Irrationality and cognitive bias at a closing in Arthur Solmssen's the comfort letter

Fordham Law Review

Volumn 69, Issue 3, 2000, Pages 1111-1137

  Painter, Richard W ^a  

^a UNIVERSITY OF ILLINOIS AT URBANA CHAMPAIGN   (United States)

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EID: 0034560873     PISSN: 0015704X     EISSN: None     Source Type: Journal    
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References (118)

1. 457 F. Supp. 682 (D.D.C. 1978).
2. Id. at 686-87.
3. Id. at 689, 695.
4. Id. at 696-97.
5. Id. at 715. The attorneys representing NSM had settled before trial similar SEC charges brought against them. Id. at 687.
6. Id. at 713.
7. Judge Parker stated that "it is unnecessary to determine the precise extent of their obligations here, since . . . they took no steps whatsoever to delay the closing." Id. at 713. One of the most difficult problems in National Student Marketing is determining what the merging companies' shareholders would have wanted to do had they known about NSM's actual earnings. Would NSM's shareholders have wanted to hurry up and close the deal? Would Interstate's shareholders have wanted a chance to reconsider the merger, knowing that NSM was not as profitable as earlier thought? Would Interstate's shareholders have believed that they were still getting a good deal and that resoliciting shareholder approval posed an unacceptable risk that the merger might be called off? NSM, for example, could try to back out of the deal while the proxy solicitation was in progress. Alternatively, NSM's stock price could, before the merger was closed, go up on account of offsetting good news. NSM might then demand a higher price for the merger. See id. at 694 Thus, even if NSM did not earn as much profit as its financial statements said it did, Interstate's shareholders might still prefer to go ahead and close the deal without delay. There is simply no way of knowing. Because corporations do not have the ability to solicit decisions about a merger at the last minute from widely dispersed shareholders, corporate directors are usually delegated the power to decide whether to close a merger transaction. Unfortunately for the defendants in National Student Marketing, this power did not extend to closing the merger if proxy votes approving the merger were obtained in violation of federal securities laws, particularly when some of the Interstate principals also sold their own NSM shares without disclosing the inaccuracies in NSM's financial statements to the buyers. Notwithstanding the possibility that some profitable deals may be lost as a result of the requirement to re-solicit shareholder approval if defects are discovered in already distributed proxy materials, the SEC, and presumably the courts, would agree that registrants' compliance with federal securities disclosure requirements takes precedence.
8. See Susan P. Koniak, When Courts Refuse to Frame the Law and Others Frame It to Their Will, 66 S. Cal. L. Rev. 1075, 1078-79 (1993) (discussing the conflict between the bar and regulatory agencies over the duties owed by a lawyer). Academic literature also debates the wisdom of imposing on lawyers an affirmative duty to disclose to regulators information which organizational clients are required to disclose but do not. Some commentators argue that mandating lawyer disclosure would interfere with the legitimate objectives of legal representation. See Joseph C. Daly & Roberta S. Karmel, Attorneys' Responsibilities: Adversaries at the Bar of the SEC, 24 Emory L.J. 747, 748 (1975). Professor Kraakman argues that "whistleblowing leaves all regulatory targets at the mercy of their private monitors" and creates for clients "a powerful incentive to withhold information from potential whistleblowers." Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 60 (1986). Other commentators argue, however, that "[u]sing lawyers as gatekeepers and whistleblowers is a relatively inexpensive mechanism to achieve widespread compliance with the law." George H. Brown, Financial Institution Lawyers as Quasi-Public Enforcers, 1 Geo. J. Legal Ethics 637, 718 (1994). The present author has already written extensively on this subject and will not do so again here. See generally Richard W. Painter, The Moral Interdependence of Corporate Lawyers and Their Clients, 67 S. Cal. L. Rev. 507 (1994) (arguing that lawyers often share responsibility for client conduct in business transactions); Richard W. Painter, Toward a Market for Lawyer Disclosure Services: In Search of Optimal Whistleblowing Rules, 63 Geo. Wash. L. Rev. 221 (1995) (proposing that lawyers and clients should voluntarily agree ex-ante that the lawyers will blow the whistle on illegal acts and arguing that this commitment is likely to be viewed favorably by regulators, transaction participants, and investors); Richard W. Painter & Jennifer E. Duggan, Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation, 50 SMU L. Rev. 225 (1996) (proposing a default rule requiring a lawyer to report a corporate client's prospective illegal acts to its full board of directors unless instructed to do otherwise by the client's articles of organization).
9. See Susan P. Koniak, When Courts Refuse to Frame the Law and Others Frame It to Their Will, 66 S. Cal. L. Rev. 1075, 1078-79 (1993) (discussing the conflict between the bar and regulatory agencies over the duties owed by a lawyer). Academic literature also debates the wisdom of imposing on lawyers an affirmative duty to disclose to regulators information which organizational clients are required to disclose but do not. Some commentators argue that mandating lawyer disclosure would interfere with the legitimate objectives of legal representation. See Joseph C. Daly & Roberta S. Karmel, Attorneys' Responsibilities: Adversaries at the Bar of the SEC, 24 Emory L.J. 747, 748 (1975). Professor Kraakman argues that "whistleblowing leaves all regulatory targets at the mercy of their private monitors" and creates for clients "a powerful incentive to withhold information from potential whistleblowers." Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 60 (1986). Other commentators argue, however, that "[u]sing lawyers as gatekeepers and whistleblowers is a relatively inexpensive mechanism to achieve widespread compliance with the law." George H. Brown, Financial Institution Lawyers as Quasi-Public Enforcers, 1 Geo. J. Legal Ethics 637, 718 (1994). The present author has already written extensively on this subject and will not do so again here. See generally Richard W. Painter, The Moral Interdependence of Corporate Lawyers and Their Clients, 67 S. Cal. L. Rev. 507 (1994) (arguing that lawyers often share responsibility for client conduct in business transactions); Richard W. Painter, Toward a Market for Lawyer Disclosure Services: In Search of Optimal Whistleblowing Rules, 63 Geo. Wash. L. Rev. 221 (1995) (proposing that lawyers and clients should voluntarily agree ex-ante that the lawyers will blow the whistle on illegal acts and arguing that this commitment is likely to be viewed favorably by regulators, transaction participants, and investors); Richard W. Painter & Jennifer E. Duggan, Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation, 50 SMU L. Rev. 225 (1996) (proposing a default rule requiring a lawyer to report a corporate client's prospective illegal acts to its full board of directors unless instructed to do otherwise by the client's articles of organization).
10. See Susan P. Koniak, When Courts Refuse to Frame the Law and Others Frame It to Their Will, 66 S. Cal. L. Rev. 1075, 1078-79 (1993) (discussing the conflict between the bar and regulatory agencies over the duties owed by a lawyer). Academic literature also debates the wisdom of imposing on lawyers an affirmative duty to disclose to regulators information which organizational clients are required to disclose but do not. Some commentators argue that mandating lawyer disclosure would interfere with the legitimate objectives of legal representation. See Joseph C. Daly & Roberta S. Karmel, Attorneys' Responsibilities: Adversaries at the Bar of the SEC, 24 Emory L.J. 747, 748 (1975). Professor Kraakman argues that "whistleblowing leaves all regulatory targets at the mercy of their private monitors" and creates for clients "a powerful incentive to withhold information from potential whistleblowers." Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 60 (1986). Other commentators argue, however, that "[u]sing lawyers as gatekeepers and whistleblowers is a relatively inexpensive mechanism to achieve widespread compliance with the law." George H. Brown, Financial Institution Lawyers as Quasi-Public Enforcers, 1 Geo. J. Legal Ethics 637, 718 (1994). The present author has already written extensively on this subject and will not do so again here. See generally Richard W. Painter, The Moral Interdependence of Corporate Lawyers and Their Clients, 67 S. Cal. L. Rev. 507 (1994) (arguing that lawyers often share responsibility for client conduct in business transactions); Richard W. Painter, Toward a Market for Lawyer Disclosure Services: In Search of Optimal Whistleblowing Rules, 63 Geo. Wash. L. Rev. 221 (1995) (proposing that lawyers and clients should voluntarily agree ex-ante that the lawyers will blow the whistle on illegal acts and arguing that this commitment is likely to be viewed favorably by regulators, transaction participants, and investors); Richard W. Painter & Jennifer E. Duggan, Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation, 50 SMU L. Rev. 225 (1996) (proposing a default rule requiring a lawyer to report a corporate client's prospective illegal acts to its full board of directors unless instructed to do otherwise by the client's articles of organization).
11. See Susan P. Koniak, When Courts Refuse to Frame the Law and Others Frame It to Their Will, 66 S. Cal. L. Rev. 1075, 1078-79 (1993) (discussing the conflict between the bar and regulatory agencies over the duties owed by a lawyer). Academic literature also debates the wisdom of imposing on lawyers an affirmative duty to disclose to regulators information which organizational clients are required to disclose but do not. Some commentators argue that mandating lawyer disclosure would interfere with the legitimate objectives of legal representation. See Joseph C. Daly & Roberta S. Karmel, Attorneys' Responsibilities: Adversaries at the Bar of the SEC, 24 Emory L.J. 747, 748 (1975). Professor Kraakman argues that "whistleblowing leaves all regulatory targets at the mercy of their private monitors" and creates for clients "a powerful incentive to withhold information from potential whistleblowers." Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 60 (1986). Other commentators argue, however, that "[u]sing lawyers as gatekeepers and whistleblowers is a relatively inexpensive mechanism to achieve widespread compliance with the law." George H. Brown, Financial Institution Lawyers as Quasi-Public Enforcers, 1 Geo. J. Legal Ethics 637, 718 (1994). The present author has already written extensively on this subject and will not do so again here. See generally Richard W. Painter, The Moral Interdependence of Corporate Lawyers and Their Clients, 67 S. Cal. L. Rev. 507 (1994) (arguing that lawyers often share responsibility for client conduct in business transactions); Richard W. Painter, Toward a Market for Lawyer Disclosure Services: In Search of Optimal Whistleblowing Rules, 63 Geo. Wash. L. Rev. 221 (1995) (proposing that lawyers and clients should voluntarily agree ex-ante that the lawyers will blow the whistle on illegal acts and arguing that this commitment is likely to be viewed favorably by regulators, transaction participants, and investors); Richard W. Painter & Jennifer E. Duggan, Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation, 50 SMU L. Rev. 225 (1996) (proposing a default rule requiring a lawyer to report a corporate client's prospective illegal acts to its full board of directors unless instructed to do otherwise by the client's articles of organization).
12. See Susan P. Koniak, When Courts Refuse to Frame the Law and Others Frame It to Their Will, 66 S. Cal. L. Rev. 1075, 1078-79 (1993) (discussing the conflict between the bar and regulatory agencies over the duties owed by a lawyer). Academic literature also debates the wisdom of imposing on lawyers an affirmative duty to disclose to regulators information which organizational clients are required to disclose but do not. Some commentators argue that mandating lawyer disclosure would interfere with the legitimate objectives of legal representation. See Joseph C. Daly & Roberta S. Karmel, Attorneys' Responsibilities: Adversaries at the Bar of the SEC, 24 Emory L.J. 747, 748 (1975). Professor Kraakman argues that "whistleblowing leaves all regulatory targets at the mercy of their private monitors" and creates for clients "a powerful incentive to withhold information from potential whistleblowers." Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 60 (1986). Other commentators argue, however, that "[u]sing lawyers as gatekeepers and whistleblowers is a relatively inexpensive mechanism to achieve widespread compliance with the law." George H. Brown, Financial Institution Lawyers as Quasi-Public Enforcers, 1 Geo. J. Legal Ethics 637, 718 (1994). The present author has already written extensively on this subject and will not do so again here. See generally Richard W. Painter, The Moral Interdependence of Corporate Lawyers and Their Clients, 67 S. Cal. L. Rev. 507 (1994) (arguing that lawyers often share responsibility for client conduct in business transactions); Richard W. Painter, Toward a Market for Lawyer Disclosure Services: In Search of Optimal Whistleblowing Rules, 63 Geo. Wash. L. Rev. 221 (1995) (proposing that lawyers and clients should voluntarily agree ex-ante that the lawyers will blow the whistle on illegal acts and arguing that this commitment is likely to be viewed favorably by regulators, transaction participants, and investors); Richard W. Painter & Jennifer E. Duggan, Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation, 50 SMU L. Rev. 225 (1996) (proposing a default rule requiring a lawyer to report a corporate client's prospective illegal acts to its full board of directors unless instructed to do otherwise by the client's articles of organization).
13. See Susan P. Koniak, When Courts Refuse to Frame the Law and Others Frame It to Their Will, 66 S. Cal. L. Rev. 1075, 1078-79 (1993) (discussing the conflict between the bar and regulatory agencies over the duties owed by a lawyer). Academic literature also debates the wisdom of imposing on lawyers an affirmative duty to disclose to regulators information which organizational clients are required to disclose but do not. Some commentators argue that mandating lawyer disclosure would interfere with the legitimate objectives of legal representation. See Joseph C. Daly & Roberta S. Karmel, Attorneys' Responsibilities: Adversaries at the Bar of the SEC, 24 Emory L.J. 747, 748 (1975). Professor Kraakman argues that "whistleblowing leaves all regulatory targets at the mercy of their private monitors" and creates for clients "a powerful incentive to withhold information from potential whistleblowers." Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 60 (1986). Other commentators argue, however, that "[u]sing lawyers as gatekeepers and whistleblowers is a relatively inexpensive mechanism to achieve widespread compliance with the law." George H. Brown, Financial Institution Lawyers as Quasi-Public Enforcers, 1 Geo. J. Legal Ethics 637, 718 (1994). The present author has already written extensively on this subject and will not do so again here. See generally Richard W. Painter, The Moral Interdependence of Corporate Lawyers and Their Clients, 67 S. Cal. L. Rev. 507 (1994) (arguing that lawyers often share responsibility for client conduct in business transactions); Richard W. Painter, Toward a Market for Lawyer Disclosure Services: In Search of Optimal Whistleblowing Rules, 63 Geo. Wash. L. Rev. 221 (1995) (proposing that lawyers and clients should voluntarily agree ex-ante that the lawyers will blow the whistle on illegal acts and arguing that this commitment is likely to be viewed favorably by regulators, transaction participants, and investors); Richard W. Painter & Jennifer E. Duggan, Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation, 50 SMU L. Rev. 225 (1996) (proposing a default rule requiring a lawyer to report a corporate client's prospective illegal acts to its full board of directors unless instructed to do otherwise by the client's articles of organization).
14. See Susan P. Koniak, When Courts Refuse to Frame the Law and Others Frame It to Their Will, 66 S. Cal. L. Rev. 1075, 1078-79 (1993) (discussing the conflict between the bar and regulatory agencies over the duties owed by a lawyer). Academic literature also debates the wisdom of imposing on lawyers an affirmative duty to disclose to regulators information which organizational clients are required to disclose but do not. Some commentators argue that mandating lawyer disclosure would interfere with the legitimate objectives of legal representation. See Joseph C. Daly & Roberta S. Karmel, Attorneys' Responsibilities: Adversaries at the Bar of the SEC, 24 Emory L.J. 747, 748 (1975). Professor Kraakman argues that "whistleblowing leaves all regulatory targets at the mercy of their private monitors" and creates for clients "a powerful incentive to withhold information from potential whistleblowers." Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 60 (1986). Other commentators argue, however, that "[u]sing lawyers as gatekeepers and whistleblowers is a relatively inexpensive mechanism to achieve widespread compliance with the law." George H. Brown, Financial Institution Lawyers as Quasi-Public Enforcers, 1 Geo. J. Legal Ethics 637, 718 (1994). The present author has already written extensively on this subject and will not do so again here. See generally Richard W. Painter, The Moral Interdependence of Corporate Lawyers and Their Clients, 67 S. Cal. L. Rev. 507 (1994) (arguing that lawyers often share responsibility for client conduct in business transactions); Richard W. Painter, Toward a Market for Lawyer Disclosure Services: In Search of Optimal Whistleblowing Rules, 63 Geo. Wash. L. Rev. 221 (1995) (proposing that lawyers and clients should voluntarily agree ex-ante that the lawyers will blow the whistle on illegal acts and arguing that this commitment is likely to be viewed favorably by regulators, transaction participants, and investors); Richard W. Painter & Jennifer E. Duggan, Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation, 50 SMU L. Rev. 225 (1996) (proposing a default rule requiring a lawyer to report a corporate client's prospective illegal acts to its full board of directors unless instructed to do otherwise by the client's articles of organization).
15. Arthur R.G. Solmssen, The Comfort Letter (1975). Substantial portions of the chapter from The Comfort Letter which is discussed in this article, are included in John T. Noonan & Richard W. Painter, Professional and Personal Responsibilities of the Lawyer 123-42 (1997). Arthur R.G. Solmssen was admitted to practice in Pennsylvania in 1954, and was a partner, and is now of counsel, at Saul, Ewing, Remick & Saul in Philadelphia, specializing in corporate and municipal securities law. He is also the author of several novels.
16. Arthur R.G. Solmssen, The Comfort Letter (1975). Substantial portions of the chapter from The Comfort Letter which is discussed in this article, are included in John T. Noonan & Richard W. Painter, Professional and Personal Responsibilities of the Lawyer 123-42 (1997). Arthur R.G. Solmssen was admitted to practice in Pennsylvania in 1954, and was a partner, and is now of counsel, at Saul, Ewing, Remick & Saul in Philadelphia, specializing in corporate and municipal securities law. He is also the author of several novels.
17. See Solmssen, supra note 9, at 158-59.
18. See id. at 298.
19. See id. at 260.
20. See Securities Act of 1933, ch. 38, tit. I, § 5 (codified at 15 U.S.C. § 77e (1994)).
21. See Solmssen, supra note 9, at 266-67.
22. See id.
23. See id. at 20.
24. See id. at 11.
25. See id. at 160. In addition, Hewitt Robinson is President of Darby Turbine, Jack Renfrew is Executive Vice President and Chief Operating Officer of CCC, and Frank Fonseca ("the Frenchman") is corporate secretary of CCC. See id. at 10, 160, 169, 277.
26. See id. at 12.
27. See id. at 277-79.
28. See id.
29. See id. at 280-82, 297.
30. Morrisson says: "[N]obody will listen to what engineering people with forty years in the coal business have to say, they let a kid just out of engineering school call the shots about building a coal-burning power plant." Id. at 277. The utility company had specified a full-scale stack gas cleaning system to comply with state environmental regulations and Darby Turbine filled the order by installing the limestone injection system and wet scrubbers, despite Mr. Morrisson's warnings that the system might not work. Id. at 278.
31. Ordway describes the problem with the defective limestone scrubbers: The fly ash and the limestone slurry tended to form hard cement-like deposits that clogged the marble beds, clogged the demisters, clogged the water jets, and clogged the inlets to the scrubbers. They were having so much trouble that the electric company had just refused to pay the last installment of the construction contract. "Can't they operate the plant without the scrubbers?" asked Tommy Sharp. Alex Morrisson shook his head. "Ever seen that valley? River's a hundred yards wide, then there's a railroad track, a highway, a half mile of bottom land, then mountains straight up on both sides. Unless you get a wind blowing down the river the smoke will lie in there, there's three little factory towns strung along that valley, they had to close a chemical plant because they couldn't get rid of the fumes -" Id. at 279.
32. The investigating attorneys were unable to uncover the problem at the power plant being built by Darby: "My God, we climbed all over that plant," said Tommy Sharp. "The underwriters were there, the people from Iselin Bros, were there, nobody said a word about this!" I didn't like the way he sounded. He sounded frightened, and Tommy isn't easily frightened. "Of course they didn't say a word about it." Alex Morrisson was not frightened at all. On the contrary, he sounded pleased. "This was their baby, their brilliant idea, Mike Barkus practically invented the scrubbers, you know -" "Who's Mike Barkus?" I asked. "Mike Barkus is a kid six years out of Carnegie Tech, a kid who's going to show the whole profession how to build coal-fired power plants, a kid who sold this whole ball of wax to people who know all about atomic energy -" Id. at 283.
33. See id. at 280.
34. See id. at 282.
35. According to John Lundquist, the CPA partner in charge of the auditing firm, Pennypacker Poole & Co.: [S]omething happened, you see, a subsequent event that changed the facts. So in the light of these new facts we obviously can't deliver the same letter on Tuesday - at least not in the form required by the underwriters. I can't very well say that nothing has come to my attention that would indicate a material adverse change in consolidated results of operations . . . . Id. at 282.
36. In particular, CCC and its officers, directors, and investment bankers could be liable under § 11 of the 1933 Act. 15 U.S.C. § 77k(a) (1994). In addition, if intent to defraud or recklessness can be shown, they may be liable under § 10(b) of the 1934 Act. Id. § 78j(b).
37. See Solmssen, supra note 9, at 296, 322. Underwriters sometimes place a sticker on the prospectus notifying prospective investors of material changes to the registrants' financial condition that are discovered after the effective date of the registration statement.
38. Sticky offerings can also pose regulatory problems for the underwriters. See generally Daniel J. Winnike & Christopher E. Nordquist, Federal Securities Law Issues for the Sticky Offering, 48 Bus. Law. 869 (1993) (describing securities law problems that arise when an underwriter takes part of an unsuccessful offering into its investment account and later tries to resell the securities).
39. See supra note 7 and accompanying text.
40. Solmssen, supra note 9, at 297-98.
41. See supra text accompanying notes 1-7 (discussing National Student Marketing).
42. See Solmssen, supra note 9, at 325.
43. Id. at 301-02.
44. Id. at 322.
45. Id. at 322-25.
46. See id. at 325-26.
47. Indeed, the entire point of due diligence, in which lawyers for both the issuer and the underwriters carefully investigate every aspect of the issuer's business, is to discover and disclose in the preliminary prospectus anything that would be material to an investor's decision to buy the issuer's securities.
48. See supra notes 23-25 and accompanying text.
49. See, e.g., Richard A. Posner, Rational Choice, Behavioral Economics, and the Law, 50 Stan. L. Rev. 1551 (1998) (advocating rational actor model); Christine Jolis, Cass R. Sunstein, and Richard Thaler, Theories and Tropes: A Reply to Posner and Kelman, 50 Stan. L. Rev. 1593, 1599 (1998) (criticizing rational actor model).
50. See, e.g., Richard A. Posner, Rational Choice, Behavioral Economics, and the Law, 50 Stan. L. Rev. 1551 (1998) (advocating rational actor model); Christine Jolis, Cass R. Sunstein, and Richard Thaler, Theories and Tropes: A Reply to Posner and Kelman, 50 Stan. L. Rev. 1593, 1599 (1998) (criticizing rational actor model).
51. See Posner, supra note 42, at 1556-57 (assuming that irrational smokers respond randomly to an increase in the tax on cigarettes). According to Judge Posner, "[i]f the distribution of these random behaviors has the same mean as the rational smokers' reaction to the tax, the effect of the tax on the quantity demanded of cigarettes will be identical to what it would be if all cigarette consumers were rational." Id. But see Jolls et al., supra note 42, at 1599 ("[Judge Posner's argument] is a common response to behavioral economics, and conceivably it could be true; but there is absolutely no reason to think it is, and (as is usually the case) none is offered by the source of the criticism."). Irrationality and cognitive biases are two distinct phenomena which are discussed separately in this article.
52. See Jolls et al., supra note 42, at 1599; Posner, supra note 42, at 1556-57.
53. Solmssen, supra note 9, at 289-91.
54. Id. at 291-92.
55. See Noonan & Painter, supra note 9, at 359-60 (discussing substance abuse in the legal profession).
56. See Solmssen, supra note 9, at 322-25.
57. See id. at 323-24. 50. Id. at 324.
58. See id.
59. Charlie's arguments reflect sentiments repeatedly expressed by persons of perhaps more profound intellect. Former President Richard Nixon's sense of persecution by a hostile "establishment" was a recurring theme both in his early career and throughout Watergate. See, e.g., Abuse of Power, The New Nixon Tapes 373 (Stanley I. Kutler ed., 1997) (transcript of a recording of Nixon telling Henry Kissinger on April 29, 1973: "And the man who . . . would be trusted by the so-called damned establishment is Elliot Richardson."). This sense of persecution eventually became an excuse for Nixon to ignore the ramifications of his refusal to obey the law. Some thinkers on both the right and left have lent a seemingly sophisticated theoretical touch to such rationalization by asserting that laws are primarily, if not exclusively, instruments used by one dominant group to oppress others. See generally Matthew W. Finkin, Quatsch!, 83 Minn. L. Rev. 1681 (1999) (discussing how the criticism of Western liberal orthodoxy by Carl Schmitt and other National Socialist legal scholars fell on willing ears after Germany's humiliation at the hands of the Allies in World War I, and how "law as oppression" arguments have again surfaced in deconstructionist scholarship of the 1980's and 1990's).
60. Charlie's arguments reflect sentiments repeatedly expressed by persons of perhaps more profound intellect. Former President Richard Nixon's sense of persecution by a hostile "establishment" was a recurring theme both in his early career and throughout Watergate. See, e.g., Abuse of Power, The New Nixon Tapes 373 (Stanley I. Kutler ed., 1997) (transcript of a recording of Nixon telling Henry Kissinger on April 29, 1973: "And the man who . . . would be trusted by the so-called damned establishment is Elliot Richardson."). This sense of persecution eventually became an excuse for Nixon to ignore the ramifications of his refusal to obey the law. Some thinkers on both the right and left have lent a seemingly sophisticated theoretical touch to such rationalization by asserting that laws are primarily, if not exclusively, instruments used by one dominant group to oppress others. See generally Matthew W. Finkin, Quatsch!, 83 Minn. L. Rev. 1681 (1999) (discussing how the criticism of Western liberal orthodoxy by Carl Schmitt and other National Socialist legal scholars fell on willing ears after Germany's humiliation at the hands of the Allies in World War I, and how "law as oppression" arguments have again surfaced in deconstructionist scholarship of the 1980's and 1990's).
61. This belief that law is a tool to oppress others stubbornly persists because it is partially true - laws, including professional responsibility rules, are promulgated by persons in power and sometimes are designed to perpetuate that power. See generally Richard L. Abel, United States: The Contradictions of Professionalism, in I Lawyers in Society (Richard L. Abel & Philip S.C. Lewis eds., 1988) (excerpted and discussed in Noonan & Painter, supra note 9, at 753-61). However, law is a lot more. Law also reflects the values of the society it governs - for example, there is a social consensus that someone should not sell securities to the public without truthful disclosure and that a lawyer should not assist a client in such conduct. See supra notes 1-7, 29 and accompanying text. Persons who violate the law either reject some of those values or subordinate them in importance to their own objectives. Teaching professional responsibility solely from the "critical" view - that professional responsibility rules are designed to preserve privilege within the bar rather than to promote professional ethics - invites students later in life to indulge in the type of rationalization used by Charlie Conroy to justify actions that amount to nothing more than selfish avoidance or even violation of the law.
62. See, e.g., Amos Tversky & Daniel Kahneman, Advances in Prospect Theory: Cumulative Representation of Uncertainty, 5 J. Risk & Uncertainty 297 (1992); Daniel Kahneman & Amos Tversky, Choices, Values and Frames, 39 Am. Psychologist 341, 342-44 (1984); Daniel Kahneman & Amos Tversky, Prospect Theory: An Analysis of Decision under Risk, 47 Econometrica 263 (1979); see also John C. Hershey & J.H. Schoemaker, Risk Taking and Problem Context in the Domain of Losses: An Expected Utility Analysis, 47 J. Risk Ins. 111, 120-29 (1980) (offering additional empirical support for Kahneman and Tversky's theory).
63. See, e.g., Amos Tversky & Daniel Kahneman, Advances in Prospect Theory: Cumulative Representation of Uncertainty, 5 J. Risk & Uncertainty 297 (1992); Daniel Kahneman & Amos Tversky, Choices, Values and Frames, 39 Am. Psychologist 341, 342-44 (1984); Daniel Kahneman & Amos Tversky, Prospect Theory: An Analysis of Decision under Risk, 47 Econometrica 263 (1979); see also John C. Hershey & J.H. Schoemaker, Risk Taking and Problem Context in the Domain of Losses: An Expected Utility Analysis, 47 J. Risk Ins. 111, 120-29 (1980) (offering additional empirical support for Kahneman and Tversky's theory).
64. See, e.g., Amos Tversky & Daniel Kahneman, Advances in Prospect Theory: Cumulative Representation of Uncertainty, 5 J. Risk & Uncertainty 297 (1992); Daniel Kahneman & Amos Tversky, Choices, Values and Frames, 39 Am. Psychologist 341, 342-44 (1984); Daniel Kahneman & Amos Tversky, Prospect Theory: An Analysis of Decision under Risk, 47 Econometrica 263 (1979); see also John C. Hershey & J.H. Schoemaker, Risk Taking and Problem Context in the Domain of Losses: An Expected Utility Analysis, 47 J. Risk Ins. 111, 120-29 (1980) (offering additional empirical support for Kahneman and Tversky's theory).
65. See, e.g., Amos Tversky & Daniel Kahneman, Advances in Prospect Theory: Cumulative Representation of Uncertainty, 5 J. Risk & Uncertainty 297 (1992); Daniel Kahneman & Amos Tversky, Choices, Values and Frames, 39 Am. Psychologist 341, 342-44 (1984); Daniel Kahneman & Amos Tversky, Prospect Theory: An Analysis of Decision under Risk, 47 Econometrica 263 (1979); see also John C. Hershey & J.H. Schoemaker, Risk Taking and Problem Context in the Domain of Losses: An Expected Utility Analysis, 47 J. Risk Ins. 111, 120-29 (1980) (offering additional empirical support for Kahneman and Tversky's theory).
66. Jeffrey J. Rachlinski, Gains, Losses, and the Psychology of Litigation, 70 S. Cal. L. Rev. 113, 124 (1996) (citing over a dozen studies confirming this cognitive bias in monetary gambles, life threatening choices, purchasing decisions, and other situations).
67. See id. at 124-25.
68. See id. at 125 n.52.
69. See id. at 128-30; see also Chris Guthrie, Better Settle Than Sorry: The Regret Aversion Theory of Litigation Behavior, 1999 U. Ill. L. Rev. 43, 45 (discussing Rachlinski's framing theory of litigation).
70. See Rachlinski, supra note 55, at 124 n.50 (citing Henry S.J. Robben et al., Decision Frame and Opportunity as Determinants of Tax Cheating: An International Experimental Study, 11 J. Econ. Psychol. 341 (1990)).
71. See id. at 142.
72. Donald C. Langevoort & Robert K. Rasmussen, Skewing the Results: The Role of Lawyers in Transmitting Legal Rules, 5 S. Cal. Interdisc. L.J. 375, 379 (1997).
73. See id. at 377-78. Agency problems explain part of this risk aversion. See Donald C. Langevoort, The Epistemology of Corporate-Securities Lawyering: Beliefs, Biases and Organizational Behavior, 63 Brook. L. Rev. 629, 655 (1997) ("A lawyer loses far more by giving the go ahead to a course of action that is later subject to legal sanction than she gains from advice that is not challenged. On the other hand, there is frequently no reputational penalty from too much caution because the client lacks the knowledge and expertise to second-guess the lawyer's judgment. In sum (and subject to some predictable exceptions), lawyers are motivated to overstate legal risk."). The importance of caution as a sociological norm of the legal profession could also be a factor. See Langevoort & Rasmussen, supra note 61, at 413-19 (discussing caution as a norm in the legal profession and the possibility that overstating legal risk could be a technique to influence clients toward caution). Psychological biases also might cause lawyers to overestimate risk. See id. at 423-26 (discussing "defensive pessimism" or the tendency to over-weigh negative outcomes); id. at 426-28 (discussing "accountability" bias or the tendency toward caution when it is known that the evaluation will itself likely be evaluated later); id. at 428-30 (discussing self-interest-ego bias or the tendency to find risk when the evaluator benefits from its presence). Other psychological biases, however, may cause a lawyer to underestimate risk. Id. at 422-23 (discussing three such biases: "cognitive conservatism," which causes people to ignore new law or facts contradicting a prior schema that is likely to be constructed around the client's intended course of action; "commitment" bias, which induces people to stick with a schema even in the face of adverse law or facts; and bias toward overoptimism).
74. Once again, other cognitive biases may also come into play. See Donald C. Langevoort, Where Were the Lawyers? A Behavioral Inquiry into Lawyers' Responsibility for Clients' Fraud, 46 Vand. L. Rev. 75, 101-11 (1993) (positing that lawyers may not be good monitors of their client's conduct because they are motivated by a number of biases to see their client's activities as permissible).
75. See Rachlinski, supra note 55, at 134-35 (discussing how subjects in litigation settlement negotiation simulation studies overestimate their chances of winning and therefore perceive their own risk-preferring reservation prices to be risk-averse) (citing George Loewenstein et al., Self-Serving Assessments of Fairness and Pretrial Bargaining, 22 J. Legal Stud. 135 (1993)).
76. See Solmssen, supra note 9, at 325.
77. See 15 U.S.C. § 77k (1994).
78. Id.
79. It is not clear that Harry Hatch's firm would necessarily have lost its legal fee if the First Hudson underwriters lost their underwriting fee. Nevertheless, because underwriters often use the same outside law firm to represent them on many transactions, the lawyers representing them may identify strongly with the interests of the underwriters, thus increasing their "commitment" bias to their clients. See generally Langevoort & Rasmussen, supra note 61, at 422-23; Donald C. Langevoort, Organized Illusions: A Behavioral Theory of Why Corporations Mislead Stock Market Investors (and Cause Other Social Harms), 146 U. Pa. L. Rev. 101 (1997) [hereinafter Langevoort, Organized Illusions] (discussing commitment bias). Furthermore, in some cases the law firm may have an informal understanding with their underwriter clients that they will write off a substantial portion of their fee in unsuccessful deals in return for charging a premium in deals that are successful.
80. Solmssen, supra note 9, at 325.
81. See id. at 282, 325.
82. See Langevoort, Organized Illusions, supra note 68, at 157.
83. Id. at 135-39.
84. Sara Kiesler & Lee Sproull, Managerial Response to Changing Environments: Perspectives on Problem Sensing from Social Cognition, 27 Admin. Sci. Q. 548, 549 (1982); Langevoort, Organized Illusions, supra note 68, at 135-39, 136 n.118 (citing Dennis A. Gioia, Pinto Fires and Personal Ethics: A Script Analysis of Missed Opportunities, 11 J. Bus. Ethics 379 (1992) (discussing how Ford Motor's product-recall personnel missed danger signs associated with the Pinto's on-road performance because of a "normalcy" schema that refused to admit that there were problems with the car's design)).
85. Sara Kiesler & Lee Sproull, Managerial Response to Changing Environments: Perspectives on Problem Sensing from Social Cognition, 27 Admin. Sci. Q. 548, 549 (1982); Langevoort, Organized Illusions, supra note 68, at 135-39, 136 n.118 (citing Dennis A. Gioia, Pinto Fires and Personal Ethics: A Script Analysis of Missed Opportunities, 11 J. Bus. Ethics 379 (1992) (discussing how Ford Motor's product-recall personnel missed danger signs associated with the Pinto's on-road performance because of a "normalcy" schema that refused to admit that there were problems with the car's design)).
86. Jack Renfrew: "Shoulda gotten rid of [Alex Morrisson] years ago. . . . Alex is a holdover from the old gang, from before Charlie got control, he's got a chip on his shoulder because other people have been put on top of him, and underneath him too." Solmssen, supra note 9, at 283.
87. Langevoort, Organized Illusions, supra note 68, at 139-41, 140 nn.133 & 135 (citing Martin E.P. Seligman, Learned Optimism 100-12 (1991), and Edward J. Zajac & Max H. Bazerman, Blind Spots for Industry and Competitor Analysis: Implications of Interfirm (Mis)perceptions for Strategic Decisions, 16 Acad. Mgmt. Rev. 37 (1991)).
88. Langevoort, Organized Illusions, supra note 68, at 139-41, 140 nn.133 & 135 (citing Martin E.P. Seligman, Learned Optimism 100-12 (1991), and Edward J. Zajac & Max H. Bazerman, Blind Spots for Industry and Competitor Analysis: Implications of Interfirm (Mis)perceptions for Strategic Decisions, 16 Acad. Mgmt. Rev. 37 (1991)).
89. Donald C. Langevoort, Taking Myths Seriously: An Essay for Lawyers, 74 Chi.-Kent L. Rev. 1569, 1581 (2000) [hereinafter Langevoort, Myths] ("Myth-making is stable in an evolutionary sense even among the 'fittest.'").
90. Solmssen, supra note 9, at 300.
91. See id. at 322-23.
92. Langevoort, Myths, supra note 76, at 1581.
93. See Langevoort, Organized Illusions, supra note 68, at 142-43, 142 n.142 (citing Barry M. Staw, The Escalation of Commitment to a Course of Action, 6 Acad. Mgmt. Rev. 577, 584 (1981)).
94. Charlie remarks: We run into a few problems and the Messrs. Conyers & Dean develop cold feet. Oh, they don't mind collecting two or three hundred grand in fees every year, even from the gardener's son - it's all money, after all - but when we get down to the nitty-gritty, when the client really has his balls in the wringer, then Messrs. Conyers & Dean suddenly develop very high ethics -. Solmssen, supra note 9, at 323.
95. See id.
96. See Langevoort, Organized Illusions, supra note 68, at 143-46, 144 n.149 (citing Dennis A. Gioia, Self-Serving Bias as a Self-Sensemaking Strategy: Explicit vs. Tacit Impression Management, in Impression Management in the Organization 219, 230-33 (Robert A. Giacalone & Paul Rosenfeld eds., 1989)).
97. Auditors who certify an issuer's books and records may not be compensated by contingent fees. American Institute of Certified Public Accountants (AICPA) Code of Prof 1 Conduct R. 302.01, at http://www.aicpa.org/about/code/et302.htm (last visited Oct. 24, 2000). The AICPA Rule defines a contingent fee as "a fee established for the performance of any service pursuant to an arrangement in which no fee will be charged unless a specified finding or result is attained, or in which the amount of the fee is otherwise dependent upon the finding or result of such service." Id. In addition, the SEC has proposed rules that extend this prohibition to contingent fees paid to the auditors' firm for other services. Revision of the Commission's Auditor Independence Requirements, SEC Release Nos. 33-7870, 34-42994, 35-27193, 2000 SEC LEXIS 1389 (June 30, 2000) Proposed rule 2-01(c)(5) states that an accountant is not independent under the SEC's standard if the accountant provides any service to an audit client or an affiliate of an audit client for a contingent fee. Id. 85. Auditors are specifically mentioned in § 11 as potential defendants with respect to the portions of the registration statement for which they are responsible, namely the audited financial statements. See 15 U.S.C. § 77k(a) (1997).
98. See supra note 84.
99. Such an ownership interest is perceived to destroy the independence of an accountant with respect to the client. See Codification of Financial Reporting Policies § 602.02(b), Fed. Sec. L. Rep. (CCH) ¶ 73,258, at 62,886 (1988); AICPA Codification of Statements on Auditing Standards No. 1, AU § 220.03 ("[A]n auditor with a substantial financial interest in a company might be unbiased in expressing his opinion on the financial statements of the company, but the public would be reluctant to believe that he was unbiased."); see also Revision of the Commission's Auditor Independence Requirements, SEC Release Nos. 33-7870, 34-42994, 35-27193, supra note 84 (proposing clarification of SEC rules on ownership interests in clients held by partners of auditing firms).
100. Such an ownership interest is perceived to destroy the independence of an accountant with respect to the client. See Codification of Financial Reporting Policies § 602.02(b), Fed. Sec. L. Rep. (CCH) ¶ 73,258, at 62,886 (1988); AICPA Codification of Statements on Auditing Standards No. 1, AU § 220.03 ("[A]n auditor with a substantial financial interest in a company might be unbiased in expressing his opinion on the financial statements of the company, but the public would be reluctant to believe that he was unbiased."); see also Revision of the Commission's Auditor Independence Requirements, SEC Release Nos. 33-7870, 34-42994, 35-27193, supra note 84 (proposing clarification of SEC rules on ownership interests in clients held by partners of auditing firms).
101. Such an ownership interest is perceived to destroy the independence of an accountant with respect to the client. See Codification of Financial Reporting Policies § 602.02(b), Fed. Sec. L. Rep. (CCH) ¶ 73,258, at 62,886 (1988); AICPA Codification of Statements on Auditing Standards No. 1, AU § 220.03 ("[A]n auditor with a substantial financial interest in a company might be unbiased in expressing his opinion on the financial statements of the company, but the public would be reluctant to believe that he was unbiased."); see also Revision of the Commission's Auditor Independence Requirements, SEC Release Nos. 33-7870, 34-42994, 35-27193, supra note 84 (proposing clarification of SEC rules on ownership interests in clients held by partners of auditing firms).
102. If the auditors were caught, they might be liable for insider trading if they knew about the problem when they sold their shares. See generally Selective Disclosure and Insider Trading, SEC Release Nos. 33,7881, 34-43154, 2000 WL 1239722, 2000 WL 1201556 (Aug. 15, 2000) (final rules effective Oct. 23, 2000)
103. See supra note 87.
104. See generally Debra Baker, Who Wants to Be a Millionaire?: Law firms investing in hot high-tech IPOs are making a fortune, but some critics worry the stock craze is clouding ethics matters, 86 A.B.A. J. 36 (Feb. 2000).
105. See id.
106. ABA Comm. on Ethics and Prof'l Responsibility, Formal Op. 00-418 (2000); see also Model Rules of Professional Conduct R. 1.7(b) (1987) [hereinafter Model Rules] ("A lawyer shall not represent a client if the representation of that client may be materially limited by the lawyer's responsibilities to another client or to a third person, or by the lawyer's own interests, unless . . . the lawyer reasonably believes the representation will not be adversely affected . . . [and] the client consents after consultation." (emphasis added)).
107. ABA Comm. on Ethics and Prof'l Responsibility, Formal Op. 00-418 (2000); see also Model Rules of Professional Conduct R. 1.7(b) (1987) [hereinafter Model Rules] ("A lawyer shall not represent a client if the representation of that client may be materially limited by the lawyer's responsibilities to another client or to a third person, or by the lawyer's own interests, unless . . . the lawyer reasonably believes the representation will not be adversely affected . . . [and] the client consents after consultation." (emphasis added)).
108. Model Rules, supra note 92, R. 2.1 ("In representing a client, a lawyer shall exercise independent professional judgment and render candid advice.")
109. See id. R. 1.5(c) ("A fee may be contingent on the outcome of the matter for which the service is rendered.").
110. See Richard W. Painter, Litigating on a Contingency: A Monopoly of Champions or a Market for Champerty, 71 Chi.-Kent L. Rev. 625 (1995) (describing the incentives that can arise out of a contingent fee arrangement and the prospect of overcharging); Richard W. Painter, The New American Rule: A First Amendment to the Client's Bill of Rights, Civ. Just. Rep. 1 (March 2000), at http://www.manhattan-institute.org/html/cjr_l.htm (recommending that contingent-fee lawyers be required to choose for each case, and then disclose to the client a dollars-per-hour limit on how high the contingent fee can go).
111. See Richard W. Painter, Litigating on a Contingency: A Monopoly of Champions or a Market for Champerty, 71 Chi.-Kent L. Rev. 625 (1995) (describing the incentives that can arise out of a contingent fee arrangement and the prospect of overcharging); Richard W. Painter, The New American Rule: A First Amendment to the Client's Bill of Rights, Civ. Just. Rep. 1 (March 2000), at http://www.manhattan-institute.org/html/cjr_l.htm (recommending that contingent-fee lawyers be required to choose for each case, and then disclose to the client a dollars-per-hour limit on how high the contingent fee can go).
112. See Daniel Hertzberg & James B. Stewart, Contingency Legal Fee for Merger Breaks Ground, Stirs Controversy, Wall St. J., Oct. 24, 1986, at 31 (discussing "performance fee" charged by Wachtell Lipton and Skadden Arps).
113. See Krysten Crawford & Karen Hall, High Rollers, Am. Law., Feb. 2000, at 19; Krysten Crawford & Karen Hall, AOL-Time Warner Merger A Big Gamble for Firm, The Legal Intelligencer, Jan. 21, 2000, at 4.
114. See Krysten Crawford & Karen Hall, High Rollers, Am. Law., Feb. 2000, at 19; Krysten Crawford & Karen Hall, AOL-Time Warner Merger A Big Gamble for Firm, The Legal Intelligencer, Jan. 21, 2000, at 4.
115. According to the New York Law Journal: The $35 million is all-inclusive, said one person familiar with the fee arrangement; it covers "everything touching getting this deal done." There is one exception. While no partner time - neither litigation nor corporate -will be paid if the deal dies, Cravath negotiated a cushion that allows it to recover fees for associates' time spent on document production. Cravath has agreed not to bill Time Warner for the first $1 million of work on the deal. Beyond that and up to $5 million, Time Warner will pay half of the associates' billings. Associate hours spent on document production in excess of $5 million will be paid in full. That could cover thousands of billable hours spent producing documents in connection with regulatory filings as well as shareholder suits. "What that tells me," said one M&A expert, "is that Cravath was not willing to assume the risk of an eternal battle." Krysten Crawford & Karen Hall, Cravath's $35 Million Fee Wager; Time Warner M&A on Contingency, N.Y. L.J., Jan. 20, 2000, at 1.
116. According to the New York Law Journal: The $35 million is all-inclusive, said one person familiar with the fee arrangement; it covers "everything touching getting this deal done." There is one exception. While no partner time - neither litigation nor corporate - will be paid if the deal dies, Cravath negotiated a cushion that allows it to recover fees for associates' time spent on document production. Cravath has agreed not to bill Time Warner for the first $1 million of work on the deal. Beyond that and up to $5 million, Time Warner will pay half of the associates' billings. Associate hours spent on document production in excess of $5 million will be paid in full. That could cover thousands of billable hours spent producing documents in connection with regulatory filings as well as shareholder suits. "What that tells me," said one M&A expert, "is that Cravath was not willing to assume the risk of an eternal battle." Krysten Crawford & Karen Hall, Cravath's $35 Million Fee Wager; Time Warner M&A on Contingency, N.Y. L.J., Jan. 20, 2000, at 1.
117. According to the New York Law Journal: The $35 million is all-inclusive, said one person familiar with the fee arrangement; it covers "everything touching getting this deal done." There is one exception. While no partner time - neither litigation nor corporate - will be paid if the deal dies, Cravath negotiated a cushion that allows it to recover fees for associates' time spent on document production. Cravath has agreed not to bill Time Warner for the first $1 million of work on the deal. Beyond that and up to $5 million, Time Warner will pay half of the associates' billings. Associate hours spent on document production in excess of $5 million will be paid in full. That could cover thousands of billable hours spent producing documents in connection with regulatory filings as well as shareholder suits. "What that tells me," said one M&A expert, "is that Cravath was not willing to assume the risk of an eternal battle." Krysten Crawford & Karen Hall, Cravath's $35 Million Fee Wager; Time Warner M&A on Contingency, N.Y. L.J., Jan. 20, 2000, at 1.
118. Solmssen, supra note 9, at 325.