Treasury Inc.: How the Bailout Reshapes Corporate Theory and Practice

Summary

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Corporate law theory and practice considers shareholder relations with companies and the implications of ownership separated from control. Yet through the Troubled Asset Relief Program (TARP) bailout and the government's resultant shareholding, ownership and control at many companies have merged, leaving corporate theory and practice for the financial and automotive sectors in chaos. The government's $700 billion bailout is a unique historical event; not merely because of its size, but also because of a resulting ripple through corporate scholarship and practice. This article builds on the author's five testimonies before Congress during the financial crisis and implementation of the TARP bailout and his consultation for the Special Inspector General for TARP. After considering corporate theory, the article offers predictions for how the Treasury Department's stock ownership reshapes the practice of corporate law. In short, TARP will result in a tectonic shift for current understanding about insider trading, securities class actions, share voting, and state corporate law fiduciary duties.

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Treasury Inc.: How the Bailout Reshapes Corporate Theory and Practice

The good and efficient working of a board of Bank Directors depends on its internal harmony ... . In France the difficulty... has been met characteristically. The Bank of France keeps the money of the State, and the State appoints its Governor. The French have generally a logical reason to give for all they do, though perhaps the results of their actions are not always so good as the reasons for them. The [Governor] has not always, I am told, been a very competent person.

Walter Bagehot, first Editor-in-Chief of The Economist, 1873(1)

Introduction

The theory and practice of corporate and securities law in the United States is a carefully constructed tapestry, woven through the time span of the American experience. Over that time, the expectations of investors, managers, and regulators have enjoyed a dance of slow experimentation toward a steady and predictable evolution. The thesis of this Article is that when the Treasury Department ("Treasury") and the Federal Reserve ("Fed"), through the Troubled Asset Relief Program (TARP) bailout, took equity positions in over six hundred of the nation's banks, as well as in the American International Group (AIG), Fannie Mae, Freddie Mac, GM, Chrysler, and GMAC, they introduced an entirely alien variable to this finely woven tapestry.

There are two foundations underlying this observation. First, the Treasury and the Fed are generally controlling shareholders, even in spite of their relatively low minority interest in particular companies. Second, they are controlling shareholders that also enjoy sovereign immunity from federal securities law and state corporation law. The presence of a control shareholder in publicly traded corporations is relatively infrequent. The presence of a control shareholder in publicly traded companies that also enjoys sovereign immunity from corporate and securities law is entirely novel. As a result of this perfect storm, a thorough investigation of the implications of the government's ownership via TARP reveals a number of uniquely unforeseen consequences to the theory and practice of corporate and securities law.

To emphasize the unique nature of the Treasury's ownership through TARP, this Article will begin by briefly considering the history of the United States government's entanglement in private business. Though the federal government has frequently chartered businesses that were wholly owned by the United States, particularly during the Second World War, and occasionally exercised power over publicly traded businesses through special provisions in their charters, as in the case of Fannie Mae and Freddie Mac, the United States government has never taken a controlling interest in a publicly traded company chartered under state law. As such, the government's ownership in businesses through TARP is a circumstance without precedent.

The emphasis of this Article is the revolutionary problems for corporate law theory and practice posed by the presence of a controlling shareholder that also enjoys sovereign immunity. Therefore, before rethinking those theoretical and practical elements, this Article will wade into these unexplored depths to consider the two threshold questions in the analysis. First, is the government really a controlling shareholder? And second, do the Treasury and Federal Reserve actually enjoy sovereign immunity from corporate and securities law?

One answer this Article proposes is that the government is likely a control shareholder for the largest TARP recipients in which it holds an interest, including Citigroup ("Citi"), AIG, GM, Fannie Mae, Freddie Mac, and, with some significant measure of certainty, the nine remaining banks from among the top nineteen banks to originally receive TARP funding. This Article then offers the suggestion that the government might, with a steadily decreasing degree of certainty based on degree of government ownership, also be considered a control shareholder for many of the other six hundred banks accepting TARP funding.

This Article then considers the application of sovereign immunity to the Treasury and Federal Reserve's exercise of ownership in TARP companies under the bailout, and suggests a number of novel theories under which a clever plaintiffs lawyer might try to challenge the federal government's sovereign immunity. It ultimately arrives at the conclusion that the federal government's belt-and-suspenders approach protecting it from liability in this arena, including the liability waivers of the Emergency Economic Stability Act (EESA),2 waivers included in the Securities Exchange Act (the "'34 Act" or the "Exchange Act"), and challenges to using other avenues, eventually forecloses meaningful challenge to the federal government's sovereign immunity in its exercise of ownership power over its TARP shares.

Thus, the first prong of this Article's thesis is that the theoretical underpinnings of American corporate law are completely unprepared for the presence of a control shareholder...

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