On Ethics, Rhetoric and Civility: A Response to Professor Frankel

One of the many positive attributes of the Harvard Law School Forum on Corporate Governance and Financial Regulation (“Forum”) is that it is democratic. It accepts and posts submissions on its website reflecting a valuable diversity of opinion, philosophy and perspective. Nowhere is this better borne out than in the ongoing back-and-forth discussion regarding a recent, substantively valuable, paper (here) co-authored by SEC Commissioner Dan Gallagher and Stanford Law Professor (and former SEC Commissioner) Joseph Grundfest (summarized on the Forum here). The Paper was critiqued with valuable substantive observations by Professor Jonathan Macey (here, here, and here), some of which were, in turn, responded to by Professor Grundfest (here and here). I foolishly entered this debate on the Forum, acknowledging the valuable insights Professors Grundfest and Macey both were offering, recommending that their continuing debate, and any other contributors to it, focus on the important substance of the Gallagher/Grundfest Paper (here). I had hoped thereby that we all might be spared from certain forms of future commentary (especially of a personal nature) that strayed from the Paper’s and Professor Macey’s scholarly substantive analysis.

In my Forum post, I confirmed the correctness of the Gallagher/Grundfest Paper’s unassailable core observation—irrespective of whether any particular proposal (or the proponent of that proposal) espousing the elimination of staggered boards in fact violated the SEC’s proxy fraud rules—those antifraud rules, by their terms, undoubtedly apply to proponents of shareholder proposals as well as to public companies’ proxy solicitation materials. In submitting my post, I suppose I anticipated that—no matter how balanced a presentation I might endeavor to offer—if emotion were to become a substitute for analysis—I might soon be swept up in any subsequent cross-fire. What I did not expect, however, was that a new voice—belonging to Boston University School of Law’s Professor Tamar Frankel, one of the Country’s pre-eminent legal experts on the application of the federal securities laws to mutual funds and other investment companies (as well as those who advise and manage collective portfolios), would enter the fray, and question the accuracy of my response to a newspaper reporter about prior precedent for a sitting SEC Commissioner to express his views on whether current/recent activities might violate of the law (here).

In her Forum post, Professor Frankel erroneously asserts that there is no precedent for a sitting SEC Commissioner to identify publicly current private sector conduct that he or she believes violates the law (or should be deemed to violate the law). From there, Professor Frankel, apparently concerned about the Gallagher/Grundfest Paper’s title and specific references to Harvard Law School and the Law School’s Shareholder Rights Project (“SRP”), utilizes a variation of a time-tested strategy employed by lawyers defending individuals or entities accused by prosecutors of serious misconduct—namely, prosecute the prosecutors. Attempting to turn the tables on Commissioner Gallagher, Professor Frankel wrongly asserts that he somehow violated SEC Ethics Rules by co-publishing a scholarly analysis of staggered board shareholder proposals.

Professor Frankel’s dismissal of the precedent I cited, although inaccurate, verifies the inherent wisdom of two oft-invoked adages—first, that no good deed ever goes unpunished, and second, be careful what you wish for. I suffer the consequences of the first adage, and Commissioner Gallagher and Professor Grundfest are experiencing the consequences of the second. For my part, having my historical reference disputed surely serves me right for entering the fray, even though I was merely trying to refocus the debate back where I believe it belongs—the substance of the Gallagher/Grundfest Paper—rather than its title. For the co-authors of the Paper, having a provocative title to a serious substantive discourse will attract attention, but not always the attention its authors might have wanted!

And so, unable to prevent the exact situation I sought to prevent by my previous post on the Forum—at least with respect to Professor Frankel’s disputation of my accurate reference to prior SEC precedent I personally witnessed during my first tour of duty at the SEC—I briefly reply to Professor Frankel’s dismissal of my reference to former SEC Commissioner Al Sommer as a precedent, and her unfortunate and incorrect suggestion that Commissioner Gallagher might have violated any provision of law administered by, or applicable to, the SEC.

Precedent

It behooves me to state, at the outset, that the existence or lack of any precedent for Commissioner Gallagher’s co-authorship of the Paper—and there is unquestionable precedent—is wholly beside the main substantive point of the Gallagher/Grundfest Paper, which is whether proponents of shareholder proposals must obey the federal securities laws antifraud provisions. For one thing, there are no restraints on the Paper’s co-author, Professor Grundfest, and that is a blessing for all of us, given Joe’s keen analytical skills, and his creativity in dissecting issues in persuasive fashion, even for those determined not to agree with him. That being the case, Commissioner Gallagher’s co-authorship of the Paper is wholly irrelevant to the validity of the Paper’s analysis. And, it is worth noting, contrary to Professor Frankel’s statement, that Commissioner Gallagher did not “issue” the Paper. It was made available on an academic website to encourage debate and commentary about the substance of the Paper. Thus, it is no answer to say—even if it were true, which it is not—that Commissioner Gallagher’s participation in co-authoring the Paper is unprecedented.

Fortunately, we need not tarry long over the existence or non-existence of precedent. I responded to a NY Times columnist’s question about whether there is precedent for a sitting Commissioner to identify troublesome conduct and assert it violates the law by referencing SEC Commissioner Al Sommer’s attack on several then-current going private transactions. I confess to having an advantage over Professor Frankel—I was SEC Chairman Ray Garrett’s Executive Assistant (today the position is called Chief of Staff), and subsequently the SEC’s General Counsel, when Al gave his pointed commentary on recent going private transactions. The Commission and its Senior Staff were troubled by going private transactions, and furnished Al with analyses of specific transactions prepared by the Staff. Al properly utilized these materials in preparing his speech.

Unfortunately, although Professor Frankel correctly states that Al Sommer’s speech’s only reference to specific companies were the names of companies involved in litigated cases cited in the footnotes to his speech, it glosses over the fact that Al deliberately described the precise details of specific current transactions—transactions that had been in the press—and then characterized those transactions quite harshly and asserted the perpetrators of those transactions were acting unethically, immorally and illegally, and deserved to be sued by someone. Thus, at page 12 of his famous going private speech at Notre Dame (here), Al attacked—among many others—a specific, “recent” going private transaction in the following words, not cited in Professor Frankel’s post, and upon which Professor Frankel seemingly did not focus when drafting her Forum post:

In one recent instance public offerings netted $696,000 for the corporation, over $12,500,000 for the offering shareholders. The corporation has now proposed to acquire all the stock held by minority shareholders for $11.00 per share. If all of the minority shareholders tender, they would receive $3.00 in cash and $8.00 in ten year subordinated debentures (which the company believes will sell at a substantial discount) for shares which were originally offered at $17.50 a share and three years ago at $21.75 a share; the dominant shareholder would go from a 7% interest to 43%, with over 3.7 million dollars (less taxes) provided by the public now safely locked up for her benefit. On a pro forma basis, had all public shares been repurchased on the basis proposed at the beginning of 1973, the corporate profits attributable to her interest would have risen from $236,000 to $1,107,000 in 1973—over 400% and from $167,000 to $688,000 for the first ten months of 1974—again over 400%–and without a single dime of additional investment by her!

I would suggest there is something wrong with that. I would further suggest that under well established legal principles such conduct may also be unlawful.

The company to which Al referred in this passage of his speech was Wells, Rich, Greene, Inc. Al did not include the name of the Company in the text of his speech, but everyone following securities transactions knew immediately that Al was referring to Wells, Rich, Greene, Inc., and its well-known Chairman, Mary Wells. Contemporaneous news articles as well as scholarly journals identified Wells, Rich, Greene, Inc. as the target of Al’s strongly disapproving comments. Al also described other specific going private transactions, in each case obtaining information from the Commission’s Staff, and describing the actual terms of current transactions, and characterizing them as immoral, illegal and deserving of plaintiffs’ and the government’s attention.

I hasten to point out—to preclude ethics charges about my revelation of SEC information from forty years ago—that my identification of Wells, Rich, Greene, Inc. is not based upon my insider’s status at the time Al Sommer gave his speech. In addition to then-current commentary, Al himself published a law review article seventeen years after his Notre Dame speech was delivered (here), and in footnote one of that article confirmed that he both had used SEC Staff analyses and was specifically referring to Wells, Rich, Greene, Inc., in his Notre Dame speech.

Although there are other precedents by other sitting Commissioners (and Chairmen, I might add), one reason I believe Al Sommer’s efforts vis-à-vis going private transactions are an apt precedent for the concerns raised by Commissioner Gallagher and Professor Grundfest about misleading statements in support of shareholder proposals is that Commissioner Gallagher is the most recent luminary honored by Fordham Law School, having delivered the 15^th Annual A.A. Sommer, Jr. Lecture on Corporate, Securities and Financial Law (here). Commissioner Gallagher’s speech is well worth reading, as are all his public statements and pronouncements.

SEC Canon of Ethics

We also need not be detained for long by Professor Frankel’s assertion that Commissioner Gallagher’s “statements raise a serious question as to whether he is acting appropriately as a Commissioner and if he acted with ‘animus, prejudice or vindictiveness.’” They do not. I will be brief here, because almost any response to Professor Frankel—and certainly a lengthy one—might be twisted by some into an implication that a lengthy rebuttal proves her assertion had merit, which would be wholly unwarranted. In a way, it reminds me of the humor my friends and I used around the time we were in the seventh grade, back in Brooklyn, NY, when someone would walk up to me and say, “Harvey, I defended you today. So-and-so said you weren’t fit to live with pigs, and I assured so-and-so that your were!” (Rim shot!!).

Professor Frankel cites the provision of the SEC’s Canon of Ethics relating to investigations, and states that Commissioner Gallagher violated it. As Isaac Asimov wisely advised in an analogous context, “the first step in making rabbit stew is catching the rabbit” (here). Professor Frankel forgot to catch a rabbit before trying to make her rabbit stew! The simple fact is that the Gallagher/Grundfest Paper does not refer to any pending investigation. Moreover, unlike Professor Frankel, others who have suggested that Commissioner Gallagher should proceed through an enforcement referral, rather than an academic policy paper, seem to have concluded that no such investigation exists. If Professor Frankel actually knows there is an ongoing investigation, she may be making an unauthorized disclosure of confidential SEC information. I want to emphasize that I don’t believe Professor Frankel has done any such thing. But it is equally certain that Commissioner Gallagher has not done that, either.

In any event, the co-authors of the Paper did not even suggest that the SEC should investigate the SRP. That makes it puzzling as to why Professor Frankel decided to cite to a provision of the SEC’s Conduct Regulation that has no applicability here. To heap more fuel on her incendiary and erroneous assertion, Professor Frankel then italicizes the Canon’s injunction against a “public pronouncement of the pendency of such an investigation.” I have no idea whether Professor Frankel thinks her emphasis of an otherwise irrelevant passage of the Canon somehow makes it relevant, but it does not, and I am confident she knows that. Nor is it apparent why she has chosen to emphasize that language, since no such pronouncement exists, or was ever made. In any event, as a former SEC Ethics Officer, I can assure Professor Frankel that her concerns about, and her suggestions of, possible impropriety are wholly unwarranted and unjustified.

Giving Professor Frankel her due, and knowing her to value fairness and integrity over rancor, I read her Forum post not as a legitimate attack on Commissioner Gallagher’s ethics or integrity—which are unassailable—but as an effort to make Commissioner Gallagher feel discomfort for co-authoring a paper that utilized a provocative title to make a serious point. A recent post by Harvard Law Professor, Noah Feldman, entitled “Free Speech for Harvard and the SEC” (here), wisely points out that muzzling sitting SEC Commissioners, to prevent them from speaking out about issues of current significance, would be bad public policy, and ultimately bad for the investors and capital markets the SEC serves. To which I respond, “Amen.”

Nonetheless, because of the great respect I have for Professor Frankel, it occurs to me that, perhaps, the co-authors of the Paper might consider a different title for subsequent versions of the Paper—not because they necessarily agree there was anything improper about the original title, but rather, because they wish to have the erudition of legal luminaries, like Professors Macey and Frankel, directed at the substance of the Paper’s analysis, rather than its title. It’s just a thought from someone the law would probably characterize as an “officious intermeddler,” and isn’t anything they should feel obligated to do.

I would also be remiss if I did not acknowledge that those who care deeply about the SEC—and I include Professor Frankel in that group—should rejoice that the Agency is able to attract someone of Dan Gallagher’s stature, ethics, intelligence, creativity and personal grace. And, whatever one thinks of the decisions being reached by the current SEC Commissioners collectively, it behooves us to recognize that the strength of our capital markets depends on substantive debates about topics of great importance, such as the one that is the focus of the Gallagher/Grundfest Paper. It is beneficial for all of us to have five Commissioners on the SEC who continually display the courage of their individual convictions, even if, on occasion, some may harbor doubt about the correctness or wisdom of some of those convictions.