Law at the End of the Day: Emerging Trends in the Convergence of Public and Private Law

Emerging Trends in the Convergence of Public and Private Law: Sovereign Wealth Funds, the Regulation of Sovereign Golden Shares, and the Regulation of Multinational Corporations

Notes of Address Given at the
Istanbul Chamber of Industry
Istanbul, Turkey
June 24, 2008

Special thanks to my hosts for the event at the Istanbul Chamber of Industry: Mete Meleksoy, its Genel Sekreter, the law firm of Çaga & Çaga (and especially Av. Barbaros Çaga & Av. Erdem Degerli), and the Yeditepe University Faculty of Law and its Dean, Haluk Kabaalioglu. There are tremendously vibrant business and intellectual activities within Turkey that ought to be better known in the United States.

I. Introduction

A. I am here today to speak about 3 topics that are currently of great interest to regulators: (1) sovereign wealth funds; (2) golden share regimes; and (3) the regulation of multinational corporations

B. For some this may be an odd combination of topics to discuss. But as a matter of law and action these have begun to converge in interesting ways. We look here not to the past and barely to the present—the focus is on the future, a regulatory future being constructed today.

C. Let us consider the connection between the three topics by looking at a number of current real world examples:

1. EXAMPLE 1: A state entity, either directly or through a wholly owned corporation purchases shares of the stock of a domestic corporation either through the stock market or in a private transaction without resort to legislation or other regulatory actions. For example: The State of Maryland, or the New York State Teachers’ Retirement Fund purhases a large block of shares of Walmart Inc.

a. As a variant, consider the same situation but the state entity has purchased a controlling interest in the domestic corporation.

b. As another variant consider the same situation when a domestic corporation purchases an equal number of shares in a domestic corporation.

2. EXAMPLE 2: A state entity, either directly or indirectly through a wholly owned corporation, purchases shares of the stock of a foreign corporation either through the stock market or in a private transaction without resort to legislation or other regulatory actions and outside the territory over which it can assert sovereign authority. For example: The Norwegian pension fund purchases shares of Parmalat: or the investment Fund of Singapore purchases shares of U.S. Steel.

a. As a variant, consider the same situation but the state entity has purchased a controlling interest in the domestic corporation.

b. As another variant consider the same situation when a corporation purchases an equal number of shares in a foreign corporation.

3. EXAMPLE 3: A multinational corporation enters into an agreement with a government for the purpose of supplying it with goods that may eventually be used to commit acts that might constitute human rights violations.

a. As a variant, consider the same situation but the multinational corporation has entered into an agreement to run the prison system or the customs and immigration operations of the government.

D. Each of these scenarios present difficult issues regulation involving choice of law, extraterritoriality, and substantive law issues that often cross borders. The legal framework within which these issues are meant to be regulated being developed is both interconnected and binds the principals in each of these scenarios in ways that legislators, policy makers and others are still barely conscious:

1. The first, sovereign wealth funds looks at the changing character of the way in which states may assert themselves beyond their borders—that is project power extraterritorially.

2. The second—golden share regimes—looks at the ways in which the character of the state can change when it acts internally, that is when it seeks to act as a participant within the territories over which it can assert sovereign, that is regulatory, power.

3. The third—the regulation of multinational corporations and similar enterprises—looks at the other side of the equation, considering the ways in which corporations ought to be held liable, as principles, for the observance of conduct rules and obligations once thought directly and solely addressed to states.

4. All three, then, deal with different aspects of the same issue: the changing understanding of the nature of states and of corporations and the changing governance relationships between states and economic actors. The first two topics look to whether states can be considered private actors to which private law, or a variation thereof, can apply. The last whether corporations can be viewed as public actors to which public law or a variation there, can apply.

a. The consequences of these efforts can be tremendous.

b. It suggests a convergence trend in the way we think about governance. It is no longer clear that there is a strict distinction between public law and private law.

c. When corporations can be treated like states with respect to some of the things they do, when states can be treated like corporations with respect to some of their activities, the legal regimes that used to govern each in its own place, will have to change or become irrelevant.

d. I am going to suggest to you today that there is a little bit of both at work today.

5. What follows is a summary of the issues presented and a suggestion of the ways in which they interrelate. My principle objects are twofold: (1) to present the core jurisprudential and policy issues within each of these problem areas, and (2) to show how resolution of the problem in one area has significant effect on resolution of the other two.

6. This necessarily short discussion is built on some recent work of mine in these three areas of regulation. For further reading, please consult the references set forth at the end of this

II. Sovereign Wealth Funds

A. What ought to be the governing law when one state seeks to invest in the economy of another state?

1.This question has become particularly acute since the rise, over the last decade of a number of large funds controlled by states, the purpose of which is to invest in economic entities wherever they may be domesticated. On the surface, this might suggest the best case for the equal treatment of states with private entities. In this case, unlike that in which the state always has the potential to legislate changes to its corporate law, the state stands in the same shoes as a private investor.

2. On the other hand, the state, even as a private investor, has the power to reach deeply into the economic affairs of other states by implementing its legislative program through shareholder activism.

B. One of the great issues of sovereign wealth funds are definitional. There is a good reason for this—the broader the definition the larger the number of types of state investment activity will be covered by regulation grounded in that definition. The opposite is true as well—the more narrow the definition, the smaller the group of wealth fund and other investment vehicles in which states participate will be covered.

1.Depending on the form of regulation proposed—and the level (state, regional or international) at which this regulation will apply—both regulators and funds will have different interests.

2. Usually, wealth funds prefer an absence of regulation, or absent that, equal treatment regulation, that is regulation that treats public and private investment vehicles in a similar way.

3. What tends to get in the way are issues of

A. Sovereign immunity (not available to non-sovereign investment vehicles

B. Disputes over the nature of the activity subject to regulation—if the investment activity has a public character then it might trip trade regulation rules—domestic, regional (E.U.) or international (WTO, BITS, FTA Agreement rules). That moves us to the other two themes: Golden Share rules and the regulation of Multi national corporations.

C. Examples of definitions.

1- Organisation for Economic Co-operation and Development (“OECD”): “Sovereign Wealth Funds (SWFs) are pools of assets owned and managed directly or indirectly by governments to achieve national objectives.”

2. Traditionally, according to the IMF, “set up for a variety of macroeconomic purposes. They are commonly funded by the transfer of foreign exchange assets that are invested long term, overseas.”

3. U.S. Treasury makes a distinction based on nature of investment:

“There is no single, universally accepted definition of a SWF. This appendix will use the term SWF to mean a government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from the official reserves of the monetary authorities (the Central Bank and reserve-related functions of the Finance Ministry). SWF managers typically have a higher risk tolerance and higher expected return than traditional official reserve managers.

C. Note that there are now about 50 states with sovereign wealth funds of some sort—mostly funded from revenues from the sale of natural resources, but some are funded by unused FOREX (foreign exchange) revenues. (Source Peterson Institute).

1. A number of states are now planning SWF: Bolivia, Brazil. India have begun discussing the possibility.

2. A few funds—Chinese, Singaporean, Dubai and Norwegian, have dominated. Most have been discrete.

D. So, what is the problem: how to deal with these funds—as extraterritorial activity of public sovereigns, that is another form of political (or public law) activity OR as private actions of public actors subject to private law rules like other private juridical persons (like corporations). EXAMPLES:

1. Assume a state greats a fund to invest in equities abroad. It buys stakes in such companies on the market and in full compliance with the securities and company law rules of the home states of incorporation of the purchased entities. The fund managers are charged by the legislature to purchase shares only in corporations that comply with the corporate public policy of the investing state, or to use its power as a shareholder to seek internal corporate changes to achieve that compliance.

2. Assume a Venezuelan sovereign investment fund purchases a large American oil company with worldwide operations. When relations between Venezuela and the United States deteriorates, the Venezuelan shareholder uses it power as a shareholder to seek to shut down the oil company’s operations in the United States and transfer them to Venezuela arguing that this move is in the long term best interests of the company.

E. Regulatory approaches:

1. Equal Treatment. Essentially the approach of the United States.

2. Treat SWF as public entities and regulate (limit) investment domestically: require notification, pre-approval or forbid.

3. Subject SWF to special rules of investment—reasonable investment rules; non-political reasons for investing rules; avoidance of extraterritorial application of domestic law investment rules, etc. Effectively the sovereign would be treated as private with respect to the funds invested and public with respect to the investment decision.

3. Impose disclosure of transparency regimes (either on basis of equal treatment rules—all funds have to comply—or applied especially to SWF).

4. Suggest development of voluntary self-regulatory transparency and disclosure regimes.

G. The different approaches to regulation suggest some of the conceptual difficulties of regulating SWF, all grounded on the question—are they public (and regulatory), are they private (and participatory), or are they something else. The answers are not clear as the problems described above suggest, and touch on issues not only of investment, but of the character of the investor (public or private) and its convergence with the regulation of other foreign entities seeking to exploit potentialities of inbound investment.

1. Even if a SWF acts purely privately, to the extent that it must maximize the interests of its owners, is it not effecting political agendas by other means?

2. If shareholders are encouraged to participate in corporate governance, would a state shareholder engaged in such activity seeking to apply its own public policy extraterritorially?

3. Does sovereign immunity principles give SWF an edge?

4. If the object of investment is wealth maximization, and states and individuals conceive of wealth and its maximization differently, is it fair or logical to restrict SWF wealth maximization to that of a hypothetical reasonable individual? The question becomes more acute when one considers that multinational corporations may have wealth maximizing goals different from such a hypothetical investor as well—with little in the way of different treatment by regulators.

H. The move now is to treat SWFs as private with respect to funds invested and public with respect to investment decisions itself as well as with respect to their conduct as shareholders. States as investors, then, are likely to face a different regulatory environment than individuals or other private parties,

1. In the U.S. SWFs will likely ber treated as other investment funds—but all investment funds may be subject to greater disclosure ands transparency requirements, or they will be pressured into adopting voluntary behavior models. Direct government investment will likely be more problematic.

2. E.U. has suggested SWF regulation based on (1) commitment to an open investment environment; (2) support multilateral approach to regulation; (3) use of existing instruments (E.U. law); (4) respect E.U. Treaty obligations; (5) proportionality and transparency.

I. But it is here that the approaches to the regulation of SWFs runs up against a great legal movement within the E.U. that touches on the character of state participation in economic activity. To understand how the regulation of SWF intersects with domestic development of the rules respecting the character of state participation in markets, it is necessary to look to the E.U. and its development of principles of in its so-called Golden Share cases.

III. Golden Shares and Free Movement of Capital

A. Issue: State activity as private or state activity as regulatory and public.

1. The Americans have long distinguished between the private (participatory) and public (regulatory) actions of the state. American courts have recognized the choice of law implications of this division, treating participatory activity as a subject of private law, and regulatory activity as a matter of public law (to which, for example, the limitations on state power contained in the 14th Amendment of the American federal Constitution apply). For a recent case in which these issues were discussed and refined, see Dept of Revenue of Kentucky v. Davis, No. 06–666, argued November 5, 2007, decided May 19, 2008, slip op. at 7-10.

2. The Europeans appear to be taking the opposite tack. Through a jurisprudence developed from out of their “golden share” cases, the European Court of Justice appears to be embracing the position that state activity is presumptively public in character, at least when directed at domestic entities, and that such activity might contravene either the prohibitions on interference with the free movement of capital (Art, 56 EC Treaty) or with the regulation of state aid under the Competition provisions of the ECT Treaty (Art. 87 EC). (For a preliminary discussion of the cases and the development of a European conception of state activity in the market form a choice of law perspective, see Larry Catá Backer, "The Private Law of Public Law: Public Authorities as Shareholders, Golden Shares, Sovereign Wealth Funds, and the Public Law Element in Private Choice of Law," Tulane Law Review, Vol. 82, 2008) .

B. History: Privatization of state owned industries in the context of the strengthening and deepening of the internal market under the EU Treaties and the significant modification of the prohibitions against restraints on free movement of capital after Masstricht Treaty in 1994.

1. PROBLEM: Germany has invested heavily in an automobile company, in which it retains a 20% stake. It has, both by legislation and a shareholder agreement among the parties when it sold most of its equity stake in the car company, provided, among other things, any decision to move production out of Germany would require a shareholder vote greater than 20%

C. The Cases:

1. Commission v. Portuguese Republic, Case C-367/98, 4 June 2002;

2. Commission v. Kingdom of Belgium, Case C-503/99, 4 June 2002;

3. Commission v. French Republic, C-483/99, 4 June 2002);

4. Commission v. Kingdom of Spain, Case C-463/00, 13 May 2003;

5. Commission v. United Kingdom of Great Britain and Northern Ireland, Case C-98/01, 13 May 2003;

6. Commission v. Netherlands, Case C-282/04;

7. Commission v. Federal Republic of Germany (Volkswagen), Case C-112/2005, dated 23 October 2007;

8. Federconsumatori v. Commune di Milano, Case C-463/04 and C-464/04, 6 Dec. 2007.

D. The nature of the legal issue: can a state ever act as a market participant within its own territory and if it can what ought to be the legal consequences of such action?

E. US position: private law applies. The constitutional limitations of states as sovereigns, and in particular the dormant Commerce Clause, does not apply.

F. European position less clear:

1. What can be extracted from the cases: There is a presumption that state investment activity in domestic economic entities are presumably regulatory in character. As such, there is a presumption of violation of the free movement of Capital rules of the EU treaty. While it is possible to overcome this presumption on the basis of derogations from Art. 56 EC, exceptions tend to be narrowly construed. The analysis does not change whatever the form of investment—statutory, financial public or private. It is all public and subject to the EU Treaty.

2. The Advocate Generals and the Commission have suggested a much broader application of the Golden Share rules. The idea is that all state activity is public, especially when such activity seeks to intervene in purely private activities—principally economic activity. There is or ought to be a presumption that all such activity is regulatory in character—directly or indirectly—and as such falls within the prohibitions of the EU Treaty. It might be possible for a state to show that its investment activity is purely private—but for that to be successfully argued the state would have to prove that it acted like a hypothetical reasonable individual private investor seeking nothing but the maximization of the financial value of his investment. Larry Catá Backer, "The Private Law of Public Law: Public Authorities as Shareholders, Golden Shares, Sovereign Wealth Funds, and the Public Law Element in Private Choice of Law," Tulane Law Review, Vol. 82, 2008) .

G. The importance of the EU’s state aid doctrines under Article 87 EC in understanding the applicability and limits of the construction of a jurisprudence on the nature of the state within the EU system:

1. With respect to the application of the discipline of the competition law rules to state investment activity in their domestic enterprises, the European Court of Justice has long held that the purchase by a Member State of equity interests in a company might be characterized as a “state aid” (Art. 87(1) EC) under the competition provisions of the EC Treaty. (e.g., Case 323/82, Intermills SA v. Commission [1984]ECR 3809). In Case T-198/01 Technische Glaswerke Ilmenau GmbH v. Commission [2004] ECR II-2717 the Court explained that

“In order to determine whether the reduction of some of the applicant’s debts to the BvS constitutes State aid, it is appropriate, in the present case, to apply the test of a private creditor in a market economy, which was referred to in the contested decision and which, moreover, was not challenged by the applicant. . . . By granting the price reduction, the BvS did not act as a public investor acting in a manner comparable to that of a private investor pursuing a structural policy – whether general or sectoral – and guided by the longer-term prospects of profitability of the capital invested. That public body had in fact to be compared to a private creditor seeking to obtain payment of sums owed to it by a debtor in financial difficulties”

Id., at ¶¶ 98-99. See Larry Catá Backer, State Subsidies and the Character of the Market Transactions of Sovereigns: The Case of EADS, Law at the End of the Day, May 29, 2008.

H. Connection to sovereign wealth funds regulation in the EU: Fundamental inconsistencies:

1. The European Union is speaking with at least 2 voices when it comes to Golden Shares, State Aids and Sovereign Wealth Funds.

A. On the one hand, the Commission appears to be taking the position that state investment in foreign corporations, at least foreign corporations within the EU ought to be treated like Golden Share or State Aid cases.

1.That was the position in the recent Airbus contest for control. See Larry Catá Backer, The End of Golden Shares in the EU: The EU Commission Takes a Step in its Abolition, It Ought to Harmonize the Rules of Sovereign Investments Instead, Law at the End of the Day, March 9, 2008.

B. On the other hand, Peter Mandelson has suggested that the appropriate approach is to treat SWF as something different from direct state investment, at least under certain conditions (when the investment is effected through separately constituted funds.

1. For them, Mandelson has suggested that the best approach might be a set of private voluntary codes of conduct—paralleling the current approach to the regulation of multinational corporations. See Larry Catá Backer, Sovereign Wealth Funds And Hungry States: Adjusting the Borders of Public and Sovereign Activity Across Borders, Law at the End of the Day, June 6, 2008, available .

IV. Regulation of Multinational Corporations

A. PROBLEM:

1. Bhopal: capitalized subsidiary taking advantage of Indian legal structures to protect parent.

2. Large multinational influencing the legislature of a small country to enact laws favorable to it in return for inbound investment (factory work and the like).

3. Large multinational operating in a country with internal conflicts deploys its own security forces.

4. Large multinational corporation dealing with the government of a state that has been accused of human rights violations (Burma: apartheid South Africa; the Taliban regime in Afghanistan, etc.) whose government might or might be subject to UN sanctions or investigations by the ICC.

B. The examples set forth above suggest the nature of the problems posed by autonomous economic actors whose operations cross borders. Like state actors, they have undertaken some important public role. But they remain effective because of their ability to take advantage of the incentives to movements of capital and other forms of economic activity. For more detail, see Larry Catá Backer, From Moral Obligation to International Law: Disclosure Systems, Markets and the Regulation of Multinational Corporations, Law at the End of the Day, January 31, 2008, available .

1. Describing the current direction of norm making for multinational corporations, John Ruggie recently noted, “[t]he state-based system of global governance has struggled for more than a generation to adjust to the expanding reach and growing influence of transnational corporations.” John Gerard Ruggie, Business and Human Rights: The Evolving International Agenda, 101 AMERICAN JOURNAL OF INTERNATIONAL LAW 819 (2007).

2. The potential and perils of large economic enterprises, at once both property in the hands of their owners and autonomously constituted legal actors, looms large in the 21st century. Globalization—a privatizing, market-based system of increasingly freely moving capital—has provided the context in which the potential for these great enterprises has come closer to being realized. And its fundamental premises have also served as the basis for tremendous disaffection.

3. The tone of elite global discourse in this context was driven to some extent by the political and economic “left,” which had never abandoned the Marxist-Leninist premise of the conflation of law, politics and economics. While the “right” was satisfied in elaborating the core ideal—strict separation between public and private, law and markets, and positing the essentially private nature of the firm and the markets through which it operated, the “left” was crafting an increasingly elaborate case for the notion that corporations were infused with a public purpose or had a public effect, and therefore had duties to maximize social as well as private value.

C. Topic 1: Basis of Traditional Regulation

1. Introduction to problem and issues of corporate regulation

2. Sources of regulation: legal personality and territoriality

D. Topic 2: Regulatory Crisis and Multinational Corporations

1. Special characteristics of multinational corporations

2. Regulatory environment of multinational corporations

a. National regulation

b. international regulation

3. Free movement of capital and establishment and the contradictions of territoriality as the basis of regulation

E. Topic 3: The Scope and Character of Regulation: What is to be Regulated

1. Elements of good governance

2. Development rights and corporate responsibility

3. Corporate social responsibility and corporate good governance; voluntary approaches

F. Topic 4: Private Law--Contract and Non-State Systems as a Regulatory Vehicle

1. Private law regulation and the expansion of a “social aspects” of contract

2. Emerging methods of regulation (contract as law)

3. Actors in systems of private regulation

4. Creating markets in product certification

G. Topic 5: Special Regulatory Problem: The State as Multinational

1. Special problems: states as multinational multi-national corporations

2. Nature of legal issues when states act in the market

3. Focus: Corruption and the enforcement of contracts against states.

H. Thus, with the regulation of multinational corporations we move from the simple treatment of economic legal persons chartered by a state and wholly within the power of a single state, to an entity operating through a large number of other separate legal entities, across borders. Now operating outside the control of a single state, it can assert power as against other entities—economic and political—that rival those of political states.

1. These entities are large enough to affect public policy

2. Yet they fall outside the control of any state

3. They resemble states in the extent of their regulatory autonomy.

4. States become factors in the production of wealth

I. Regulation, then, begins to take on the same character of the regulation of states as economic participants

1. It is at this point that the character of public bodies—states—and private bodies—multinational corporations—converge.

2. Thus the approach to the regulation of SWFs and that proposed for multinational corporations, are substantially similar.

a. John Ruggie’s report prepared for the U.N. emphasized an approach based on multilateralism, state regulation and voluntary (self-regulatory) codes of conduct and disclosure. See “Business and Human Rights: Mapping International Standards of Responsibility and Accountability for Corporate Acts” Report of the Special Representative of the Secretary-General (SRSG) on the issue of human rights and transnational corporations and other business enterprises, A/HRC/4/035, February 9 2007, at ¶ 50.

b. This is very similar to the proposal coming from the E.U. for the regulation of SWFs operating as separate investment vehicles.

c. The World Economic Forum suggests a similar approach: Among the most important integrity-maintaining functions for markets is the provision of information. This is understood by even the more conservative elements of the organized transnational business community. The fourth Principle of the World Economic Forum’s Framework for Action on corporate social responsibility is transparency.

“BE TRANSPARENT ABOUT IT: Build confidence by communicating consistently with different stakeholders about the company’s principles, policies and practices in a transparent manner, within the bounds of commercial confidentiality. One of the most consistent demands that companies are facing from different stakeholders, ranging from institutional investors to social and environmental activists, is to be more transparent about their wider economic, social and environmental performance.” (World Economic Forum, Global Corporate Citizenship: The Leadership Challenge for CEOs and Boards, accessed Jan. 26, 2008).

V. Final Thoughts:

A. All of this, ironically enough, seems to add a measure of strength to the arguments of a vanguard of thinkers and policy makers that the distinctions between public and private entities are falling away.

B. That insight should produce a necessary reevaluation of the nature of regulatory deficiencies and ought to reinvigorate the debate about the character of appropriate responses. All of that has been difficult to do when the focus has been on the regulatory dimensions of corporations as state actors. But it is becoming increasingly clear that the solution to the problem of corporations as public actors will have to solved at the same time that regulators confront the regulatory dimensions of states as corporate actors.

C. The two principal approaches to each shows that regulatory policy is far form converging.

Law at the End of the Day

Wednesday, July 30, 2008

Emerging Trends in the Convergence of Public and Private Law

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