Thursday, July 30, 2009

The New CEO of Xerox: When it Comes to Employment Discrimination, African American Executives May Not Make a Difference

For the first time in American history an African American woman became CEO of a Fortune 500 company. Ursula Burns took over Xerox on July 1st, 2009. Her rise to the top of a major U.S. corporation is one of several exciting firsts for people of color in America. This year the first African American U.S. Attorney General was appointed by the first African American president, and Judge Sonia Sotomayor will be the first Latina confirmed to the U.S. Supreme Court. Marc Morial, President and CEO of the National Urban League , compared Obama, Sotomayor, and Burns. All three were raised without fathers, and their success is the result of a hard-earned meteoric rise from the economically-modest family lives into which they were born.

U.S. corporations like Xerox are microcosms of American society and culture. Xerox, like other American companies, reflects American life. Comparing Xerox and the nation invokes another comparison between Burns and Obama. Their success has convinced many that racism and discrimination are no longer serious problems in the U.S. This is reflected in two comments to an article about the new Xerox CEO. One commentator wrote than “many roadblocks” were “taken down” with Burns’ appointment. Another wrote, “Thank you Ms. Burns for clearing the path for my daughter.” And, of course, as far as President Obama is concerned, Americans have engaged in a protracted debate about whether his election proves that we now live in a post-racial society.

Another comparison - President Obama took over an extremely troubled nation, and Burns took over a very troubled Xerox. In an hour-long lecture at the Whitman School of Management in 2008, Burns talked about the need for good corporate citizenship and she described Xerox as a great place to work. Burns also discussed the fact that Xerox had been a troubled company, and she enumerated the ways the company has attempted to address those troubles. She revealed that senior management worried about “every detail” related to some of the troubles the company faced in recent years. At Xerox, “it’s all about the people” she said. “We love difference.” She described the company’s corporate climate as a culture of diversity, mentioning the usual laundry-list of diversity concerns – age, sexual orientation, gender, race and religion.

During her lecture, Burns talked very briefly and superficially about diversity but she was careful not to mention the “D-word” – discrimination. This is surprising because she said that Xerox managers worried about the details that got them into trouble in recent years. One of those troublesome details should have included the corporate climate that led over one thousand African American sales representatives to file a race discrimination suit that had been settled just months before Burns’ speech. Even though Xerox “adamantly” denied wrongdoing, the company paid twelve million dollars to 1,100 African American sales representatives who alleged race discrimination in promotion, pay, and the assignment of sales territories. Some plaintiffs also complained about blatantly racist comments, and the plaintiffs’ expert proved a “statistically significant disparity between the earnings of black and white salespersons at Xerox.” The company’s response to this was that the disparity was the result of “inferior performance.”

Burns never mentioned the race discrimination class action in her speech at Whitman. I cannot find any reports that include any comments she may have made about the litigation, the settlement, or the issue of race discrimination at Xerox. Perhaps Burns agrees with commentators who assert that the U.S. is now post-racial and that roadblocks or impediments that impede the professional advancement of people of color no longer exist. But disparities in income and promotion rates belie the conclusions that racism is no longer a problem, and so do the number of complaints about race discrimination filed with the Equal Employment Opportunity Commission and in courts. Every day life in America for most people of color establishes that racism persists.

Xerox’s response to the race discrimination class action – adamantly denying all allegations and blaming pay disparities on the inferior performance of hundreds of African American sales representatives – ensures that very little will change for the company’s employees of color. Because corporations are microcosms of society in which racism persists, it is very unlikely that there is no discrimination within a company that employs thousands. Even though a task force was established as part of the settlement, it is not likely that things will improve as far as discrimination is concerned if the discrimination problem is not discussed or even acknowledged. Things certainly cannot improve if corporate leaders do not even mention the persisting problem of discrimination.

Burns and other corporate leaders are willing to talk about diversity but are silent about discrimination. In a law review article, I wrote about the important difference between discrimination and diversity. A company that focuses only on diversity efforts, without considering the persistent problem of discrimination, will inevitably and predictably face complaints from, and possibly litigation brought by, employees of color. This is so because American corporations are part of a society that has not eradicated race discrimination. Diversity efforts will increase the numbers of people of color in a corporate workplace, but diversity efforts, without anti-discrimination efforts, make it more likely that the company will have to litigate or mediate disputes about discrimination.

Before Ursula Burns at Xerox, only seven African Americans have served as CEO of Fortune 500 companies - all of them male. None have spoken out against societal or corporate race discrimination. As far as corporate race discrimination is concerned, very little seems to change when the CEO is Black.

The fact that Burns failed to mention discrimination in her 2008 speech that was given just months after Xerox settled a race discrimination class action inspires yet another comparison to President Obama. He too has seemed reticent to talk about race and racism. For example, when asked to comment on the disproportionate impact of the economic downturn on African Americans and Latinos, President Obama’s typical response is that things will improve for people of color when things improve for all Americans, regardless of race. But his answer ignores the many types of economic discrimination that impede the economic advancement of Americans of color. For example, in the years leading up to the current economic downturn, African Americans and Latinos were targeted for predatory loans. Even middle-income African Americans and Latinos were targeted and offered subprime mortgages even though they were creditworthy, and even though similarly-situated white borrowers received prime loans. There is discrimination in retail sales also. African American and Latino consumers pay more for cars, and receive inferior service in many retail stores. And, recent unemployment rates for African Americans and Latinos are significantly and disproportionately higher than the unemployment rate for white Americans.

Look what happened when President Obama did speak explicitly about race. Negative reaction to the president’s comments about the arrest of Professor Henry Gates in his own home eclipsed his attempts to reform health insurance. And, Judge Sotomayor’s “wise Latina” comment in speeches made before her nomination caused some delusional conservatives to call her a racist. These are symptoms of a society in which the discourse about race is frustratingly pallid. No wonder Burns and most African American CEOs stay away from the topic of race.

Wednesday, July 29, 2009

Consumer Financial Protection, Understandable Disclosure and Financial Education

Congress has developed a 10-member commission to determine the causes of the financial crisis. The commission will be chaired by former California State Treasurer Phil Angelides and former Ways and Means Committee Chairman Bill Thomas will serve as vice chairman. As we await the findings of the report, there are certain observations that we can make. Firstly a “pricing correction” can occur when investors least expect it, in any sector—real estate, insurance, and, of course, banking. Secondly, the federal government will provide an infusion of necessary capital when certain companies that are viewed as “too big to fail” are on the precipice of a financial meltdown. Thirdly, despite federal disclosure laws, investors are not always given “understandable disclosure” that allow investors to adequately comprehend investment options and to make reasonable investment decisions. For example, whether lenders adequately explain the intricacies between a fixed rate 30-year mortgage vis-à-vis a 3-5-or-7-year adjustable rate mortgage to potential homeowners is never clear. Presuming that lenders do provide adequate explanation of loan terms, a fundamental question remains– does the average investor “sufficiently understand” the loan terms to make a “reasonable” decision as to what is best for him or her?

It is this disconnect between disclosure, understandability and reasonable decision-making, which challenged Professor Elizabeth Warren to propose the creation of the Consumer Financial Protection Agency Act of 2009 (“CFP”). Congress has been listening to Professor Warren and it appears as if the proposed Consumer Financial Protection Agency Act of 2009 will likely be adopted. CFP will have regulatory authority over retail financial products including mortgages and credit cards. CFP’s principal directive is to ensure that consumers “have, understand, and can use the information they need to make responsible decisions.” CFP will accomplish its goal by doing more than simply providing information to the public; it will develop “standard” consumer financial products that consumers can compare to financial products offered by the private sector. More importantly, CFP can prohibit the private sector from offering to sell financial products in the marketplace that create “substantial injury to consumers” which is “not reasonably avoidable by consumers” such as the rapid loss of home values, in part due to, underwriters’ over-valuation of homes.

As part of CFP’s consumer protection mandate, it will design standard plain vanilla financial products that should be offered to potential borrowers along with the more exotic financial products offered by private sector lenders. More importantly, CFP has the authority to require that private lenders modify the terms of their financial products that would create “substantial injury to consumers” which is “not reasonably avoidable by consumers. Some commentators have argued that consumers will more than likely select the CFP financial product in lieu of the private sector financial products. However, private lenders that sell CFP designed standard vanilla financial products will be insulated from lawsuits, that is, to say they will be to a large extent, litigation-proof. Protection from litigation is a major advantage for the private lenders, because it shifts the investment risks including interest rate fluctuation, corporate wrongdoing, and poor financial product design, to the consumer. This is not the case for private lenders that sell their financial products despite modifications that CFP may have required the lenders to make to their financial product terms. They are not protected from litigation. Consumers are free to sue such private lenders for any wrongdoing in which a lender may have engaged. We seem to have gone from one extreme to another. I am not certain as to what the correct answer should be. However, a more balanced alternative should at least be considered.

Additionally financial education has been pushed to the forefront of the consumer financial protection debate; the Treasury Department recently issued a white paper that concluded consumer finance can be based on actual data “about how people make financial decisions.” The findings of the research indicated that a majority of consumers do not make reasonable decisions because they cannot understand financial product terms. This should not be a surprising discovery to any one involved with the financial and securities industries. The Financial Regulatory Administration Investor Education Foundation has been providing and sponsoring investor education and research programs for years. [link]Several years ago, I was appointed as the inaugural director of the St. John’s University School of Law Securities Arbitration Clinic (“Clinic”). In addition, to representing small investors in securities disputes with their financial advisors, the Clinic provided financial literacy seminars to the public. The Clinic captured a great deal of empirical data from investor questionnaires, interviews, and intake sheets that reflected a dearth of basic understanding of investment terminology. Nevertheless, these investors were usually categorized by their financial advisors as having an aggressive investment profile with a high risk tolerance. It was always a mystery to me as to how these small investors could be so grossly mis-categorized as to their risk tolerance. Oftentimes, it was simply a matter of an investor misunderstanding what the investment term actually meant. For example, “aggressive profile” does not relate to a personality trait. It relates to whether an investor can withstand the financial and emotional upswings and unpredictable downswings of their investment. It seems almost laughable but many, many investors do not understand the meaning of such basic investment terminology. More importantly, a misunderstanding of this magnitude usually resulted in an investment loss because the investor is inappropriately invested based on his risk profile. Therefore, if consumer financial protection is to be effective, financial education must be an integral part of consumer financial protection.

Financial education should not be left to federal agencies and business schools to provide. Consumer financial protection overlaps commercial, investment and legal issues. Law schools can play a pivotal role in providing financial education programs to the communities within which they are located. I have encouraged law students at St. Thomas University to provide financial education seminars to under-served communities in South Florida with the cooperation of the Federal Reserve Bank of Georgia and War on Poverty FL-Inc. In a time when many law schools are incorporating practicum components to their law school curriculum, financial education programs appear to be the proverbial win-win because the program benefits law students by providing them with a better understanding of the financial world in which they will be practicing attorneys, and the program unquestionably benefits the consuming public.

Monday, July 27, 2009


One of the key failures of the too-big-to-fail approach to systemic financial insolvency is its failure to stem economic catastrophe to any substantial extent. In fact, after the federal government rescued the reckless bankers from their self-created abyss, those same bankers proceeded to strangle the economy by hoarding capital and reducing lending. The chart illustrates the point. After the government expended vast sums to bailout the banks they reduced lending by 23% and hoarded capital at the Fed (where bank reserves soared). Meanwhile, massive capital flowed into the purchase of short term Treasury obligations (driving yields to zero and even into negative territory). This amounts to an historic flight to safety driven by severe risk aversion. This sudden reduction in credit led to GDP contractions of over 6% in both Q4 of 2008 and Q1 of 2009, the worst performance since 1947. The credit crisis caused the economic contraction, not the other way around. The bailouts thus failed. Therefore, avoiding the costs of too-big-to-fail in the future is the critical litmus test of any putative financial reform.

In a forthcoming law review article, entitled “Subprime Bailouts,” I argue that financial elites hopelessly distorted the government’s response to the recent financial calamity. More specifically, I suggest that our political leaders eagerly protected the financial elite from the harsh consequences of failing within a capitalist framework while leaving the taxpayer to pay the bill. Moreover, our leaders neglected the most compelling needs of our society in general, such as rendering aid to the victims of predatory lending or resolving the foreclosure crisis plaguing residential real estate.

I also articulate a minimalist solution to the problem of “too-big-to-fail” that is at the core of the issue. As I previously discussed on this blog, the Obama administration decided to formalize the actions of the Bush administration with respect to very large financial institutions; under both administrations the government ultimately stood behind such financial behemoths and expended trillions to keep them out of bankruptcy or FDIC receivership. Obama takes the Bush approach one step further: under the administration’s proposal the law would now explicitly empower regulators to extend special financial assistance for so-called “tier one financial holding companies.

One simple solution to the “too-big-to-fail” quandary would be to empower a federal regulatory agency to monitor the systemic risk posed by any large financial institution and to order the divestiture of assets, divisions or particular operations if the financial institution poses a significant risk of requiring federal assistance under the proposal promulgated by the Obama administration. Government ordered divestitures already have a successful history ranging from AT&T in the 1980s to the Standard Oil Company at the turn of the century. Given the very costly bailouts of recent vintage, and the cratering of the economy in the aftermath of the bailouts, the government certainly has a compelling interest in the divestiture of financial institutions that threaten the entire global economy.

The administration’s proposed legislation currently includes a divestiture provision, in section 6A(f)(2)(F). That divestiture provision is only triggered if an affiliate nears insolvency or poses a significant threat to the financial holding company. The power to order divestiture should be expanded to permit regulators to order divestiture whenever a firm becomes or threatens to become too-big-to-fail. Regulators would consequently have the power of paring back any bank that even threatens to become too-big-to-fail. A single additional sentence could achieve this outcome. The solution proposed here supplements the approach of the Obama administration (and others). By focusing on systemic risk (rather than mere size) presented by a financial firm it is the most direct means of dealing with systemic risk. Creditors could not assume that any firm would remain too-big-to-fail and would therefore have the right incentives to secure repayment.

Such divestitures would be highly unlikely to harm shareholders as it could be accomplished through a spinoff of shares to shareholders. Moreover, even before the recent financial crisis there was little proof that these financial behemoths enjoyed real economies of scale. It appears that the real driving force towards concentration in the financial services industry is the elimination of competition and the compensation of CEOs, which increases with each empire-building acquisition.

The financial elite that benefits from the bailouts implicit in too-big-to-fail should support this proposal for prudential divestitures. The system of implied bailouts from a supposed principle of too-big-to-fail spawned enormous excess risk in the global financial system. Numerous firms looked into the abyss of insolvency, and global financial meltdown. Certainly, the outstanding leaders within the financial sector would appreciate the risks of artificially cheap capital flowing into large financial firms combined with an explicit “heads I win, tails you lose” legal framework. Such a system is inherently unstable, and could create enormous political backlash for far more punitive regulatory reform. Only an elite obsessed with short term profits would ignore the dangers of an unfettered too-big-to-fail legal regime. Such an elite ought not to assume that future calamities will operate as beneficially as the recent crisis in terms of their interests.

Professor Steven Ramirez

Loyola University Chicago

Sunday, July 26, 2009

What is "Corporate Justice?"

In preparing my first blog post, I began to ponder the meaning of the words “corporate justice.” Immediately, I was reminded of Plato’s book entitled The Republic, detailing Socrates’ dialogue with Thrasymachus, Adeimantus and Glaucon, outside the city of Athens at Polemarchus’ house. It is with this backdrop in mind that I began to contemplate the true meaning of “corporate justice.”

Socrates defined justice as "working at that which he is naturally best suited," and "to do one's own business and not to be a busybody." He further explained that justice must sustain and perfect the three cardinal virtues of temperance, wisdom, and courage. Socrates did not include justice as one of the cardinal virtues. Instead, a close reading of The Republic reveals that Socrates believed justice to be a function of structure, order and control. According to Socrates, justice is not a priori; people are not hardwired for it.

As a result of these fundamental tenants, Socrates reasoned that in order to have a just society, society needs order. To accomplish this ideal society, Socrates created a republic wherein people were divided into three classes; the ruler, the soldier, and the producer. If the members of each class did what they were supposed to do, then justice would prevail. The rulers were responsible for giving orders that were motivated by an interest to benefit society rather than self gain (not surprisingly, in Socrates’ just society, the rulers happened to be the philosophers or what Socrates called the “philosopher kings”), the warriors were responsible for carrying out these orders, and the producers were responsible for obeying these orders. The people that made up each of the classes were separated by their ability to control their “worldly” appetites or indulgences. The rulers had to exercise the greatest level of control. In exercising this responsibility, their primary objective was to put their own selfish motivations aside and to act in the greatest interest of society.

Based on Socrates’ aforementioned conception of justice, in modern society the corporation (really the board of directors) has become the modern day philosopher king (ruler). The officers and upper level management are the “warriors,” and everyone else is a “producer.” Because of the corporation’s role as the ruler, the corporation has a larger social responsibility. Much like, the philosopher kings in Socrates just society, the corporation must control its appetites and avoid the temptation of indulgence.

This begs the question of how a corporation must act within a just society. Extrapolating from Socrates’ discussion in the Republic, a corporation in a just society will “do what it is naturally best suited to do.” This responsibility may include tasks such as selling products, or consulting with clients, etc. In exercising these tasks, corporations in a just society must act with an interest to benefit society rather than an interest solely of profit. Thus, corporate justice should focus on diversity, acceptance, advancement of a global marketplace, and more importantly, the overall interests of society rather than selfish gain because these things focus on societal good and social responsibility.

The prevailing motivation of the corporation in modern times is that of profit maximization and shareholder gain. This system promotes injustice because it often only rewards those corporations that are profitable and reinforces a mantra of “profit at all cost.”

If Socrates’ conception of justice and its relationship to order is accurate, in re-evaluating the way in which we think about corporate justice, should the law impose greater controls to accomplish a more just society? More specifically, does greater corporate governance promote corporate justice? For example, in addition to the duties that a corporation (really the board of directors) owes to its shareholders, should the law go a step further and impose an affirmative duty of care/loyalty from the corporation to society as a whole? If such a duty did exist, would we have experienced the most recent occurrences of financial greed and corruption (Enron, AIG, Lehman Brothers, etc.) ?

Saturday, July 25, 2009


Affinity Fraud: A Major Problem that the General Public Knows Little About

With the large downtick in the economy, there has been a noticeable uptick in fraudulent activity. INVESTOR BEWARE!!! Recently, Securities and Exchange Commission (“SEC”) Commissioner Luis Aguilar delivered a speech in Atlanta on May 28, 2009, at the Third Annual Fraud and Forensic Accounting Education Conference where he talked about fraud at home and abroad. Commissioner Aguilar spent time in his speech talking about affinity fraud and Bernie Madoff’s Ponzi Scheme. When you utter the words “affinity fraud” to most members of the general public you undoubtedly draw a blank and a puzzled expression. What is affinity fraud? Well, affinity fraud is the name given to a fraudulent scheme that targets members of a specific demographic. Victims of affinity fraud are often targeted because of their race, ethnicity, age, class, gender, national origin, religion, immigrant status, social, cultural, or professional affiliations. Affinity fraud organizers portray themselves as members of the targeted group or as individuals who can relate to members of the group in order to garner the group member’s trust and money.

Peeling back the layers, Ponzi and Pyramid schemes often exhibit elements of affinity fraud in that a particular demographic is targeted and victimized. A Ponzi scheme is a fraudulent investing scam promising high rates of return with little risk to the investor. The Ponzi scheme generates returns for old investors by acquiring new investors. Eventually, Ponzi schemes collapse when new investors can no longer be acquired. A Pyramid scheme is an illegal investment scam based on a hierarchical setup. “New recruits make up the base of the pyramid and provide funding, or so-called returns, given to the earlier investors/recruits above them.”

The dialogue in an affinity fraud scheme is often basic. “You can trust me because I’m African-American just like you,” the scam artist will often say. The affinity label or demographic identification can go on and on and on. “I’m a Baptist like you.” “I’m a member of your fraternity.” “You know you can trust me because I’m elderly like yourself.” I think you get the picture. The scam artist will conclude by saying “because we share the same experience and background invest your money with me, I’ll get you a fabulous return.”

Affinity fraud has become such a large problem that recently the SEC publicized the problem in a publication designed to educate the public. Affinity fraud is on the radar screen of state regulators, securities and corporate commissions, and attorneys general. Indeed, affinity fraud schemes have been uncovered in Canada, Australia, and New Zealand and throughout the world.

Bernie Madoff and Affinity Fraud

In recent months, unless you have been living under a rock, or lived on a deserted island as a result of a plane crash, we have all heard the name Bernard “Bernie” Madoff at least mentioned and discussed. One thing is certain: Bernie Madoff will live in infamy!!! Usually, in legal circles we lament the leniency of white collar crime sentences. In June, Bernie Madoff was sentenced to 150 years in prison. This month, Madoff was moved to a federal prison in North Carolina, to serve his sentence for his part in a $50 billion Ponzi scheme. This represented an extremely harsh and unprecedented sentence for a white collar crime. United States District Court Judge Denny Chin had no remorse for the 71 year-old Madoff, and balked at the 12 year sentence suggested by Madoff’s lawyers based on his age. Perhaps this time for a white collar criminal, the time fit the crime.

Madoff’s “client” or “victim” list ran over 160 pages in length and included over 13,500 names. The Madoff scandal amounts to “…a $50 billion Ponzi scheme that preyed heavily on fellow Jews and ultimately drained the fortunes of numerous Jewish charities and institutions.” One important factor lost in the Madoff scandal is how he used his religious affiliation and background to target other Jews who trusted him. In some ways, Madoff exploited his religion to extend his fraudulent scheme.

Examples of Recent Affinity Fraud Schemes Investigated by the SEC

A selected group of recent affinity fraud schemes uncovered by the SEC include the following:

Ponzi scheme solicited elderly members of Jehovah’s Witnesses congregations
The SEC complaint alleges that the defendants operated a Ponzi scheme and used investor funds to pay lavish personal expenses. The defendants raised over $16 million from more than 190 investors nationwide. Many of the victims were elderly members of Jehovah’s Witnesses congregations and were promised returns of up to 75 percent.

Ponzi scheme targeted African-Americans and Christians
Defendants perpetrated an affinity fraud, raising at least $16.5 million from mostly African-Americans and Christians by falsely representing they would receive returns through investments in, among other things, real estate, small businesses, and "markets of the world."

"Church Funding Project" costs faithful investors over $3 Million
This nationwide scheme primarily targeted African-American churches and raised at least $3 million from over 1000 investing churches located throughout the United States. Believing they would receive large sums of money from the investments, many of the church victims committed to building projects, acquired new debt, spent building funds, and contracted with builders.

125 members of various Christian churches lose $7.4 million
The fraudsters allegedly sold members non-existent "prime bank" trading programs by using a sales pitch heavily laden with Biblical references and by enlisting members of the church communities to unwittingly spread the word about the bogus investment.

Practical Advice on How to Avoid Affinity Fraud

Often, regulators and governmental authorities move in too late to protect the general public from affinity fraud. The Madoff scandal is a prime example of the late and ineffectual policing of affinity fraud schemes on the part of governmental actors. Ironically, the SEC thought it was important to educate the public about affinity fraud; but ignored or failed to investigate concrete allegations against Madoff that had been brought to the SEC’s attention months and years before the Madoff scandal became public knowledge. The government can’t always help you avoid affinity fraud. YOU MUST PROTECT YOURSELF FROM AFFINITY FRAUD. Here are some tips and suggestions to follow:

· Make sure that the seller/promoter and investment are registered and licensed in your state. Call your state securities regulator.

· Seek the advice of a neutral professional, not affiliated with the investment or group, who you trust to evaluate the risks and merits of the investment. This could be an attorney, accountant, or financial planner you trust.

· Investigate all statements and representations, even those coming from friends or loved ones; after all they may have been duped themselves. Do your own due diligence.

· Be extremely cautious of investments that are “no-risk” offer or “spectacular” and “guaranteed” profits and returns. VIRUTALLY ALL INVESTMENTS INVOLVE RISK. If it is too good to be true, it probably is too good to be true.

· Get it in writing! If an investment is not described in writing this should raise a major red flag. If someone tells you to keep an investment confidential, be cautious. Obtain a prospectus or other written information on the investment.

· Scam artists are tech-savvy. Watch out for unsolicited emails from people you don’t know that introduce you to an investment opportunity.

· Take your time to investigate. Don’t feel pressured to rush into an investment before you have had time to think about it. “Once in a lifetime” opportunities may ruin your financial life and well-being.

Friday, July 24, 2009

Credit Card Accountability Responsibility and Disclosure Act

At President Obama's request, Congress recently passed legislation to protect consumers from rapacious credit card companies practices. I have written at length about how credit card legislation is necessary to protect all Americans, but in particular college students, whose credit card use often leads to overspending and amassing debt.

Every fall, credit card companies descend on college campuses armed with free gifts to entice students to sign up for credit cards. The newly-enacted Credit Card Accountability Responsibility and Disclosure Act of 2009 attempts to curb these practices. In 2010, a credit card company will not be able to issue cards to a consumer under the age of 21 unless the consumer has a consigner or demonstrates he or she is financially capable of repaying credit card purchases. Unfortunately, that means students with limited resources and from economically disadvantaged backgrounds could be shut off from obtaining credit when they need it most (i.e. to purchase books for classes). The Board of Governors of the Federal Reserve System is supposed to propose safe harbor provisions to prevent this problem.

The Board should also come up with guidelines regarding mandatory education. The root of the credit card debt problem among college students is illiteracy. The Board could create a model program that universities could institute to educate their students on responsible credit practices. The kind of education that is necessary is financial education that enables students to make financially wise decisions and protect their credit history – the asset or liability that will follow them the rest of their lives.

Creola Johnson
Professor of Law
The Ohio State University Moritz College of Law

Thursday, July 23, 2009

Holding Big Business Accountable: Judge Sotomayor, Empathy and Judicial Decision Making

Last week's confirmation hearings for Judge Sonia Sotomayor's nomination to the United States Supreme Court made few waves in the business community. This is most likely because Judge Sotomayor is a centrist when it comes to business-related decisions. "Judge Sotomayor has a track record of moderation on issues of importance to the business community." The fact that she is a moderate means that she will continue to face criticism from both conservatives and progressives. But, progressives, particularly those concerned about the impact big business has on social issues, may truly have something to worry about.

Observing that the role of judges is to interpret law and not make law, President Obama announced that he searched for a Supreme Court nominee with "a commitment to impartial justice." At the same time, however, the president acknowledged that experience and empathy were important and desirable components of judicial decision making. In several speeches she made in the years before she was nominated, Judge Sotomayor expressed a similar sentiment. "Our experiences as women and people of color affect our decisions. The aspiration to impartiality is just that -- it's an aspiration because it denies the fact that we are by our experiences making different choices than others." In her speeches, Judge Sotomayor eloquently expressed the careful balancing that she attempts as a judge. "Life experiences have to influence you", she said. Sotomayor explained that judges should acknowledge their personal feelings and then "set them aside". She posed a rhetorical question in one of her speeches. "I wonder whether by ignoring our differences as women or men of color we do a disservice both to the law and society."

Judge Sotomayor is right about the impact of the experiences of women and people of color on their decision making. But she omitted an important corollary to her observations. Race and gender not only impact the decisions of women and people of color. The decisions of Sotomayor's white male colleagues are influenced by their race and gender also. Whiteness and maleness are experientially relevant to the thought processes of white men.

In the days leading up to the confirmation hearings, Republicans expressed concern about the President's search of an empathetic justice, arguing that "empathy" was "code for injecting liberal ideology into the law". During the hearings, Sotomayor was questioned about potential bias in her judicial decision making based on her race and gender. Senator Jeff Sessions argued that a judge who allowed personal experiences or background to affect her decisions would violate "the American ideal and oath that a judge takes to be fair to every party." What I found frustrating about the questioning on this issue is that it implied that white men do not have biases based on their race and gender.

Even more discouraging for me were Judge Sotomayor's responses to this line of questioning. The judge seemed to back away from the ideas she expressed in her speeches about the effects of personal experience on judicial decision making. She said that the speeches were her ruminations on an academic issue and were meant to inspire the women and Latinos who were in the audience. At some point, however, she said the following: "Life experiences have to influence you. We're not robots who listen to evidence and don't have feelings. We have to recognize those feelings, and put them aside. That's what my speech was saying." As I watched the hearings, I wanted her to say more on this. I wanted her to emphasize that her observations applied not only to women and people of color, but to white men also. I wanted her to make clear that the decision making of white men is informed by their race and gender.

The fact that life experiences and empathy influence decision making does not mean that judges cannot be fair. But, fairness is more easily accomplished once the possibility of empathic understanding, or the lack thereof, based on race, gender, class and other factors is acknowledged. And, if men and women, whites and people of color, fail to acknowledge the role empathy plays in their thought processes, fair decision making is impossible.

That race and gender, and other aspects of our personal background impact our decision making is not a new idea. Critical legal studies scholars, feminist legal theorists and critical race theorists made this point a long time ago. Even the Delaware Supreme Court explicitly acknowledged the role empathy plays when corporate directors are asked to determine whether shareholder litigation should go forward. Because the suits allege wrongdoing on the part of the directors' colleagues and friends, the court wrote, "we must be mindful that directors are passing judgment on fellow directors in the same corporation.... The question naturally arises whether a 'there but for the grace of God go I' empathy might not play a role."

She has not been confirmed yet, but most agree that Judge Sotomayor will in fact become the first Latina to serve on the Supreme Court. I am concerned about the impact of big business on social issues, so I am worried about Judge Sotomayor's willingness to retreat a bit from the basic observations made in her speeches about the role of life experience in judicial decision making. Does her retreat predict diminished empathy on her part for the women, people of color, or the poor and working classes who will ask the Supreme Court to consider discrimination, harassment and other types of cases brought against big business?

Much as been written about the corporate scandals of 2001 and 2002 - Enron, WorldCom, Tyco, Adelphia, etc.; and the excessive risk taking of business leaders that contributed to the current economic downturn. To say that greed was the root of these particular evils is too simplistic. The causes are far more nuanced. Understanding the relevant aspects of human nature is imperative. Acknowledging the role of empathy in judicial decision making and corporate governance is an important first step.

Wednesday, July 22, 2009

The “WTF Number”

I am putting together a symposium titled, “The Financial Crisis: New Administration Initiatives and How Practitioners Should Advise Clients as a Result.” The morning portion of the program will focus on the impact of the financial crisis on corporate governance and what boards should do in the wake of the financial crisis. The program's afternoon portion will focus on financing strategies, restructuring, reorganizations and bankruptcy, and also consider board and senior management fiduciary duties in the context of financing distressed business. On a conference call to discuss the morning session, one of the panelists began to talk about the role that institutional investors should play in reforming corporate governance practices. I intended to explore this issue in my blog post today. However, yesterday I caught an NPR Marketplace story that was so astounding I need to write about the Marketplace story instead.

According to Marketplace, Neil Barofsky, the Special Inspector General overseeing TARP, reported to Congress that the financial system rescue could cost American taxpayers $23.7 trillion. Yes, that’s right, $23.7 trillion. That number was described as a “WTF number”. In case you (like me) are not familiar with the expression, “WTF number,” use your imagination, or recall the first expression that came to your mind when you heard that taxpayers may be on the hook for close to $24 trillion. Get the picture?

The number is unimaginable, although some in Congress have attempted to wrap their minds around the figure. The New York Times and ABC reported that Representative Darrell Issa of California (R), on the House Committee on Oversight and Government Reform, calculated “If you spent a million dollars a day going back to the birth of Christ, that wouldn’t even come close to just one trillion dollars . . . .”

But let’s not blithely talk about how the bailout could cost American taxpayers $23.7 trillion, and then move on. First, it is important to note that Mr. Barofsky came up with that figure by adding up the maximum costs of the approximately 50 different rescue programs, including Federal Reserve and Treasury Department programs, FDIC deposit guarantees, funds for bailing out troubled automakers, and funds earmarked for other mortgage related programs, and then assuming that all of the programs would be implemented and maxed out at the same time. Second, Mr. Barofsky explained in a report that he was calculating the worst possible scenarios. In a Bloomberg interview, Andrew Williams, a Treasury Department spokesperson, noted that the US has spent less than $2 trillion, so far.

Why did Mr. Barofsky report $23.7 trillion? Apparently, Mr. Barofsky is of the opinion that transparency and accountability is lacking with respect to how TARP funds, and other financial rescue funds, are being spent and the value of the investments. In my view, transparency IS lacking. As Scott Jagow noted on the Marketplace Scratch Pad blog, the $23.7 trillion figure in and of itself may not be a useful number. However, if Mr. Barofsky’s motivation for reporting that shocking figure was to make a point about the need to implement his recommendations—such as the recommendation to require TARP recipients to report how they use TARP funds—then I hope his point hit home on Capitol Hill. You may listen to a conversation between Mr. Barofsky and Jake Tapper, ABC News Senior White House Correspondant, regarding the most recent quarterly report from the Office of the Special Inspector General for the Troubled Asset Relief Program on ABC News’ Shuffle podcast posted earlier this afternoon.

Thank you, Mr. Barofsky.

Professor R. Burch
Capital University Law School
July 22, 2009

Too Big to Fail Mega-Banks Post Sizzling Hot Second Quarter Earnings While Maintaining Dismal Outlook for the Present and Future

Late last week several major banks including Bank of America Corp., JP Morgan Chase & Co., Goldman Sachs Group Inc., and Citigroup Inc., posted better-than-expected second quarter earnings; they made billions in three months. The collective earnings year-to-date of these 4 banks is approximately $13.6 billion. This has been a very good year. These results are interesting given that losses from failed loans continued to increase, and more interestingly, that the senior executives of these financial institutions previously stated that the banks would not perform well in the second quarter. For example, Kenneth Lewis, Bank of America’s CEO, said in a statement that continued weakness in the economy, rising unemployment and deteriorating credit quality would affect the company for the rest of this year and next. Yet, Bank of America posted earnings of $2.42 billion. Bank of America’s earnings per share were $0.33 which was much higher than the analyst forecast of $0.28.

This is an amazing achievement when the majority of the banking industry is fighting for survival and struggling to overcome bad debts, rising foreclosures, and escalating individual bankruptcies. These profits are especially intriguing when Bank of America, JPMorgan Chase, and Citigroup all reported they lost more money on loans during the second quarter. How did these banks manage to post such spectacular returns? And, more importantly, why did senior executives continue to make pessimistic forward looking statements when their banks posted significant profits within days of such statements?

This interesting dichotomy of pessimistic outlook and better-than-expected earnings was not particular to Bank of America. Senior executives from JPMorgan also reported continuing loan problems on Thursday evening, within hours JPMorgan posted a fantastic second-quarter earnings of $3.2 billion. JPMorgan’s earnings per share were $0.28. JP Morgan credits the strength of its consumer and investment banking businesses as well as increased bond trading activity for the profits that it earned in the second quarter. Not surprisingly, JPMorgan’s CEO, Jamie Dimon, cautioned that it’s not clear whether the economy will deteriorate further in the second half of the year, which presumptively would have a negative impact on JPMorgan’s earnings.

Leading the path of sizzling hot profits was Goldman, who earlier last week posted a stunning $3.44 billion profit. Goldman's earnings per share were $4.93. Goldman’s CFO, David Viniar, stated that Goldman continues to benefit from having virtually no direct exposure to the retail consumer business. Goldman’s profits were driven by record investment banking fees, including the underwriting of new stock sales for companies trying to raise cash. It must be noted that Goldman is the last of the original investment powerhouses left standing, given Lehman Brothers’ bankruptcy, Bear Stearns acquisition by JPMorgan, Smith Barney’s sale to Morgan Stanley and Merrill Lynch’s acquisition by Bank of America. This all seems to be a rather anti-competitive environment. Perhaps, Congress was willing to overlook the lack of arms length transactional nature of these arrangements given that survival of the investment banking industry was critical. Perhaps at some point in the not so distant future, Congress may want to revisit its decision regarding these arrangements.

Citigroup reported that it earned $4.3 billion in profits. Citigroup’s earnings-per-share were $0.49. Surprisingly, analysts had projected that Citigroup would post a loss of $0.37 per share for the second quarter. How did the analysts so grossly miscalculate earnings? The reality is that Citigroup’s earnings were boosted by an infusion of $6.7 billion from selling its majority stake in Smith Barney to Morgan Stanley. Citigroup’s CEO, Vikram Pandit, previously stated that losses in Citigroup’s consumer businesses have been growing for some time, and expects slow U.S. economic growth in coming years. To be fair, in examining the mega-banks’ strategy during the second quarter, it appears that the mega-banks under promised their earnings and were able to post profits from increased revenues from their trading activities and asset sales of desirable units. In addition, to Citigroup’s sale of Smith Barney, Bank of America sold its interests in China Construction Bank and a merchant processing business for $5.3 billion and $3.8 billion, respectively.
As to how these very profitable banks are doing with regard to repaying their bailout loans, Citigroup received $45 billion in funds from the government which it has yet to repay. The government is in the process of acquiring a 34 percent stake in Citigroup as part of a broader debt exchange program by converting preferred shares into common shares. Goldman and JPMorgan have already repaid their bailout loans, $10 billion and $25 billion, respectively. Bank of America’s don’t know; don’t tell policy may set the stage for the future. Bank of America received $45 billion in bailout funds. Despite its stellar earnings performance in the second quarter, Bank of America stated that it “did not know when” it will be able to repay the government. Interesting.

Monday, July 20, 2009

Obama's Too-Big-to-Fail Failure

On July 9, 2009, Gary Stern, the President of the Federal Reserve Bank of Minneapolis, gave a little-noted speech to the Helena Business Leaders in Montana. Stern suggested that the Obama Administration’s recent proposal for financial reform “fails to deal adequately with the too-big-to-fail problem and therefore, unless strengthened, will leave the financial system susceptible to future bouts of resource misallocation and serious instability.” Stern explains: “there is nothing in the [Obama] proposal designed to put creditors of large, systemically important financial institutions at risk of loss.” So, under the administration’s proposal, creditors may assume that our largest financial firms are now legally deemed too-big-to-fail and that they will consequently be protected by the government in the event such a firm becomes insolvent. Stern is not the only voice raising objections to the approach of the Administration to financial institutions that are supposedly too-big-to-fail.

MIT economist Simon Johnson maintains that the financial sector used its prodigious political muscle to maintain its too-big-to-fail umbilical cord to the United States Treasury. According to Johnson: “The government blinked in the face of financial sector complexity and scale. ‘Too big to fail’ is ‘too big to exist,’ but the president’s document goes nowhere near this fundamental principle.”

The question is simply this: can we tolerate a financial sector that privatizes profits (particularly in the form of huge payouts to CEOs) but socializes losses? That is the upshot of the Obama “reform” plan. It hard-wires “heads I win, tails you lose” into our financial regulatory system for CEOs, at the expense of the U.S. taxpayer, on a permanent basis. It creates perverse incentives for financial firm executives to take greater risks to beef-up current profits (and especially their own compensation) without respect to future losses which are absorbed by the taxpayer. Creditors will no doubt be attracted to the government guarantee applicable to these firms and therefore will provide them with cheap capital. Thus, every financial firm will rationally seek to become too-big-to-fail, so that they too may gamble for big paydays with cheap money while leaving the losses to the U.S. taxpayer.

Such a financial system is doomed to failure, under the crushing burden of excessive risk. Moreover, the very regulators that missed the subprime fiasco are not likely to exercise sustained regulatory oversight to control these risks.

The Treasury proposal includes a “special resolution regime.” Under this regime the Treasury would have power (after consulting with the President and subject to approval by the Federal Reserve Board as well as the FDIC to “stabilize a failing institution (including one that is in conservatorship or receivership) by providing loans to the firm, purchasing assets from the firm, guaranteeing the liabilities of the firm, or making equity investments in the firm.” The Treasury is obligated to consider: “the effectiveness of an action for mitigating potential adverse effects on the financial system or the economy, the action’s cost to the taxpayers, and the action’s potential for increasing moral hazard.” Further, the Treasury proposes to empower the Fed explicitly now to use its power to lend to avoid the “disorderly failure” of any financial firm, subject to approval from the Treasury.

This amounts to nothing less than the formalization into law of “Ersatz Capitalism,” which is terminology used by Nobel laureate Joseph E . Stiglitz to describe the “privatizing of gains and the socializing of losses.” He like Professor Johnson argues that it is time to break-up big finance, “vertically and horizontally.”

Too-big-to-fail is already a known failure. The concept created perverse incentives that contributed directly to the entire subprime debacle. To the extent firms suspected that they were immune from the unpleasantries of bankruptcy or FDIC receivership they had the incentive to take the inordinate risks that formed the foundation of the subprime debacle.

The cost to the taxpayer is up to 12 trillion dollars and counting, according to an analysis from the Chicago Tribune of all the expenditures and commitments of the U.S. government. If only half of that amount ultimately is expended, that will total about $20,000 for every man, woman and child in the United States. Of course, the politicians hope that the voters are too ill-informed to figure out the vast wealth being transferred to the financial titans. It is the most massive transfer of wealth from the disempowered to the powerful in history.

Going forward, we can avoid a repeat of this nightmare simply by outlawing firms that are too-big-to-fail, breaking them up, and forcing them into a resolution regime like that of the FDIC if insolvency occurs. The FDIC exists to liquidate insolvent banks (which are typically placed into receivership) and protect primarily depositors. After all, the FDIC took control of Continental Illinois in 1984, then the seventh largest bank in the country. During the 1980s, the government took control of literally thousands of insolvent banks and savings and loans. More recently, Washington Mutual, then the largest thrift in the nation was seized last September, and immediately resold, with no cost to the government backed insurance fund.

Of course, bank managers would not fare well under FDIC receiverships. They are typically replaced and often sued for breach of fiduciary duty. Unsecured creditors and shareholders also fare poorly. Usually there are insufficient funds to pay-off much more than depositor claims and the claims of the FDIC as receiver and deposit insurer when a bank faces insolvency. FDIC receiverships terrify senior management and unsecured creditors.

This explains why the Obama proposal includes the legal formalization of too-big-to-fail. The administration included bank executives and lobbyists in its deliberations on financial reform. Nor, is there much hope that Congress will right this ship: according to Senate majority whip Dick Durbin, the banks “own the place.” According to Congressman Collin Peterson they merely “run the place.” Many experts have formulated various alternatives to massive subsidies for the most powerful firms in our economy; but, their brilliance apparently cannot fund a political campaign. In Switzerland, the regulatory authorities are threatening to break-up banks that are too big to fail. Small is beautiful for banks.”

There are other flaws with the administration’s proposal that similarly reinforce the very same distorted incentives that caused the subprime debacle. So, unless our lawmakers suddenly come to their senses, brace for Subprime Debacles II and III and IV . . . and so on. The system will now be hard-wired for reckless banking. After spending trillions in bailouts, the Administration’s proposal to ensconce too-big-to-fail in law is tantamount to telling taxpayers: “Keep that checkbook open!”

Professor Steven A. Ramirez

Loyola University Chicago

School of Law

July 20, 2009

The Corporate Justice Blog

Welcome to the Corporate Justice Blog.

We are most assuredly past the point of no return. As we are now comfortably living in the digital age and the Obama era, it appears that the days of network newscasts and the relevance of newspaper reporting are dwindling. When considering our brave new world of (a) blogging; (b) social networking, including facebook, myspace, linked in and twitter, (c) 24-7 news availability via the internet, (d) reality television programming that continues unabated and (e) the emerging technologies that will further take us into interpersonal connectiveness that we could have scarcely imagined merely months ago, the question on the table is: why launch ANOTHER blog?

While we recognize that there are very good corporate law blogs successfully providing daily insights, we believe that there exists space for a unique perspective and one that we feel is not fully represented in the blogosphere. Thus, the eight of us have decided that a progressive, critical voice is necessary and currently missing in the world of corporate law, and in particular with connection to issues of corporate justice. Therefore, we have decided to launch the Corporate Justice Blog as a means of providing insight, sharing commentary and shining light on what we adjudge to be the many inequities that exist in corporate America and the global marketplace in connection with race, equality, opportunity, fairness, diversity, discrimination and class. We expect that this blog will provide provocative, compelling and controversial viewpoints. We hope that this blog will play some small role in bringing attention to the issues of fairness and equality in connection with corporate law and the global markets.

Of course, we remain completely open to commentary and insights of all readers and followers of the Corporate Justice Blog. We invite you to read, enjoy (we hope) and engage.

andre douglas pond cummings
Professor of Law
West Virginia University College of Law
Visiting Professor of Law, University of Utah S.J. Quinney College of Law (fall 2009)
Visiting Professor of Law, University of Iowa College of Law (spring 2010)