April 22, 2019

Ep. 31: "Executive Privilege"

In light of all the recent news surrounding the Mueller investigation's findings, episode 31 of the "What Trump Can Teach Us About Con Law" podcast looks at "executive privilege," a term that is relatively new and that rarely has been tested in court.

 

April 10, 2019

Enhanced Scrutiny on the Buy-Side

[Co-written with the Hon. J. Travis Laster and cross-posted from Harvard Law School Forum on Corporate Governance and Financial Regulation]

Editor’s Note: Afra Afsharipour is Senior Associate Dean for Academic Affairs and professor of law at UC Davis School of Law; The Honorable J. Travis Laster is vice chancellor of the Delaware Court of Chancery. This post is based on their recent article, published in the Georgia Law Review, and is part of the Delaware law series; links to other posts in the series are available here.

Empirical studies of acquisitions consistently find that public company bidders often overpay for targets, imposing significant losses on bidder shareholders. Research also indicates that the losses represent true wealth destruction in the aggregate and not simply a wealth transfer from bidder shareholders to target shareholders.

Numerous studies have connected bidder overpayment with managerial agency costs and behavioral biases that reflect management self-interest. Agency theorists in law, management, and finance argue that agency costs explain bidder overpayment—that is management pursues wealth-destroying acquisitions at the expense of shareholders. Numerous studies provide evidence that acquisitions offer significant benefits to bidder management—particularly bidder CEOs—in the form of increased compensation, power, and prestige. For example, studies have found that CEOs are financially rewarded for acquisitions in the form of large, new options and grants, but are not similarly rewarded for other types of major transactions. A second, complementary contributor to bidder overpayment is behavioral bias, such as overconfidence and ego gratification. Managers may overestimate their ability to price a target accurately or their ability to integrate its operations and generate synergies. They may also get caught up in the competitive dynamic of a bidding contest, leading to the winner’s curse. Studies have shown that social factors can undermine decision making and lead to poor acquisitions. These factors include the existence of extensive business or educational ties between the managers of the bidder and target firms, the presence of fewer independent directors on the bidder’s board, and the desire to keep up with peers.

For purposes of corporate law, these concerns implicate the behavior of fiduciaries—the officers and directors of the acquiring entity—and raise questions about whether those fiduciaries are fulfilling their fiduciary duties.

Beginning in the 1980s, to address circumstances that present a high risk of self-interest, the Delaware courts began to develop an intermediate standard of review known as enhanced scrutiny. The situations evaluated in these cases did not encompass the flagrant self-dealing often observed in traditional duty of loyalty cases, but instead involved the potential risk of soft conflicts and fiduciary self-interest. Much of Delaware’s enhanced scrutiny jurisprudence was developed through scrutiny of decisions by sell-side fiduciaries. We argue that the enhanced scrutiny framework has become a means of screening for improperly motivated actions “when the realities of the decision-making context can subtly undermine the decisions of even independent and disinterested directors.” (Reis v. Hazelett Strip-Casting Corp., 28 A.3d 442, 457 (Del. Ch. 2011)).

In the article, we expand on three primary reasons to extend enhanced scrutiny to decisions of buy-side fiduciaries. Most importantly, the core conflict-derived rationale that supports applying enhanced scrutiny to actions by sell-side fiduciaries applies equally on the buy-side M&A scenarios. The decision to undertake a significant acquisition differs from other routine business judgments taken by directors and officers. As in the sell-side scenario, acquisitions are often large transactions that are plagued by subtle personal interests that affect the decision-making process. Empirical evidence suggests that in acquisitions, particularly significant acquisitions, the business judgment of boards is contaminated by the interests of managers on whom boards of directors rely. The board’s judgment is even more contaminated in public company acquisitions where the potential for realization of the value of the transaction is uncertain, but the prestige and compensation connected with purchasing another public company is high.

In addition, the sell-side concern that contingently compensated advisors may magnify the confounding incentives faced by senior managers applies to the buy-side as well. Like potential sellers, potential acquirers regularly hire investment bankers under contingency fee arrangements, which gives the bankers powerful financial incentives to pursue and close deals. Unlike on the sell-side, where the acquisition of a client and the resulting disappearance of a source of business may mitigate the advisor’s eagerness to support a sale, similar relationships on the buy-side reinforce the financial incentive. A longstanding advisor’s personal relationship with management may give the advisor additional reason to support an acquisition that management favors, particularly if a successful acquisition may lead to a bigger company that will purchase more companies in the future.

The real-world decision-making context in which boards operate also supports extending enhanced scrutiny to buy-side decisions. At present, there is reason to suspect that without a jurisprudential prod like enhanced scrutiny, directors may not be sufficiently involved in the buy-side acquisition process—just as they were less involved in the sell-side acquisition process before the systemic shock of cases such as Van Gorkom and Revlon. Descriptive accounts indicate that boards are reluctant to become deeply involved in acquisitions, preferring to leave the process in the hands of management and their advisors, with the board restricting itself to advisory and oversight roles. Although the board theoretically retains ultimate approval authority, once management and its advisors begin to feel committed to a deal and have expended significant resources to move forward on a transaction, abandoning plans can be quite difficult.

Although doctrinally coherent, we caution that extending enhanced scrutiny to the buy-side presents several concerns. Most significantly, applying enhanced scrutiny to buy-side decisions would open the door to well-documented stockholder litigation pathologies that have undermined the effectiveness of the sell-side regime. In recent years, the Delaware courts have strived to lessen the impact of these pathologies. One powerful intervention has been to lower the standard of review from enhanced scrutiny to the business judgment rule if the transaction receives fully informed stockholder approval. Logically, this innovation also would apply to bidder fiduciaries.

It seems likely, therefore, that a principal consequence of applying enhanced scrutiny to bidder decisions would be to induce more buy-side stockholder votes. There are substantial reasons to believe that buy-side stockholder votes would be an effective tool to limit the bidder overpayment phenomenon. And recent empirical literature finds that voting by stockholders can provide an important counterbalance to guard against the self-interest and biases that lead to bidder overpayment.

On balance, extending enhanced scrutiny to decisions by buy-side fiduciaries should lead to a superior regime in which stockholders can provide a meaningful check on bidder overpayment.

The complete article is available for download here.

 

April 1, 2019

California must act to protect state's remaining wetlands from Trump's destructive plans

[Cross-posted from Sacbee.com, and co-written by David Mogavero]

California’s wetland resources provide an abundance of human and environmental benefits: flood protection, filtration of water pollutants, surface and groundwater supplies, wildlife habitat, open space, public recreational opportunities and more.

Sadly, historical filling and development projects have reduced our wetlands to a mere 10 percent of their original extent. The loss of coastal wetlands is even more alarming: 95 percent of the formerly abundant lagoons and marshes along California’s coastline have been destroyed.

In 1972, Congress enacted the Clean Water Act, which included a program designed to preserve the nation’s dwindling wetlands. This federal program has never been wholly successful in achieving that goal. In recent decades, litigation over the extent of federal authority to protect wetlands, federal regulators’ failure to delineate clearly that authority and, now, the Trump administration’s overt plans to open wetland areas to development have combined to threaten America’s few remaining wetlands.

California has the ability to fill this alarming regulatory gap, at least here in the Golden State. California’s State Water Resources Control Board possesses independent power to protect and preserve the state’s remaining wetlands. Indeed, it has broader authority to do so than do federal regulators. Years ago, Gov. Pete Wilson announced a “no net loss” goal for California wetlands, but the board is only now considering a specific policy to do just that.

In January, the board released a final draft of its proposed state wetlands policy. Earlier this month, it held a well-attended public workshop to receive public testimony. Real estate interests and land speculators have expressed their opposition to that proposal on three main grounds. They say:

The board plan is rushed and premature.

The draft policy unduly elevates environmental concerns over economic considerations.

Adoption of the plan would undermine California’s efforts to address its current housing crisis.

Each of these criticisms is utterly without merit.

First, industry’s claim that the water board is rushing to judgment is patently false. In fact, the board has been debating its wetlands policy for nearly a decade in a transparent and publicly-inclusive process that has involved no less than a dozen opportunities for public engagement and comment.

Second, the draft policy is measured and moderate. That’s underscored by the fact that 11 of California’s most respected environmental organizations have filed formal comments with the board complaining that the draft wetlands policy is too lax and urging the board to consider strengthening it. We agree that the board’s draft wetlands policy is, if anything, too weak rather than too stringent. We certainly do not believe that this policy should be weakened any further.

Finally, industry’s claim that adoption of the proposed wetlands policy will undermine achievement of the state’s affordable housing goals is its most cynical and specious. That’s because there are literally hundreds of thousands of acres of undeveloped or underdeveloped properties currently available for building new housing across California.

These properties are generally located in existing communities close to jobs, shopping, schools and transit, thus allowing Californians to substantially reduce their commutes and costs, and consequently shrink their cost of living.

Focusing new housing in existing communities also accomplishes multiple other important public policy objectives, such as reducing state greenhouse gas emissions, encouraging investment in existing communities and increasing the tax base to pay for existing infrastructure maintenance.

Conversely, building in remote, currently undeveloped regions of the state is the only type of housing project that endangers California wetlands. It also contradicts the explicit state policy of encouraging infill development. It’s precisely the type of housing that polls indicate most Californians no longer want.

The water board’s proposed wetlands policy is measured, reasonable, critically needed and long overdue. The board should adopt it without further delay.

Richard M. Frank is professor of Environmental Practice and director of the California Environmental Law & Policy Center at U.C. Davis School of Law. David Mogavero is senior partner of Mogavero Architects in Sacramento.

Read more here: https://www.sacbee.com/opinion
/op-ed/article228596469.html#storylink=cpy
Read more here: https://www.sacbee.com/opinion/op-ed/article228596469.html#storylink=cpy

 

April 1, 2019

A consumer DNA testing company's alarming new marketing pivot

[Cross-posted from Slate.com]

Sometimes a marketing pivot serves a truth-telling function. A new television ad for the consumer DNA database FamilyTreeDNA asks the public to share their DNA with the company not to find out whether they’re at high risk for breast cancer, whether their ancestors were black, or what their Spotify playlist should include. Instead, the father of Elizabeth Smart, who was abducted in 2002, observes that “when a loved one is a victim of a violent crime, families want answers. … If you are one of the millions of people who have taken a DNA test, your help can provide the missing link.”

FamilyTreeDNA makes explicit the use of consumer DNA testing that law enforcement agencies have increasingly relied on to solve cases. When police identified Joseph DeAngelo in 2018 as the suspected Golden State Killer responsible for a series of rapes and murders in California several decades ago, they did so with the aid of genetic genealogy: the combination of genetic matching and traditional genealogical methods. Police uploaded crime scene DNA to GEDmatch, a free service where people submit genetic information (typically from consumer testing services like 23andMe) to find relatives and ancestors. A genetic genealogist combined the identification of those genetically related to the then-unknown suspect with genealogical aids like birth records and newspaper clippings. DNA taken from his trash and car door confirmed the match between DeAngelo and the crime scene evidence.

The two largest DNA testing companies take the position that they will provide customer data only with a lawful order like a subpoena or a warrant. Indeed, 23andMe is explicit in its position of using “all practical and legal administrative resources to resist such requests.” FamilyTreeDNA distinguishes itself by not just allowing law enforcement access to its consumer data but embracing the tactic. It asks consumers to contribute genetic information for the express purpose of helping the police solve crimes.  (If you’ve taken a DNA test elsewhere with a competing company, you can upload your file for free to FamilyTreeDNA.) This marketing shift follows its earlier acknowledgment that the company had already been working with the FBI.  As a result, the company is effectively crowdsourcing criminal investigations.

But when you volunteer your DNA sample, you’re volunteering your genetic family tree, without having asked your parents, siblings, cousins, and distant cousins if they agree. That upends the usual way we think about providing information to law enforcement. You can’t give the police lawful consent to search your third cousin’s house, even if your third cousin (who you may never have met) is suspected of having been involved in a serious crime. Why are we allowing a distant relative to grant police permission to your DNA?

When you volunteer your DNA sample, you’re volunteering your genetic family tree.

And genetic genealogy creates difficulties for the relative who objects to your volunteering the genetic family tree to law enforcement. A woman whose DNA on GEDmatch recently helped lead to the arrest of a second cousin twice removed told a local Iowa newspaper that before she got the test done, her brother raised concerns about getting a family member arrested. But her brother’s objections didn’t mean much.  The consumer DNA companies don’t appear to allow relatives to raise privacy objections to submitted genetic samples. And should a relative later be charged with a crime with the help of genetic genealogy, the Fourth Amendment would be unlikely to allow the relative turned suspect to object to the way he was identified. Even if a relative convinced you that the submission of a DNA sample to a consumer database was regrettable, it turns out that “deleting your DNA” is a very difficult thing to do.

Becoming a genetic informant on your extended family isn’t the only issue here. On its website, FamilyTreeDNA says law enforcement access to its database is limited to cases “identifying the remains of a deceased individual or a perpetrator of a homicide or sexual assault.” Today law enforcement agencies appear to be relying on these consumer DNA databases for long-unresolved homicide cases. And few would object to solving the Golden State Killer case, which involved dozens of violent crimes spanning more than a decade. For now, the genetic genealogy used in that case is time-consuming, and following all of the potential leads raised by a partial DNA match takes considerable police resources.

But if history is any guide, these means will become easier and cheaper to use.  Police already use direct DNA matches to solve crimes like auto theft and burglary.  Imagine if a distant relative’s decision to submit DNA led to your 13-year-old self being arrested for spitting on the bus.

Perhaps you wouldn’t object. Perhaps you think everyone committing a crime, no matter how minor, should be caught. Then, legislators should have a direct and open conversation about a population-wide database: a DNA sample compelled from every person in the United States for the purposes of law enforcement. If that is the goal, we should arrive there directly, not as a de facto matter.

And that leads to perhaps the biggest question raised by FamilyTreeDNA’s ad spot. These are urgent questions about the proper balance between privacy and law enforcement and individual and familial rights. Yet it is a private company making these policy choices, changing the conversation, and shaping its terms. Few would respond well to the question: “Join us as a genetic informant!” But many will likely be moved to “help bring closure to families and victims.” Nor should we forget that while contributors may feel altruistic, the company has many motives. Although uploading your genetic file is free, you can “unlock” all of the company’s features for only $19.

Future Tense is a partnership of Slate, New America, and Arizona State University that examines emerging technologies, public policy, and society.