December 2, 2006
Lerach Liable for Attorney's Fees
A federal district court judge in Houston has ordered a plaintiff's law firm, Lerach, Coughlin, Stoia, Getter, Rudman & Robbins, to pay the attorney's fees of a defendant in a class action securities suit. The case was part of the Enron litigation and the defendant wqas AllianceBernstein, a money management firm. Lerach had included Alliance in a list of defendants because an Alliance Executive was on Enron's board for two years. The Judge found that the allegations that Alliance was a "control party," controlling the actions of its executive while on the Enron board, were groundless. Section 11(e) of the Securities and Exchange Act of 1934 does allow a judge to order that a plaintiff to pay a defendant's attorney's fees if the action is baseless but the section is rarely invoked. In most cases in which the plaintiff's case is frivolous, the plaintiff is a small shareholder, often without the means to make the payment. Judge Harmon's solution, directing that the plaintiff's lawyers pay the defendant's attorneys fees, is unique. There is no authority in favor and limited authority against the holding. The Judge's ruling is a symptom of a growing unrest over class action securities litigation in the United States. The Committee on Capital Markets Regulation has also published its views on the matter. Courts can nibble at the problem in individual holdings but only Congress, the SEC, or the drafters of the rules of procedure (or all three) can make the comprehensive changes necessary to re-balance our securities class action litigation practice.
December 1, 2006
Corportions and Social Responsibility
It was predictable. Milton Friedman died and his death was an opportunity to rehash tired arguments on corporate social responsibility. Henry G. Manne writes an editorial in the WSJ cited Friedman's "the social responsibility of business is to increase its profits" and a flood of responses in the letters to the editor appear. The moves are familiar. One dutifully writes that Friedman is never quoted properly because he hedges with "while conforming to the basic rules of society, both those embodied in law and those embodied in ethical custom." Another writes that incorporation is a social privilege and comes with social duties; yet another writes that corporations are large and powerful and can hurt folks and that insiders do not bear the costs they inflict. It is like watching a well-known and well-rehearsed Greek tragedy. Friedman, with the qualifier, is, of course, correct. At issue is who decides what "ethical" custom is, particularly if compliance may hurts the bottom line. Managers? Shareholders? Government? Academics? I go with shareholders (whose views are implemented by managers).
Senator Grassley (R-Iowa), departing Chairperson of the Senate Finance Committee, has asked the NASD some straightforward questions on insider trading. At the core of his questions is the data, long understood by financial economists, that there is a high probability of abnormal stock trading in the securities of companies involved in deal negotiations, before any deal is announced. The latest data, gathered last August by the New York Times, is that 41% of the companies in big deals show abnormal returns in the pre-announcement period. Gains in stock price can be as high as 40 percent and often average over one- third of the overall run up in price of the target due to the deal. Insider trading around deals is, sad to say, commonplace. How much of the price run up is caused by illegal trading is hard to quantify because shadow trading by those who observe price jumps caused by insider trading is also a common trading practice. Grassley wonders why the NASD is not more successful in stopping such trading. Grassley asked for data on the NASD enforcement actions. His questions have also caught the attention of the GAO, which has agreed to review SEC enforcement practices. Grassley's questions will focus on what is, in reality, an acknowledged and understood weakness in insider trading enforcement. The answers may contain surprises. I, for one, believe that some of the problem is created by an overly broad definition of what is illegal. Enforcement would benefit from a more targeted group of trading crimes.
November 30, 2006
I think I have this right: Ford is raising $18 billion, mortgaging everything everywhere, in order to spend $17 billion in a restructuring to stop its current revenue loss of close to $10 billion a year. 38,000 employees, a startling percentage of Ford's workforce, have headed for the exit, taking Ford's buyout offer. [This is a class action suit waiting to happen. Those that have left will sue if the company does well (company lied) and those that remain will sue it if does not (company lied).] So the new creditors are betting that Ford will service the new debt with its new profits generated after the turnaround that will follow the restructuring. Its new products that will produce the profit look like Lexus knockoffs (the knockoff strategy worked for Japan in the 70s). I hope the creditors will enjoy running their new automobile company in a year or two. I will take the Jaguar division if they want to sell it for a couple of bucks plus an assumption of its obligations.
Committee On Capital Markets Report
The Committee on Capital Markets, a high powered committee attempting to provide political cover for needed changes in our regulation of the securities markets, has issued its 135 page report. There are no surprises in the report. The Committee recommends that we lighten Section 404 of Sarbanes Oxley and decrease the bite of litigation (public and private) against companies and their "gatekeepers" (auditors and directors). To fend off charges that the Committee is for lax corporate governance the report also supports more shareholder rights (majority voting bylaws and votes on poison pills). It takes no position, however, on the thorny questions of executive compensation and the new AIG case (shareholder nominations to the board). The ultimate irony of the recommendations is the Committee's conclusion that the President should direct another committee -- the Working Group on Financial Markets (Paulson is on this committee; he sponsored the Committee on Capital Markets)-- to "examine" the recommendations and "propose" reforms. So Secretary of the Treasury Paulson is, in essence, has his committee recommending that another committee of which he is a member be directed to study the recommendations and propose reforms. Perhaps the Working Group will then recommend that the Secretary of the Treasury support and champion the reforms in Congress and the SEC.
NYSE and NASD SROs Merge
The Self-Regulatory Arms of the NYSE and the NASD have agreed to merge to create a super regulatory agency. The move is hailed by, among others, the Wall Street Journal editorial page who notes that the merger will "reduce regulatory duplication and thus the costs of compliance." The WSJ then noted that "a special dunce cap goes to those claiming this will reduce regulatory competition.'" Put the dunce cap on me; I will wear it proudly, although I do not argue for "regulatory" competition. My argument has been that the the SRO system itself is flawed. The SEC ought to regulate and license directly and the trading markets can chose to have their own internal compliance mechanisms that are not mandated and subject to rule based SEC oversight but are, instead, part of the individual trading markets efforts to market themselves to those who list and those who trade. In other words, I do not argue for regulatory competition; I argue for trading market competition. Just as brokerage offices advertise their fidelity with client money, trading markets will advertise their integrity in their trading practices. The formal SRO system should be dismantled; it has never worked well and is a front for for lax and compliance (not overly-heavy) regulation. The real danger of a single system is that it will be co-oped by those it regulates and that it will serve as a chimera for real and substantial regulation by those who are more accountable for regulatory failure, the political appointees of the SEC Commission. In the next few years we will be left to wonder, when the next wave of financial scandals breaks in the trading markets, why the new super regulatory SRO did nothing. The SEC will wring its hands, change the SRO rules and procedures, claim the problem is solved and tout the function of the SRO, and we will wait until the next wave of scandals, when we will repeat the process all over again. Note how inbred the process was. Two ex-SEC officials, running the two regulatory units, worked with an SEC Commissioner and its chair to cut the deal. The super-regulatory SRO will be a employment unit for ex-SEC enforcement officials who will step up from public salaries to considerably higher salaries in the SRO. Note also that NASD, which needs an affirmative vote of 5,100 members to do the merger, is offering a "sweetener" of $35,000 to each member firm contingent on their voting their approval. If the deal is so grand why the bribe?? One reason perhaps is that member firms are losing the one-firm, one-vote system (votes will be weighted by size). The sweetener is reminiscent of similar payments made by companies to their common shareholders in order to get their approval for dual class voting systems that take away their voting power (giving it to an insider group holding non-publicly traded Class B shares). The NASD rules frown on such offers.
This is like watching a slow motion train wreck.
November 28, 2006
The Facts on Income Growth
The new tax data shows the following: 1) Average income rose 27 percent (in real terms) from 1979 to 2004. Only those in the top 5 percent had significant gains, however. One third of the entire national increase in reported income went to the top 1 percent; one-sixth of the total increase went to the top one-tenth of one percent. 2) The data from 200 to 2004 shows a different trend, however. The bottom fifth has an average income gain of 2.4 percent while those in the top one-tenth of one percent reported average income losses of almost 17 percent.
Committee on Capital Markets Regulation
The first report to the Committee on Capital Markets Regulation, authored by Luigi Zingales (Chicago Bus. School), found that the premium for listing on both United States and a foreign market for foreign companies has dropped significantly since 2002. Shares of a foreign company are worth more if they are listed on the United States markets as well as home markets. In theory, investors will pay more for the stock because they have more confidence in a company covered by the United States regulatory system. The cross listing premium has declined significantly for company also listed in countries with a well regarded corporate governance controls of their own (e.g., Canada, Hong Kong, Japan and the UK). The premium remains robust only for countries with weak corporate governance controls (e.g., Italy, Austria, Brazil and Turkey). The implication -- the United States is losing its competitive edge in corporate governance regulations to several other countries with competitive financial markets.
November 27, 2006
Privately Held Companies: Better Run??
An argument in favor of privately held firms, financed by private equity funds, is that the privately held companies are better managed. See, e.g., Donald J.Gogel, "What's So Great About Private Equity" (todays WSJ at A13). The argument is, in short, that managers of private firms can focus on the bottom line and are not "responding to the cacophony of their many, multiple constituencies." The argument is, in essence, an attack on the many new rules -- legal, ethical and best practice rules -- that we expect a board in a publicly traded firm to obey. If the argument is correct, public investors are better off investing in private equity funds that then invest in privately held companies than they are investing in the same companies as public shareholders. A more efficient solution would be to let publicly traded firms set their own management rules (have fewer mandatory rules) and let public investors select among the management systems in which they have the most confidence.
November 26, 2006
The Australian Version of Contingency Fees
Australian does not permit lawyers to use contingency fees in class action and derivative litigation. The Australian High Court has legitimized a new wrinkle however. Companies, called "litigation funding companies," can purchase a share of a lawsuit, paying litigation expenses and lawyer's fees, in exchange for a percentage of the recovery (usually one-third to two-thirds). Hedge funds, including some in the United States, back the funding companies. We allow the limited assignment of some debt claims in the United States but do not allow full-scale claims sales by injured private plaintiffs. The Australian experiment will be worth watching.
The Teleflex Case
The Supreme Court will decide on the definition of "obvious," a block for investors seeking patents, in the KSR v Teleflex case. A high number of "friend of the court" briefs from interested parties have been filed. There is growing concern over whether intellectual property is overprotected in the United States. This case will give the Supreme Court a chance to weigh in on the controversy.
Herb Greenberg on IPOs
Herb Greenberg on "Market Watch", a unit of Dow Jones, has written an article arguing that the decline in foreign IPOs floated in the United States may not be so bad. He notes that the total amount of IPOs in the United States is still healthy and that many of the IPOs that have fled to London's AIM market are not doing well. He also noted that money is chasing deals in the private market and these investors may soon be looking to dump their companies on the public. He favors only the "safe" IPOs in the public markets. Do investors in the public markets need such coddling?