ADR and Governance News from Jim Reiman

April/May, 2017

Friends and colleagues

Spring has arrived!?!  I wrote those words in the introduction of my February/March issue, only to have nature laugh at me with more weeks of cold and wet.  This time, I believe it’s here to stay.

This edition of the Newsletter commenced as my April, 2017 issue, but I delayed its appearance in order to make an announcement which I have been unable to make until now.  Given its late publication, this issue will serve as my April/May edition.

My announcement is this:  I’m honored to relate that I’ve been appointed to the board of directors of Ener-Core, Inc. (OTCQB:ENCR).  Ener-Core created a technology called Power Oxidation which is the only clean power generation that runs directly on low pressure, low-quality gases that otherwise would be flared as waste gasses at landfills, refineries, and other installations.  The process not only converts what is normally burned as waste into a usable energy source, it does so with ultra low NOx emissions (> 1ppm) and without a catalyst or other chemicals.  Dresser-Rand, a Siemens business, has licensed the technology for use in their 2-4 MGW generators and produced a 4 minute video about the tech which is worth viewing.  Here’s a link to the video.  Granted, I’m biased, but this is truly revolutionary tech that has the potential to significantly reduce air pollution.

So much for announcements and shameless self-promotion.  As regular readers of thisNewsletter know, each issue I present a summary of recent research reports, legal decisions and news articles that I hope my readers will find of interest and worthy of their time to peruse and perhaps download and read in their entirety.  I focus on two areas:  corporate governance and alternative dispute resolution (“ADR”).  Additionally, I almost always include one or two (sometimes three) articles concerning matters of general interest in my “Interesting Cases/Articles of the Month” section.

Beginning with Governance, this month I present two articles.  The first is actually a pair of articles appearing in the Harvard Law School Forum on Corporate Governance and Financial Regulation regarding the Wells Fargo – dare I say “corrupt” – sales practices and the report prepared by the board’s independent directors and their counsel and investigator.  The first of the two articles article describes the report, and the second is a commentary on the report titled:  “Vote the Bums Out.”

The second governance piece presented is an article appearing in the New York Timesregarding JP Morgan Chase’s internet advertising.  Partly in response to concerns that its ads were appearing on sites with content that many find offensive, JP Morgan Chase commenced advertising only on pre-approved sites, thereby reducing the number of websites on which its internet ads were displayed from over 400,000 to 5,000.  Interestingly, its impression (viewership) results remained virtually the same.

For my ADR readers, I present a case and a news/information piece.  The case: a late March DC Court of Appeals decision affirming an arbitral award against the country of Belize challenged because one of the arbitrators in that matter failed to disclose that another member of the English chambers that he belonged to had, in a previous unrelated matter, advised a partial owner of the opposing party and “represented other interests adverse to Belize.”  The case is noteworthy because it sets out a clear statement of the New York Convention’s “public policy” basis for vacating an award, and establishes the precedent that English chambers are not to be treated the same as US law firms for conflicts disclosure purposes.  The news/information piece is a summary of the new ICC rules for expedited proceedings, which became effective on March 1, 2017.

Lastly, I present three articles of general interest in my “Interesting Cases/Articles of the Month” section.  I try to avoid politics, but seem to be unable to do so in the era of Trump.  Hence, the first is an article describing a recent suit brought against our president by several of his business competitors who allege that he is unfairly siphoning business away from their competing hotel and restaurant businesses and violating the emoluments clauses of the Constitution.  Second, we’ve all been alarmed by the impact and growing prevalence of fake news.  Why do we read that stuff and why do we believe it?  The presented article, appearing in Kellogg Insight titled “The Psychology of Fake News,” discusses these questions.  Finally, I must admit – I’m a closet geek.  If I could add and subtract, let alone understand even basic algebra, I would have been an engineer. Thus, when I saw the article “Do Your Shoelaces Keep Coming Undone? Engineers Explain Why” I had to read it.  I present it for other closet (or outed) geeks.

This Month’s Articles

Corporate Governance

• Wells Fargo Sales Practices Investigation Report:  Most will remember the scandal that broke late last year wherein it was revealed that thousands of Wells Fargo bank employees had opened deposit accounts and issued credit cards without customers’ knowledge or consent so that employees could satisfy sales goals and earn financial rewards.  The result:  the bank paid $185 million in penalties plus consumer restitution, the CEO John Stumpf and other senior executives resigned, and multiple private lawsuits have been filed.  Another result:  the board designated four independent directors to review what happened and report to the entire board.  They, in turn, engaged the law firm Sherman and Sterling to assist them in their investigation.  In early April, just 2 weeks before the company’s annual meeting and board elections, the independent directors issued their report.  The two articles presented discuss and comment on that report.
• JP  Morgan Chase Web Advertising:  While not, strictly speaking, a governance article, the piece presented describes a significant change in the bank’s advertising driven by governance concerns which had unexpected results:  none.  I found the article thought provoking and potentially worthy of a board discussion when reviewing company messaging policies and strategies, hence I present it here.

Alternative Dispute Resolution

• Belize Bank Limited V. Government of Belize:  This US Court of Appeals for the District of Columbia addresses 2 issues:  i) what constitutes a public policy issue sufficient to refuse to confirm and enforce an arbitral award, and ii) the differences between US law firms and English chambers, and the different disclosure requirements of the two.  The case concerns the government of Belize’s refusal to honor a loan guarantee signed by the country’s Prime Minister in secret and arguably without proper governmental authority.
• ICC Amended Rules – New Expedited Procedures Rules:  Effective March 1, 2017, the ICC amended its Rules of Arbitration.  The most significant change:  new rules for expedited proceedings for small (US$ 2 million and less) matters.  The most significant rule changes are highlighted.

Interesting Articles/Cases of the Month

• Trump’s Business Competitors’ Claims of Unfair Competition and Emoluments Violations:  We’ve all heard speculation that President Trump is violating the emoluments clauses of the US Constitution.  A group calling itself Citizens for Responsibility and Ethics in Washington (“CREW”) has filed suit against our president in New York Federal court.  Presented is an article describing the suit and several of its claims, as well as the emoluments clauses of the Constitution and the basis of the argument that the clauses are being violated.
• The Psychology of Fake News:  Political positions among those on the right, left, and even those in the middle are hardening, and often being reinforced positively and negatively by fake news.  Factually accurate “corrective” news seems not to be heard.  Why?  The article presented looks to psychology for the answer, and finds a partial explanation in the way peoples’ brains are hard wired.
• Engineers Explain Why Shoelaces Keep Coming Undone:  The title says it all.  For those who have always wanted to know, read on!

I hope you find one or more of the below articles of interest and worthy of your inbox’s space.

Warm regards,

Jim Reiman

Articles / Corporate Governance

Wells Fargo Sales Practices Investigation Report  

The big financial scandal of 2016 was the September breaking news that Wells Fargo’s retail bank employees had opened 1.5 million bank accounts and issued 565,000 credit cards for customers without their consent in order to meet sales goals and bonus targets, and 5,300 of the banks’ employees (2% of its workforce) had been terminated for “sales practice violations.”  The result:  the CEO and offending bank division’s president resigned, $185 million in fines and penalties were paid plus customer restitution (no numbers regarding private lawsuit settlements yet), and $180 million in executive compensation claw-backs were made.  Another result:  the board appointed 4 independent directors to investigate what happened and report to the full board.

The independent directors retained the law firm Sherman and Sterling, and together they presented a 110 page report to the board in early April, just 2 weeks before the company’s annual meeting and shareholder elections.  Two leading proxy advisory firms (ISS and Glass Lewis) advocated removal of some or all of the Wells Fargo directors (Glass Lewis recommended a negative vote for 6 directors; ISS recommended a negative vote for all).  All 12 directors retained their positions in April’s elections by narrowly exceeding the minimum 50% vote requirement).

Two articles are presented, both appearing in the Harvard Law School Forum on Corporate Governance and Financial Regulation.  The first, titled “Lessons Learned from the Wells Fargo Sales Practices Investigation Report,” (the “Report”) describes the Report and, as the title implies, relates the “lessons learned.”  Those lessons can be summarized as:

• The bank had a “decentralized corporate structure, which gave too much autonomy to the Community Bank’s senior leadership, which was ‘unwilling to change the sales model or even recognize it as the root cause.’”  Recommendation:  centralized corporate structure and centralized, independent control functions.
• “Management’s reports [to the board]. . .‘generally lacked detail and were not accompanied by concrete action plans and metrics to track performance.’”  Recommendation:  “more detailed reports and concrete action plans.”
• “[T]he report highlights the need to focus on issues of ‘tone at the top’ and a strong ethics and compliance culture that permeates the organization and allows for dissent and disagreement.”  Recommendation:  “Bolstering ethics and compliance culture.”
• “A key theme of the report is that, throughout the bank, these problems were generally seen as individual in nature, and there was insufficient consideration of deeper, systemic causes.”  Recommendation:  “greater consideration of systemic causes.”

The second article presented is a far more entertaining read.  Authored by Howell Jackson, a Harvard Law School professor, it pillories the Wells Fargo board and the Report, as indicated by its title:  “One Take on the Report of the Independent Directors of Wells Fargo: Vote the Bums Out.”

After summarizing what occurred, Jackson begins by stating:

Let me start with aspects of the Report that are simultaneously self-serving and silly. On its first page, the Report asserts that “The Board only learned approximately 5,300 employees had been terminated for sales practice violations” with the public announcement of the fines in September 2016. The 5,300 figure is an eye popping one as it represents nearly two percent of the entire Wells Fargo workforce. And it may technically be true that the Board did not have that particular number until September of 2016 when the firm’s $185 million penalty was made public. But what this factoid obscures is that the Board, earlier in the spring of 2016, had been informed that 2,000 to 3,000 firings—roughly one percent of the workforce—were due to sales violations. And that a full year before that, in the Spring of 2015, internal Wells Fargo investigations had already identified thousands of employee firings for sale misconduct but the Board apparently failed to corner the right personnel early on to get a realistic assessment of employee turnover rates. They simply took note of several hundred reported firings without digging further to find the full scope of the problem.

Jackson then addresses the risk management disclosures and presumed procedures at the bank, sub-titling the section of his article:  “One False Narrative.”  He notes the Report’s analysis of the decentralized corporate structure (the first “lesson learned” as noted in the first article) and then states:

Reading through these sections of the Report, one almost starts to feel sorry for the Wells Fargo Board, betrayed by a decentralized management team and ill-served by a corporate risk team not yet prepared for major league action. Still, one might reasonably ask why the Board did not examine its decentralization more expertly and reviewed its risk team’s competence more appropriately. There are people who think that’s exactly what corporate boards are supposed to do.

From a shareholder perspective, the failures of Wells Fargo’s risk management function is made all the more galling because they’d suggested quite a different arrangement in prior SEC filings. For example, in the firm’s 2013 annual report—the annual report outstanding when the mis-selling scandal was first picked up in Los Angeles Times reporting—the Board had assured shareholders that at Wells Fargo risk management was controlled at the top:

Our risk culture also depends on the “tone at the top” set by our Board, CEO, and Operating Committee members. Through oversight of the three lines of defense, the Board and the Operating Committee are the starting point for establishing and reinforcing our risk culture and have overall and ultimate responsibility for oversight of our risks, which they carry out through committees with specific risk management functions.

So back in 2013, the Board of Directors was ready to assume “ultimate responsibility” for the oversight of risk. But in the Shearman & Sterling Report of 2017, the Board has become an innocent victim of a risk management function that somehow failed to stand up on its own. As the Shearman & Sterling Report wistfully admits, “Wells Fargo should have moved toward the centralization of the risk function earlier than it did.” This admission makes good sense, but needs the missing conclusion: that the failure to do so clearly falls at the feet of the firm’s directors.

Jackson next ridicules the Report’s exoneration of the board’s oversight in a section titled:  “A Second False Narrative: Vigorous and Effective Board Action After 2013” and concludes with “And One Great Big Whopper.”

One final and egregious misstatement in the Shearman & Sterling Report concerns the point of time at which the Wells Fargo directors became aware of mis-selling problems within the organization. On its second page, the Report asserts “Sales practices were not identified to the Board as a noteworthy risk until 2014,” and then back on page 97, the assertion is repeated: “Prior to 2014, sales practice or sales integrity issues were not flagged as noteworthy risks either to the Board of Directors as a whole or to any Board committee.” If one parses carefully the discussion that follows, the basis for this assertion is the content of internal reports circulated to the Board’s Risk Committee, which classified risks in various categories, such as high or medium. Mis-selling practices apparently did not get placed into the high category until after the Los Angeles Times story appeared in December 2013. So, the fine lawyers at Shearman & Sterling apparently reasoned that the Board must not have been on notice of these problems until 2014 and hence the report proceeds under the assumption that the Board had no responsibility to investigate the matter before then.

This is an outrageous position but one that the Wells Fargo Board has adopted in accepting the Shearman & Sterling Report.

And, here’s how you can tell it’s outrageous. Just google the phrase “Wells Fargo retail banking sales practices” with a time restriction of before 2014. (If you don’t know how to do this, just ask anyone under 30.) On the first page of results, you’ll see accounts of a July 20, 2011, consent order against Wells Fargo by the Federal Reserve Board imposing an $85 million civil penalty based on allegations that internal compensation arrangements would encourage Wells Fargo sales personnel to steer borrowers that qualified for prime mortgage into subprime products that were more profitable for Wells Fargo.  In other words, Wells Fargo paid a substantial fine in 2011 based on allegations of incentive-based mis-selling to customers.

As noted at the head of this piece’s description, the entire Wells Fargo board was reelected last week.  I don’t have sufficient facts to have a strong opinion, and I also don’t want to be an apologist, but I do note that its easy for an academic to sit back and throw stones, ignoring the multitude of other material issues that the board dealt with well during the relevant time period.  That said, the Report certainly appears to be anything but “independent” in its conclusions and exoneration of the board, and the “lessons learned,” struck this reader as a bit simplistic.

“Independent Directors of the Board of Wells Fargo & Company Sales Practices Investigation Report,” April 10, 2017

Brad S. Karp and Roberto J. Gonzalez, “Lessons Learned from the Wells Fargo Sales Practices Investigation Report,” Harvard Law School Forum on Corporate Governance and Financial Regulation, April 22, 2017

Howell E. Jackson, “One Take on the Report of the Independent Directors of Wells Fargo: Vote the Bums Out,” Harvard Law School Forum on Corporate Governance and Financial Regulation, April 22, 2017

JP  Morgan Chase Web Advertising

This month’s Newsletter seems to be focused on banks.  The second piece presented, as noted in the introduction, is not really a governance piece.  Rather, it is a report about the impact of JP Morgan Chase’s revised web advertising policy, and the surprising results of the change.

As reported in a New York Times article by Sapna Maheshwari titled:  “Chase Had Ads on 400,000 Sites. Then on Just 5,000. Same Results,” Chase changed its on-line web advertising policy in March in an effort to prevent its ads appearing next to toxic content, fake news, or other offensive content.   Prior to the change, like most large marketing enterprises, Chase had “shunned buying ads on individual sites in favor of cheaply targeting groups of people across the web based on their browsing habits, a process known as programmatic advertising — enabling, say, a Gerber ad to show up on a local mother’s blog, or a purse in an online shopping cart to follow a person around the internet for weeks.”

In March, the bank changed its policy and began placing ads only on pre-approved sites.  As a result, as noted in the article’s title, the number of sites that Chase’s ads appeared on was reduced from 400,000 to just 5,000.  Chase’s marketing people had anticipated that the number of ad impressions (when an ad appears on a screen) would decrease significantly after its change.  While the Times article appeared only “a few days after the policy change,” a spokesperson for the bank reported that “we haven’t seen any deterioration on our performance metrics.”

Granted, the New York Times article was likely targeted to advertising and marketing readers and not governance folk, hence some may be asking:  Why has Reiman presented the piece here?  My answer:  the article implicitly raises questions regarding the impact and wisdom of certain kinds of advertising.  JP Morgan Chase changed their procedures if not their policies – to use “governance speak” – in order to reduce the risk to their corporate reputation.  That is a good thing in the opinion of this commentator, hence I present it to my readers to stimulate thought and perhaps discussion.

 Maheshwari, Sapna, “Chase Had Ads on 400,000 Sites. Then on Just 5,000. Same Results.” New York Times, March 29, 2017

Articles / Alternative Dispute Resolution

Vacating Awards As Against Public Policy – English Chambers are Not US Law Firms: 

In March, the DC Court of Appeals affirmed a decision by the District Court refusing to vacate an arbitral award entered in a dispute seated in London and thereby affirmed the enforcement of the award.  As noted in the introduction to this Newsletter, the case, Belize Bank Limited V. Government of Belize, is noteworthy for 2 reasons:  First it discusses and reiterates the very narrow public policy exception to enforcement set forth in the New York Convention and, secondly, it states clearly and unequivocally that English chambers are not the same as US law firms, hence different disclosure standards apply to lawyers in law firms and lawyers in chambers.

Beginning with the public policy issue, the case is interesting because if one looks through the technical legal arguments, a good public policy argument might exist.  The Court, however, stuck to the law and did not look to the greater non-legal issues.

The case concerned a confidential agreement signed by the 2004 prime minister of Belize under which Belize agreed to guaranty a loan made by The Bank of Belize Limited (“Bank”) to a Belizean health services provider.  A default occurred under the loan and in 2007 Belize, in a settlement agreement with the Bank, agreed to pay the loan in full.  “Shortly thereafter, the settlement agreement became public knowledge and a firestorm erupted—protesters, branding the deal corrupt, marched on the Belizean capital; and Belizean public interest groups, believing that [the prime minister who signed the guarantee and settlement agreement] lacked the authority to financially bind Belize without the approval of the Belizean National Assembly, challenged the settlement agreement in the Belizean court. Responding to the pressure, Belize refused to make any payment pursuant to the settlement agreement with the Bank.”

Following Belize’s refusal to make payment, the Bank commenced an arbitration in London pursuant to the settlement agreement’s dispute resolution clause.  Belize, in addition to refusing to make payment, refused to participate in the arbitration.  The arbitration agreement called for three arbitrators, one selected by each party and the two party selected arbitrators to select the third.  When Belize failed to appoint an arbitrator, pursuant to the rules of the arbitration, the arbitration’s administrator – the London Court of International Arbitration (LCIA) – appointed an arbitrator for Belize.  The arbitration then ensued.

Five years after the arbitration commenced, Belize objected to the arbitrator appointed by the LCIA (Douglas), arguing that “another member of the English chambers Douglas belonged to . . . had—in previous unrelated matters—advised a partial owner of the Bank and represented other interests adverse to Belize.  Belize questioned Douglas’s impartiality as a member of the arbitral tribunal and argued that Douglas had a duty to disclose information detailing [his chambers’] practices and representations or, alternatively, that Douglas should be removed from the arbitral panel.”

Suffice it to say, the LCIA refused to remove Douglas or mandate the requested disclosures and the tribunal eventually entered an award in favor the Bank.  The Bank thereupon “filed a Petition to Confirm Foreign Arbitration Award and to Enter Judgment” in the US District Court for the District of Columbia.  The District Court granted the petition and concluded “that enforcement of the award in the United States was not contrary to United States public policy under New York Convention Article V(2)(b).”  Belize appealed, and the DC Court of Appeals affirmed the District Court’s decision.

At issue on appeal was “whether there is a U.S. public policy against enforcement of [the] arbitral award.”  Significantly, the underlying aroma and allegations of corruption relating to the Belize Prime Minister’s signing a confidential loan guaranty and the country’s refusal to make payment to the bank once knowledge of the guaranty and the subsequent settlement agreement became public are absent from the Appellate Court’s public policy analysis and discussion.  Rather, the sole public policy issue addressed was the propriety of Douglas serving as an arbitrator.

The Appellate Court commenced its analysis by reviewing the scope of review in an action to confirm an arbitral award.

The New York Convention is part of a “carefully crafted framework for the enforcement of international arbitration awards.” [citation omitted]  It is “clear that when an action for enforcement is brought in a foreign state, the state may refuse to enforce the award only on the grounds explicitly set forth in Article V of the Convention.” [citation omitted]  Article V(2)(b), in turn, states that “[r]ecognition and enforcement of an arbitral award may be refused if the competent authority in the country where recognition and enforcement is sought finds that [t]he recognition or enforcement of the award would be contrary to the public policy of that country.”  New York Convention art. V(2)(b).

[citation omitted] [We have stated that] Article V(2)(b) does not require a fly-specking of the ABA Model Rules of Professional Conduct. [citation omitted]  (“[C]ourts have been very careful not to stretch the compass of ‘public policy.’ ”).  Rather, with appropriate deference to other sovereign nations, the “public policy defense is to be construed narrowly to be applied only where enforcement would violate the [United States’] most basic notions of morality and justice.” [citation omitted]  “[T]he question of public policy is ultimately one for resolution by the courts, and thus, if enforcement of the Award based on [an arbitration panel’s] interpretation of [a contract] violates a public policy of the United States then the district court [is] obligated to refrain from enforcing it.”).  Because Belize challenges enforcement of the arbitral award, it “bears the burden of proof” of meeting this exacting standard. [citation omitted]  

Next, the Court addressed Belize’s claim that US public policy mandated that the award be vacated because the arbitrator appointed by the LCIA – Douglas – had failed to disclose relationships and thus his impartiality could not be trusted.

Belize insists that the LCIA’s failure to disqualify—or require certain disclosures from—Douglas created an unacceptable appearance of impartiality viewed through the lens of United States public policy. [citation omitted]  That is, Belize claims that, “if the rules applicable to U.S. law firms were applied to Douglas and [his c]hambers,” it would be “undisputed that bias and a lack of impartiality” tainted the arbitral tribunal so long as Douglas was a member.

The Appellate Court rejected this argument in total.

As an initial matter, Article V(2)(b)’s requirement that we replace foreign ethical standards with United States public policy in scrutinizing an arbitral award . . .  does not give us license to replace the facts of a case with an Americanized version thereof. Contrary to Belize’s description, [Douglas’ chambers] is not a law firm—it is an English chambers.

The Court then examined the many and substantial differences between chambers and law firms, and the relationships between partners in a law firm and lawyers who are members of a chambers and found the two “vastly different.”  It thus summarily rejected as inapplicable the case law relied upon by Belize which related to American lawyers in law firms.

The Appellate Court also rejected all arguments of Belize regarding the appearance of impropriety stating:  “questions about appearance are resolved from the perspective of the parties.”  The Court noted the historical relationship between Belize and England (Belize had been a UK colony) and concluded that the “chambers system of barristers acting as independent practitioners was ‘familiar’ to Belize based on Belize’s historical association with the British justice system.”  The Court also noted that “in an earlier proceeding involving Belize, [Douglas’ chambers’] barristers appeared on opposing sides of the same appeal with no objection from Belize.”

Finding no basis under the New York Convention to not enforce the arbitral award, the Appellate Court affirmed the District Court’s decision.  As noted above, the arguable corruption underlying the contract underpinning the arbitral award, and the arguable public policy implications of enforcing a corrupt contract, were not addressed.

The full decision:  Belize Bank Limited, Appellee V. Government of Belize, United States Court of Appeals, District of Columbia Circuit, No. 16-7083, decided: March 31, 2017

New ICC Expedited Rules:

Effective March 1, 2017, the ICC (International Chamber of Commerce) amended its Rules of Arbitration.  Per the Foreword of the new Rules,

“The most significant of the 2017 amendments is the introduction of an expedited procedure providing for a streamlined arbitration with a reduced scale of fees. This procedure is automatically applicable in cases where the amount in dispute does not exceed US$ 2 million, unless the parties decide to opt out. It will apply only to arbitration agreements concluded after 1 March 2017. 

One of the important features of the Expedited Procedure Rules is that the ICC Court may appoint a sole arbitrator, even if the arbitration agreement provides otherwise. The expedited procedure is also available on an opt-in basis for higher-value cases, and will be an attractive answer to users’ concerns over time and cost. 

To further enhance the efficacy of ICC arbitrations, the time limit for establishing Terms of Reference has been reduced from two months to one month, and there are no Terms of Reference in the expedited procedure. 

Other significant provisions of the new expedited rules:

• The case management conference “must be convened no later than 15 days after the date on which the file was transmitted to the arbitral tribunal.”
• After the arbitral tribunal has been constituted, no party may make new claims unless authorized by the arbitral tribunal, which “shall consider the nature of such new claims, the stage of the arbitration, any cost implications and any other relevant circumstances.”
• The arbitral tribunal shall have discretion to “decide not to allow requests for document production or to limit the number, length and scope of written submissions and written witness evidence (both fact witnesses and experts).”
• “The arbitral tribunal may, after consulting the parties, decide the dispute solely on the basis of the documents submitted by the parties, with no hearing and no examination of witnesses or experts.”
• “The time limit within which the arbitral tribunal must render its final award is six months from the date of the case management conference”

 Rules of Arbitration of the International Chamber of Commerce in force as from 1 March 2017

Articles / Interesting Case of the Month

President Donald Trump and the Emoluments Clause of the Constitution:  

There have been numerous articles and talk show discussions regarding our current president’s refusal to sell his businesses or create a blind trust, and his seeming use of the presidency to enhance and promote his and family’s businesses.  One group has taken their concerns beyond just “talking” and filed a lawsuit against the president.

The organization, Citizens for Responsibility and Ethics in Washington (“CREW”), per the organization’s self-description on its website, “uses aggressive legal action, in-depth research, and bold communications to reduce the influence of money in politics and help foster a government that is ethical and accountable.”  CREW’s legal team comprises some of the country’s highest profile legal scholars, and includes as counsel on its complaint Laurence H. Tribe (Harvard Law School), Erwin Chemerinsky (Dean of the School of Law, University of California, Irvine), and Ambassador (Ret.) Norman L. Eisen.  Put simply, the CREW lawsuit is not an action brought by lightweights or some seeking a quick buck or their five minutes of fame.

The lawsuit was initially filed in January immediately after the president’s inauguration.  It seeks to find the president in violation of the emoluments clauses of the Constitution, which prohibit Trump from receiving anything of value from foreign governments, including foreign government-owned businesses, without the approval of Congress, and prohibits him from receiving during his term of office any “emoluments” other than his compensation from the United States.

Details matter, and many have spoken about the emoluments clauses, so I thought it appropriate to set forth their exact language.  There are two emoluments clauses:  one dealing with emoluments received from foreign entities, and one from domestic.  Both are set forth in full below.

Beginning with the foreign emoluments clause, it is embedded in the section of the Constitution prohibiting the granting of titles of nobility.  The entire clause (US Constitution, Article I, Section 9, Clause 8) states as follows:

No Title of Nobility shall be granted by the United States: And no Person holding any Office of Profit or Trust under them, shall, without the Consent of the Congress, accept of any present, Emolument, Office, or Title, of any kind whatever, from any King, Prince, or foreign State.

The domestic emoluments clause (US Constitution, Article II, Section 1, Clause 7) states:

The President shall, at stated Times, receive for his Services, a Compensation, which shall neither be increased nor diminished during the Period for which he shall have been elected, and he shall not receive within that Period any other Emolument from the United States, or any of them.

Nowhere in the Constitution is the word “emoluments” defined.  Thus, the CREW complaint sets forth its understanding of the definition of the term:

Consistent with the Framers’ intent, the definition of a “present” or “Emolument” under the Foreign Emoluments Clause is properly interpreted in a broad manner, to cover anything of value, monetary or nonmonetary.  The text of the clause itself prohibits the receipt of both a “present,” which, presumably, is provided without a return of anything of equal value, and an “Emolument,” which could cover anything else of value, including without limitation payments, transactions granting special treatment, and transactions above marginal cost.  The Foreign Emoluments Clause also explicitly prohibits the receipt of “any present [or] Emolument . . . of any kind whatever,” emphasizing the breadth of the things of value covered under the provision.

The same concept of “anything of value” applies to the domestic emoluments clause.

Per the CREW complaint:   “Though courts have not had many occasions to interpret [the emoluments clauses],. . .it is widely understood—and CREW agrees—that [the foreign emoluments] clause covers the President of the United States and prevents him or her from accepting anything of value, monetary or nonmonetary, from any foreign government or its agent or instrument without congressional consent.  The Framers inserted this clause into the Constitution to prevent any type of foreign influence or corruption from infiltrating the United States government.”

CREW alleges that –

Defendant has violated the Constitution during the opening moments of his presidency and is poised to do so continually thereafter for the duration of his administration.  Specifically, Defendant has committed and will commit Foreign Emoluments Clause violations involving at least: (a) leases held by foreign-government-owned entities in New York’s Trump Tower; (b) room reservations and the use of venues and other services and goods by foreign governments and diplomats at Defendant’s Washington, D.C. hotel; (c) hotel stays, property leases, and other business transactions tied to foreign governments at other domestic and international establishments owned, operated, or licensed by Defendant; (d) payments from foreign-government-owned broadcasters related to rebroadcasts and foreign versions of the television program “The Apprentice” and its spinoffs; and (e) property interests or other business dealings tied to foreign governments in numerous other countries.

The complaint goes on to detail numerous financial arrangements between Trump businesses and foreign entities.  For example, the complaint notes in some detail that the largest tenant of Trump Tower in New York is the Industrial and Commercial Bank of China (“ICBC”), “which is a Chinese majority-state-owned enterprise.”  Other examples:

The Trump International Hotel Washington, D.C. recently opened and is located at 1100 Pennsylvania Avenue N.W., Washington, D.C. 20004, just blocks from the White House.  Defendant owns and controls this hotel through various entities. 

*     *     *

Defendant, through entities he owns, receives payments made to the Trump International Hotel by guests who stay in hotel rooms or pay for a venue or other goods or services in this hotel.

*     *     *

Since the election, Trump International Hotel has specifically marketed itself to the diplomatic community.

Subsequent to Defendant’s election, the Trump International Hotel held an event where it pitched the hotel to about 100 foreign diplomats. 

The hotel also hired a “director of diplomatic sales” to facilitate business with foreign states and their diplomats and agents, luring the director away from a competitor hotel in Washington.

Diplomats and their agents have expressed an intention to stay at or hold events at the Trump International Hotel.  One “Middle Eastern diplomat” told the Washington Post about the hotel: “Believe me, all the delegations will go there.”

An “Asian diplomat”explained: “Why wouldn’t I stay at his hotel blocks from the White House, so I can tell the new president, ‘I love your new hotel!’  Isn’t it rude to come to his city and say, ‘I am staying at your competitor?’”

In April, CREW expanded its complaint adding Restaurant Opportunities Centers United and a woman who books embassy events for two Washington hotels to its complaint.  Restaurant Opportunities Centers United represents more than 200 restaurants and nearly 25,000 employees. Its clients compete directly with restaurants that Mr. Trump owns or in which he has a financial interest.

Per Sharon LaFraniere, writing for the New York Times –

By failing to sufficiently distance himself from his companies, CREW has charged, Mr. Trump has violated clauses of the Constitution that ban the acceptance of any government-bestowed benefits, or “emoluments,” either at home or abroad. Among those benefits, the organization contends, was China’s decision this year to grant preliminary approval of 38 trademarks protecting Mr. Trump’s name.

Justice Department lawyers, who have been working for weeks on their answer to the lawsuit, plan to counter that the framers of the Constitution meant only to rule out gifts and compensation for services. The Justice Department is expected to argue that ordinary arm’s length transactions for services, like the payment of a restaurant bill at a hotel, are not prohibited.

They will also contend that only Congress can intervene if a president violates either the domestic or foreign emoluments clause of the Constitution. Under the separation of powers doctrine, they argue, courts are powerless to act.

Personally, I’m not sufficiently knowledgeable about the emoluments clauses to have an opinion regarding the merits of the case.  I do find it deeply troubling, however, that our president has been holding diplomatic meetings at his Mar a Lago resort, and that the State Department posted a de facto ad regarding Mar a Lago.  I also find it troubling that tax payor dollars are being used to defend the president and fight the CREW lawsuit (the Justice Department is defending the case).

 The Amended Complaint in Citizens For Responsibility And Ethics In Washington, Restaurant Opportunities Centers (ROC) United, Inc. and Jill Phaneuf v. Donald J. Trump

 Andrew Denney, “Trump Business Competitors Allege Unfair Impact in Emoluments Suit,” New York Law Journal, April 18, 2017

 CREW Press Release upon filing its complaint

Japan PM Abe at Mar a Lago:  Julie Hirschfeld Davis, “A Presidential Golf Outing, With a Twist: Trump Owns the Place,” New York Times, Feb 11, 2017
State Department Website and Mar a Lago:  The Washington Post

State Department Website and Mar a Lago:  The Daily Beast

The Psychology of Fake News:

One of the hottest topics in news, politics and media generally today is “fake news.”  Setting aside the politically expanded definition (it seems that news is now “fake” if one disagrees with the content of what is reported, regardless of the facts), many (myself included) have wondered how any rational person could possibly believe some of the factually fake news content that is being published or broadcast.

While social media and politically biased media outlets such as Fox News and MSNBC are often blamed, Adam Waytz, an associate professor of management and organizations at the Kellogg School, believes that there are deeper reasons.

“To understand how people in the same country, or same family, can have such vastly differing takes on reality, Waytz suggests we should focus not on the role of social media, but on the role of social psychology—in particular, the cognitive bias that stems from our tribal mentalities.  For Waytz, before we can learn to address our divisiveness, it is important to understand its roots.

“There’s an assumption that fake news exacerbates polarization,” Waytz says.  “But it might be the case that polarization exacerbates fake news.”

Waytz identifies two psychological concepts to explain the phenomenon:  “motivated reasoning” and “naïve realism.”  Motivated reasoning is “the idea that we are motivated to believe whatever confirms our opinions.”  For example, if “you’re motivated to believe negative things about Hillary Clinton, you’re more likely to trust outrageous stories about her that might not be true.  Over time, motivated reasoning can lead to a false social consensus.”

Naïve realism is “our tendency to believe that our perception of reality is the only accurate view, and that people who disagree with us are necessarily uninformed, irrational, or biased.”

Much of our susceptibility to fake news has to do with how our brains are wired.  We like to think our political convictions correspond to a higher truth, but in fact they might be less robust and more malleable than we realize.

To some extent. . .our political beliefs are not so different from our preferences about music or food.  In one unpublished study, Waytz and his fellow researchers presented participants with a number of statements. These included factual statements that could be proven or disproven (such as “the very first waffle cone was invented in Chicago, Illinois”), preference statements that people could assess subjectively (such as “any ice cream flavor tastes better when served in a crunchy waffle cone”), and moral–political belief statements that people could assess in terms of right or wrong (such as “it is unethical for businesses to promote sugary products to children”).

In one study, a group of participants was directly asked to read and rate statements as resembling a fact, a preference, or a moral belief. In a second study, a group of participants had their brains scanned using MRI while reading each statement and evaluating how much they agreed or disagreed with it. After the scan, they answered questions as in the first study about whether each statement resembled a fact, a preference, or a moral belief.

Waytz and his colleagues found that, in both groups of participants, people processed the moral–political beliefs more like preferences than like facts. Not only did participants directly rate moral–political beliefs as “preference-like,” but, says Waytz, “when they read moral–political statements while having their brains scanned, the scans showed a pattern of activity that’s comparable to preferences.”

This “hard wiring” of people’s brains may explain why many of the responses to fake news have failed to achieve any meaningful results in the effort to correct people’s false beliefs.

“One of the things we’re learning,” Waytz says, “is that fact-based arguments don’t always work.” Take, for instance, a 2014 study . . . that found that even presenting parents with hard scientific evidence that vaccines do not cause autism did nothing to persuade those parents who had previously held that belief.”

*     *     *

So, how do we overcome ideological biases and counteract the polarization that fuels “fake news?” Waytz says that social psychology also points to a way forward.

Encouragingly, there is evidence that when you alert people to their biases, they tend to succumb to them less. A study involving Israelis and Palestinians—two groups that are famously entrenched in naïve realism—demonstrated that when the concept of naïve realism was explained to them, the groups were less hostile towards each other. “When they were told, ‘Hey, this bias exists,’ even the most hawkish among them were more conciliatory,” Waytz says.

Other studies have shown that people can overcome naïve realism by legitimizing one of their opponent’s legitimate (or semi-legitimate) points.

The article is thought provoking and worthy of a read, whether one is interested in calming the country’s political discord, convincing one’s young-adult children that their current thinking is ill-advised, or even negotiating the resolution of a dispute or aligning contrary positions of one’s fellow board members.

Waytz, Adam, “The Psychology Behind Fake News,” Kellogg Insight, March 6, 2017

Engineers Explain Why Shoelaces Keep Coming Undone:

I admitted in the introduction to this Newsletter that I’m a closet geek, and that were I able to add or subtract I would likely have gone to engineering school rather than law school.  So, when I spotted an article in the New York Times’ science section on why I’m forever tying and re-tying my shoelaces, it was a MUST read.  For those like me, I present the answer to that long burning question.  For those not like me, I hope you found the rest of this Newsletter worthy of your time and in-box’s space.

So, shoelaces:  why to do they never stay tied?

[T]he force of your foot striking the ground and the motion of your leg combine to help loosen and ultimately untie the knot. 

When running, the foot hits the ground at about seven times the force of gravity.  That impact is transmitted to the knot, which stretches and relaxes in response. As the knot loosens, swinging legs apply an inertial force on the free ends of the laces and — voilà! — pretty soon your laces are flopping around, looking like overcooked spaghetti.

The article goes into greater detail, but the above summarizes what occurs.  The same process takes place when walking, but the forces of the of foot hitting the ground are of course less, hence the “untying” takes longer.

 Mele, Christopher, “Do Your Shoelaces Keep Coming Undone?  Engineers Explain Why,” New York Times, April 13, 2017