Should America Export Natural Gas? The Debate Rages On

With the development of new technology for drilling natural gas in shale formations, both economists and oil & gas experts are projecting shifts in American natural gas usage and supply. What does this mean for the energy market, American energy consumers, and environmental groups?

In 2010, natural gas generated 33.1% of the energy produced and 25.2% of the energy consumed in the United States. The United States Energy Information Administration’s (EIA) Annual Energy Outlook 2012 estimated that domestically produced natural gas will increase by 29% between 2010 and 2035 (from 21.6 trillion cubic feet in 2010 to 27.9 trillion cubic feet in 2035); while still highly speculative, almost all of this increase is attributable to projected growth in shale gas production.

This projected increase is in stark contrast to the turn of the millennium, when U.S. natural gas needs exceeded supply and U.S. companies invested billions into liquefied natural gas (LNG) import facilities. As recently as 2007, more than sixty LNG import projects were proposed in North America. Now, many of these same companies are moving to convert existing import facilities into natural gas exporting centers. Only one LNG export facility has received approval from the Federal Energy Regulatory Commission (FERC) and the U.S. Department of Energy: the Sabine Pass LNG export terminal in Louisiana.

Currently, experts are debating whether America should export natural gas to nations like South Korea and China. In January 2012, the EIA released a study analyzing the effect of increased LNG exports on domestic energy markets, concluding that exporting LNG would raise the price of natural gas domestically while increasing production. Proponents of increased exports (and lower regulatory hurdles) argue that exporting natural gas is vital to stabilizing the price of natural gas in the United States and to stimulating the economy in the long run. Opponents point to the EIA study, arguing that higher domestic prices for natural gas will slow the economy. Environmental groups such as the Sierra Club also oppose LNG exports, arguing that increasing natural gas exports will have negative environmental impacts due to the controversial “hydraulic fracturing” process used to extract gas from shale.

Both Republicans and Democrats are steering clear of this highly contentious issue. Unlike most black-and-white political issues, LNG exports affect not only U.S. consumers concerned with higher prices, but also America’s international allies, rivals, and largest corporations. Furthermore, it pits America’s traditional free-trade orthodoxy against the domestic need for cheaper and longer-term fuel solutions. The U.S. Department of Energy is currently finalizing a study analyzing the commercial effects of exporting LNG to worldwide markets, including China and other Asian economies. The DOE and FERC have declined to approve any more LNG export facilities until the study is released.

The Economic Consequences of the Endangered Species Act in the Central Valley

Who gets the water in the California Bay Delta has been a controversy spanning multiple decades primarily because of the estuary’s importance as a unique environmental habitat and as a valuable natural resource for Central Valley farmers. Near continuous litigation has spawned over the Delta’s designation as a “critical habitat” for a number of endangered species that live in the watershed like the Delta smelt and Chinook salmon. The Central Valley Project (“CVP”) is one of many Bureau of Reclamation water projects that divert northern California’s water from this watershed to Central Valley farmers. However, while these diversions provide necessary water to the agricultural industry, they simultaneously diminish the survival of endangered fish species.

Currently, environmentalists use the Endangered Species Act as the basis for lawsuits seeking to reduce the amount of diverted water. Reducing diversions helps fish species by inhibiting the spread of disease, lowering river temperatures to promote breeding, and increasing the optimal habitat range.

However, disputes arise when there is not enough water to satisfy user demands and protect endangered species at the same time. Drought has exacerbated this problem. For instance, the National Oceanic and Atmospheric Administration has found that recent weather patterns have caused the worst drought in America since 1956. Farmers have responded with increasing challenges to fish protection in order to receive their contractual water allocations from the state and federal water projects. For farmers, limitations on water supply create dire economic consequences, primarily felt by most Americans in the form of increased prices.  Additionally, farmers facing restrictive water allocations react by pumping water from wells, fallowing lands, and switching crops to less water-intensive plants. These usage restrictions negatively affect job creation, access to credit, air pollution, and consequently, the economic viability of central valley farming.

However, there are also economic consequences in satisfying cities’ and farmers’ demands for water.  For example, when salmon fisheries were closed due to lack of water during the early 2000s, California’s economy lost about $150 million.

This year, the drought has stretched beyond California affecting mid-west farmers. As grains become more expensive due to increases in water prices, farmers that rely on these grains to feed their livestock cannot afford to pay these skyrocketing prices, so they pass the expense along to consumers.

The constant polarization of this controversy has served only to make these water allocation disputes more adversarial than necessary. California has to recognize that choosing sides cannot be a viable solution going forward. Interests must be balanced to accommodate California’s growing water demand. If such a balanced solution is not reached, the consequences could be drastic going forward; especially considering California’s population is expected to exceed 40 Million by 2018.

California Governor Jerry Brown’s administration has proposed a plan to try to build a “peripheral canal” around the Delta to satisfy both water users and environmentalists. This next step in California’s water battle is an extensive environmental undertaking with the potential to restore many endangered species populations. However, the project also has a significant price tag ranging from 17 to 50 Billion dollars. The potential gains are plentiful, but critics argue that the price is too high and the positive effects are too uncertain.

Despite these concerns, it’s important that California moves forward in developing a solution that satisfies farming and environmental stakeholders rather than keeping the status quo. Policy makers must recognize that leaving controversial decisions such as this to the judicial system, as has been the tendency in the past, only undermines the state’s long term interests by creating long litigation and leaving important policy decisions to a judiciary ill-suited for the task.

Cap and Trade: The Uncertain Future of California’s Climate Policy

With almost four months between now and the first carbon allowance auction, questions remain about the feasibility and economic impact of California’s Cap-and-Trade program. While the legal question has been resolved, some commentators have been critical about the consequences of California’s environmental policy path.

The California First District Court of Appeals case AIR v. CARB sheds light on recent legal attempts to derail California’s Cap-and-Trade regulations passed under California’s Global Warming Solutions Act, AB 32. As part of the AB 32 Scoping plan, Cap-and-Trade sets government mandated limits, “caps”, on major sources of greenhouse gas emissions from refineries, power plants, industrial facilities, and transportation fuels. The goal of the “cap” is to reduce greenhouse gas emissions to 1990 levels by the year 2020 by incrementally lowering the total amount of green house gases allowed to be emitted. The “Trade” aspect of the program refers to swapping allowances between participants that emit greenhouse gases. If a particular entity’s operations are over its allowances, that facility may buy or trade for extra allowances to increase its limit.

Legal challenges are not the only way opponents resist California’s institution of Cap-and-Trade program. Western States Petroleum Association (WSPA), in combination with Boston Consulting Group (BCG), recently published a study challenging the science and economic repercussions that this policy creates.  In a letter to California Governor Jerry Brown, Catherine Reheis-Boyd, President of the WSPA stated, “[t]he current fuels policies will have significant unintended consequences on California’s refiners, and consequently their employees, consumers and the state.” Brad Van Tassel, Senior Partner and lead researcher for the study, also commented, “California’s [Cap and Trade] policies pose some really impossible challenges for refiners in California that have the potential to disrupt fuel markets and fuel supplies in very serious ways.”

An example of these fuel market disruptions would be the institution of Carbon Intensity Reductions within the AB 32 Low Carbon Fuel Standard (LCFS) that requires facilities to use lower carbon intensity fuels. This mandate creates a 1% reduction in Carbon Intensity by 2013; a 5% reduction by 2017; and a 10% reduction by 2020.

The problem for fuel markets is that only cellulosic ethanol and Brazilian cane ethanol have low enough Carbon Intensities to materially reduce the Carbon Intensity of existing fuels. But cellulosic ethanol cannot be produced in sufficient commercial quantities with today’s technology, and Brazil does not produce enough cane ethanol to meet California’s demand at the specified CI, even if all of it were sent to California. This scenario would require 150% of the current supply of ethanol fuel from Brazil and could possibly stress fuel supply if there is high demand. Others have brought up concerns about the potential for market manipulation, non-compliance, and fraud; as has happened to California before with the electricity markets in 2000-2001.

Despite these concerns, California policy makers have not changed their minds with respect to Cap-and-Trade’s pending institution. Whether it is a belief in California’s capacity to adapt to certain market stressors or the inability to reverse the charted course, none can say for certain. What is certain is that California is heading into uncharted territory, and as in all transitional periods of policy, certain set backs are to be expected. The question then is how many of these set backs are Californians willing to endure in order to preserve California’s environmental image and the benefits of Cap-and-Trade.

Facebook Goes Public: The Tumultuous IPO Process

Is Facebook a force that will define a generation? Or is it a transient manifestation of the bigger social media revolution – springing from the demand to connect using the latest technologies?  While Facebook’s cultural impact raises such philosophical questions, its business model and recent IPO have raised legal questions that are likely going to take just as long to answer.

Throughout Facebook’s history, it has sought to balance its social and corporate missions. In a letter to prospective investors during the IPO process, Mark Zuckerberg remarked that Facebook was built “to accomplish a social mission” of creating a more connected world. Arguably, Facebook has fared well in its social mission. Through the power of networking, Facebook has helped connect diverse populations, crossing geographical, ethnic, and cultural boundaries. In some cases, Facebook even has helped facilitate revolutions. Not surprisingly, Facebook also is in a position to foretell where Internet usage is trending. Through placing certain advertisers in users’ newsfeeds, Facebook has shown the ability to increase traffic to advertisers three-fold.


BITs with the BRICs? Bilateral Investment Treaty negotiations to begin following revised model text

The United States is restarting Bilateral Investment Treaty (BIT) negotiations with BRIC countries (Brazil, Russia, India and China) after a recent revision to the United States’ model BIT.  On April 20, 2012, the Office of the United States Trade Representative (USTR) released the new 2012 model BIT after a lengthy three-year review and revision process.

BIT negotiations with the United States, until recently, had been on hold since 2009.  Upon taking office in 2009, President Obama immediately called for a review of the model text to ensure its consistency with the “public interest” and the Administration’s overall economic agenda, as well as to make certain that “U.S. companies benefit from a level playing field in foreign markets.”

BITs are bilateral agreements between two States aimed to protect private investors (either companies or individuals) of one State operating in the territory of the other host State.  BITs entered into by the United States, unlike Free Trade Agreements (FTAs), have tended to address a more limited number of issues by focusing on treatment of foreign investment once a host State has availed itself to such investment rather than regulating access of foreign investment into the host State.

The United States often takes a hard stance in negotiating BITs, insisting that other countries accept the provisions of its model text.  The model text was last revised in 2004 after President Bush took office.  The United States is currently a party to 46 BITs, including six that have been signed, but not ratified. Worldwide, 178 economies have entered into more than 2500 BITs.

United States BITs are important tools for protecting overseas investment. BITs protect United States companies and individuals investing abroad or facing adverse actions from a host State while invested abroad.  The United States model text aims to afford investors national treatment or most-favored nation treatment, compensation in the event of expropriation, and protections against currency inconvertibility of funds into and out of a host State.  The model text also provides restrictions against imposing performance requirements onto investments, as well as the rights to select top management regardless of nationality and to submit an investment dispute to international arbitration, rather than being subjected to the host State’s domestic courts.

In updating the model text, USTR and the State Department solicited input on provisions relating to dispute settlement, state-owned enterprises, and financial services. Businesses, non-governmental organizations, Congress and the public provided comments. Among other stakeholders, the Advisory Committee on International Economic Policy (ACIEP), which includes Berkeley Law’s Professor David Caron, submitted a report regarding its view of the model text.  As Professor Caron described “the deep challenge for the State Department in considering the many viewpoints expressed was to work at questions of expertise while simultaneously also weighing fundamentally different philosophical and political values.”

The 2012 model BIT made some changes as a result of perceived shortcomings in the prior text.  One such change is that obligations under BITs also extend to entities that are delegated (through formal and informal means) governmental authority, which clarifies concerns that state-owned enterprises were receiving preferential treatment relative to foreign investors. (Article 2.2.a footnote 8).  Another such change relates to prohibitions against performance measures that require an investor to show a preference to 1) the host State’s technology and/or 2) any particular technology.  (Article 8.1.h). A further revision relates to transparency, requiring publication of regulatory actions and transparency into State regulatory matters.  The goal is to appraise investors of upcoming regulatory changes in host States. (Articles 11.3 and 11.4).   Lastly, the 2012 model BIT includes language that places obligations onto host States to recognize, enforce and not derogate from domestic environmental and labor laws (Articles 12.1, 13.1, 12.2, 13.2).  A full analysis of the revisions can be found here.

Ultimately, the Obama Administration declined to adopt many of the modifications proposed during the review.  The 2012 model BIT retains the core substantive investment protections, which include non-discriminatory treatment (Articles 3 and 4), treatment in accordance with customary international law (Article 5) and compensation for expropriation (Article 6).  The text also retained the investor-State dispute settlement clauses (Article 23-36), disappointing some critics of investment treaty arbitration.

Reactions to the new 2012 model BIT are sharply divided between those who want to protect domestic public interests and sovereign rule of law and those who want to protect U.S. investments overseas and eliminate foreign barriers.  The Administration appears to have spent a great deal of effort analyzing the provisions of the model text, but ultimately chose to preserve a similar balance as in the 2004 model.  Admittedly, this is a difficult balance.

While the revisions to the model text will not modify existing treaties, the new provisions will form the basis of future negotiations.  The completion of the new model BIT text seems to have renewed negotiations with both China and India.  Russia has also expressed interest in engaging in negotiations, and the US has sought to engage Brazil in beginning talks.  Other opportunities for negotiation also are emerging with various African countries.

[Note: Professor Caron’s quote added after initial publication]

How Vodafone Changed India’s Taxation of Indirect Share Transfers

If an asset is physically located within India, Indian Revenue has a legitimate tax claim on its disposition.  But a recent case, involving the sale of a telecom company, challenged the taxability of such dispositions.

Factual Background:

In 2005, Vodafone acquired a stake in India’s largest telecom operator, Airtel. India was a huge market, so when another Indian operator, Hutch, came up for sale, Vodafone bid almost $11 billion. To complete this transaction, Vodafone acquired interests in a Cayman Islands corporation, CGP, which owned a majority stake in HEL, which in turn owned Hutch.

Vodafone’s $11 billion represented 51.96% of effective shareholding and 67% of Hutch’s economic value. A prominent audit firm reviewed the deal’s tax implications and concluded there would be no Indian tax consequences, since the transaction involved sale of shares in a Cayman Islands corporation.

Noting that a major telecom operator had changed hands without any taxes on the transaction, the Indian Income Tax Department charged Vodafone, under S. 201 of the Income Tax Act 1961, with flouting S. 195. Under S. 195, anyone paying a foreign company which does not have a tax presence in India must withhold from the purchase price an amount equivalent to the tax chargeable on the transaction.

Vodafone petitioned the Bombay High Court against the charge.  The court concluded that since the transaction had a ”direct effect” on India, it was taxable. The Supreme Court, however, ruled in favor of Vodafone, and chided the Union Government to establish clear tax policy in order to attract foreign investment.

Holdings of the Supreme Court:

1) S. 9 is not a look through provision.

The Court agreed with the purpose of S. 9: income accruing from activities in India must be taxable by India whether the income arises directly or indirectly. Nonetheless, the Tax Department cannot “look through” a transaction, but merely “look at” it to evaluate taxability. If the legislature intended to tax gains arising from transferring the shares of a corporation that owns Indian assets, an indirect accrual of income, then it must explicitly so provide.

2) The control premium exercised in HEL was not a property right extinguished by this transaction.

A parent corporation’s de-facto control over its subsidiaries cannot be equated with a legally enforceable right.  This is especially true in a situation like Vodafone, where the subsidiary enjoys considerable autonomy. The rights transferred to Vodafone were protective or participative rights, transferred normally given to minority shareholders to address concerns of usurpation of control by majority.  Such rights cannot be equated to a property transfer.

3) Legitimate use of multi-jurisdictional entity structures by multinationals is not unjustified.

After evaluating the maze of contractual agreements, the Indian Supreme Court found it vital to the transaction that Vodafone acquired an upstream corporation instead of directly acquiring a stake in HEL. Had Vodafone acquired a 67% direct equity stake, it would have breached India’s cap on foreign investment for the telecom sector.

4) Vodafone was not an assessee in default.

The Indian Supreme Court concluded that Vodafone’s transaction was between two non-residents, and transferred an asset situated outside India. There was no ground for India to tax the transaction, and hence no default by Vodafone.

Retrospective Amendment:

The Indian Government was unhappy with the verdict, and introduced Finance Bill 2012. This bill amends S. 9, overruling the Court’s decision. The bill adds elements that were argued by Revenue before the Court:

  • The rights and entitlements approach: An explanation was attached to S. 2(14), clarifying that “‘property’ includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever.” An explanation was also added to S. 2(47), broadening the definition of transfer to include transfers of rights associated with shares of an Indian corporation.
  • Understanding “through” in S. 9: Explanation 4 has been attached to S. 9, and states that “through” shall be understood as “in consequence of,” “by reasons of,” or “by means of.”
  • Explicit Clarification: If a foreign corporation derives, directly or indirectly, its value substantially from assets located in India, shares of that corporation are deemed situated in India. This amendment has been applied retrospectively from 1st April 1962.


Since the S. 9 amendment dates back to 1962, a series of high-profile acquisitions concerning non-resident parties are suddenly taxable. This is viewed as yet another decision by India to push away foreign investment instead of facilitating it. Though this is not the first time the 1961 Act or S. 9 has been retrospectively amended, this amendment has drawn immense criticism from tax practitioners.

Was the litigation necessary?

For Vodafone the litigation was unnecessary. As the buyer in the transaction, Vodafone was not liable for tax on capital gains. Vodafone was charged as an “assessee in default,” having failed to deduct tax payable by the seller. However, the safe harbor certificate under S. 195 allows the payee to proceed with payment with the assessing officer’s authorization.  Thus, the S. 195 exemption could have prevented this litigation.

The Complexity of the Derivative Action in Asia: An Inconvenient Truth

By Dan W. Puchniak, Assistant Professor, Faculty of Law, National University of Singapore. Author of the forthcoming article in the Berkeley Business Law Journal, “The Derivative Action in Asia: A Complex Reality.”

In this era of globalization, the field of comparative corporate law has come of age.   With corporations and capital increasingly transcending national borders, academics have been on a quest to uncover grand universal truths about corporate law which similarly transcend national borders. Ostensibly, this quest for universal truths has produced impressive results.  Indeed, the field of comparative corporate law has come to be defined by a series of grand theories which all claim universal applicability.

The theory that common law countries provide better protection for shareholders than their civil law counterparts (the “common law superiority theory”) has monopolized the minds of comparative corporate law scholars for over a decade and has been used to explain the postwar dominance of American and British capital markets.  The theory that corporate law regimes around the world are converging on a single optimally efficient shareholder primacy model (the “convergence theory”) has similarly produced a cottage industry of experts and provided a rationale for America’s postwar rise to the position of the world’s leading economic superpower. The theory that shareholders will only sue when the financial benefit of suing exceeds the cost (the “economically motivated and rational shareholder theory”) has become the dominant approach for understanding shareholder litigation around the world and is a byproduct of the Chicago School’s law and economics movement, which has been a bulwark in modern American legal scholarship for the production of grand universal claims.

Indeed, the combined impact of these three grand universal theories has shaped a generation of comparative corporate law scholarship. However, in spite of their monumental impact and grand universal claims, these theories have been primarily derived from and/or evaluated based on the American corporate law and governance experience. More recently, some efforts have been made to test the robustness of these ostensibly universal (American-centric) theories by evaluating their explanatory and predictive value in the context of evidence from other leading Western countries. Thus far, however, limited efforts have been made to test the robustness of these ostensibly universal theories in the context of Asia—an oversight which has become glaring in the face of the immense shift in economic power towards Asia.

My forthcoming article in the Berkeley Business Law Journal, “The Derivative Action in Asia: A Complex Reality,”** which extends upon my forthcoming co-edited Cambridge University Press Book, The Derivative Action in Asia: A Comparative and Functional Approach, attempts to reduce this glaring oversight. The article (and book) uses derivative actions in Asia as a lens to re-evaluate the robustness of the grand universal theories.  It demonstrates that in the context of Asia, the grand universal theories not only mislead, but are often turned on their heads. Indeed, based on evidence from derivative actions, civil law countries in Asia often appear to protect shareholders better than their common law counterparts; the corporate law appears more often to diverge than converge with the American corporate governance model; and the primary driver of derivative actions appears to be politics and not economics.

In this sense, the truth revealed in the article (and book) is an inconvenient one. The fact is that the forces that drive derivative actions in Asia’s leading economies are far too complex to conform to any one grand universal theory. This means that to accurately understand how derivative actions (and, most likely, all other areas of corporate law) function in Asia (and, most likely, everywhere else), it is necessary to consider a myriad of local factors that affect derivative actions in each individual jurisdiction, including the specific regulatory framework, case law, economic forces, corporate governance institutions, sociopolitical environment, and local (but not monolithic Asian) culture.

Such an approach may seem like common sense—because it is. Unfortunately, the field of comparative corporate law has increasingly shunned such an approach in its lust for elegant grand universal theories. Hopefully, the article (and book) will spark a new trend in comparative corporate law scholarship to embrace, rather than avoid, the complex reality that is comparative corporate law—for beautiful academic theories are sure to become historical footnotes unless they actually help explain the world in which we live.

**A link to this article will be added upon publication.

A New Business Model for a High-Demand Market

By Ana Amodaj, J.D. Candidate 2014, UC Berkeley School of Law

LegalZoom, the leading provider of non-lawyer online legal services to consumers, filed an S-1 form last month for an IPO seeking to raise as much as $120 million. Recent success and expansion of companies like LegalZoom into the market for affordable legal services has stirred up debate. The main points of disagreement relate to the sustainability of their business model, and whether such ventures should be allowed to operate outside of the bar regulations imposed on formal legal service providers.

LegalZoom has secured a very large consumer base (totaling over 2 million consumers in the past 10 years) thanks to its unorthodox business model that combines market-driven venture capital with the idea of providing limited, low-cost non-lawyer legal solutions. In essence, this model is a market-generated response to the troubling reality that many residents do not have access to the U.S. civil legal system. In fact, many modest-means and middle-class Americans fall into this “justice gap” because they do not qualify for free legal assistance, but at the same time cannot afford the high cost of retaining legal counsel.

Moreover, the combination of the recent economic downturn with the increasing cost of full-service legal representation has resulted in a surge in pro se litigants, which has slowed down courtrooms and caused procedural delays due to self-representing individuals’ unfamiliarity with the court system. While traditionally opposed to limited representation and quasi-legal services, courts and bar associations are now increasingly supportive of the self-help movement and are encouraging attorneys to perform unbundled services as a way to alleviate the justice gap and provide alternatives for pro se litigants. Several states, including California, even provide user-friendly limited representation forms and guides, rather than requiring filing of a more time-consuming formal pleading.

This change in policy has created an opportunity for companies like LegalZoom to enter the high-volume and high-demand market of consumers seeking any kind of legal assistance they can afford. In theory, these conditions make commoditization of legal services a very lucrative enterprise and even ensure high consumer satisfaction since the market is largely composed of individuals who would have little or no assistance at all, but for this low-cost alternative.

But there is a catch. Because LegalZoom is not exclusively owned by licensed attorneys, it cannot get a license to practice law in the U.S., or employ licensed attorneys to provide legal advice to its customers. Rule 5.4 of the U.S. Rules of Professional Responsibility (“USPR”) explicitly prohibits ownership and investment in U.S. law firms by non-lawyer entities in order to ensure professional independence of lawyers. Under the current regulatory scheme, non-lawyer entities can only distribute self-help materials and cannot provide any form of legal service.

LegalZoom self-identifies as an online service that helps consumers make their own legal documents. However, LegalZoom not only sells software but also employs 400 professional document reviewers. This blurs the line between a limited representation document preparation service and self-help software. Furthermore, whether this business model constitutes the practice of law is a controversial question because subjecting LegalZoom to strict bar regulations would severely limit access to legal services for those unable to afford full or limited representation by legal counsel. On the other hand, allowing investors to dictate the business of a high-volume legal service provider could damage credibility of the legal profession.

LegalZoom has recently settled several class action lawsuits alleging that its business amounts to an unauthorized practice of law, in violation of Rule 5.5 of USPR. The company has stated that losses from such lawsuits are expected to reach $16 million this year and are likely to continue in the future, causing many scholars and practitioners to doubt the practical sustainability of this business model.

Overall, venture capital has entered the high-demand market for affordable legal solutions and the question of whether it is there to stay or will eventually be pushed out by regulation or ethical challenges will have very significant consequences for the market and the legal profession in general.

“I Plead the Fifth,” Says Former Maxim CEO, Over 150 Times.

The Ninth Circuit recently upheld a jury verdict against Maxim Integrated Products Inc.’s former CFO, Carl Jasper, for various fraudulent interstate transactions resulting from stock option backdating. In so doing, the court’s most significant holding was to uphold jury instructions regarding the Jasper’s more than 150 Fifth Amendment invocations.

As background, firms can grant “in the money” options (exercise price is less than the market price), “at the money” (exercise price is equal to the market price), or “out of the money” (the exercise price is greater than the market price). For accounting purposes, companies must book as an expense the value of “in the money” options. They need not do so with “at the money” or “out of the money” options. For tax purposes, a firm may not deduct from its tax liability the value of “in the money” options granted to an employee whose compensation is greater than $1 million. However, firms may deduct the value of “at the money” options. Backdating is when a firm writes an “at the money” option dated as of a certain day in the past when the stock price was lower. Thus, technically, the employee has an “in the money” option (because it can be immediately exercised for a profit), while the firm tracks the option as “at the money” for accounting and tax purposes.

While this practice is legally permissible, it can present civil and criminal liability when a firm overstates its profits and misleads investors. According to the court, from 2000-2005, Maxim overstated its income by $838.3 million, $515 million of which was the result of additional expenses “incurred as a result of stock-based compensation.” The court upheld the jury verdict that Jasper violated SEC Rule 10b-5 by participating in a “scheme to over-state Maxim’s net income,” and that he violated various subsections of 15 U.S.C. § 78(m) by aiding and abetting Maxim’s failure to maintain accurate records.

During the jury trial, the district court permitted the SEC to introduce as evidence a video tape of Jasper repeatedly invoking the Fifth Amendment and thereby “allowed the SEC to introduce written discovery responses” despite Jasper’s attempt to invoke his Fifth Amendment rights 150 times. Jasper argued on appeal that the district court abused its discretion by failing to scrutinize the admissibility of each invocation on a question-by-question basis. However, Ninth Circuit rejected that argument and held that it was within the district court’s discretion to review and admit them all into evidence as a group because: 1) these invocations were presented to and dealt with by the district court at a high level of generality and 2) Jasper “united his invocations into identified groupings of questions.”

Financial Services Providers Race (Cautiously) to Conquer Social Media

The first of this month Goldman Sachs announced that it would be hiring a new “social media community manager.” This report comes on the heels of Morgan Stanley’s announcement in March that it was launching a new social media program designed to enable its nearly 17,800 financial advisers to use Twitter and LinkedIn to disseminate investment information and insights. The moves by these two giants are sure to trigger a race in Wall Street to conquer the social media landscape for financial and investment services.

But why has the financial services industry been so slow to join the social media frenzy? For one, it worries about the legal pitfalls of letting their legions of advisers loose into unchartered territory. And their unease is not totally unfounded. As posted previously on The Network, the Financial Regulatory Authority (FINRA) brought an action last year to suspend and fine a California-based broker $10,000 for promoting certain investments in “a series of ‘misrepresentative and unbalanced’ messages” to her 1,400 Twitter followers. And as recently as a few months ago, the Securities and Exchange Commission (SEC) charged an Illinois-based investment adviser with securities fraud for offering to sell “more than $500 billion in fictitious securities through various social media websites.” These regulatory actions precede a set of notable guidance letters from both the SEC and FINRA, briefly discussed in the prior post, but reviewed in more depth below.