This article draws from the introduction to Missing the Target: Why Stock Market Short-Termism Is Not the Problem (Oxford University Press, 2022). More on this book can be found here.

Look at the ten largest US firms by stock value in 2020, shown in this table:

Source: Fortune 500, https://fortune.com/fortune500/2020/search/?f500_mktval=desc (last visited July 9, 2020).

A stock market that accords a value of several trillion dollars to Amazon, Apple, Google, Facebook, and Microsoft is not one that we should worry about being too short-term oriented. These five are quintessentially longer-term companies that do much research and development—anemic R&D is seen as a core cost of a short-term stock market, but it’s not shortchanged at these companies. Because their current money making cannot justify their stocks’ high prices, the stock market is paying for their future earnings and growth—as it has right from when they first sold their stock decades ago. Yes, their power, political influence, and market share are legitimate concerns, but their time horizons are not. These companies’ longstanding sky-high value contradicts the widespread idea that the stock market is unable to look beyond the next quarter’s financial statements.

Yet fear that stock-market-driven short-termism is seriously harming the US economy is pervasive. A widely-held view among Washington policymakers, corporate executives, the media, and the public is that frenzied, short-term stock market trading has coupled with Wall Street’s unquenchable thirst for immediate results to disrupt US firms and badly hurt the economy. Something must be done to reverse short-termism’s impact. Jobs are destroyed and technological progress is stunted, while solutions seem, in the public view, so easy to implement that one is angered at their absence. Corporate executives and their allies castigate stock market short-termism for inducing poor economic performance, which, they say, could be improved if executives and boards had more autonomy from stock markets.

But I show in this book, first, that the evidence for stock-market-driven short-termism is much weaker than is usually thought and, second, that working to lengthen corporate time horizons will not bring us closer to the fairer and environmentally stronger society that policy leaders seek. The two issues—the corporation’s time horizon and its purpose—are largely separate issues that public discourse often conflates. A long-term factory could keep workers employed and be good for stockholders too over the long run but still degrade the environment. And so, this book also provides friendly advice on why to avoid this policy path.

* * *

Stock-market-driven short-termism is the rare corporate structural issue that both resonates with the public and has a place in political rhetoric. Most corporate law issues are technical—for experts, for lawyers, and for corporate interests. But especially when businesses are threatened with closure, political leaders react and often justify their response as not just seeking to save a local business with loyal employees who did nothing wrong but also as fighting Wall Street short-termism.

Consider how senators reacted to the shutdown of a major paper mill in Wisconsin. Hedge fund activists were said to have forced the Wausau Paper Company to close its paper mill—throwing lifetime employees out of work and devastating the mill town. In response, Wisconsin’s Democratic senator, Tammy Baldwin, joined with Georgia’s Republican senator, David Perdue (Georgia also has major paper mills) to sponsor a major anti-hedge-fund bill aiming to reduce the influence of hedge funds on businesses. The sponsors described it as a “bipartisan reform to protect Main St from Wall St hedge funds” so as to “fight against increasing short-termism in our economy.”^[1] Senators who had proposed a prior version of the bill castigated predatory activists who “demand[] short-term returns and buybacks at the expense of the company’s long-term future.” This short-termism, they said, must end:

[T]here is [a] growing chorus who believe short-termism is holding America back . . . . [S]hort-termism . . . is the focus on short time horizons by both corporate managers and financial markets. It results in corporate funds being used for payouts to shareholders in the form of dividends and buybacks rather than investment in workers, R&D, infrastructure, and long-term success.^[2]

The senators’ statement shows why stock market short-termism is not just a specialists’ issue but also a political one: it’s blamed for the Wausau mill closing and other setbacks, and for widespread US economic degradation. That’s what I examine in this book: Does stock market short-termism really worm its way in to do major damage to the economy? Was the Wausau closing really the result of a pernicious short-term stock market? Even if it was, does the problem scale up to the economy-wide level to cripple US R&D, investment, and long-term business focus, as the senators argue? Or is the Wausau closing better seen as a local misfortune that’s mistakenly categorized as due to a dysfunctional time horizon and then exaggerated as indicating an economy-wide problem?

Political convenience can lead politicians to blame the stock market’s purportedly faulty time horizon for economic setbacks for which its responsibility is minor or nil. Faulting Wall Street is politically satisfying and looks like forward-moving action both to voters and to senators trying to do their best. But the evidence is that doing so avoids the hard political effort to address the disruption’s root causes and effects. True, many shortcomings could be pinned on large corporations. But excessively truncated time horizons and a crippling inability to bring forward good new technologies and products or to stick with tried-and-true good ones, to do the underlying R&D when needed, and to adapt to new markets and political realities are not among the large corporation’s major faults. The evidence, we shall see, does not support the idea that the stock market’s time horizon is damaging the economy in any major way.

Dislocations and closings are real problems for those thrown out of work, yes, but lengthening Wall Street’s time horizons to more highly value good results years down the road will do little or nothing for the US worker, for greater equality, or for the environment and climate degradation. It’s not the best target if there’s a major R&D shortfall. Aiming at purportedly truncated time horizons to fix these problems is aiming at the wrong target.

Even the Wausau paper mill result in Wisconsin deserves further thought. Paper manufacturing had been in a long-term decline in the United States when Wausau closed its Wisconsin mill, government data tells us.^[3] The company was slow to adjust to the country’s declining use of print paper. The cause was obvious: computerization changed how businesspeople communicated, emails meant fewer letters and fewer office memos, and online media and ebooks meant fewer printed newspapers, magazines, and books.^[4] The senators and their supporters viewed the Wausau paper mill as a victim of stock market short-termism, but the workers’ and their families’ pain was more likely due to the company’s excessive long-termism. It clung for too long to an outmoded business plan, leading to the company having to abruptly pivot to the realities of declining paper use.

But the political impact is clear: a mill closes, workers lose jobs, and senators blame Wall Street short-termism, extol legislation to diminish Wall Street influence, and paint vivid imagery of Wall Street “wolf packs” hunting down companies to close and jobs to eliminate. If stock market short-termism wasn’t central—and it wasn’t—to the Wausau paper mill shutdown, other policies are in order.

The senators blamed the financial market messenger bringing an unwanted message. Accelerating technological change, not the stock market, was the real culprit. The senators’ action was a symbolic gesture of sympathy for affected constituents. But they were not helping long-term adjustment—and their plans would maybe even slow it down.

They found a scapegoat, not a solution.

* * *

By corporate short-termism I mean overvaluing current corporate results at the expense of future profits and well-being. In recent years, stock market short-termism has also become intertwined in public rhetoric with conceptualizations of corporate social responsibility, corporate purpose, and the need to emphasize corporate attention to the environment, stakeholders, and the risk of climate catastrophe, the so-called ESG issues. There is a widely held view that shifting the large US corporation from its supposed short-term orientation to a longer one is needed to ameliorate a raft of social and economic problems, such as employment, equality, and R&D. According to this thinking, lengthening the stock market’s time horizon will release a dammed up investment tide, while also doing much to save the planet from climate catastrophe. It’s satisfying to think so, because if the stock market’s time horizon is the main culprit and long-term companies are inherently environmentally friendly, then there is less need to do the hard political and economic work to more directly handle these problems. But we’ll see in Chapter 3 that these corporate responsibility considerations are for the most part not time horizon issues; making the large firm more long-term focused will have little or no impact here.

Stock market short-termism and lawmaking ideas on how to handle it are also prominent in part because they implicate interests. Employees with good jobs, along with their policy supporters, see stock market short-termism as degrading employees’ well-being and as fostering risky, economically costly policies throughout corporate America. Much of the public rhetoric on short-termism aims to help employees and advance social well-being, but the beneficiaries often end up being executives seeking autonomy. Liberal-minded judges, policymakers, and political leaders are more likely to accord executives more autonomy from the stock market when these leaders see themselves as helping the economy, employees, and the environment; they support corporate structure outcomes—more power and more autonomy for executives—that if presented to them directly and starkly, would induce them to be more skeptical.

In corporate policymaking circles, executives and their allies often see stock market short-termism as hurting the economy. Many insist that insulating management from the stock market’s purported short-termism would bolster the economy. That many executives genuinely believe that the stock market hurts the economy does not undermine the fact that these beliefs align with their interests. Misdiagnosis—attributing too many societal problems to a stock market time horizon problem—leads to stock market rules that insulate executives and boards from feedback, allowing some strategic mistakes to persist unnecessarily.

* * *

Getting this right is important because misdiagnosis leads us to policies that fail to cure real problems. The real target is a better-performing, more equitable economy. Aiming at the purported damage emanating from a purportedly excessively short-term stock market will miss that bigger and better target for something small and not particularly problematic.

Consider government support for R&D and for better climate and environmental policy.

Government’s declining support for research and development. R&D is weakening in the United States, the critics say, and stock market short-termism is to blame. Stock buybacks, exacerbated by short-termism, starve large firms of the cash they need to invest and to do more R&D. If those diagnoses were correct, a policy of insulating firms and their executives from stock market pressure could have cogency.

But corporate R&D spending is rising, not falling. Perhaps R&D should be rising more, yes. But a more obvious R&D weakness, as I show in Chapter 4, is the spectacular fall in US government R&D spending. Government-backed R&D often leads to breakthroughs in basic technology that greatly boost prosperity. If the decline-in-R&D culprit is mostly the sharply shrinking government support for basic research, then no amount of new time-horizon-focused stock market rules will fix the problem.

Figure 1: R&D spending in the United States rising as a proportion of GDP, 1977–2021. Source: Federal Reserve Bank of St. Louis, FRED https://fred.stlouisfed.org/tags/series?t=r%26d (accessed Jan. 4, 2022). The underlying data is from U.S. Dep’t of Commerce, Bureau of Econ. Analysis, National Income and Product Accounts, U.S. Dep’t of Commerce, Table 5.6.5, lines 2 & 6, http://www.bea.gov/itable/ [https://perma.cc/HM9A-7XM3].

Thinking that stock market short-termism’s truncating of corporate time horizons is the primary cause of weakened US R&D leads policymakers astray—to aim at the wrong target.

Weakened environmental and climate change rules. Critics complain that corporations contribute gravely to climate change and environmental degradation, with stock market short-termism particularly to blame. But weak corporate respect for the environment is not due to individual firms’ shortened time horizons but to the ability of firms to push the costs of environmental and climate damage away from themselves and onto others. They can do this in the short-term and the long-term, and can profit from offloading environmental costs while others pay. Indeed, maintaining a factory with toxic emissions into the future may look long-term to some and could save jobs but be bad for the environment. The right focus is not on when the damage is done—the time horizon problem—but rather on who suffers from the damage.

In too much public discourse, the stock market’s time horizon is mixed up with what the corporation aims for—profits instead of doing good in and of itself. But these two are largely separate: a firm can be long-term and profit-focused, or it can be short-term and generous. Thinking that time horizons and purpose are one and the same, or that changing the firm’s time horizon will make it less profit-focused, weakens our resolve for implementing better environmental regulation and climate solutions. What we need are better rules that prevent players—corporate and individual—from externalizing environmental costs to society while keeping the profits and convenience for themselves. No amount of tinkering with stock market time horizons will fix that problem. Thinking that tinkering with time horizons can fix it misses the real targets—the corporation’s (and our own) warped incentives—and prevents us from reaching the best solution.

Or any solution.

* * *

Consider the following when you think about how plausible it is that the stock market’s time horizon is persistently and perniciously too short: Tech companies that had their initial stock offerings in 2018 and 2019 before the Covid-19 slowdown included Dropbox, Survey Monkey, Cloudflare, and Spotify. Not one was profitable;^[5] the stock market bought them on a future-oriented view. Similarly, a slew of money-losing biotech companies made their initial stock offerings in 2018. In 2019 seven of the top ten biotech IPOs had no approved drug—hence, the market valued those companies for their long-term prospects not their immediate marketing capabilities—and still they collectively raised more than $1.95 billion from the stock market.^[6] Future possibilities, not current profits, drove investors, who were betting on the firms’ potential successes in drugs that would treat maladies such as autoimmune disorders and cancer.^[7]

This is not an accidental or one-time event. Recall the companies that were the largest by stock market capitalization in 2020—listed in Table 1. Years ago, when Amazon first sold its stock to the public, it had no earnings but still was accorded a half-billion-dollar value by the stock market, while Apple, Facebook and Google obtained a stock price about one hundred times their earnings when they first sold their stock—more than five times the stock market’s overall ratio of stock price to earnings.^[8]

All this indicates the stock market does value the distant future and has been doing so for decades.

Moreover, the logic behind the theory that there is pervasive economy-wide short-termism is not strong. For stock-market-driven short-termism to deeply afflict the US economy—as opposed to damaging only some firms, here and there—normal market processes must fail. When one big firm is too short-term and gives up long-term profit, others can jump in to profit from the short-termers’ neglect. The United States’ dynamic venture capital and private equity sectors make money from opportunities big firms don’t take. Or another big public firm that isn’t tied up by the stock market can pick up the slack. They all have the profit incentive to do so.

The Covid-19 crisis opened another window into short-termism. The consensus view among short-term critics is that the stock market overreacts to quarterly earnings changes. A few pennies up in quarterly profit and the stock soars. A few pennies down and the stock price plummets. Surely there’s some truth to this; but how seriously detrimental is it? In the first months of 2020, the Covid-19 lockdown froze more and more economic activity and gross domestic product plummeted, with forecasters then expecting a severe 2020 GDP decline of 5.8%. Unemployment rose to post–World War II highs. The Covid-19 lockdown and resulting decline in much economic activity crushed corporate earnings. By early June 2020, second quarter earnings were estimated to be down by more than 40% compared to the prior year—a swift and steep drop.^[9]

Yet during that time the stock market, after a modest decline, recovered strongly. The 40% estimated earnings decline was not matched by a 40% stock market fall, and the stock market reached an all-time high at the end of 2020. The critics who see the stock market as excessively short-run and obsessively quarterly focused need to explain why we did not see Covid-19-induced stock market declines as steep as the Covid-19-induced fall in earnings.

The easiest explanation is that the stock market is nowhere nearly as short-run oriented as critics say it is. The stock market’s long-run expectation was that the economy would recover in a year or two, when a good-enough vaccine or a cure became available, and it priced stocks for the long-run, not the immediate short-run. Yes, there is a coldness to a stock market assessing long-term economic value as a medical tragedy unfolded, but the stock market’s reaction to the Covid-19 crisis was hardly a short-term stock market at work.^[10]

* * *

Broader social and economic reasons help to explain why stock market short-termism is seen as seriously pernicious, as opposed to a small issue that might be better handled. These reasons are rooted in part in rapid economic change and in hard-to-resolve, perhaps irresolvable, conflict.

Economic change is accelerating. New technologies rise, dominate, and then are superseded. Markets open and close. Companies with high-flying stocks find themselves after several years with outmoded technologies, and their stock price falls. Long-established papermakers find people buy less paper than before. Retailers sell books one year and VCR tapes the next until DVD mailers put the VCR rental firms out of business and then online streaming forces the DVD distributors to recede. Newspapers are read on tablets; books are ordered, delivered, and read online; banks become virtual. Physical capital assets become obsolete before they have worn out. All these make the stock market jump, as new technologies change old ways.

The pace of economic change quickens and disrupts more jobs. Both those who are affected and their political protectors react, blaming the stock market for inducing the changes and being too short-term. Even if new technologies make many people better off, those who do not benefit—the employees and executives whose working lives, personal lives, and sense of self are diminished—do not sit still. They act and constitute a sympathetic audience for leaders who blame financial market short-termism for the disruption. And executives who want more autonomy from financial markets applaud and seek more autonomy from stock markets. Corporate lawmakers give them a sympathetic hearing.

We have more than a simple problem of technical data interpretation at hand. We are not just examining whether the stock market is too slow or too fast, but whether it is the conduit for disrupting too many people’s lives and livelihoods. Instead of a pure time horizon problem, we have serious underlying conflict and social dislocation, with the rhetoric of short-termism having become a means for criticizing the economy and the corporation. The rhetoric of stock market short-termism has become a manifestation of political, policy, and social combat as much as it is an economic problem for data inquiry, analysis, and a weighing of the evidence.

1. Senators Tammy Baldwin (Wisconsin) and David Perdue (Georgia), Brokaw Act: Bipartisan Reform to Protect Main St from Wall St Hedge Funds, www.baldwin.senate.gov/imo/media/doc/Brokaw%20Act%20OnePager.pdf. ↑

2. Senators Tammy Baldwin (Wisconsin) and Jeff Merkley (Oregon), The Brokaw Act: Strengthening Oversight of Activist Hedge Funds, www.baldwin.senate.gov/imo/media/doc/3.7.16%20-%20Brokaw%20Act%201.pdf. ↑

3. Jeffrey P. Prestemon et al., U.S. Dep’t of Agric., The Global Position of the U.S. Forest Products Industry 3, fig. 2 (E-Gen. Tech. Rep. SRS-204, 2015). ↑

4. Alon Brav, J.B. Heaton & Jonathan Zandberg, Failed Anti-Activist Legislation: The Curious Case of the Brokaw Act, 11 J. Bus. Entrepreneurship & L. 329 (2018). ↑

5. Ben Eisen, No Profit? No Problem! Loss-Making Companies Flood the IPO Market, Wall St. J., Mar. 16, 2018; Alex Wilhelm, Over 80% of 2018 IPOs Are Unprofitable Setting New Record, Crunchbase News, Oct. 2, 2018, https://news.crunchbase.com/news/over-80-of-2018-ipos-are-unprofitable-setting-new-record/; Cloudflare S-1 filing, Aug. 15, 2019, www.sec.gov/Archives/edgar/data/1477333/000119312519222176/d735023ds1.htm. Much of the data on these IPO issues originates with Jay Ritter’s IPO database, to be further discussed later in chapters 2 and 6. ↑

6. Melanie Senior, The Biopharmaceutical Anomaly, 38 Nature Biotechnology 798 (2020); Eisen, supra note 9. ↑

7. Kate Rooney, More Money-losing Companies Than Ever Are Going Public, Even Compared with the Dotcom Bubble, CNBC News, Oct. 1, 2018; Joanna Glasner, While Tech Waffles on Going Public, Biotech IPOs Boom, TechCrunch, July 2018. ↑

8. More specifically, the S&P 500’s price to earnings ratio was 9, 15, and 19, when the three went public. Microsoft was, comparatively speaking, the laggard, with a price-to-earnings ratio of 25 when the stock market overall was selling at about 16 times its prior year’s earnings. ↑

9. Factset, Earnings Insights, July 10, 2020, www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_071020.pdf (last visited July 13, 2020). ↑

10. Matt Levine, the Bloomberg columnist, sharply analyzes this Covid-19 short-term versus long-term contradiction. Matt Levine, Stocks Are Trying to Forget 2020, Bloomberg Opinion—Money Stuff, June 1, 2020. A New York Times story on the stock market’s strength despite the Covid-19 hit to the economy reflects the forward-looking nature of the stock market, where—in theory—investors buy stock based on long-term expectation for profits and dividends they expect companies to generate, rather than on how they’re faring when the shares are purchased. Matt Phillips, “This Market Is Nuts”: Stocks Defy a Recession, N.Y. Times, Aug. 19, 2020, at A1, A10. The Federal Reserve’s low interest policy during the Covid-19 economic setback—which buoys the stock market—cannot be ignored here. ↑

For further reading, in addition to Missing the Target: Why Stock Market Short-Termism Is Not the Problem,  please see author Mark J. Roe’s related work in The Business Lawyer:

Mark J. Roe & Federico Cenzi Venezze, Will Loyalty Shares Do Much for Corporate Short-Termism?, 76 Bus. Law. 467 (2021).

Mark J. Roe, Corporate Short-Termism—In the Boardroom and in the Courtroom, 68 Bus. Law. 977 (2013). (This article is also presented in The Best of The Business Lawyer: 75 Years of Corporate Law, edited by Karl John Ege and John F . Olson.)

A few years ago, my company did not yet have a leader dedicated to Diversity, Equity, and Inclusion (DEI).^[1] It was 2019, and I recognized the potential risk and critical opportunity for our company from oversight by our Board of Directors^[2] to employee engagement. I took my passionate commitment to my legal team, to see if there was any appetite to engage on DEI. My team is diverse in gender, ethnicity, and other characteristics. So, it didn’t come as a surprise that there was definite interest to lead on DEI at our company. That same month, we organized the Amyris Legal DEI Initiative.

We started in our own camp: inquiring with our outside law firms on what they each did to incorporate DEI in how they provided their services to our team. We wanted to know if our law firms prioritized diversity in their own hiring, what measures they took to be inclusive in their professional development practices, how well their partnership composition statistics reflected diversity, and whether they were inclusive of diverse partners in the disposition of power across their own leadership. Being a smaller public company, we recognized that hiring/firing a law firm based solely on its DEI metrics wasn’t a viable option for us. But we believed that communicating our commitment to DEI could have real impact in our profession. We believed that inclusive professional practices lead to more creative and holistic advice and were, therefore, relevant from our client perspective. By conducting our review, we sent a message to our outside law firms: DEI matters to us as lawyers, and we were watching how each of our law firms was measuring up. Last fall, we conducted a follow-up DEI pulse survey with our outside law firms. We refreshed our message of commitment to DEI, and this time our survey was informed by my membership in the Leadership Council on Legal Diversity. This year, our Legal DEI Initiative formalized our position by developing our DEI Standards of Engagement that we now require our outside law firms to comply with when doing work for our company.

After engaging with our law firms, we decided to start leveraging cultural events and international holidays to educate on, and encourage dialogue around, DEI. Starting with International Women’s Day in 2019, I sourced “You Go Girl” t-shirts for us all to wear, and we took a group photo in our t-shirts and posted it on our intranet site and my LinkedIn page. It was a fun, simple gesture that modeled positive, inclusive messaging across our company. Later that spring, on behalf of our Legal DEI Initiative and in my executive capacity, I joined over 200 other public company GC/CLOs in an amici curiae brief to the Supreme Court that argued Title VII’s prohibition of employment discrimination included discrimination based on sexual orientation or gender identity (the Supreme Court agreed, 6–3, in July 2020). And in June 2019, we collaborated with our company’s LGBTQ+ employee affiliation group to co-sponsor a happy hour event to celebrate PRIDE month. Again, an easy way for our Legal DEI Initiative to show up in a positive way to message inclusivity with our own employees.

In August 2019, I joined the board of my company’s women’s group as its executive sponsor. My first move was to launch the first mentoring program at my company, by and for women. The program was so successful that it is now in its second iteration. In addition to this company-wide program, I have used my position on the board to forge alliances across my company’s employee affiliation groups, as I believe that collaboration on educational efforts and inclusive programming will render our company culture richer for everyone.

That fall, when it was my turn to do a “Talks in 20” at our employee townhall—where an executive presents and answers questions for 20 minutes on a topic that is relevant to the company’s mission and growth—I chose to present on “Diversity/Inclusion: Foundation Blocks for a Winning Company.” I brought my own angle to the topic: my diverse perspective as half French-Algerian; my passion for sports (women’s soccer, surfing, race car driving) and the issue of equal pay for women professional athletes; and my respect for female leadership and accomplishments in science and business. I outlined statistics from Boston Consulting Group^[3] and McKinsey^[4] on how diverse employees provide a company with creative approaches to business ideas and solutions, and how a company’s inclusive leadership not only drives higher revenues but allows for disruptive leadership in that company’s industry. It was a rich and engaging exchange that lasted well past 40 minutes. I took that as an indication that DEI was front-and-center in our employees’ minds.

When our country witnessed the atrocity of George Floyd’s murder in May 2020, my team’s DEI Initiative assumed a leadership position in our company’s internal dialogue about this tragedy and the concomitant social justice issues that had seized center stage across our country. We organized our company’s first Roundtable on Diversity, Inclusion, Education, and Acceptance on the last day of June—a symbolic gesture of solidarity with our LGBTQ+ community—that included representatives from all of our employee affiliation groups and our CPO. Our team’s DEI Initiative moderated the event and managed both the Q&A with our company’s employees (more than 50% joined the lunchtime Zoom event) and follow-up on employee-requested deliverables. This roundtable event is now serving as the foundation for a company-wide DEI committee. Since the first quarter of 2021, my DEI Initiative has been running quarterly sensitivity and educational sessions on topics from hate incident bystander training to transgender inclusion in the workplace.

In January 2021, my team launched its second initiative: AMRS Legal Gives Back. Focused on efforts to give back to the community, on behalf of both our legal team and our company, this initiative seeks to address issues of social justice that surround us today. Last year, this initiative donated a set of seven books to multiple local elementary schools to educate about cultural diversity and understanding amid rising incidents of hate and violence against Asian Americans and Pacific Islanders. And this year, we’re coordinating with an edtech company in Brazil to donate paper microscopes to fifth-grade public school students in the Brazil province where we’re building our new manufacturing facility. By supporting our community through the lens of education, we believe we’re fulfilling our ethical obligations to give back to others—to, in our own small way, make our piece of the planet safer, better, more equitable.

I’m also focused on cultivating future diverse leaders in the law. For the past three years, for ten weeks every winter, my team has had the pleasure of working with a diverse group of externs from Northwestern Law’s annual Bay Area externship program. And this summer, my team will welcome a first-year law student participating in Gibson Dunn’s Summer Diversity Internship program. By supporting diversity within the structure of legal education, I intend to contribute to the development of our profession into one that better represents the diversity of our society and its legal needs.

Lawyers are ethically bound to uphold the laws and to defend the legal rights of all peoples, and therefore, I see leadership on DEI as a natural extension of our professional ethical obligations. Employees come to the legal team for a range of assistance, advice, guidance. And so, it is altogether appropriate for lawyers to lead on DEI within their companies. I do it with a mission of promoting DEI through education; by engaging in DEI, you will find a purpose that resonates with you as a leader. By better understanding ourselves and each other, we can impact positive change both at our company and in our local and global communities. You will also build a legal team comprised of champions of equity and belonging. When you do, you will certainly witness increased education, awareness, and collaboration among your employees, and across your executive leadership teams. This engagement will both inspire and fortify you to lead with a broader perspective, and it will enrich your experience of practicing law.

Editor’s note, April 29, 2022: This article’s discussion of the author’s initial recognition of the opportunity for further engagement on DEI issues at her company has been updated.

1. I’m pleased to note that, as of this spring, my company has a Diversity, Equity, Inclusion & Belonging leader who is focused on building a program attuned to our company’s mission and responsive to our employees’ needs. ↑

2. In addition, in August 2021, the SEC approved Nasdaq’s new board diversity rule (Rule 5605(f)), requiring its listed companies to have at least two diverse members or provide reasons for not meeting its new standard. And in late 2021, the two leading proxy advisory firms (the Institutional Shareholder Services and Glass, Lewis & Co.) updated their guidelines to recommend a vote against the chair of the nominating committee of a board of directors which fails to meet certain diversity thresholds (gender and race/ethnicity) in its composition. ↑

3. https://www.bcg.com/en-us/publications/2018/how-diverse-leadership-teams-boost-innovation ↑

4. https://www.mckinsey.com/business-functions/people-and-organizational-performance/our-insights/delivering-through-diversity ↑

Ten years ago, the average person did not know what facial recognition was. Now, especially after its use in locating persons involved in the January 6, 2021, riots at the US Capitol, almost everyone knows its utility and power to find anyone who shows up in a video or “snap.” Many from both the left and the right sides of the aisle see its unregulated use as an intrusion into the privacy of the individual. State legislators, as explained below, are exercising their power to regulate the use of facial recognition by law enforcement and by private companies. The states are taking facial recognition regulation into their own hands while the federal government is at a standstill on passing privacy laws curbing the use of this powerful new software tool.

We pose and smile for selfies with friends and put them on Facebook, TikTok, Instagram, and Snapchat. We look up as we walk outside and see cameras on every street intersection pole, or at the city park. We believe they are looking for cars going through red lights or watching out for crime. What we may not realize is that our favorite apps and ever-present street cameras are using facial recognition to identify us and, using advanced A.I. software, tag us as we move from location to location. We also may not be aware that cameras can identify us by our gait and body movement, as well as our face. “Walk that way” has a new meaning.

New York City police reportedly used facial recognition from 15,000 cameras 22,000 times to identify individuals since 2017.^[1] Fear of crime is driving us, or being used to drive us, to give up our privacy by allowing law enforcement to use those ubiquitous street cameras to identify where we are, and even to listen to our words to recognize us. This technique, commonly called “voiceprint” identification, lets surveillance equipment instantly turn our words into searchable text as we walk down the street.

The legal issue of advanced technologies taking away our right of privacy is not new. In 1890, a young Boston lawyer, Louis Brandeis, co-wrote a Harvard Review article asserting that privacy was a fundamental right even if not listed as a right in the US Constitution. Brandeis was upset that two new inventions, the Kodak camera and the Edison dictating machine, were invading our private lives, exposing them to the public without our consent:

Instantaneous photographs and newspaper enterprise have invaded the sacred precincts of private and domestic life; and numerous mechanical devices threaten to make good the prediction that “what is whispered in the closet shall be proclaimed from the house-tops.” ^[2]

In 1928, almost four decades later, then-Supreme Court Justice Brandeis penned his famous Olmsted v. US dissent on the issue of privacy. The case involved law enforcement wiretapping a new device located on the sidewalk: the public telephone. Brandeis explained:

Whenever a telephone line is tapped, the privacy of the persons at both ends of the line is invaded, and all conversations between them upon any subject, and although proper, confidential, and privileged, may be overheard.^[3]

Justice Brandeis advocated limiting law enforcement’s use of wiretapping. His views on regulating privacy rights eventually became law. Nine decades later, state legislators are again working to rein in the use of new technology: the pervasive placement of high-quality cameras and corresponding use of A.I. software. The concept of facial and biometric recognition has been around since the 1960s. However, the technology to make facial recognition accurate and fast has only been achieved in the last two decades with improvements in “computer vision” algorithms, faster processers, ubiquitous broadband, and inexpensive cameras. Law enforcement showed the world the effectiveness of the cameras and biometric A.I. software after the January 6^th Insurrection by accurately identifying hundreds of perpetrators within days.

Several states and municipalities are seeking to protect persons from abuse of biometrics by private companies and by law enforcement. The new laws generally attempt to limit private firms from using facial recognition without opt-in consent, or to limit law enforcement’s use of biometric identification tools.

Illinois Law Allows a Private Right of Action

Illinois led the way in this legislative trend by limiting private firms’ ability to collect biometric data without consent. In 2008, the state passed the Biometric Information Privacy Act, or BIPA. BIPA arose in response to a software company that collected fingerprint data at cash registers to allow for easy checkout but then, when the company went bankrupt, attempted to sell the customers’ fingerprint data as a bankruptcy asset. BIPA defines a biometric identifier as “a retina or iris scan, fingerprint, voiceprint, or scan of hand or face geometry.” The law requires written consent for an entity to collect, capture, purchase, receive, disclose, or disseminate biometric information. Most significantly, it gives a person a right of action “against an offending party.” Damages are set per violation: $1,000 if caused by negligence and $5,000 if intentional.

The private right of action is one of the most controversial aspects of various privacy laws being proposed around the country. With a private right of action, plaintiffs’ attorneys are enforcing the privacy law by constantly seeking out potential defendants who are allegedly violating the law. Without a private right of action, state attorney generals must decide who to sue, if there are resources to sue, and if it is politically a good move to sue. Companies are often adamantly opposed to laws creating a private right of action, as such suits can result in large, complex class actions lasting for years and, potentially, very large judgements and settlements.

One result of the Illinois BIPA’s private right of action is that many online web firms and off-line companies are either stopping their use of biometric identification or more carefully obtaining opt-in consent from their customers and employees. The door opened for class actions and large judgments when in 2018, the Illinois Supreme Court ruled in Rosenbach v. Six Flags that BIPA did not require a showing of damages, only a showing that a violation occurred.^[4] Then in February 2022, the Illinois Supreme Court held in McDonald v. Symphony Bronzeville Park that the Illinois Workers’ Compensation Act does not protect companies from statutory BIPA damages. The McDonald case involved a nursing home collecting employees’ fingerprints without their consent, and the court found that the BIPA claims for statutory damages were not barred by the exclusivity provisions of the Illinois Workers’ Compensation Act.

In 2021, Facebook paid $650 million in a historic settlement of a BIPA lawsuit. Class members are to be awarded at least $345 each, though the payments have been delayed. Notably, Facebook announced it would stop using facial recognition just a few months later. Other plaintiffs and their attorneys also sued other web platforms including TikTok, Snapchat, and Google under BIPA. In 2021, TikTok announced that it settled an Illinois class action for $92 million.^[5] Shortly thereafter, in June 2021, TikTok changed its privacy policy to state that TikTok “may collect biometric identifiers” including “faceprints and voiceprints.” Plaintiffs filed a class action suit against Snapchat in 2020 for violations of BIPA.^[6] The case is currently before the Seventh Circuit on the issue of whether the minor plaintiff is subject to the Snapchat terms and conditions’ arbitration requirement. Microsoft, Amazon, and Shutterfly have also been sued for alleged BIPA violations. Reportedly, these cases involved photos uploaded from Flickr that were later used by IBM to “train” facial recognition software to help accurately identify people of color. The project was called “Diversity of Faces.” The IBM training database was then used by Microsoft and Amazon to improve their facial recognition systems.

Non-web firms have also been sued under BIPA. In 2021, for example, in Rosenbach v. Six Flags, Six Flags settled an Illinois class action for $36 million for fingerprints taken without consent.

Other States Take Action

Other states have also passed statutes limiting companies’ biometric use, but none with the “teeth” of a private right of action like Illinois’s BIPA. Texas was one of those states. In 2009, Texas passed the “Capture or Use of Biometric Identifier Act,” or CUBI. CUBI imposes a penalty of “not more than” $25,000 for each violation. However, unlike Illinois, there is no private right of action. In February 2022, Texas Attorney General Ken Paxton took action under the CUBI legislation and filed suit against Facebook, claiming that Facebook owed billions to the state for violating CUBI for not obtaining user consent when collecting the biometric data of more than 20 million Texas residents.

Still other states have passed laws limiting law enforcement’s use of facial recognition and biometric data. In October 2020, Vermont passed the “Moratorium on Facial Recognition Technology,” prohibiting law enforcement from using facial recognition. The Moratorium provides “a law enforcement officer shall not use facial recognition technology or information acquired through the use of facial recognition technology unless the use would be permitted with respect to drones….” Notably, the Vermont law expanded the definition of facial recognition to include recognition of “sentiment”:

“Facial recognition” means… the automated or semiautomated process by which the characteristics of a person’s face are analyzed to determine the person’s sentiment, state of mind, or other propensities, including the person’s level of dangerousness.

The COVID pandemic has been a busy time for new facial recognition laws. In 2021, Virginia enacted the “Facial recognition technology; authorization of use by local law-enforcement agencies” legislation (HB 2031) prohibiting local law enforcement and campus police from “purchasing or deploying” facial recognition. The Virginia statute did not prevent local law enforcement from using facial recognition deployed by others. Also, by prohibiting just “local law-enforcement agencies,” the law allowed other Virginia law enforcement agencies to use the technology. Interestingly, the law addressed only facial recognition and not the recognition of gait, fingerprints, voiceprints, or state of mind.

The same year, Massachusetts passed the “Facial and Other Remote Biometric Recognition” legislation limiting state law enforcement’s use of facial recognition. The law expressly included in the definition of facial recognition the “characteristics of an individual’s face, head or body to infer emotion, associations, activities or the location of an individual… gait, voice or other biometric characteristic.” The law required a court order or an immediate emergency where there could be a risk of harm to a person for use of facial recognition. It also limited all law enforcement agencies in the state, not just local law enforcement as in Virginia.

In 2021, Maine passed the “Act To Increase Privacy and Security by Prohibiting the Use of Facial Surveillance by Certain Government Employees and Officials,” which is similar to the “Facial and Other Remote Biometric Recognition” legislation in Massachusetts. However, Maine’s law applied to all government employees, not just law enforcement. Maine also allowed government employees to use facial recognition without a court order as long as the state employee was investigating a “serious crime” and believed there was “probable cause to believe that an unidentified individual in an image has committed the serious crime,” or under a limited number of additional exceptions. Massachusetts, by contrast, required a court order issued by a court that issues criminal warrants. Utah passed a similar law to that of Maine in 2021, limiting the government’s use of facial recognition except for investigations where there is a “fair probability” the individual is connected to the crime.

In other states:

• New York passed a 2021 law prohibiting facial recognition in schools.
• Washington state passed a law prohibiting government agencies from using facial recognition except with a warrant or in an emergency.
• In 2014, New Hampshire limited government agencies from using biometric data but allowed them to use it to solve a crime without a warrant.
• A 2020 Maryland law prohibits employers from using facial recognition during interviews without a signed consent.
• California passed a new law that banned law enforcement from using facial recognition in their body cameras but not in other police surveillance cameras. The law expires on January 1, 2023.
• Similarly, Oregon limited law enforcement from using facial recognition on body cameras.

While there appears to be a new trend in privacy rights among states, the majority of states—like Colorado and Montana—have failed in attempts to enact facial recognition legislation. Today as when Justice Brandeis opined on the topic 94 years ago, we are still balancing our right of privacy from the law enforcement with our fear of crime and the need to allow law enforcement to freely act. In addition, while Illinois, Texas, and California are limiting private companies from using biometric data without prior opt-in consent, most states have not enacted regulation to prevent private firms from using the technology, for now.

While the federal government is not addressing the thorny issue of facial recognition, states appear to be on a roll and are taking matters into their own hands. It is clear that both the left and the right of the political spectrum are seeking to curb the use of facial recognition and biometric software by law enforcement. Also, the implementation of a private right of action by Illinois has produced results in terms of keeping companies in line with regard to privacy rights. We should expect to see more state legislation granting private rights of action in cases related to violations of limitations on facial recognition and biometric data use, particularly in states with strong plaintiffs’ bars.

1. Amnesty International, “Surveillance city: NYPD can use more than 15,000 cameras to track people using facial recognition in Manhattan, Bronx and Brooklyn,” (June 3, 2021) https://www.amnesty.org/en/latest/news/2021/06/scale-new-york-police-facial-recognition-revealed/ ↑

2. Samuel D. Warren and Louis Brandeis, “The Right to Privacy,” Harvard Law Review, Vol. IV, No. 5 (1890), https://groups.csail.mit.edu/mac/classes/6.805/articles/privacy/Privacy_brand_warr2.html ↑

3. Olmsted v US, 277 U.S. 438 (1928) ↑

4. Rosenbach v. Six Flags Ent. Corp., 129 N.E.3d 1197(Ill. 2019) ↑

5. In Re: Tiktok, Inc., Consumer Privacy Litigation ILND 1:20-cv-04699; Joe Walsh, “TikTok Settles Privacy Lawsuit For $92 Million,” Forbes (February 25, 2021) https://www.forbes.com/sites/joewalsh/2021/02/25/tiktok-settles-privacy-lawsuit-for-92-million/ ↑

6.  Clark v Snap Inc. Case 3:21-cv-00009-DWD (US District Court Southern District of Illinois) (2021) ↑

It would be very satisfying to say, “Sorry, IRS, you are too late to audit me!”^[1] It can save you stress and expense, and it can allow you to avoid having to prove that you were entitled to a deduction or find receipts. The IRS statute of limitations is important for heading off and handling audit trouble; you need to know how long you are exposed. And surprisingly, the rules are consistent whether you are an individual, corporation, partnership, or nonprofit organization. Here’s what you need to know.

Myth #1: The IRS Has Three Years, and Then You’re Home Free.

Not really. It is true that the main federal tax statute of limitations runs three years after you file your tax return. But there are many exceptions that give the IRS six years or longer. Timing can be critical. If your tax return is due April 15, but you file early, the normal statute runs three years after the due date. Filing early does not start the clock on those three years. If you get an extension and file on October 15, however, your three years run from then. If you file late and do not have an extension, the statute runs three years following your actual (late) filing date.

The statute is six years if your return includes a “substantial understatement of income.” Generally, this means you have left off more than 25 percent of your gross income. Suppose that you earned $200,000 but only reported $140,000? You omitted more than 25 percent, so that means you can be audited for six years.

The circumstances can matter, too. Maybe this was unintentional, or you were reporting in reliance on a good argument that the extra $60,000 wasn’t your income. In that case, the six-year statute still applies. But be aware that the IRS could argue that your $60,000 omission was fraudulent. The IRS gets an unlimited number of years to audit for fraud, as we will see.

What about not an omission of income, but overstated deductions? The six-year statute of limitations does not apply if the underpayment of tax was due to the overstatement of deductions or credits.

Myth #2: Only Omitting 25% of Your Income Triggers the Six-Year Statute of Limitations.

Actually, the 25% threshold is a practical one. For years, there was litigation over what it means to omit income from your return. Taxpayers and some courts said “omit” means leave off, as in don’t report. But the IRS said it was much broader.

Example: You sell a piece of property for three million dollars ($3M), claiming that your basis (what you invested in the property) was $1.5M. In fact, your basis was only $500,000. The effect of your basis overstatement was that you paid tax on $1.5M of gain, when you should have paid tax on $2.5M.

In U.S. v. Home Concrete & Supply, LLC,^[2] the Supreme Court slapped down the IRS, holding that overstating your basis is not the same as omitting income. The Supreme Court said three years was plenty of time for the IRS to audit in such cases. But Congress overruled the Supreme Court and gave the IRS six years in such a case, so that is the current law. Six years can be a long time.

Myth #3: The Only Way the IRS Can Have No Time Limit for an Audit Is If No Return or a Fraudulent Return Was Filed.

The IRS has no time limit if you never file a return, or if it can prove civil or criminal fraud. If you file a return, can the IRS ever claim that your return didn’t count, so that the statute of limitations never starts to run? Yes. If you don’t sign your return, the IRS does not consider it a valid tax return. That means the three years can never start to run.

Another big no-no is altering the “penalties of perjury” language at the bottom of the return where you sign. If you alter that language, it also can mean that the tax return does not count. Such a move may sound like tax protester statement. However, some well-meaning taxpayers forget to sign, or may unwittingly change the penalties of perjury wording. Some other taxpayers just miss a form to end up in audit purgatory.

Myth #4: Foreign Income, Foreign Gifts, and Assets Are the Same.

Nope, foreign income and assets are different to the IRS, and they trigger tougher audit rules. The three years is also doubled if you omitted more than $5,000 of foreign income (say, interest on an overseas account). The IRS is still going after offshore income and assets in a big way, which dovetails with this audit rule.

This rule applies even if you disclosed the existence of the account on your tax return, and even if you filed a Report of Foreign Bank and Financial Accounts (FBAR) reporting the existence of the account; this rule’s six-year audit period matches the audit period for FBARs in any case. FBARs are offshore bank account reports that can carry civil and even criminal penalties far worse than those for tax evasion.

Certain other forms related to foreign assets and foreign gifts or inheritances are also important. For example, if you receive a gift or inheritance of over $100,000 from a non-U.S. person, you must file Form 3520. If you fail to file it, your statute of limitations never starts to run. Incidentally, penalties for failing to file these forms or for filing late are steep.

IRS Form 8938 was added to the tax law by the Foreign Account Tax Compliance Act (FATCA). Form 8938 requires U.S. filers to disclose the details of foreign financial accounts and assets over certain thresholds. This form is separate from FBARs and is normally filed with your tax return.

The threshold for disclosure can be as low as $50,000, so it pays to check out the filing requirements for your situation. Higher thresholds apply to married taxpayers filing jointly and U.S. persons residing abroad. But the forms are nothing to ignore. If you are required to file Form 8938 and skip it, the IRS clock never even starts to run.

Myth #5: U.S. and Foreign Companies are Treated the Same.

Not hardly. If you own part of a foreign corporation, it can trigger extra reporting, including filing an IRS Form 5471. It is an understatement to say this form is important. Failing to file it means penalties, generally $10,000 per form. A separate penalty can apply to each Form 5471 filed late, incomplete, or inaccurate. This penalty can apply even if no tax is due on the whole tax return. That is harsh, but the rule about the statute of limitations is even harsher.

If you fail to file a required Form 5471, your entire tax return remains open for audit indefinitely. This override of the normal three-year or six-year IRS statute of limitations is sweeping. The IRS not only has an indefinite period to examine and assess taxes on items relating to the missing Form 5471, but in addition, the IRS can make any adjustments to the entire tax return, with no expiration until the required Form 5471 is filed.

You can think of a Form 5471 a bit like the signature on your tax return. Without the form, it is almost as if you didn’t file a return. Forms 5471 are not only required of U.S. shareholders in controlled foreign corporations. They are also required when a U.S. shareholder acquires stock resulting in ten percent ownership in any foreign company. The harsh statute of limitation rule for Form 5471 was enacted in 2010 as part of the same law that brought us FATCA.

Myth #6: Amended Tax Returns Always Extend the Audit Period.

If you want to amend your tax return, you must do it within three years of the original filing date. You might think that amending a tax return would restart the IRS’s three-year audit statute, but it doesn’t. However, where your amended tax return shows an increase in tax, and when you submit the amended return within 60 days before the three-year statute runs, the IRS only has 60 days after it receives the amended return to make an assessment. This narrow window can present planning opportunities. In contrast, an amended return that does not report a net increase in tax does not trigger an extension of the statute.

Myth #7: There Are No Time Limits on Tax Refunds.

Getting money back from the IRS is hard. If you pay estimated taxes, or have tax withholding on your paycheck but fail to file a return, you generally have only two years (not three) to try to get it back. Suppose you make tax payments (by withholding or estimated tax payments), but you have not filed tax returns for five years. When you file those long-past-due returns, you may find that overpayments in one year may not offset underpayments in another. This is painful, resulting in lost tax money, and it catches many taxpayers unaware.

Myth #8: It’s a Mistake to Give the IRS More Time.

On the contrary, if the IRS wants more time to audit you, you should generally agree. The IRS must normally examine a tax return within three years, unless one of the exceptions discussed here applies, and though it tracks the three-year statute, it may need more time to audit.

The IRS may contact you asking you to sign a form extending the statute. It can be tempting to say no, but saying no is often a mistake.

It usually prompts the IRS to send a notice assessing extra taxes, without taking the time to thoroughly review your explanation of why you do not owe more. The IRS may make very unfavorable assumptions. Thus, most tax advisers tell clients to agree to the requested extension. You may, however, be able to limit the scope of the extension to certain tax issues, or to limit the time (say, to an extra year).

Myth #9: Counting the Years of the Audit Period Is Easy.

Counting three years is easy, but it can be tough to apply the statute and to count those three years in some cases. For example, say an IRS notice is sent to a partnership, but not to its individual partners. The partnership tax rules may give the IRS extra time. In other cases, the statute may be “tolled” (held in abeyance) by an IRS John Doe summons, even though you have no notice of it.

A John Doe summons is issued not to taxpayers but to banks and other third parties who have relationships with taxpayers. You may have no actual notice that the summons was issued. Yet it can extend your statute of limitations. This can occur if a promoter has sold you on a tax strategy. The IRS may issue the promoter a summons asking for all the names of his client/customers. While he fights turning those names over, the statute of limitations clock for all of those clients is stopped.

Another situation in which the IRS statute is tolled is where the taxpayer is outside the United States. If you flee the country for years and return, you may find that your tax problems can spring back to life.

Myth #10: You Don’t Need to Worry about the States.

Actually, state tax filings matter a lot. The IRS may audit first and the state later, or the reverse. They are usually connected. Some states have the same three- and six-year statutes as the IRS. Some have their own, like California, where the basic tax statute of limitations is four years, not three. In California, if the IRS adjusts your federal return, you are required to file an amended return to match up what the feds did. If you don’t, the California statute will never run out.

In most states, if you never file a return, the state statute never starts to run. That means thinking about your exposure. In California, for example, if you move out, filing non-resident returns just to report California source income to start California’s statute can be wise. There can be many tricky interactions between state and federal statutes of limitations.

Myth #11: Proof of Filing Isn’t Important.

Being able to prove exactly when you filed and exactly what forms were included can be critical. For that reason, keep scrupulous records, including proof of when you mailed your returns. The difference between winning and losing may depend on your records. The vast majority of IRS disputes are settled, and getting a good or mediocre settlement can hinge on your records, too. The statute usually begins to run when a return is filed, so keep certified mail or courier confirmation.

If you file electronically, keep all the electronic data, plus a hard copy of your return. As for record retention, many people feel safe about destroying receipts and back-up data after six or seven years. However, never destroy old tax returns. Keep copies forever. Also, do not destroy old receipts if they relate to basis in an asset.

For example, receipts for home remodeling 15 years ago are still relevant for as long as you own the house. You may need to prove your basis when you later sell it, and you will want to claim a basis increase for the remodeling 15 years back. For all these reasons, be careful and keep good records.

Conclusions.

An audit can involve targeted questions and requests on particular items only. Alternatively, audits can cover the waterfront, asking for proof of virtually every line item. Even if you do your best with your taxes, taxes are horribly complex. Innocent mistakes can sometimes be interpreted as suspect, and digging into the past is rarely pleasant. Records that were at your fingertips when you filed might be buried or gone even a few years later, so the stakes can be large.

Tax lawyers and accountants are used to monitoring the duration of their clients’ audit exposure, and so should you. It pays to know how far back you can be asked to prove your income, expenses, bank deposits, and more. Watch the calendar until you are in the clear.

1. Robert W. Wood practices law with Wood LLP (www.WoodLLP.com) and is the author of Taxation of Damage Awards and Settlement Payments and other books available at www.TaxInstitute.com. This discussion is not intended as legal advice. ↑

2. 132 S. Ct. 1836 (2012). ↑

“The Rule of Law and Business: Lessons from Experiments in South America” is the eighth article in a series on intersections between business law and the rule of law, and their importance for business lawyers, created by the American Bar Association Business Law Section’s Rule of Law Working Group. Read more articles in the series.

“The rule of law is crucial for promoting economic growth, sustainable development, human rights and access to justice. Where the rule of law is strong, people and businesses can feel confident about investing in the future.”

Former United Nations Secretary-General Ban Ki-moon

The United Nation’s Sustainable Development Goal 16 (SDG 16) reflects a global commitment to “Promote peaceful and inclusive societies for sustainable development, provide access to justice for all, and build effective, accountable, and inclusive institutions at all levels.”^[1] Considered both a goal, in and of itself, and a key enabler for the rest of the United Nations 2030 agenda, SDG 16 is grounded in the understanding that promotion of the rule of law is good for business.^[2] Despite this global and unequivocal recognition of the link between the rule of law and business, business lawyers still face resistance when introducing the Rule of Law as a tangible aspect of their professional practice, in part due to an apparent lack of opportunities to advance this fundamental principle in a pragmatic way, while providing advice to their clients.

Experimenting with reimagining what lawyers can do to advance business and the rule of law, CAMINNOS Soc. Civ., a business lawyer–led organization, is testing and developing novel approaches to business law tailored to support communities in rural South America using innovative approaches to individual and collective entrepreneurship. CAMINNOS works with new entrepreneurs to help them build capacity to engage with real world challenges by helping them cultivate experience- and results-driven thought leadership. One of the main goals of this approach is to empower small and medium business owners to engage with lawmakers to collaborate around using business frameworks to proactively solve or regulate societal problems. In supporting this kind of capacity building through law in business, CAMINNOS (co-founded and led by the author) operates on the understanding that the Rule of Law is of paramount importance—for businesspeople—in solving business problems and creating a healthy business environment in the long run.

CAMINNOS’s approach to business advising is grounded in educating clients on their Rule of Law obligations. At the big picture level, CAMINNOS uses Base-of-the-Pyramid (BoP) business models^[3] and blockchain technology^[4] to empower rural communities in strategic sectors to generate resources for development in their territories, with a focus on sustainability.^[5] In CAMINNOS’s case, the governance model of its community-owned companies provides families within each community with control and equal voting power to determine how to reinvest the companies’ revenue into sustainable development projects. Moreover, the start-up companies that CAMINNOS structures and advises allow each of the communities that have ownership in them to create an additional income source, to diversify their local economies through revenue reinvestment, and to change their members’ mindset, from a welfare to an entrepreneurial mentality.^[6] Thus, CAMINNOS acts to serve not only its clients’ businesses but also its clients’ larger vision of how these business will live in and impact society for the good.

Legal advising is at the core of these projects, and CAMINNOS adapts traditional approaches to lawyering by designing into them capacity-building programming and technical support that allow clients to learn how to operate their business entities independently by complying with sector regulations providing transparency, and promoting good governance across large shareholder bases. Based on this experience on the ground, CAMINNOS sees the role of the lawyer, particularly for lawyers advising small, medium, and new businesses, as including educating clients on the rule of law, including by emphasizing corporate ethics and the role of environmental sustainability and social impact together with profit.

At CAMINNOS, business law advising is not only about helping clients mitigate risk but also about empowering clients to learn to identify and address the legal frameworks underlying the root causes of such risks. Implementing such an approach, in 2021, CAMINNOS developed a project to introduce indigenous populations to the rural tourism sector through companies owned by the members of their communities. This project was the winning initiative in the Local Innovators Contest 2021^[7] organized by the Local Innovation Network^[8] and Ashoka,^[9] and selected from the proposals of more than 120 local government leaders paired with social entrepreneurs. The innovative component of the project was the design of a digital inclusion program that allowed collaboration between business lawyers, local government, and rural communities to develop and implement a digital tourism program formed as business entity run by its shareholders, with equal participation from business and the community. By facilitating multistakeholder collaboration^[10] in response to client demands, CAMINNOS was able to find long-term and systemic legal and business law solutions to the difficulties and limitations that rural tourism in Bolivia had to face during COVID-19 lockdowns. Reaching out to key allies, CAMINNOS gathered the National Protected Areas Authority, tech startups, NGOs, and academic institutions to design strategies to support rural communities in the tourism sector, creating legal frameworks to integrate such communities as direct participants in the sector. This collaborative public-private pipeline was able to implement a digital tourism program for rural communities to gain skills to create digital tourism experiences and digital artwork using blockchain technology that promoted and sold the works as non-fungible tokens^[11] in cryptoart galleries. The initiative was selected from among 80 public-private partnership proposals, as the most innovative project in the Local Innovators Contest 2021 international competition. This project and CAMINNOS’s work provide an example of the potential at the intersection of business and public policy that will be replicated in 2022 by other communities and the public sector in Bolivia and Argentina.

From working at the intersection of business and law, CAMINNOS has learned that business lawyers are key to activating the potential for businesses’ leadership within the business community. Moreover, CAMMINNOS has found that delivering innovative legal advice to clients that allows them to go beyond compliance with “minimum” safeguards to focus on the more enterprising “do no harm”^[12] principle invigorates business and inspires business leadership. It also creates within business clients an interest in and a commitment to engage in strengthening the rule of law by building and growing more accountable business institutions. These actions can be defined as part of the “changemaker” movement, a rather uncommon term for the legal profession, yet understandable enough to indicate that professionals on this level of engagement are committed to assume a different approach to attain new and better results in their effort to uphold the Rule of Law and achieve their clients’ social goals. Driven by its clients’ goals and aspirations, CAMINNOS is creating a community development model through new governance structures in rural communities, causing a change of mindset that redefines the relationship and power dynamics in communities, with a special focus on gender equity and the interactions between communities and other actors such as governments, private investors, NGOs, and civil society movements. The organization continually works to promote specific legal regulation to change the status of sustainable development for rural areas to allow indigenous communities’ inclusion in disruptive and scalable industries, such as the energy and technology sectors, enabling them as business actors.

CONCLUSION

Applying business law frameworks, CAMINNOS has trained rural communities on how to construct and operate community-led gas stations, as well as how to reinvest their profits into sustainable development projects. Anchored in business law and principles of rule of law, CAMINNOS has also deployed multidisciplinary teams of researchers, engineers, and financial and legal specialists to structure a corporate governance model that has enabled the creation of community-owned gas stations for five communities, granting ownership to more than 4500 families and enabling them to exercise their shareholder rights and comply with corporate regulations that govern commercial entities in that jurisdiction.

Some of the lessons that CAMINNOS has learned through its work are specific to South America. However, the core of CAMINNOS’s approach appears to have universal application. For example, incorporating advising on the nature and value of the rule of law into traditional business advising to help clients cultivate business leadership skills is an approach that business lawyers advising new or socially minded business clients can immediately experiment with and adopt. Moreover, business lawyers can also begin to develop networks beyond the legal community so that, where affordable, they can offer their clients collaborative and big picture opportunities for business growth and innovation that support and enhance the rule of law in a way that advances their clients’ leadership positions. In this context, an innovative approach to legal advising can be understood as a process to provide clients with effective solutions to systemic social and environmental issues, using strategic and multidisciplinary approaches, grounded first and foremost in business law and, more broadly, in principles of rule of law. The concept itself calls for an intervention that goes beyond traditional legal counseling, requiring a deeper understanding of the social problems, the culture, and the context, driving business lawyers to question whether existing law is helpful to the highest aspirations of the businesses and business clients they serve in given circumstances and how the Rule of Law can be upheld and relied upon in such work.

As an added fruit, given that the impact of socially conscious business projects is measured in both financial and social terms, this approach to business lawyering also allows lawyers to measure their own social impact, in addition to their financial impact—a measure that might make them more appealing and attractive to socially-minded entrepreneurs, who are increasingly numerous. Keep in mind that measuring social gains initially requires the design of a theory of change model, understanding the underlying needs of your clients and the communities they wish to serve and translating them into objectives, which must be aligned to identified needs in the relevant communities, needs also targeted as pressing social issues listed in the 17 Sustainable Development Goals^[13] promoted by the United Nations.

1. Any errors or omissions, and the opinions expressed in this Article, are the author’s own. The author can be contacted at [email protected]. ↑

2. https://www.un.org/ruleoflaw/sdg-16/ ↑

3. The term is used in economics to refer to the poorest two-thirds of the economic human pyramid, a group of more than four billion people living in abject poverty. Business for the Base of the Pyramid as a strategy was popularized by C.K. Prahalad, as well as other writers, such as Ted London, reframing the world’s poor living on less than US$ 1.25 per day as “resilient and creative entrepreneurs” as well as “value-conscious consumers.” ↑

4. Blockchain can be understood as a system to record information in a way that makes it extremely difficult to change or be hacked. It works as a decentralized ledger that records the origin and ownership of a digital asset. It gained notoriety as the technology used to created and support cryptocurrency, such as Bitcoin, Ethereum, and other digital coins. It is used for many purposes, such as to register digital assets, create Decentralized Finance (DeFi) structures, program Smart Contracts, and form Decentralized Autonomous Organizations (DAO), among its most common applications. ↑

5. More information can be found at https://caminnos.org/. See, “Assessing the Impact of Social Enterprises Using the U.N. Sustainable Development Goals and IRIS,” http://www.sonencapital.com/news-posts/assessing-impact-social-enterprises-using-u-n-sustainable-development-goals-iris/. “Social entrepreneurship is increasingly recognized as a means of addressing the world’s most pressing social and environmental problems. However, assessing the impact of social enterprises continues to be challenging. Part of the challenge is to find a shared language of impact in the myriad approaches used by social entrepreneurs, impact investors, and development agencies to code, classify, and interpret impact.” ↑

6. See, e.g., “Rural Youth Innovation Award honours youth leaders fighting COVID-19,” https://www.ifad.org/en/web/latest/-/rural-youth-innovation-award-honours-youth-leaders-fighting-covid-19. CAMINNOS works closely with rural communities, and we will see two of the projects launched by this organization led by an attorney in Bolivia that are examples of systemic change as an effect of strategic legal advice. ↑

7. The Local Innovators Contest is an initiative driven by Ayni | Systemic Innovation Communities, an alliance between different organizations of the Latam region with a strong commitment to innovation and the transformation of our cities. Its fifth edition, Collaborative Cities, was targeted to foster territorial transformation through open and participatory work between local government leaders and social innovators (social entrepreneurs). More than 120 teams registered for this initiative to co-design transformative solutions to local problems in areas as diverse as citizen participation, waste management, environmental issues, social inclusion, health, and food security, among others. ↑

8. The Local Innovation Network (Red de Innovación Local) supports local government teams to become leaders in the development of their communities through the improvement of their management capacities, the construction of collaborative networks, and the promotion of innovative public policies. ↑

9. Ashoka: Innovators for the Public, an NGO based in the United States and ranked as the fifth best NGO in the world by independent media organization NGO Advisor, builds and cultivates a community of over 3900 social entrepreneurs and change leaders who transform institutions and cultures so they support changemaking for the good of society. ↑

10. “Driving deep social change most often requires us to work in collaboration with diverse stakeholders on shifting a system together. While such multi-stakeholder collaboration can have a transformational impact on a system, it also comes with its own challenges and requires a specific type of leadership and strategy to be effective.” Ashoka Europe Fellowship Program developed a course to strengthen the leadership skills and strategy of social entrepreneurs for facilitating multi-stakeholder collaboration: https://fellowship-europe.ashoka.org/multi-stakeholder-collaboration. ↑

11. Non-fungible tokens (NFTs) are digital art pieces registered as unique tokens or items, using blockchain technology to create a smart contract that grants authenticity and proof of ownership. Its value is in the blockchain, which removes the middleman and confirms the origins or authorship of the art. ↑

12. See “Emerging Voices: ‘Do No Harm’ and The Development of General Corporate Human Rights Obligations,” Gabriel Armas-Cardona, Opinio Juris (August 28, 2015), http://opiniojuris.org/2015/08/28/emerging-voices-do-no-harm-and-the-development-of-general-corporate-human-rights-obligations/. (Emphasizing that “The principle of ‘do no harm’ has been used as a touchstone in corporate human rights obligations since at least 2002 and is a surprisingly suitable standard for developing a structure for general obligations.” Yet, this principle is not designed to guide the actions of business entities towards social good contributions, but to restrict them to avoid human rights violations.) ↑

13. See “Assessing the Impact of Social Enterprises Using the U.N. Sustainable Development Goals and IRIS,” http://www.sonencapital.com/news-posts/assessing-impact-social-enterprises-using-u-n-sustainable-development-goals-iris/, quoted at note 5. ↑

During 2020 and 2021, Cuatrecasas advised on thirty-two private equity deals with transaction values greater than €10 million. Based on this experience, we can highlight some of the most relevant market trends in the Spanish private equity market.

General overview

In 2021, almost half the transactions reviewed were deals valued at over €100 million.

Investment was distributed among different sectors, but the food industry and technology, media, and telecom (TMT) sectors were particularly active.

In 2020, there was a clear change in trend from previous years, and investments (compared to exits or SBOs) were dominant with 82% of the transactions.

In recent years, an increasing number of private equity funds and financial sponsors have been adopting alternative investment strategies to buyouts. In this scenario, some traditional funds have sought to diversify their strategies and products. These alternative strategies often result in innovative structures and instruments such as minority investments, which are more flexible and can be adapted to the company’s needs and to the risk profile.

However, when a private equity fund invests, the most common transaction continues to be one in which it buys 100% of the target company’s capital stock or takes a majority shareholding through a pure share purchase deal.

Approximately one-quarter of transactions continue to be ones in which the private equity fund, instead of buying a majority shareholding directly, buys the target company through a special purpose vehicle (SPV), after which the seller reinvests in the SPV, usually through a capital increase. Although this happens for many reasons, tax, indebtedness and regulatory reasons are the most common.

Deal process

In 2021, more than half the transactions reviewed were auctions with tighter deadlines due to the pandemic.

During the first year of the pandemic, there were fewer transactions with conditions precedent (47% in 2020) compared to previous years. Based on our experience, this is probably because, unless conditions precedent were strictly necessary, the uncertain circumstances made parties prefer fast transactions with simultaneous signing and closing.

In March 2020, Spain followed the trend of other European countries (e.g., France, Germany, and Italy) and implemented a prior authorization system for foreign direct investments (FDIs), either because the investment is made in a strategic sector or because of the investor’s profile. This was in line with Regulation (EU) 2019/452 (the “FDI Regulation”) and the EU Commission’s guidance—which called on all EU Member States to set up a full-fledged foreign direct investment (FDI) screening mechanism. This became the most remarkable aspect within the M&A market.

A transitional authorization system for EU investors also applies until December 31, 2022, but it only applies to investments in (i) Spanish listed companies that carry out their business in a strategic sector, and (ii) unlisted companies if the value of the investment exceeds €500 million and they also carry out their business in a strategic sector.

Despite the initial concern and uncertainty as to how the new regulation would affect the implementation of M&A deals (mainly owing to the regulation’s being unclear), in practice, it has not discouraged investment.

Due to funds’ interest in strategic sectors, an FDI analysis was needed in most transactions. Apart from this new condition precedent, which became increasingly regulated due to the pandemic, the negotiation and regulation of interim periods have not been as affected by the pandemic as was previously expected.

Unlike in previous years, when almost half the transactions requiring regulatory approval included a “hell or high water” clause, this was rarely the case in 2020 and 2021. Instead, the most common practice was to establish that the conditions the regulatory authorities could impose had to be assumed unless they were especially burdensome or exceeded certain limits.

Although the opposite could have been expected, there was a progressive decrease in the use of break-up fees in 2020 and 2021 in case the closing did not occur or there was a breach of the closing obligations. Also, the use of conditions subsequent was again scarce (less than 10% of transactions).

Consideration and pricing mechanisms

The locked-box mechanism consolidated its dominance in 2021 as the most used pricing mechanism (66% of transactions). Even though the locked-box mechanism has become the most used, the completion accounts mechanism was still used in 32% of the deals in which net debt and working capital were the most widely used financial parameters for the post-closing adjustment.

The use of equity tickers continues to grow, and structuring them as a fixed daily amount is more common than setting a fixed daily rate.

The seller’s liability under leakage compensation is either capped at the leakage amount effectively received, or expenses and taxes are added.

All transactions with deferred consideration were earn-outs or a combination of fixed deferred price and earn-outs. When an earn-out is agreed, there are sometimes covenants to protect the seller, but this is uncommon. Most earn-outs are linked to EBITDA or, in general, to the company’s benefits.

Warranties and indemnity undertaking

In 2020 and 2021, when there was more than one seller, their liability was usually joint or individual, or a combination of both (individual for the fundamental warranties and joint for the business warranties). Joint and several liability was hardly seen.

In 85% of transactions with a deferred closing, the seller was considered to repeat the representations and warranties (R&Ws) on completion.

Share purchase agreements (SPAs) are usually limited quantitatively and temporarily. However, those limits differ depending on whether there is an investment or an exit and whether warrant and indemnity (W&I) insurance is taken out. In Spain, the impact of a buyer’s actual or deemed knowledge on claims for breach of warranties is usually negotiated under SPAs.

In 2020 and 2021, an 18-month limitation period became the most used, abandoning the trend of longer periods in previous years. The most used liability cap for business and tax warranties has increased slightly and is now 20% to 30% of the purchase price.

During 2020, in all exit transactions, the private equity fund was not liable for the breach of business or tax warranties because a W&I insurance had been agreed. However, during 2021, this happened only in 40% of the transactions. However, as usual, in all transactions in which private equity funds invested, industrial sellers granted business and tax warranties, or W&I insurance was agreed. Specific indemnities were almost always included in transactions where W&I insurance was not agreed, and a private equity fund was investing.

Unless a W&I insurance was agreed, all deals had lower and upper limits. Regarding lower limits (and excluding W&I transactions), (i) the seller was not usually obliged to indemnify for losses if each loss, considered individually, was less than a certain amount (de minimis exclusion or de minimis amount), and (ii) all the deals included a basket. In these cases, the seller is not liable for damages unless the aggregate amount of the claim, together with all the claims (each over the de minimis amount), exceeds the basket amount. In cases where a basket is agreed, 77% took the form of tipping baskets and 23% of non-tipping baskets.

There have been more transactions with an anti-sandbagging clause than with a pro-sandbagging clause.

Buyer’s remedies against seller’s liability

In general, during 2021, funds have been less demanding in the seller’s guarantees, either because they were buying highly demanded assets or because the valuation was beneficial and there was no need for further guarantees.

Regarding classic buyer’s remedies, third-party guarantors were the most used, exceeding escrows, which were the most used in the past five years. This is probably because, as money was cheap, some escrow agreements were charging interest instead of giving it, discouraging parties. No transaction used a bank guarantee as a seller’s guarantee.

W&I insurance continues to be the most used buyer’s remedy, albeit less markedly so than in the past. Its use has become widespread, both when private equity funds are investing and disinvesting, and not only within the framework of an exit, though its use has focused on clean exits (90% of W&I transactions).

Dispute resolution

Parties opted for arbitration in 41% of transactions as the dispute resolution mechanism to resolve conflicts arising from the agreement.

The most common seat of arbitration was Madrid. Arbitration proceedings were mostly managed by the International Court of Arbitration of the International Chamber of Commerce (ICC), or by the Court of Arbitration of Madrid.

In California, workers’ compensation claims sometimes lead to crossover employment actions, or even California Division of Occupational Safety and Health (“Cal/OSHA”) cases, stemming from the same set of facts and circumstances. Consider, for instance, an employee working for a construction company who falls off a ladder and breaks his back during the course and scope of his job. There is no dispute that this incident is a work-related injury. However, it could also result in a Cal/OSHA action and might snowball into a Serious and Willful Misconduct claim, a wrongful termination lawsuit, or even a Labor Code Section 132a claim in the hands of the right attorney, if the employee is separated after the fall and the circumstances tangentially support the allegation.

While the employer in this example may be aware of the obvious (i.e., that the injury will result in a workers’ compensation case, and an expensive one at that), the employer may not foresee how the incident can also result in multiple types of claims and potential liability. Generally, there is a three-step process that every employer should take when a work-related injury occurs to mitigate exposure.

The first step is to identify all potential claims that can arise from a work-related injury and how the handling of the claims might overlap within the company. Many employers recognize how industrial and employment-related claims intersect and take specific action when appropriate, including but not limited to offering modified duties to an injured worker to cut off temporary total disability benefits in the workers’ compensation claim, as compared to making the determination and/or engaging in dialogue with the injured worker to initiate an adequate interactive process under the California Fair Employment and Housing Act (“FEHA”). However, most businesses (large ones in particular) that have designated departments to handle workers’ compensation cases, leaves of absences, and the interactive process fail to ensure crossover handling of the claims. As a result, problems arise because the departments are siloed. Indeed, businesses, and their insurance companies, that take a narrow approach to handling workers’ compensation claims can overlook the potential for significant civil exposure and the opportunity to shut down that risk before it escalates into a bigger, more costly problem given the substantial costs involved with defending an employment lawsuit and the exorbitant damages that can be recovered.

As an example: an employee, Mary Jane, is called into a performance review on November 15, 2021, where she learns that she is not meeting expectations. The week prior, Mary Jane had complained to her manager about her neck and elbows hurting from typing at work, but she was not offered any medical treatment or accommodations to alleviate the pain. Mary Jane is distraught by the news regarding her performance, and is concerned about being terminated, so she goes to see her doctor to consult on both the neck and elbow pain as well as her psychological distress. In mid-December 2021, Mary Jane submits a doctor’s note to the employer advising that she needs a month off due to work stress, as well as to allow sufficient time for her neck and elbow pain to subside. However, when Mary Jane fails to submit formal leave paperwork as requested by the employer, she is terminated prior to the end of that month. Mary Jane seeks legal counsel and finds an attorney to file a workers’ compensation claim on her behalf. She claims a continuous trauma of work stress and injury to her neck and elbows. Early in the litigation, the defense team quickly resolves the workers’ compensation claim by Compromise and Release for $15,000. Mary Jane and her workers’ compensation attorney walk away with their settlement.

A couple of months later, the employer receives a six-figure settlement demand letter from a different civil attorney alleging violations under the FEHA and whistleblower retaliations on Mary Jane’s behalf. In hindsight, when rushing to close the file on the workers’ compensation side, the potential civil exposure was completely neglected. Here, although Mary Jane had a straightforward workers’ compensation claim, the employer either missed, or purposely chose not to accommodate, the month off per the original doctor’s note. In terminating her, the employer may have unknowingly established a viable disability discrimination action including liability on the derivative claims, such as failure to provide reasonable accommodations and/or failure to engage in the interactive process, in addition to a retaliation claim for the adverse employment action (i.e., the discipline and subsequent termination following Mary Jane’s complaint about her neck and elbows).

Under this scenario, the best way to prevent crossover exposure and potential for substantial damages is open communication between departments, including Human Resources (“HR”), Risk Management, Leave of Absence, Workers’ Compensation, and Legal. Civil exposure for businesses is often the result of the “right hand not knowing what the left hand is doing.” Here, if the HR and the Workers’ Compensation departments had communicated at the outset of the injury, there would have likely been more consideration given to the timing of the performance review meeting in relation to Mary Jane’s complaint about neck and elbow pain. Further, if the employer had a consistent date on which they delivered performance reviews to all their employees, the appearance of retaliation would be mitigated. That is, if Mary Jane and her peers were reviewed the same day, the argument that she was disciplined based on reporting work-related pain to her neck and elbows loses traction. However, if the employer does not follow a consistent review date, and the performance review meeting date at issue was arbitrarily selected, the employer will have a more difficult time justifying the reason for the date of the meeting and how the meeting was unrelated to her pain complaint the week prior. Furthermore, if the HR, Workers’ Compensation, and Leave of Absence departments had communicated about Mary Jane’s return-to-work status, they would have likely recognized termination may not have been appropriate at that time.

The second step to mitigate exposure on potential crossover claims is to remember that all adverse actions, especially terminations or suspensions, should be reviewed with experienced employment counsel. If counsel is not available, then a trained HR professional with knowledge and expertise in employee risk management, and the importance of timelines, should be consulted. In this scenario, the advice of counsel or senior HR management may have prevented Mary Jane’s termination from proceeding while Mary Jane was engaging in protected activity.

The third and final step to mitigate exposure, and a best practice when settling a workers’ compensation claim with potential civil liability, is to secure a general civil release with separate consideration. California workers’ compensation settlements need to be approved by an administrative law judge (“ALJ”); general releases should not be presented to the ALJ approving the workers’ compensation settlement, as the ALJ does not necessarily have jurisdiction over claims outside of the work-related injury. Nevertheless, if a business insists on and is successful at negotiating with the injured worker and/or their counsel for a solid general release as a term of the resolution, this provides far more protection than a simple voluntary resignation. In this instance, had the workers’ compensation defense team secured a solid release, the employer could have presented the release to the employee’s civil attorney, and the employment-related claims would have been dead on arrival.

In sum, identification coupled with open communication, coordination, and a global litigation strategy that covers the varying but related claims is key for businesses to minimize the snowball effect that can arise out of what might appear to be a simple workers’ compensation case.

“Do you have full authority to settle this matter?” the U.S. District Court Judge directed to me in a tone that made quite clear he doubted very much that could be true. As a thirtysomething lawyer sitting next to an even younger law firm associate, I understood why he was incredulous. He was right to be so, but not because of our relative youth and inexperience. Put simply, I appeared at this mandatory settlement conference with no intention of settling the case. I could put a modest number on the table if the plaintiff wanted to fold his cards and go home. But we thought we wanted to try the case. The plaintiff had occupied a prominent spot in our organization, which gave the case visibility. We believed he would make a bad witness. Our star witness, the president of a billion-dollar division, would surely connect with the jury. Plus, we believed the sole practitioner local lawyer representing the plaintiff could never outshine our big firm/big city litigator.

I muttered something about having “sufficient authority” in response to the judge’s question. I might as well have lit a firecracker—he bellowed at me, “I don’t care about what you think is sufficient authority, I want the person here with complete and total authority!” As I started to explain that “total” authority would require that we convene a meeting of our board in his chambers, the associate mercifully cut me off and said, “Your honor, we have full authority.” The mini-crisis I had inexplicably created passed, and the settlement conference ended an hour later. Only plaintiff’s counsel seemed irritated, correctly observing that we could not have expected his client to take our miserly offer.

Fast forward a few months, and I am sure you can guess what happened next. If your guess is that the plaintiff and his counsel dazzled the jury, our star witness and impressive litigator fell flat, and the jury punished us with a monster damage award, you might be surprised to learn that none of that happened. Our witnesses did great, having been superbly prepared by counsel who threw themselves at the trial with all their energy. The jury returned a defense verdict, and we congratulated ourselves on devising and executing a brilliant strategy. But the celebration did not last very long.

First, there were the legal fees. Defense counsel did what they were supposed to do, working night and day in the weeks leading up to and through the two-week trial. But the bill seemed staggering, and a lot more than the former employee would have taken in settlement. The CFO remarked that we must have lost our minds to spend that much. My boss turned on his longtime outside counsel and demanded to know why she thought it was reasonable to bill that much time. Her completely reasonable response was, “When you committed to try the case, I did think you wanted to win it.” But in the longstanding tradition of general counsel scapegoating outside counsel, the damage was done, and the lawyer-client relationship had been broken beyond repair.

Second, the various witnesses who had taken precious days away from running the business to testify at trial were uniformly irritated. To a person, they proclaimed that with their experience, winning personalities, and general brilliance, they did not need the extensive preparation they endured before testifying. Objectively, they were quite wrong—anyone who has tried a case or defended a deposition has seen the chasm between the prepared and unprepared witness. But with no objective standard to consult and the division president pressing his thumb heavily on the scales, the narrative that the legal department had let outside counsel run amok took hold and became accepted wisdom.

As a legal team, we had foreseen those potential negative outcomes and had prepared ourselves to deal with them. We thought any blowback would be worth it because our demonstrated willingness to try and win this case would have a deterrent effect. Future disgruntled employees would think twice before filing a case and risking our wrath. But it never really works that way. No matter how hard you try to avoid mistakes, they will occur, and the company will sometimes be on the wrong side of a dispute. Moreover, the employee who thinks they have been treated unfairly will not likely be dissuaded because some other employee lost their case. If there had been some deterrent effect, it would not have lasted long, as memories fade quickly for those not directly involved. In fact, it’s been some time since I have been able to remember the plaintiff’s name.

The less than stellar result of the case did not hit the legal team like a thunderclap that forced us to reevaluate and change our ways. I don’t think we even discussed it formally. However, in hindsight, the win that felt like a loss made a big contribution to how my approach to litigation and settlement opportunities changed over the next twenty years. I learned that the most important imperative is to understand the difference between cases that you must take to final judgment versus cases you are willing to take to trial. The cases you must take to final judgment are centered around something fundamental to your business. For example, when you terminate one of your senior executives who has corruptly influenced procurement decisions, you must take the ensuing wrongful termination case to its conclusion. A financial settlement will be viewed as condoning corrosive behavior and will make a dreadful statement to your team about what you really value. In other words, the cases you must take to final judgment are existential: either the company cannot exist if it does not prevail, or something about the case will cause the company to compromise a fundamental value if you choose to settle.

Deciding whether a case fits in the “must not settle” category will require thorough analysis and should rarely produce a “yes” answer. Deciding whether a case falls in the “willing to keep litigating through trial” category is a bit simpler. Do you think you can win? If the answer is yes, ask next, “Why do you think so, and will the case have to be tried?” Answering those questions is a great starting point for inside and outside counsel to determine the approach for a mediation or settlement conference.

Believing that a case can be won does not mean that it will be won or that winning will not ultimately feel more like losing. Thus, being willing to litigate, up to and including through trial, should also mean that you want to make serious efforts to settle the case. Mediations and settlement conferences usually provide the best opportunity to have those efforts bear fruit. The introduction of a neutral third party can have a powerful effect on how litigants view cases, so while many cases do not require that intervention, parties and their counsel should make the most of the opportunity when it is there.

But too often litigants and their lawyers view settlement conferences as a step to be endured before getting to the main event. Mediations are largely voluntary events, but the same view often holds true. Because most cases do settle it might seem strange that this view persists. I believe the reason is that too many litigation teams view the mediation or settlement conference as another opportunity to win the case. Trial lawyers are perhaps the most naturally competitive people on Earth—you can’t put them in a situation that they won’t try to win, whether it’s a jury trial or ordering lunch. Viewing every situation as an opportunity to win can make outside counsel impede instead of facilitate a successful mediation.

Successful mediation requires that the question of authority is thought through well in advance of the event. You need to decide where your bottom line is and arm the negotiating team with enough authority to get there. When you have too many disputes to handle personally, you need to train surrogates in how to use their authority wisely and develop a level of trust in them to provide sufficient authority. The first few times I found myself in the position of sending a surrogate to a settlement conference instead of being the surrogate, I discovered that I had checked neither of those boxes.

We had an employment discrimination case we had acquired in a merger of public companies that I thought we should settle, but my colleagues were less certain. We had no hope of winning a summary judgment motion, so the case had reached the “try or settle” decision point. Instead of fighting to get the necessary authority for that stage of the case, I sent my associate GC to a mandatory settlement conference with a five-figure number, $90,000 if I remember correctly. (I had more authority than that but held back the last $50,000). I did not expect it to be enough but hoped that the gap would at least be narrowed between the plaintiff’s prior half-million dollar demands and the nuisance value number we had previously offered. The conference was set to start at 9:00. An hour or so later, my phone rang.

“Where do we stand?” I asked my associate GC.

“I am going to need more authority,” she said, guessing that I had more to give.

“OK, how far apart are we?”

“We are at $90,000; plaintiff has come down from $500,000 to $480,000.”

“OK, come home and let’s discuss what happened.”

What had happened was that the judge had asked the parties privately for their final numbers at the start of the conference. My colleague had answered the question directly and used her full authority when she was still many miles from a deal. It happens a lot and says a lot about why some judges do not make very good mediators. But it also showed that I had failed to impart to my team how to handle the situation. The former employee’s counsel was not near her final number but had nowhere to go when my colleague used her full authority on the first exchange of numbers. Too late for that case, I imparted to my team the lesson I had learned from hundreds of experiences in that situation—do not use up your authority unless you are very close to making the deal.

But what if you show up with “enough” authority to make a deal and the other side is unreasonable? Perhaps the answer is that the person clinging to an unreasonable position may know full well that they are putting forward a losing argument. They may have their own problems with emotion and reason on their side and have themselves not been given enough authority to get to a deal. You cannot pummel someone who lacks authority into accepting your position. They simply cannot meet your demands. If you insist on demonstrating that you are right, you will not make the deal, and you might damage the relationship. As one of my colleagues said to me in private when I had just spent fifteen minutes eviscerating the utter stupidity of the argument put forward by a junior lawyer of an important supplier on a key point in a negotiation, “Have you considered the possibility that he understands everything you are saying and does not have permission to agree with you?” I calmed down, apologized to my opposite number in the negotiation, and accepted that we were not going to finish that day. The deal was completed three weeks later, and the relationship stayed strong.

Returning to my initial experience with the federal judge where I fumbled the authority question, there was one other subsequent conversation worth noting. I asked our CFO a few days after the experience, “If I went nuts and exceeded my authority at a settlement conference, would the company pay what I agreed to?” He looked at me quizzically and replied, “We certainly would. We would also probably fire you. Where is this going?” I replied, “That’s all I needed to know.” From then on, whenever I was asked “Do you have full authority to settle this matter?” I could confidently reply, “Yes, your honor, I have full authority.”

Despite the existence of a global pandemic that we continue to navigate, the payments ecosystem is experiencing robust growth, amplifying certain trends such as shifting to omnichannel and contactless payments. We are seeing disruption across the payments ecosystem as new competitors enter the fray and scale up and new business models emerge. The pandemic has led to a surge in e-commerce, including transactions on “marketplaces”—online sites that match buyers and third-party sellers. Previously, it was primarily brick-and-mortar merchants who entered e-commerce through online platforms.

The development of new payment technologies, such as peer-to-peer payment technologies and contactless payment technologies, shows the payments ecosystem has evolved to provide an expanded set of point-of-sale payments options for consumers. The payments ecosystem is leveraging improvements in technology to adapt to consumer demand for speed and convenience, as well as for “touchless” aspects that make such technology desirable for consumers to use at point-of-sale during a pandemic.  

The panel “Payments Link: Rails, Platforms, and Deals,” held virtually on September 22, 2021, as part of the 2021 Business Law Virtual Section Annual Meeting, shed light on the aforementioned issues by featuring a discussion on the current payments landscape and key considerations for merchants and consumers with respect to their preferred payment methods. The speakers on the panel were:

• Judy Mok, Partner at Ballard Spahr (moderator)
• Tracy Cheney, General Counsel of Early Warning Services
• Lisa Detig, Vice President & Associate General Counsel Americas at Match Group, LLC
• Ryan Richardson, Lead Global Partnerships Counsel at Stripe Inc.
• Ling Ling Ang, Associate Director at NERA Economic Consulting

This program is currently available as an ABA on-demand CLE on the ABA website: https://www.americanbar.org/events-cle/ecd/ondemand/418241486.html.

In this panel, Ling Ling Ang highlighted recent (at the time) antitrust developments related to the payments ecosystem, such as the termination of Visa’s proposed acquisition of Plaid following a suit filed by the U.S. Department of Justice; Square, Inc.’s acquisition of Afterpay; and the filing of Camp Grounds Coffee, LLC et al. v. Visa, Inc. et al. Interest in antitrust in financial services at the federal level is demonstrated by the U.S. Department of Justice’s newly established Financial Services, Fintech, and Banking Section, along with the July 9, 2021, Executive Order on Promoting Competition in the American Economy. Antitrust considerations in payments include the effects of vertical mergers, the role of platforms, digitization, and consumer welfare. The panel discussed how the evolution of payments ecosystems appears to call for additional critical legal and economic analysis, likely applying novel models and techniques.

There was an in-depth discussion on Zelle, a peer-to-peer payment solution provider and how it works. Tracy Cheney provided basic statistics about Zelle in terms of volume and participants. Cheney discussed how the money movement flows with Zelle, its distribution channels, and integration with settlement rails such as Visa, Mastercard, ACH, and RTP. Cheney also highlighted some payment opportunities using Zelle, including:

• Person-to-Person Payments (P2P): paying a babysitter, a mom sending emergency money to a kid at college, or paying a friend back for purchasing concert tickets
• Consumer-to-Business Payments (C2B): paying for general services around the house, such as landscaping or cleaning; paying rent; paying a personal trainer or groomer
• Business-to-Consumer Payments (B2C): insurance companies disbursing insurance proceeds to a homeowner, an employer reimbursing employees for travel and expenses, a class action administrator disbursing a settlement pool

Cheney also discussed the Zelle Network’s governance structure.

Ryan Richardson discussed the flow of data and funds in the payment system, and Stripe’s role in the payment system. This role differs country to country: “Stripe is an acquirer in most of the European Union and the United Kingdom, Hong Kong, Singapore, and many parts of Asia, but in the United States and some other markets, [Stripe] is not a direct or a principal member of the payment system.” He also discussed other services Stripe provides to its customers, including business analytics services.

The panel also discussed the rise of other payment options, including card not present transactions and buy now, pay later (BNPL) programs (the latter of which may be offered in both online and in-store channels), which is consistent with payment methods having evolved to address pain points in the way customers shop and pay online. Judy Mok discussed how millennials make up a substantial portion of the customer base for BNPL programs because these types of programs tend to appeal to younger consumers who may be wary of credit cards. Traditional financial services players and Silicon Valley giants alike are trying to enter this line of business that fintechs have pioneered. Some recent examples include Comenity Bank’s acquisition of Bread and Apple Inc. and Goldman Sachs’s entry into the BNPL space, along with Square, Inc.’s acquisition of Afterpay.

The panel discussed how, for merchants to offer payment solutions that are attractive to consumers (whether on the acceptance or issuance side), merchants must enter into commercial agreements with payments solution providers (whether such a provider is a financial institution, a fintech partner or some other third-party provider) to provide such offerings to their customers. Lisa Detig spoke about procurement processes for and considerations of merchants in strategic payments arrangements. Considerations include information security and data privacy, the long-term nature of the partnerships, and potential evolution in the payments landscape.

Panelists shared legal contractual considerations for merchants looking to enter strategic partnership arrangements in the payments space. The panel also discussed allocation of risk in the payment world including liability for unauthorized transactions, misdirected payments, and scams.

On February 24, 2022, Lex Machina released its 2022 Law Firms Activity Report (the “Report”). The Report ranked firms across sixteen federal practice areas over the last three years, revealing which firms filed and defended the most cases in how many districts and involving what amounts of damages.

In the past, in-house attorneys have used this report as a starting point for selecting outside counsel. Law firms have historically used the report to understand how they compare to their peers and competitors in order to maximize their strategies in bids for clients. However, the report also provides valuable data-driven insights into evolving litigation trends across practice areas, districts, and time.

One of the most interesting trends highlighted in the report involves the effect of the COVID-19 pandemic on case filings in various practice areas. When the pandemic first began two years ago, Lex Machina began to track cases caused by COVID-19 (the “COVID Cases”), and it continues to do so now. The data and analytics from tracking these cases reveal that the impact of COVID-19 on litigation activity in different practice areas has continued to evolve and change as the pandemic has progressed.

For example, several of the most active law firms involved in COVID Cases filed cases under the American Disabilities Act (the “ADA”) or alleged employment claims. This pattern contrasts with litigation activity in the early stages of the pandemic, when according to Lex Machina’s previous Law Firms Activity Report, contracts and securities case filings were some of the most robust, as plaintiffs reacted to broken contracts and plummeting stock value. These trends likely reflect the fact that the later stages of the pandemic have tended to heavily impact different practice areas, such as employment and civil rights cases involving the ADA. This stands to reason, as over time, remote-work situations and morphing government mandates have given rise to a new host of legal issues. The Report indicated that employment defense firms were especially busy, filing cases involving claims related to vaccine mandates, disability discrimination, whistleblower retaliation, and lack of protective equipment, among other claims.

In addition, the case filing trends revealed that class actions and lawsuits related to singular large-scale events continued to influence the legal landscape and drive up case counts, particularly in the areas of product liability, torts, and insurance. For example, in product liability, the most active law firms representing plaintiffs and defendants were each involved in approximately 800 cases in 2020 that were related to a Bard medical device, which drove up their three-year case counts and placed them at the top of the lists of most active firms.

Some other trends revealed in the Report include the Department of Justice’s continued dominance as the most active counsel overall. In terms of the most active law firms, the Legal Analytics showed that while some law firms with high case counts had dedicated specializations, there were several national litigation firms that appeared in multiple practice areas. For example, Skadden, Arps, Slate, Meagher, & Flom topped two different lists for defense firms in the practice areas of Antitrust and Securities, while Fox Rothschild appeared in multiple lists of top firms in the Bankruptcy, Contracts, Copyright, False Claims, Trade Secret, and Trademark practice areas. Many of the most active employment firms, such as Jackson Lewis, also appeared in the lists of the most active firms with cases caused by COVID, as well as the most active firms overall.

The Report revealed several key litigation trends over the last three years, as well as highlighting the law firms and counsel that were most active in different practice areas during this time. Leveraging the data-driven insights provided by the Report can be powerful for gaining an enhanced understanding of the evolving landscape of federal litigation.

Lex Machina’s Law Firms Activity Report presented data from Lex Machina’s Legal Analytics platform. Using machine learning and technology-assisted attorney review, raw data was extracted from PACER (Public Access to Court Electronic Records), which contains documents from federal district court. The raw data was then cleaned, tagged, structured, and loaded into Lex Machina’s proprietary platform. The report was prepared by the Lex Machina Product Team using charts and graphs from the platform. The commentary was provided by Lex Machina’s legal experts.