations to improve corporate governance at publicly traded companies in which they are shareowners,” has been working all year to force public companies to de-stagger their boards.

They have submitted proposals to over 80 of the S&P 500, and 42 (one third of the S&P 500 with staggered boards) have agreed to move to annual elections of the entire board.  The list includes Alcoa, BlackRock, Cigna, Lilly, McDonald’s and PPG.

Several aspects are fascinating.  Leave it to Harvard to apply some of its student outrage in the support of retirement funds who have invested in public companies; not exactly the poor huddled masses being dragged upwards by the power of the law.  Leave it to Harvard to take the training ground of the conservative corporate advisors and turn it towards the “democratization” of corporate governance.  Leave it to Harvard to undertake the remaking of concepts of corporate governance in a way that empowers shareholders whose interests may be short-term and inconsistent with long-term measured corporate growth.

It is not clear where they will turn next, but this kind of success is not going to do anything except further inspire Professor Bebchuck and his hearty band.  The shopping list of corporate democracy demands includes broad proxy access, greater ratchet on comp,  independent board chairs, and independent board majorities.

While no doubt entrenched boards beholden to management sometimes in the past led to failure to respond to favorable takeover bids and to over-compensation of top executives, the causes for these lapses are many and complex and cannot be made to disappear by granting greater power to shareholders.  The small shareholder is and will remain without power.  The larger shareholders have, and are legally entitled to, their own agendas; those agendas may be short term and short sighted and not consistent with healthy corporate growth or innovation.

Two lessons emerge: first, this initiative will ultimate fuel the M&A market; second, directors had better start listening more closely to Professor Bebchuck, whose message and flat presentation have not exactly made him the darling of the corporate speakers’ circuit around Boston.  He is single-handedly remaking corporate governance in America and he is doing it under many radar screens that ought to be picking up the incoming blips.