1 Legal Environment and business decision making Introduction to the course To what extent do companies have to deal with different legal environments? How do they manage these environments? How can these environments be a source of opportunities or threats regarding companies’ strategies and business decisions? What are executives and managers’ responsibilities and duties? (What can be the consequences of a bad behaviour of a manager?) Legal Environment: multi-national legal environments and business opportunities. Porter’s five forces: external environment, in which the company evolves, composed by three circles: It is about legal norms included in the « general environment » (legislators and governments acts; jurisprudence), that is the same for all firms; legal norms included in the « industrial environment » (agencies regulation and decisions (ARGEL, AMF); codes of good conduct; industrial norms and standards) and finally, legal norms included in the « competitor environment » (rights and legal resources owned and controlled by competitors). The « legal flood »: more and more legal rules (good for lawyers but also for the companies: more opportunities for some objective and subjective reasons (re-elections etc.) (Codified law: organised in codes) In the EU, in 2009 ▪ 17 European Treaties ▪ 14,500 derived normative acts ▪ 97,000 pages in the OJEU There are still big differences between EU’s countries because of the national laws. In the USA: Wall Street regulation bill = 2,300 pages long. In some countries (for example, China): they produce their own rules ▪ Creation and development of a property rights system ▪ Development of a strong IP system ➔Such a variety of treaties implies a « legal complexity »: « There is the usual failure to see that modern life and modern commerce are so complex and diversified that to expect a tax form which shall read like a pill advertisement on the railway, and yet close down upon every case, is asking for the moon » (Dr J.C. Stamp, 1919) ✓ The volume… ✓ The world itself is complex ✓ Cognitive difficulties and litigation complexity (what country’s law?) ✓ Law as a business: the more complexity, the more need of lawyers expertise The legal diversity can be explained by the diversity of legal systems between countries. We notice a competition between international and multi-national environments. This competition between legal systems fosters a law shopping, to benefit from the most profitable system. Companies face multiple “regulatory choices” regarding their business opportunities: property rights, intellectual property rights, contracts 2 Legal Environment and business decision making efficiency and enforcement, corporate structures, tax constraints, judiciary threats Some key-characteristics of legal systems are: - The « normative model » ▪ « Hard law » (a set of mandatory rules, and if you do not respect them -> sanctions) vs « Soft law » (the rules are not mandatory, they are more recommendations, suggestions) ▪ The growing importance of « Codes of good practices » (example IMF with transparency) - Competition between legal systems: ▪ The example of class actions: (=a form of lawsuit in which a large group of people collectively bring a claim to court and/or in which a class of defendants is being sued) http://www.vivendiclassaction.com/us/home.php3 ▪ The example of the Delaware State: one strong key point, more than 90% of quoted companies are registered in the Delaware State because there is a very flexible system, and is profitable to board members. → To attract big companies http://www.delawareintercorp.com/t-WhyIncorporateinDelaware.aspx However, legal shopping has some limits. The “long arm of the law” exists: even if a company tries to take benefit of a specific national legal environment, it does not mean this company is not concerned by the other national environments. Example of the UKBA: the UK bribery act (= corruption) -> you have to take measures to prevent from this kind of behaviour. If one of your employees, partners etc. is involved in corruption, even if it is in Mexico, you can be sued in the UK. Taking Business Decisions in Legal environments: value creation and value destruction because of (lack of) legal intelligence. In order to create value (strategic, financial, institutional values), companies: ▪ Take benefit from deregulation opportunities − The energy market example (Poweo) − The mobile phone network market (Free and the 4th License) − The online betting market Competitors react (lobbying and judiciary systems): lobby to the government (failed), seized the European commission (failed), and appealed to the French Conseil d’Etat (failed). ▪ Take benefit from grey areas regarding the legal norms. The Web 2.0 example: YouTube; Google Adwords… − Create and develop strategic assets through legal norms ▪ Intellectual property rights strategy: IBM success story In the early 90’s, IBM was declining. IBM regenerated its sleeping patents portfolio and created a new source of revenue (licensing policy and aggressive management of infringements = violations): patent-licensing royalties increased from $30 million in 1990 to $1 billion in 2000, to match that sort of net revenue stream, IBM would have to sell roughly $20 billion worth of additional products each year! ▪ Holding strategy (Artemis Group example) − Build trust with public authorities ▪ Through cooperation 3 Legal Environment and business decision making ▪ Through compliance programmes However, for some companies there is a risk of value destruction ▪ Illegal decision making…Enron, Siemens, HP ▪ Legal decision making in uncertain environment: Michelin and Schangaï Tyre and Rubber Managerial responsibility: duties and liability This section will provide a comparative overview over: Managerial duties (toward shareholders, employees, creditors...) Civil liability of managers Criminal liability of managers From legal liabilities to ethical responsibilities of managers: how to go beyond legal compliance. 4 Legal Environment and business decision making Session 1: From competition between national legal environments to legal shopping. Laws and sources, norms. LEGAL FRAGMENTATION: on a national scale, the legal order is organized hierarchically whereas on a global scale, there is no clear priority; local law (example: a company needs a building permit to construct offices, communal zoning laws may apply), regional law (example: in Federal systems like Germany or the USA, each state has its own body of law). In the USA large parts of business law fall under state competency, national, transnational (European Union laws) and international laws (GATT, GATS…). Law is in principal made by a state or transnational bodies (law-making may be delegated to private institutions if provided for by law), while the state itself is bound by the law. It creates and acknowledges enforceable rights and obligations and thereby limits power and guarantees individual freedom. When the laws doe not come from the State, it can come from divine. -> 2nd source of law Laws and norms: incident, cases or behaviour change laws, principles and standards. Who makes the norm? Who applies the norm? What form does the norm application take? Who imposes consequences? What form do the consequences take? How grave are they? -> Are all these things which make the norms legitimate? • Company internal rules and processes: legally binding (company statutes…) and non-binding (principles, guidelines…). • Extra-legal norms and standards that can become binding through a reference in the law, but that can also rely on informal sanctioning (ethics code, “best practices”…). • Legally binding obligations through private regulation or contracts (listing rules, investment agreements…). • Default legal provisions: legal provisions that are open to disapplication through private decisions (contract laws…) • Mandatory laws (regulations of financial authorities…). Case “FIFA” During the African Cup of Nations 2004 in Tunisia Cameroon wore its flamboyant one-piece uniform. The outfit featured lion claw marks down both sides of a jersey which was attached to the shorts. The dress does not comply with “Law 4” of the FIFA’s “Laws of the Game”, which provides that players must wear two-piece uniforms. FIFA received assurances from Cameroon that it would discontinue wearing the one-piece uniform after the group stages. However, Cameroon wore the same outfit in the quarterfinals, where it lost 2-1 to Nigeria. 5 Legal Environment and business decision making The FIFA Disciplinary Committee fined the Cameroon football association CHF 200,000 and deducted six points from its national team in the preliminary competition for the 2006 FIFA World Cup. What is the FIFA? What are the FIFA’s “Laws of the Game”? The Fédération Internationale de Football Association (FIFA) is an association registered in the Commercial Register in accordance with art. 60 ff. of the Swiss Civil Code. By joining the FIFA members (any association which is responsible for organizing and supervising football in its country) agree to always comply with the Statutes, regulations and decisions of FIFA and of its Confederation and to comply with the “Laws of the Game”. Case “IFRS” All listed companies within the E.U. are by law required to draw up their consolidated annual reports according to international accounting standards (IAS). (See Regulation (EC) No. 1606/2002 of the European Parliament and of the Council of July 19, 2002 and Regulation (EC) No. 1725/2003 of the European Commission of September 29, 2003) Article 2 EC Regulation 1606/2002: “Definitions, For the purpose of this Regulation, ‘international accounting standards’ shall mean International Accounting Standards (IAS), International Financial Reporting Standards (IFRS) and related Interpretations (SIC-IFRIC interpretations), subsequent amendments to those standards and related interpretations, future standards and related interpretations issued or adopted by the International Accounting Standards Board (IASB).” The standards are drafted and published by the International Accounting Standards Board (IASB), which is an independent, privately-funded accounting standard-setter based in London, UK. Representative international and national organizations select trustees to govern the IFRS Foundation. The foundations appoints 15 (from 2012 on 16) members to the IASB coming from different countries and having a variety of functional backgrounds. All standards and interpretations are then adopted, following a certain procedure, in which the European Commission interacts with the IASB in form of a European regulation • Are the IAS, IFRS laws? Rule of law - advantages for business: • Investments are more secure. Property is protected. • Foreign business is less dependent on informal local networks. • Contracts may be relied upon. • Higher predictability of business outcomes. • Possibility of fair dispute resolution. • Lower risk and lower costs ➔ more economic activity. Central features of the rule of law: • Government that (itself) is governed by publicly known rules (“government of law” instead of “government of men”) • Protection of individual (subjective) rights • Functioning court system • Functioning law enforcement bodies (courts, state attorneys, police, bailiffs, law enforcement agencies, etc.) • Well-trained lawyers • Absence of corruption Sources of Business Law: texts, case law, custom and usages, and general principles of law In France for instance there is a hierarchy of legal texts (Pyramid: an inferior text must be in conformity with the superior text): Constitution of 1958 ➔ Laws ➔ Regulation (règlements), règlements d’application (décret, arrêté), règlements autonome… In French legal practice case law has become an indirect source of law, by • Publication of the legal grounds of an individual judgment that enables making general conclusions about the contents of the law 6 Legal Environment and business decision making • The fact that Judges in practice follow precedents and also respect the hierarchy of the court system, for example the authority of the Cour de Cassation • interpretation of legal statutes that are vague, contain dynamic terms, or have become obsolete • Art. 4 CC that forbids a judge not to render a judgment arguing that the law is silent on a certain issue, thus opening the path to find solutions in individual cases. By repeated application of certain findings in several in individual judgments, judges can create “jurisprudence”, thus “judge-made” law. International sources of Business Law: – European law: EU-law regulates many aspects of business law within the EU. The main sources of EU law are the Treaty on European Union and the Treaty on the Functioning of the European Union, EU directives and EU regulations, Commission Decisions and case law of the Court of Justice of the EU (see p9) – International Treaties: International treaties are principally addressed to the signatory states and need to be ratified by a national parliamentarian act. – Internationally harmonized law: Internationally harmonized law that is directly applicable to individuals, example: CISG (Convention on contracts for International Sale of Goods) – International “soft-law”: Soft law are rules that are not enforceable or have limited enforceability. If the issuing bodies (for example UN, OECD, etc) enjoy a high reputation, addressees could be forced to follow soft law by public pressure. – Standard terms, commercial practices, self-regulation: are – strictly speaking – not law, but can in practice achieve a normative effect that is equivalent or even stronger than the law (example ICC UCP 500, ICC incoterms). The law may also refer to a standard set by a self-regulatory body (example: IFRS) – General legal principles: do they exist? Here we confront the fundamental discussion between positivism and natural law. – Polycentricity – the future of “global business law” facing fragmentation or a void of law made by a state? Legitimacy? Comparing legal systems. In view of the vast number of different (national and trans-national) legal systems in the world today, the question arises, if there is a way to categorize and group them. The crucial factors of a legal system could be categorized as follows: • Historical context − development of civil law in continental Europe on the basis of Roman law and exportation of legal systems during the colonial era − Independent development of common law in England (less influence from Roman law) and spread of common law system during the colonial era • Function of the law in society and ideology: law as guarantee and limits of individual freedom vs. law as collective order vs. law as instrument of power Mode of legal thinking: inductive legal thinking in Common Law systems (Start with the case and try to find similar case: inductive) vs. systematic legal thinking in continental “civil law” European systems (from principal to the case, apply text to the case). • Religion: interrelation between Islamic law (“Shariah”) and state legislature Important expansion of common law systems because of powerful Anglo-American companies… Common law: importance of common law for international business 7 Legal Environment and business decision making The Common Law system must be of high interest for any lawyer or business person who is engaged in international legal matters: In the colonial ages, the British Crown “exported” its legal tradition to large parts of the world. Today, roughly 30 % of the world’s population live in regions where the law has been more or less influenced by the Common Law (USA, India, Australia and New Zealand, Canada (except Quebec), large parts of Africa (including South Africa) and South-East Asia…). Furthermore, large law firms, who advise internationally active enterprises, are – nearly exclusively – either English or U.S.-American. Their working style has been strongly influenced by lawyers educated in the Common Law tradition of legal thinking. For this reason it is not surprising that international legal language and many international legal practices are marked by Common Law. For example: many international transactions are based on models drafted by common law jurists. Modes of legal thinking Historical context of common law – Historical continuity - No explosive political upheaval that would replace one legal system by another (in contrast to France of 1789) – English legal practice was not affected by the idea of codification, “the idea – born of the law of nature and the Enlightment – that the disorderly and patchy historical growth of law could be pruned and planed into a generally comprehensible form as a result of deliberate and planned legislation based on a rational system.” – Consequence: The approach of Common law is not that of an abstract “logical” system, but is devoted to the resolution of practical problems based on historical experience. – We can characterize this approach as inductive. Contrarily, a Civil Law judge will try to apply a particular given rule or general principle to the facts underlying the actual case. We could classify this approach as deductive. “The civilian naturally reasons from principles to instances, the common lawyer from instances to principles.” Civil Law and Common Law: drafting of legal texts The different approach to legal thinking and to legal texts also has consequences for the drafting of legal texts. While a Common Lawyer will try to capture all imaginable practical situations, in which a conflict could arise, a Civil Lawyer may tend to rely on a system of abstract legal principles. See for example the different implementation of Art. 6 of the European Directive on Liability for Defective Products: France Art. 1386-4 (2) CC: “Dans l’appréciation de la sécurité à laquelle on peut légitimement s’attendre, il doit être tenu compte de toutes les circonstances et notamment de la présentation du produit, de l’usage qui peut en être raisonnablement attendu et du moment de sa mise en circulation.” In the UK implementation the term “présentation du produit” becomes the following (see section 3 (2)(a) of the Consumer Protection Act 1987): “the manner in which, and the purposes for which, the product has been marketed, its get-up, the use of any mark in relation to the product and any instructions for, or warnings with respect to, doing or refraining from doing anything with or in relation to the product.” It is often put forward that Common Law legal systems are better for business, since they are more flexible and can adapt better to social and technological changes. ➔Economic comparisons: In economic theory, scholars have attempted to draw comparisons between legal systems with regard to their respective impact on a country’s economic development. Legal origin theory (Shleifer, Lopez de Silanes) • Economists classified countries as to their adherence to a certain legal family (roman civil law, german civil law, common law, nordic law) and performed empirical research trying to find correlations between economic indicators and that legal family classification. • According to the advocates of the Legal Origins Theory, common law countries tend to be economically more developed and more market friendly. These theses are hotly disputed. • “Legal origin” approaches in economics had influence on the Worldbank’s “doing business” rankings. 8 Legal Environment and business decision making • http://www.doingbusiness.org/rankings C2 – Part 2 Legal shopping → a matter of choice: - Judge: “forum shopping” - Law: “law shopping” Both are linked. A judge belongs to a national system and applies national law. Diversity -> Fragmentation of legal system Logically organized system in the civil law: a hierarchy between different types of laws. The judge will be the servant of the law, he is not supposed to create laws. Common law: Everything is based on judge-made law. Judge will find precedent law, similarity and differences. Chinese law is based on German law. In a contract you can choose the jurisdiction in a clause. At the end of the contract because it is often in case of disagreement, problems etc. Freedom in the choice of the law applicable. Common sense of justice: ex aequo et bono (amiable composition): link of the choice of arbitration (private judges) > mission of resolving a dispute. National law? Lex mercatoria (general principles regulating business)? Arbitrator common sense -> ex aequo et bono (but more uncertainty) What are the consideration leading to such or such law? What are the preferred laws: English -> Suisse -> German -> US -> French What are the preferred laws other than your own: Suisse -> England (…) When conducting cross-border transactions 72% try to avoid some law: US (complex and not very organized) -> Islamic countries (uncertainty of the outcomes) Do you tend to avoid these contract laws because of: predictability of the outcomes -> corruption -> fairness of the outcomes -> contract law -> speed of dispute resolution -> quality of judges and courts -> bureaucracy -> costs What are the preferred fora: Suisse -> English -> French What influences the choice: quality of judges and courts -> fairness of the outcomes -> corruption -> predictability of the outcomes -> speed of dispute resolution -> contract law -> arbitration -> language How to deal with fragmentation of the law/ Example of eBay (truth from this side (of the Atlantic) error beyond. LVMH vs. EBay: distribution of products such as LV bags is protected (?) 30 June 2008: eBay condemned €40 million by the Commercial Court of Paris for - Allowing auctions of fake products - And violating LVMH selective distribution networks At the same time, for the same kind of case with Tiffany & co. -> the opposite issue. Judge ruled that eBay is not required to make greater effort for policing its site for counterfeit items, the primary burden for protecting a brand resting with its owner. L’Oréal vs. eBay: eBay cannot be held responsible for fake products sold through its auction web site. (High Court of Justice) EBay is making a reasonable effort to keep fake goods off its site. (TGI Paris) -> EBay won. Decision of the EU Court of Justice: online marketplace operators may be responsible for trademark infringements carried out by users. If they played an “active role” in facilitating the infringing conduct, or in case of “negligent failure” = market place operators will have to assume more responsibility to prevent infringements on theirs platform → A brand-owner friendly approach A marketing approach to the law? 9 Legal Environment and business decision making Legal shopping regulatory competition. ‘Legal shopping’ implies that business have choices with regard to the laws that may be relevant to their operations. If they have choices, law can become an element of strategy (corporate structure, submission to regulatory authorities…). Some choices can be made by ‘mere’ agreement (example: contracts), others require factual activity (offering of securities in a certain market), others again require fundamental decisions for the business (location of production sites, company headquarters, …) Case in point: the “nationality” of EADS Does EADS have a particular nationality? EADS bears the legal entity form of a Dutch NV (public limited company), thus is subject to Dutch company and financial supervision laws. EADS’ shares are admitted to trading in France, Germany and Spain. Thus, EADS has to observe French, German and Spanish capital market laws. Major shareholders of EADS are (30. September 2011): - Daimler AG (22.36%) - Sogeade (22.36%) (a joint holding between the French state (SOGEPA) and the Lagardère Group giving the French state a veto right) - SEPI (5.44%) ("Sociedad Estatal de Participaciones Industriales“, held 100% by the state of Spain) - Free float (49.34%) ➔ Resulting in a basically Franco-German top management structure (according to company statutes the two main shareholders jointly propose CEO and chairman). EADS has employees all over the world. For example, its 100% subsidiary has major production sites in Toulouse, Hamburg and through a joint venture (Airbus holding 51%) also in Tianjin, China The term forum shopping is used in the context of international litigation. Since there is no international law that coordinates jurisdiction of courts internationally, it is possible that several courts are competent to hear the same case. Authorities, to some extent, compete for authority by offering regimes that appear ‘attractive’ to companies ➔ Ireland with a very flexible tax regime manage to attract Google. Example: A regulatory strategy to attract financial service businesses (and jobs!) and enlarge a domestic capital markets, would be to offer flexible market friendly financial regulation. Example: Tax regimes, company and employment law are important factors for a business for choosing an appropriate location of its operations. Legal regimes are not necessarily attractive, because they grant utmost flexibility or lead to saving costs. Flexibility is one factor. Other factors are reliability, level of rule of law, protection of rights, laws that guarantee social freedom, etc. Regulatory competition: narrow sens Sometimes a national legislature decides to establish competing authorities with the objective that one authority limits the power of the other. In this perspective regulatory competition is a regulatory strategy of balancing power. The question has surfaced for example with regard to the governance of financial Competence, regulation. While some countries decided to install single regulators (UK Financial Applicable Law Enforcement jurisdiction, authority power Services Authority (FSA), German Bundeanstalt für Finanzdienstleistungsaufsicht (BaFin)) to make economies of scale and scope, to better manage conflicts between different objectives of regulation and to overcome the more and more obsolete traditional functional separation between banking, insurance and securities regulation, other countries have opted for regulatory competition models (such as the USA). 10 Legal Environment and business decision making The arguments put forward in favour of regulatory competition are to avoid too much power accumulation in a single agency, avoid unintended degree of “tunnel” vision, improve quality of regulation (is the argument flawless?), and resolve conflicts on a political level rather than by a single regulator. Legal shopping. Due to diversity of law systems, the fragmentation of law, it exists a legal shopping. 91% of people believe it is important to be able to choose the governing law when conducting cross-border transactions. The preferred choice of governing contract law is England (21%), Germany (16%), France and Switzerland (14%)…US (4%). There are diverse reasons which explain that some contracts law are avoided: predictability of the outcomes, corruption, fairness of the outcome, costs, bureaucracy, quality of judges and courts… EBAY and the sale of counterfeit luxury good: - LVMH vs eBay: 30/06/08 eBay condemned paying 40million euros by the Commercial Court of Paris for allowing auctions of fake products and violating LVMH selective distribution networks (sales of perfumes marketed through unauthorized channels). 14/07/08 A US federal court clears eBay of all liability. Judged rules that eBay is not required to make greater effort for policing its site for counterfeit items, the primary burden for protecting a brand resting with its owner. - LOréal vs eBay: eBay wins again!: High court of Justice 22/05/09 eBay cannot be held responsible for fake products sold through its uction website. TGI 13/05/09 eBays is making a reasonable effort to keep fake good off its site ➔12/07/11 Decision of the EU Court of Justice: online marketplace operators may be responsible for trademark infringements carried out by users, if they played an “active role” in facilitating the infringing conduct. Marketplace operators will have to assume more responsibility to prevent infringements on their platform. Does legal shopping mean that Law is a product? Implications of this assertion: - Market: producers (the law-making factory and the importance of private producers), consumers (analysing/meeting demand needs, quality of the law-making process=intelligibility, predictability, accessibility and quality of the after-sale service) and “merchants” of law (the role of big law firms)… - Competition - Globalization: benchmarking (business reports, import/export and legal borrowing (whistle blowing, compliance, corporate governance…), forum shopping (choosing the Judge, choosing the Law and viceversa), “the long arm of the law” and “the long arm of the Judge” Is Law a product? - Converging factors to consider law as a product: o Legal instrumentalisation: law as a means to reach an end o Threat to the Rule of Law ? - But Law still implies something more…governing human behaviours, seeking common goods, integrating values… 11 Legal Environment and business decision making Session 2: Creating value through law Strategic value. It refers to the use of legal resources in order to improve the company’s position in the market: strategic alliances, M&A, barriers to entry through IP rights, international development, price competition, innovation, etc. It can also be the firm’s reputation. 1. ENTERING NEW MARKETS: ❖ Anticipate the deregulation (see online betting case or Poweo example) ❖ Provoke a legal change through lobbying and judiciary actions (Leclerc case and FedEx example) FedEx changed the regulatory environment: an incentive for its entrepreneurial strategy: - FedEx obtained an exemption to the heavy regulation existing for air cargo (exemption for « air taxi ») - As « airtaxi » was not sufficiently profitable, FedEx provoked a deregulation in the sector of « air cargo », after 6 years of lobbying actions. - Then FedEx targeted the trucking market to obtain an exemption for all ground transportation shipments incidental to air transportation. FedEx targeted the sector of intrastate trucking, first, state by state, looking for the most flexible one, and then at the Congress level (FedEx obtained a deregulation decision in California). UPS joined FedEx at the Congress level. - FedEx targeted the market of letters delivering (market monopolized by the USPS, which was a buyer of FedEx services). Fedex obtained an exemption for « extremely urgent letters ». In 1995, FedEx asked Congress to eliminate the USPS monopoly. In 2001, FedEx and the USPS announced the creation of a $6 billion, 7 years, joint venture (FedEx can develop new services) - FedEx extended its market presence in Asia (international air shipping rights). FedEx used its political influence in the US Senate to have a resolution introduced threatening sanctions against Japanese airlines. In 1998, Japan and the USA reached agreement on a new treaty, and the biggest winner was FedEx Seizing legal opportunities: Free case: In 2005, the French Competition Authority condemned the 3 main mobile phone operators to pay a fine of 534,000,000€ (after freezing the prices). Decision to introduce a new actor: Free. The ARCEP launched an invitation for tender. Finally Free offer was accepted by the ARCEP. Competitors reacted (lobbying and judiciary tactics): to the Government, European Commission, French Conseil d’Etat 2. SUPPORTING THE BUSINESS MODEL: The Google example and adwords Programme: In 2000, Google launched the Adwords programme. In 2008, advertising on Google pages provided $5 Billion to Google Company. 97% of Google’s revenues came from advertising. Adwords Programme: - Heterogeneity of the jurisprudence in the EU - Prejudicial questions asked in 2008 to the ECJ by the French Cour de cassation In March 2010, the ECJ answered 3. SUPPORTING AN ACQUISITION STRATEGY: The LVMH / Hermes example (below, 2006 data) LVMH targeted Hermes… 12 Legal Environment and business decision making - First, acquisition of 4,9% of Hermes shares Then LVMH took benefit from a « grey area » in the AMF regulation Equity swaps with a cash exit negotiated in 2007; an exit planned for January and May 2011; endorsement negotiated in October 2010; the exit is no more in cash but in shares: 14.2%. Finally… http://www.styleite.com/media/hermes-lvmh/ Hermes « families » reaction = Creation of a holding. http://www.bloomberg.com/news/2010-12-05/hermes-family-to-create-holding-company-for-half-of-capital.html 4. SUPPORTING AN ALLIANCE STRATEGY The Disney – Pixar example Pixar R&C - 3D tech competency (partly because of proprietary software): royalties through licenses - Strong artistic dimension - Disney R&C Legitimacy in animation movies industry Powerful distribution networks Strong financial resources Marketing competencies Derivate products competencies Combination of both R&C - Disney creates more value when associated with Pixar - Be more performant than Dreamworks How did Disney avoid the «departure» Of Pixar? A specific contract provision: Disney does not need Pixar agreement to produce sequels to co-produced movies. In January 2006, Disney acquired Pixar (7.4 billions $ deal) 5. STRATEGY IN THE LUXURY INDUSTRY In the luxury industry, you cannot have strategy without a strong trademark policy. Brand is a marketing concept, one element of the marketing mix, not a legal concept. The legal concept is the trademark. How to you switch from, one to another -> you have to register, globally a national process. Cost, period of protection? 10 years but you can renew it, million of euro every year for firms like LVMH Build a relevant distribution network through specific agreements (exclusive/ selective distribution) -> protect image, brand reputation and from a marketing analysis, luxury means high price and rarity, scarcity, otherwise how to justify the price? This type of contract is based on exclusivity, so other are excluded -> by nature it is not competitive. They have to justify to what extent this exclusion is necessary regarding to the interests of the customers. To show that this choice has more profitable effects for the customers You cannot exclude a category of retailers except with a real justification. But you have a risk of parallel distribution if you are not working on some networks, because there may be a demand. Pierre Fabre, only in pharmaceutical shops -> forbid on the Internet etc. It was not accepted if a site opens and is clear and able to sell these products. Down-raids: investigators in your office to have more information Financial value. 13 Legal Environment and business decision making Several definitions of “financial value” and how to measure it do exist (CVA, EVA, MVA, REVA…) - Through contracts ▪ Long term contracts (Ikea: “do it yourself”, price is low. You do not have big choice and the quality is medium. Why is the price so low? Ikea depends a lot on raw materials, commodities and especially wood. The problem of the potential boom in the prices. So normally you have to impact the increase on the customer price. But not Ikea: long-term contracts -> even if there is a boom, no impact on the price of raw materials.) ▪ Clauses dedicated to revenue sharing (for instance, licensing agreements, joint ventures or franchising). Franchisees pay for the brand, for an access to the supply chain, and for know-how specific to this network - Through corporate statutes and design: the LBO mechanism - Through Property rights ▪ Patenting for profit: (a process can be patented but not a picture -> trademark or copyrighted) In 1999, Dell signed a patents cross-licensing deal with IBM ($16 billion). In the mid-1980s, Texas Instruments faced bankruptcy; in 2000, their current licensing revenue from patents was $800 million. ▪ Trademarks: contribution to the financial value of the brand through registration, through trademark policy… The legal management of the brand contributes to build the brand notoriety. To evaluate the value: how much the brand invests in the trademark policy? - Through Litigations to recover money Oracle sued SAP and won $1.3 billion in damages in a corporate theft lawsuit against TomorrowNow which downloaded software and support materials illegally from an Oracle website. Kodak: In 1975, Kodak launched a new line of cameras and films. In 1990, a Court ruled that Kodak infringed Polaroid’s patents. Kodak had to pay $925 million in damages to Polaroid. Institutional value. The level of trust in the relationships with regulatory authorities - Source of these good relationships: ▪ A global positive attitude regarding legal norms ▪ A real willingness to develop compliance and good practices - Consequences of these good relationships ▪ Ability to develop lobbying actions ▪ Less scrutiny of company behaviour ▪ Better understanding of legal policies 14 Legal Environment and business decision making Session 3: Destroying value because of legal risks 1. Parmalat SpA, an Italian dairy and food company and Europe's biggest dairy company, was declared bankrupt in late 2003. 8 billion euro hole was discovered in its accounting records. The disclosure sent shockwaves throughout Italy, worrying investors and knocking market confidence. In fact, the fraud was so extensive that almost 80% of the company's income for one sales year was fabricated of lies, and all of its profits were made up. 2. American International Group Inc. and some of its directors and officers have agreed in 2010 to a $725 million settlement to resolve allegations of wide-ranging fraud laid out in a class action suit led by Ohio pension funds. If the necessary amount can't be raised, plaintiffs will have three options: terminate the agreement, acquire shares of AIG stock ($550 million) grant an extension. The suit alleged that AIG committed accounting fraud that culminated in a $3.9 billion restatement in May 2005. 3. Wal-Mart Stores Inc. has agreed in 2010 to pay $27.6 million to settle allegations that it improperly handled and dumped hazardous waste at stores across California Wal-Mart was accused of improperly disposing of pesticide, fertilizer, paint, aerosols and other chemicals. The company will pay $20 million in penalties to the various prosecuting and investigating agencies, more than $1.6 million in investigative costs and $3 million for environmental projects. It also will invest $3 million to guarantee its stores will remain in compliance. Legal Risk could be defined as the combination of a legal norm and a particular event, under uncertainty: an encounter between an event and a legal norm (uncertain event and/or uncertain legal norm). How to identify the link between a legal risk and value destruction? Use the VALUE CHAIN: The sequential set of primary and support activities than a firm performs to turn inputs into value-added outputs for its external customers. 15 Legal Environment and business decision making 1. BRANDS AND DOMAIN NAMES - Legal Uncertainty Factual uncertainty Legal rules dedicated to trademarks - Country culture regarding copies and are not reliable. fake products A changing jurisprudence. - Willingness and capacity of trademarks Company’s policy in the trademarks owners to react domain (registration, licensing, guarantees in the contracts with suppliers) is not sufficiently strong. Value destroyed: - Strategic: weakening of the brand reputation/blow to company’s reputation. - Financial: weakening of the brand equity/fines and damages. Legal Uncertainty Diversity and complexity of the norms applicable to products and to conditions of their manufacturing. 2. STANDARDS FOR THE PRODUCTS - 3. RELATIONSHIPS WITH SUPPLIERS: ABUSIVE TERMINATION, ABUSIVE CLAUSES, VERTICAL RESTRAINTS. - Factual uncertainty - Capacity of the company’s suppliers to comply with these norms. - Capacity of the manufacturers to comply with these norms. - Capacity of the company to control this compliance. Value destroyed: Strategic: blow to company’s reputation. Financial: costs related to the products destruction, fines and damages. Institutional: weakening the level of trust with certification authorities. Legal Uncertainty Factual uncertainty Diversity and complexity of the legal - Financial situation of the supplier rules applicable to suppliers/retailers - Dependency of the supplier relationships (contract law, - Supplier’s tendency to litigate competition law). Doctrine relative to the concept of “relevant market”. Contract clarity Value destroyed: - Strategic: blow to company’s reputation, obligation to change its contract policy. - Financial: fines and damages. - Institutional: weakening the level of trust with competition authorities. 16 Legal Environment and business decision making 4. SUPPLIERS IMPLIED IN CRIMINAL ACTIVITIES 5. WORKING CONDITIONS IN THE WAREHOUSES (WORKERS SAFETY AND WELL-BEING) - - - 6. PROPERTY RIGHTS ON THE SHOPS AND SHOPS RUNNING - 7. CLASS ACTIONS - Legal Uncertainty Factual uncertainty Diversity and complexity of the legal - Difficulty to perfectly know rules related to criminal activities supplier “profile”. (corruption…) Volatility of these legal rules. Value destroyed: - Strategic: blow to company’s reputation. the Legal Uncertainty Factual uncertainty Diversity of the legal rules related to - Works specificities. working conditions. - Tendency of the workers to litigate. Value destroyed: - Strategic: blow to company’s reputation, organizational climate in the company. - Financial: fines and damages, damage cost to bring warehouses into compliance. Legal Uncertainty Factual uncertainty Weak legal system regarding - Fairness, honesty and stability of the property rights. public and judiciary institutions. “Shaky” acquisition contracts. Risk of expropriation Weakness of the administrative authorizations. Value destroyed: - Strategic: loss of property rights, putting at risk the business development. - Financial: loss of property rights, loss of commercial revenues Legal Uncertainty Factual uncertainty Creation of a class action regime in - Ability of the victims to mobilize one country. - Reliability of the company’s products. Conditions for the class recognition. Value destroyed: - Strategic: blow to company’s reputation. - Financial: procedures costs, damages. 17 Legal Environment and business decision making Session 4: Compliance management as value creation In a management context, compliance consists of all organizational measures of a company to deal with the demands of legal and extra-legal norms. Conformity and compliance: mostly the terms are used as synonyms. However, we can make out a slight difference: conformity underlines the voluntary adaptation of one’s behavior to a norm, whereas compliance emphasizes the submission of one’s behavior to the demands of a norm. Compliance management principally targets managers who have decision-making powers! Compliance management is dedicated to: - Prevent organizational liability (civil and penal liability of companies for acts committed by management and employees). Differences between legal systems with regard to the penal liability of corporations (many systems today view the traditional principle “societas delinquere non potest“ as outdated). For example, in France companies have penal liability (see art. 121-2 Code pénal). In Germany there is no general penal liability for companies (however, administrative fines and certain penal sanctions are possible). - To be in accordance with regulatory obligations which oblige companies to have a compliance function. Either because of regulatory incentives or of regulatory pressures (see Siemense case). - Risk management: “ethical risks” for instance viewed as an autonomous reason to subscribe a compliance management program. Indeed, it is more and more a choice to be an ethical company to attract employees, investors, customers… The fields of compliance management are the following: - Employee relations: workplace safety; discrimination; conflicts of interest; sexual harassment… - Corruption - Fraud - Environmental issues - Human Rights - Antitrust , competition - Supply Chain (in particular violation of basic labor rights through suppliers) - Reporting and disclosure, financial reporting - Data protection, employee privacy - Money laundering And it enjoys some instruments: - Board committees (ethics, risk management, sustainable development, …) - Executive committees (ethics, compliance, risk management, …) - Compliance Officers - General Principles of a Company, Corporate Values - Codes of Conduct (Employees, Suppliers – see extra course on “ethics codes”) - Systematic compliance audits - Contact Persons, Functions: Ombudsman, Anonymous hotlines, whistle-blowing - Surveillance and investigations - Training - Discipline and Sanctions - Communication - Participation of employees in elaboration of ethical standards 18 Legal Environment and business decision making The Governance of compliance management concerns the question of how responsibilities and decision-making powers with regard to compliance and ethics are allocated and delegated within an organization. Compliance and ethics management: Adding ethics to compliance management emphasizes that the compliance & ethics function is more than fulfilling legal obligations. Why ethics and compliance? 1. Hypothesis about effectiveness (confirmed in some empirical research, see readings): Ethical “culture” reduces the risk of criminal conduct within an organization. 2. Formulating ethics through internal policies can unite standards throughout a multinational organization that is implanted in different jurisdictions. 3. Ethical decision-making as legal compliance strategy, in particular in areas, in which laws are not clear (see Hewlett Packard Case) Some problems related to compliance management: - Instrumentalisation - Costs vs effectiveness - State-corporate complicity against employees: it’s a win-win situation because the state can “outsource” the enforcement of law and corporations can reduce the risk of penalties and liability. To ease this problem, one can imagine some measures: mandatory requirement for companies to allow legal representation of employees suspected of a crime, regulation of information between corporations and the state… - Paradox of control: On the one hand, a compliance program may be more effective if it promotes a culture of trust, fairness and honesty among employees and management, while on the other, it may be necessary to resort to surveillance and control means, which risk undermining these same values. Corporate Internal Investigations Objective: establish, document and secure facts, when evidence or substantial allegations of illegal or unethical conduct within a company surface. Examples for the use of investigations: - to prepare for litigation/arbitration, - to limit potential regulatory fines, 19 Legal Environment and business decision making - to establish a sound basis for remedial measures and corrections, to identify security and confidentiality leaks to draw conclusions in terms of lessons learned, to cooperate with a regulator or prosecutor, regaining the trust of the company's statutory auditor, disclosure against stakeholders, for example, contractual partners, employees, suppliers shareholders, etc. However, there are ethical choices: - Communication VS secrecy - Employee Cooperation VS putting employee rights at risk, for example privacy and data protection - Proportionality VS investigative effectiveness and rapidity - Independent governance VS control Negative example of corporate internal investigations: Employee Surveillance at Deutsche Telekom: In order to identify a leak of sensitive company information to the public, Deutsche Telekom investigated in telephone records of its supervisory board members, trade union members, and journalists. Employee surveillance at Deutsche Bahn: Deutsche Bahn, spied on more than 1,000 of its own employees, including many top managers in order to identify corruption and other business crime within the company. Among other measures the investigators systematically checked private bank accounts of Deutsche Bahn employees. Pre-texting at Hewlett-Packard (we will discuss this case in detail): In an effort to expose a board member who made unauthorized media disclosures, investigators hired by HP used false pretenses, so called “pre-texting”, to obtain the telephone records of board members, employees and journalists. They also had one board member and some journalists tailed. Initial internal investigation in the Enron affair: Among the many failures in the Enron debacle was the engagement of a law firm that was well familiar with Enron for the internal investigation. See Special Investigative Committee of the Board of Directors of Enron Corp. (2002, p. 176 et seq.). 20 Legal Environment and business decision making Session 5: Managerial powers and duties Powers to represent the company – comparative overview Capacity of the company: the limited use of ultra vires in relation to the validity of a transaction with third parties. The ‘corporate object’ as determined by the founders and shareholders of the company in the constitutional documents used to install some control over management. Today control is exercised differently; ultra vires (beyond delegated powers) is basically used in the internal relationship between the shareholders and the management or the company and the management but not to invalidate transactions towards third parties (as being out of the scope of the company’s delegated powers). Authority of the agent: the company deals through agents that have the power to represent the company. General rules of agency law are applicable – those who have constitutional powers may delegate powers through contract to other employees within the company. Yet, for third parties it is often difficult to know whether the agent has actual authority to bind the company. Powers pursuant to company law: - Company laws generally give power to the board of directors except when it’s about transactions with other directors. - Chain of authority: two-tier structure: supervisory board exceptionally represents the company in its dealing (…) Protection of third parties acting in good faith: Yet, for 3rd parties it is often difficult to know whether the agent has actual authority to bind the company. On what can they rely on? Case by case evaluation, when principal or someone with actual authority creates or allows the impression of authority and when the 3rd party reasonably relies in good faith on such impression, then the agency may be valid, or at least there may be rights for the 3rd party. Executive duties and (civil) liability for damages Remember: Difference between civil liability for damages and penal liability for having committed a crime What is the management liable for? Who can claim and what may be claimed? Liability for negligence, liability for intention but also strict liability: car drivers, if they make an accident but it is not their fault, they are still liable. DUTIES TO WHOM DO MANAGERS OWE DUTIES? o o o Germany: to the company: management must mediate the differing partial interests of employees, creditors and shareholders France: to the company: case to case, often company interest will be congruent with shareholder interests but in some cases it could be that creditor interests or those of other constituencies matter. Delaware: directors must act in the “best interests of the corporation”, which has been interpreted as to represent a fiduciary duty to a company and its shareholders or as to promote the interest of the shareholders. Exceptions possible (creditors, when company approaches insolvency...) Regulating duties: Rules and Standards 21 Legal Environment and business decision making Detailed rules are used, when the problem to be dealt with appears in predictable situations. Rules function ex ante, because they prohibit a certain action or typical behavior. Rules can prevent a disloyal action from happening in the first place, but, since they concern typical situations are rather inflexible. Standards enable judging a situation ex post and are more flexible as they apply to many different types of situations. Typical standards would be the requirement to act “in good faith”, or “in the interests of the company”, to make “fair” transactions, or to “avoid conflicts of interest”. The interpretability of these terms offer flexibility, but bear a good degree of uncertainty. DUTY OF LOYALTY: typical situations in which there is a risk that director may act disloyally... - When a director has a personal interest in a transaction of the company (self dealings)… o The director is the contractual counterparty in the transaction (executive compensation; loan to a director; sale of property by or to a director…) o The director receives a compensation for the transaction’s success or failure (example: fee paid, being fired or promoted because of a merger) - When a director competes with the company or uses business opportunities for him/herself… o The director owns or manages a competing business o The director does not exploit an opportunity for the company but rather for his/her personal benefit. DUTY OF CARE Under many legal systems managers must fulfil duties of care. However, in many jurisdictions, courts will rule that disinterested directors making business decisions in good faith have met their duty of care absent egregious mismanagement. The reason lies in the nature of a business decision that consciously assumes risks of uncertain outcomes. A business decision that turns out the be bad does not trigger liability of the executive director! After all, judging (bad) business decisions ex post would discourage management from taking risks! This principle is expressed differently in various jurisdictions: - U.S.: Business Judgment Rule: ‘a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company’ (Aronson v. Lewis, Supreme Court of Delaware 473 A 2d 805 [1984]). – If a plaintiff can rebut any presumed elements, it’s up to the director to show that the decision was a good one. - Germany: § 93 (1) AktG: German directors are also shielded from judicial review of taking risk. However, the director has the burden to prove that he did not violate the standard of care, whereas the plaintiff corporation only needs to prove the damages to the corporation, and that the conduct of the director caused the damages. - UK: Difference between non-actionable decision that fails to achieve success and actionable ‘serious mismanagement’… - France: liability of executive directors is established on the basis of non-compliance with laws applicable to the company, violation of the company’s statutes and…’mismanagement’ (faute de gestion, see also Art. L. 225-251 c. com). The ‘faute de gestion’ is not defined in the law and has been determined on a case to case basis through jurisprudence. Plaintiffs must prove that a director’s behavior was not conform to the interests of the company (intérêt de la société). PROCEDURES WHO CAN BRING AN ACTION TO ENABLE JUDICIAL REVIEW OF A BUSINESS DECISION? Possible plaintiffs (who can sue the executive management for wrongdoings) “While anybody can bring an action against an executive for wrongdoings, any jurisdiction will provide a shield, that the executive may only be liable to third parties to the extent that the executive was not acting in his/her function of 22 Legal Environment and business decision making directing the company. In most cases, third party claims will be limited towards the company itself. However, typical plaintiffs in actions against executives could be the company itself and its shareholders.” If duties are owed to the company, the obvious plaintiff will be? The Company! ...but what if the board representing the company doesn’t want to sue one of its executive members (for example through a litigation committee or, if existent, through the supervisory board?) Can the shareholders force the company to sue? The question of derivative action… DERIVATIVE ACTIONS - UK: individual shareholders may bring a derivative action “only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company.” (sec. 260 (3) CA 2006). Note: only the company, not the shareholder may obtain damages in a derivative action. Second, the procedure contains a requirement that a shareholder will require the court’s consent to sue – and must overcome a number of hurdles before this consent can be obtained. Thus, while there is a wide expansion of scope of derivative action, procedural safeguards limit abuse of litigation. - Germany: the supervisory board represents the company when suing the management board for corporate wrongs (112, 93 AktG); however, a shareholder derivative action is possible under specific procedure § 147 et seq. AktG: 1 % of share capital or at least 100.000 € share capital - France: any existing shareholder may become plaintiff (but most pay the procedure); a group of shareholders may make a derivative action, but in that case, the group must represent at least 5% of the share capital, or in the case of listed companies a shareholder association may become plaintiff. The shareholder through a “direct action”. In general: reserved for enforcing individual shareholder rights (information rights, participation rights...). Problem: can you claim financial damages through a direct action? The difference to a derivative action is that the shareholder claims own damages and not those of the company. DIRECT ACTIONS The requirements for direct actions differ from jurisdiction to jurisdiction: - France: direct action is not excluded but very limited, in particular with regard to damages claims on the ground of a devaluation of the share value as a consequence of a director’s breach of duties. French jurisprudence requires that the individual shareholder must claim a personal damage and not one that reflects a damage suffered by the company. (for example a disproportional distribution of dividends could be grounds for an individual loss) - Germany: almost as limited as in France. A novelty is a special form of “model action”, in which an investor may bring a damages claim for false, misleading or lacking capital market disclosures, and obtain a “model judgment”, that may be declared binding for all (at least 10) cases that are based on the same facts and concern the same legal issues. - US: direct action in the form of individual actions and class actions are possible under state corporate or federal securities law. Also here courts might dismiss a direct action, if the company’s interest is concerned rather than the individual shareholder’s interest. However the possibility of direct actions is wide. Special attention to actions under Federal securities law: S.E.C. Rule 10b-5, the far-reaching provision which provides a private right of action against companies and directors for material misstatements that affect secondary trading of securities (trade in securities already issued). - UK: similar limitations as in France and Germany (remember: directors owe duties to the company and not directly to the shareholders). Some possibilities to bring direct suits under violations of corporate law and securities fraud under common law and statutory law. Non-executive directors or supervisory board members may also become individually liable for breaches of duties of loyalty or care. However, the nature of their activity must be taken into account… 23 Legal Environment and business decision making Some issues with regards to securities laws: liability for insider trading and liability for (wrongful) disclosure We have seen that the applicability of “securities laws” (laws related to the secondary trading of securities) may trigger further duties of directors, in particular with regard to disclosure, insider trading, directors dealings, executive compensation, etc. But what are securities laws? And what triggers their application? Security is an arrangement, under which individuals “invest money in a common enterprise with the expectation that they would earn a profit solely through the efforts of someone other than themselves. Special duties under securities laws: insider trading. Many duties (and sources of liability) under securities laws will concern stricter rules pertaining to the prohibition and/or disclosure of director’s transactions with the company. In the following, we will focus on insider trading: With regard to directors: doesn’t passing on inside information amount to a breach of confidentiality and result in a violation of duties? So why specific insider trading rules? - Problem: does insider trading damage the company? - Some economists might say that insider trading helps efficiently introduce information into the market prices… - However most agree: insider trading damages the integrity of markets, and also damages the company’s reputation… Who are insiders? What is ‘inside information’? When and how should inside information be disclosed? (When) is it permitted to pass on inside information? When is punishable to trade on the basis of inside information? Let’s have a look at the SEC Rule 10b-5 “Employment of Manipulative and Deceptive Practices” and the EU framework... - It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, o To employ any device, scheme, or artifice to defraud, o To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or o To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, - in connection with the purchase or sale of any security." No general disclose or abstain duty. Misappropriation theory (US Supreme Court in US v. O’Hagan): that misappropriating confidential information for securities trading purposes, in breach of a duty owed to the source of that information, gives rise to a duty to disclose or abstain. Market abuse directive – European Rules concerning Insider training: Directive 2003/6/EC : Model: “Disclose and Abstain” Art. 6 (1) contains the rule that all inside information shall be disclosed as soon as possible. Art. 6 (2) contains the possible exceptions to immediate disclosure (delay of public disclosure) The “Disclose and Abstain” model of the directive entails two problematic consequences: - The notion “inside information” becomes the crucial issue. Art. 1 (1), 1. para. Directive 2003/6/EC : ‘Inside Information’ shall mean information of a precise nature which has not been made public, relating, directly or 24 Legal Environment and business decision making - indirectly, to one or more issuers of financial instruments or to one or more financial instruments and which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments. The framework leaves little room to overcome the conflict between the disclosure obligation and the legitimate interest of companies to keep certain inside information confidential. Insider dealings prohibitions under European directive: Art. 2: Prohibition of trading using any kind of inside information. Art. 3: Prohibition of disclosing inside information to any other person (unless in the normal course of the exercise of employment, profession or duties). Prohibition to recommend or induce other persons to acquire or dispose of financial instruments on the basis of inside information Dislcosure obligation connected to inside information – inherent problems of « disclose and abstain »? Mannix writes in: Euromoney, Feb2003, Vol. 34 Issue 406, p. 34: “Take UK construction company Wolseley, whose share price fell by 12 % last September after it announced asbestos liabilities, even though profits were up 15 % and the company was insured against any damages. (There has been no suggestion of insider dealing in Wolseley stock.) Under the new rules, an insider could have got away with dealing in its stock before the announcement by claiming that a reasonable investor would discount the information on asbestos as immaterial. A reasonable investor would have ignored it because Wolseley had adequate insurance. But investors and markets aren’t always reasonable and the asbestos news did move the stock price.” Disclosure obligation under European framework for insider trading: Art. 6 (1), para. 1 reads: “Member States shall ensure that issuers of financial instruments inform the public as soon as possible of inside information which directly concerns the said issuers” Problem of liability for disclosure: If we compare the liability for mismanagement (for example Business Judgment Rule or faute de gestion) with liability for wrongful or misleading disclosure we will find different logics: - Wrongful disclosure of information pertaining to a company is not a management decision; it does not directly bind the company’s assets, but is directed to mislead stakeholders. - For this reason, liability for disclosure follows its own specific rules. - Disclosure liability therefore mostly comes into play in the context of the secondary trading of securities Some necessary requirements for any disclosure liability: If investors who made their decisions upon wrongfully disclosed information, seek damages, they should prove three things: (a) the wrongful disclosure, (b) the causality between disclosure and the decision to make an investment, and (c) the impact of the disclosure on the share price. The Fraud-on-the-market Theory US Supreme Court in Basic Inc. v. Levinson, 485 US 224 (1988): The theory offers a far-reaching presumption favorable to plaintiffs: it is assumed that where the market for a security is shown to be efficient, the market quickly and completely absorbs all public information and reflects it in the stock price. Under the fraud-on-the-market theory, a plaintiff does not have to prove individual reliance on a specific misrepresentation, as long as the security in question traded in an efficient market and the defendant is unable to rebut the presumption of reliance. However, a plaintiff still must prove loss causation, which requires proof that the stock price declined after a corrective disclosure. That presumption, however, is rebuttable through “[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff or his decision to trade at a fair market price ...” Id. at 248. Large investors are sophisticated enough to make trading decisions based on their own market evaluations. Defendants can seek to prove that plaintiff investors based their investment decisions on other than reliance on fair prices. 25 Legal Environment and business decision making « La perte de chance » See for example: Cass. com., 9 March 2010, aff. EPF Partners, « Attendu que celui qui acquiert ou conserve des titres émis par voie d'offre au public au vu d'informations inexactes, imprécises ou trompeuses sur la situation de la société émettrice perd seulement une chance d'investir ses capitaux dans un autre placement ou de renoncer à celui déjà réalisé » (étendu également au cas de la vente de titres par une jurisprudence précédente). Logic for damages claim: the investor that bases investment decision on wrongful disclosure was not able to invest in other target and lost an opportunity. Consequence: the investor does not recover the losses from the decline of a share price but rather an indemnification for a loss of opportunity. French jurisprudence employs lump sum calculations to specify such “loss of opportunity”. Penal liability – just a few words Who brings the action? What are the possible consequences? Can a third party become party in a penal proceeding against an executive director? Typical torts: Abuse of assets (abus de biens) asset misappropriation Abuse of credit (abus de crédit) Bankruptcy Communication of privileged information Forging of documents, Faux, usage des faux Tax fraud (fraude fiscale) Insider trading (delit initié – see above) Fraudulent valuation of contribution in kind (majoration frauduleuse des apports en nature) Stock price manipulation Non-disclosure of criminal acts Misstatements of financial reports Breach of confidentiality Penal laws may require that any abusive dealings are to the detriment of the company. Case in point: Is using corporate funds for corruption asset misappropriation? What if the executive can prove that the corruption enabled the company to enter into lucrative business projects? France, Cass. Crim. 27 Oct 1997, l’affaire “Carignon” Facts: The mayor of a major French city receives several benefits (an apartment in Paris, luxury cruises, private use of airplanes…) from two corporate groups in exchange of awarding two corporate groups business in the course of the privatization of municipal water distribution services. This is corruption, but is it also asset misappropriation? “(translation) whatever the short term advantage for the company, the use of company funds for the sole purpose of committing a crime such as corruption is contrary to the company’s interests, because this activity exposes the legal entity to the abnormal risk of penal or fiscal sanctions against the company and its directors and it damages the company’s creditworthiness or reputation.”
