March 27, 2010
Draw Your Own Conclusions
Item 1. The Wall Street Journal reports on a couple of post-Citizens United campaign finance cases here. In at least one of them (according to the story), the Republican National Committee was against the particular restriction at issue while the Democratic National Committee was in favor.
Item 2. An affiliate of the U.S. Chamber of Commerce has ranked Delaware No. 1 in terms of "litigation climate" for the 7th year in a row.
March 26, 2010
Davidoff on International Securities Regulation
Steven M. Davidoff has posted Rhetoric and Reality: A Historical Perspective on the SEC's Regulation of Foreign Private Issuers on SSRN with the following abstract:
Rhetoric can drive reform. Watch-words like “mutual recognition” and “global competition” have masked a political economy story which has driven the SEC’s deregulation of foreign private issuers. While the substantive result may have been appropriate, the over-all SEC regulatory process did not produce a nuanced and holistic regulatory product. Instead, this process resulted in one-size fits all regulation for foreign private issuers. Filipino or Chinese issuers listed only in the United States are now regulated in equal measure as a U.K. issuer listed on the London Stock Exchange and New York Stock Exchange. This is despite the differing risk profiles and regulatory posture of these issuers. This essay's historical analysis highlights these issues as well as the difficulty of implementing more rigorous and insulating regulatory techniques such as cost-benefit analysis as rhetoric and the politics of regulation overwhelm such approaches. The relevance of this story is front and center as we face coming SEC regulatory reform in light of the financial crisis under new watch-words such as “investor protection”.
Implicitly Too Big To FailSenator Richard Shelby yesterday provided a letter to Treasure Secretary Timothy Geithner listing his complaints related to the financial reform bill that was approved by the Senate Banking Committee on Monday. The Banking Committee bill includes a provision requiring large financial companies to pay into a $50 billion fund to be used for dismantling a failing company deemed critical to the market (see, e.g., AIG). Senator Shelby complains that the market would view the firms required to pay into the fund as (1) having been designated “too big to fail” by the federal government and (2) “implicitly backed by the government.”
As for the first part, I agree with Senator Shelby. It’s hard to argue that the list of companies required to pay into the fund wouldn’t be deemed companies the government views as critical to the market, even if there were no guarantee the government would actually use the fund if the company failed.
For the second part, he is probably right, too, but it shouldn’t matter. I have never been fond of “implied guarantees,” either in this context or in the context of government-related entities such as Fannie Mae and Freddie Mac. (For good, and somewhat competing, overviews, see this article, by Richard Scott Carnell, and this one, by David Reiss.)
At least in the world of high finance, I just don’t like the concept of implied or implicit guarantees at all. If you are savvy and sophisticated and you want a guarantee, get one – the explicit kind. If not, there isn't one. Otherwise, the guarantee is simply a hope – a calculated risk – that someone will step in and conduct a bailout if it is needed
This is not unlike a local shop granting a 22-year-old child of wealthy parents a line of credit. The shop knows who the child is and knows who his parents are, and figures it’s worth the risk because the parent will likely cover any outstanding charges. The parent may choose, and perhaps is likely to choose, to pay the bill to protect the reputation of the child, the family, or both. However, unless the parent has agreed to be obligated to cover the bill, the shop always runs the risk that the parents will decide it is no longer worth it.
This holds true on the large scale, too. The debate shouldn’t be about whether the government has made implicit guarantees, and, in fact, the bill should explicitly state the government is not making any guarantees. Absent explicit guarantees, the debate needs to be about whether the government should step in, not whether it must.
-- Josh Fershee
March 25, 2010
Symposium on International Finance After the Crash: Regional Responses to the Global Financial Crisis
Cleveland-Marshall College of Law's Global Business Law Review is hosting a symposium on Friday, April 9, entitled: International Finance After the Crash: Regional Responses to the Global Financial Crisis. For more information, go here.
If you think the lack of diversity in corporate boardrooms is a problem...
...then the composition of South Carolina University's Board of Trustees will likely make you apoplectic. In a state where over a quarter of the population is African-American, the 22-member board will apparently not have a single African-American representative by the end of next month. In good SEC fashion, the debate is reaching the gridiron.
March 24, 2010
Flechtner on International Commercial Law
Harry M. Flechtner has posted Globalization of Law as Documented in the Law on International Sales of Goods on SSRN with the following abstract:This paper, presented as part of the 2008-09 Willy Delva Lecture series at the University of Gent (Belgium) and published in Nieuw Internationaal Privaatrecht: Meer Europees, Meer Globaal 541 (J. Erauw & P. Taelman, eds.) (Kluwer, 2009), explores the extent to which the United Nations Convention on Contracts for the International Sales of Goods (“CISG”) is meeting the most fundamental challenge it confronts. The CISG adopts a particularly demanding vision of globalized law, but eschews the most potent means to achieve the uniform interpretation that vision requires. The CISG relies instead on an admonition that it be interpreted with regard for, inter alia, “its international character and the need to promote uniformity in its application....” Remarkable resources have appeared to aid in achieving this goal, creating a new information infrastructure and a new method of conducting legal research and practicing law. This paper analyzes three specific issues to test the success of courts and arbitral panels in employing these resources and achieving a uniform interpretation of the CISG: 1) the interpretation of choice of law clauses that designate the law of a Contracting State; 2) determining whether a seller must deliver goods that comply with domestic regulations of the buyer’s state; 3) incorporation of standards terms under the CISG, including adoption of the “rolling contract” theory under the Convention. Examining the treatment of these issues shows a mixed picture of success in implementing the uniformity mandate of the CISG, but one that leaves the author hopeful about the future of the Convention and its lofty ambitions.
It's Time to Trust the Housing Market AgainA major, and continuing, part of the financial crisis relates to the struggling housing market. According to the National Association of Realtors, housing inventories are up slightly, possibly driven by those seeking to “trade up” in the “down market.” This could help signal (and fuel) a turn around in the housing market. However, credit remains difficult to obtain, and just as important (and unfortunate), home buyers (and sellers) are facing a difficult appraisal market, too. An interesting aside: All-cash sales are a remarkable 27% of all sales (10% is the more typical number), another indicator that banks aren’t fueling a recovery in the market. All-cash sales, of course, skip the need for mortgage approval (and appraisal).
The Home Valuation Code of Conduct, or HVCC, which went into effect last year, puts restrictions on appraisals for any loan with funds related to Fannie Mae and Freddie Mac. The rules place significant restrictions on the process used for appraisers, and while designed to help solidify the industry, there are indications that it adding additional restrictions to the process that are further limiting a housing market rebound.
The biggest concern with home sales used to be that the buyer would not get financing approval or that the inspection would be a problem. Now appraisals are become a major concern, with appraisals coming back as much as 30% below the negotiated sale price. It’s hard to argue that the appraisal system was not out of control during the housing boom in the early part of the decade, when the negotiated price seemed to dictate the appraisal. (Of course, market price is not necessarily a bad standard for valuation, but there is no reason for a third-party appraiser if the negotiated price is going to be the appraised value, anyway.) In this market, though, allowing market negotiations to determine prices should be more, not less, accurate than during a boom cycle. There is a surplus of homes on the market and buyers are not (usually) competing in bidding wars that will cloud their judgment. Thus, buyers have time to see what is available, analyze the market, and determine a wise price. Realtors, similarly, are able to consider the market and work with their clients (on both sides of the negotiation) to assess the value of a home in a way that moves the property.
Obviously, sellers and realtors on both sides of the transaction are interested in getting the most money they out of the transaction that they can. This doesn't necessarily mean they are wrong in their price estimations (or at least not wildly wrong), especially once a buyer agrees to a price. After all, if there is no transaction, there is zero benefit for the realtors or the seller.
When, as now, a market is hard to assess, perhaps a mechanism for expressly considering the negotiated price as part of the appraisal process is needed. Otherwise, gun-shy appraisers may be compelled to “over learn” their lesson, thus exacerbating a problem they helped create.
March 22, 2010
My, what changes 3 years (and $3 trillion in recovery money) can bring...
"Prominent figures in the U.S. are warning that the nation's financial markets have been handicapped by post-Enron regulatory overreach. Treasury Secretary Henry Paulson has made addressing the problem a signature political issue. A blue-ribbon committee chaired by former Bush economist Glenn Hubbard has echoed this sentiment, as does a report commissioned by Sen. Charles Schumer of New York and New York City Mayor Michael Bloomberg. Their key evidence is data suggesting that U.S. stock markets are increasingly unattractive places for companies to list shares...Their solution: a lighter touch in regulating corporate behavior...." [from "In Call to Deregulate Business, a Global Twist," The Wall Street Journal, January 25, 2007].
Such was the collective sentiment on strong regulation three years ago. Scholars, elected officials, and others rallying opposition to Sarbanes-Oxley, itself a reaction to the costs of the notorious frauds of 2001/2002.
With the health care issue decided, regulatory reform seems poised for the full attention of the White House. This time, may academia, Washington, Wall Street and Main Street understand the true cost of the subordination of regulation to theories on competition.
On Regulatory Staffing
An op-ed piece in The New York Times on Friday questioned whether the mission of S.E.C. reform is best served through traditional remedies. Specifically, "A Foreign Service for Wall Street," while acknowledging that the Commission has already "taken steps" to raise employee pay, enhance training, and employ experts, nonetheless stated, "But as long as the agencies are plagued by high turnover rates, increasing their training budgets will simply result in better-trained former staffers, while the establishment of new departments will only move vacancies around the organizational charts".
It is encouraging that the revolving door at the S.E.C. is being both noted and critiqued. Perhaps the manifest urgency to keep the most experienced at the Commission must simultaneously confess the following:
1. The Need for Budgetary Independence
The Congress of 1934 never anticipated that the agency would be apolitical - Section 4 of the Exchange Act contemplates an ideally bipartisan Commissioner level. But even the default goal of bipartisanship has resulted over time in the agency becoming subject to the philosophy of the party holding the White House. Combine this subservience with the annual quest for funding and the S.E.C. most always focus on headlines, a strategy that applauds such specialization as victories in actions centering on insider trading and foreign bribery (as opposed to success in demanding net capital compliance and preventing good old fashioned theft).
If either self-funded or funded by taxes on the industry membership, the Commission would be free to diversify its training to equally focus upon detection and advisement. Such a reshuffling would, in turn, dilute the diploma of the most celebrated graduate: The expert S.E.C. litigant.
Of course, such a re-prioritization of goals and means would also require that all acknowledge the true scope of the Commission's powers.
2. The Need for Clarification of the Role of Self-Regulatory Organizations
The stock exchanges (Self Regulatory Organizations, or "SROs" under Section 6 of the Exchange Act) perform myriad duties in the regulatory mosaic. Indeed, students of the subject are often surprised to see that it is the SRO rulebook that solely caps commissions and day-to-day margin. In other areas, sovereignty is shared with the S.E.C., who may, of course, at any time supersede more local regulatory efforts.
A crucial step involves cleaning up those jurisdictional turf wars that have cemented over time. Is an NYSE broker-dealer examination the first line of defense, or is the S.E.C. solely responsible when a firm has "cooked the books"? Either reporting line might be adequate, but a supervisory system vaguely relying on both wastes resources, forestalls effectiveness, and clouds deterrence.
3. The Imposition of a Time Bar on Subsequent Employment
Industry arbitrators are accustomed to limitations on their roles based upon the nature of their employment. For example, a former brokerage house attorney is classified as "Industry" (as opposed to "Public") for five years after leaving the securities private sector; the result is that such arbitrator, among other things, 1) is subject to a heightened scrutiny during the selection process, and 2) cannot serve as a panel Chair in cases involving customers. Is such a presumption arbitrary and cumbersome? Most definitely. But the arbitrator knows the rules governing his service upon seeking inclusion in the FINRA pool.
Likewise, the countless applicants to the Commission should be subject to such clearly stated limitations. Leave the Commission Division of Enforcement, and you have to wait three years to represent firms/individuals to represent clients. Perhaps more young attorneys would stay at the Commission, and the Commission would benefit from a more robust institutional knowledge.
Alternatively, the S.E.C. could reaffirm its storied "3-year commitment," an agreement asked of new hires that weds them to the job for a period exceeding their training.
In sum, the Times op-ed piece represents an enlightened look at a taboo topic. Unfortunately, like so many other issues clouded by the continuing economic storm, the solution may be staggered and multi-faceted. When it comes to the thorny problem of S.E.C. staffing, several of those facets will likely involve compromising with other regulators, addressing political influence, and imposing some awkward but justifiable employment limitations.
Free Market + Adam Smith = Regulation?In President Obama’s weekly radio address, he explained his view that “free markets” and “regulation” are not inherently contradictory:
I have long been a vigorous defender of free markets. And I believe we need a strong and vibrant financial sector so that businesses can get loans; families can afford mortgages; entrepreneurs can find the capital to start a new company, sell a new product, offer a new service. But what we have seen over the past two years is that without reasonable and clear rules to check abuse and protect families, markets don’t function freely. In fact, it was just the opposite.
At first, I thought of the many people who would be shocked (and/or appalled) at this notion of regulating “free” markets; Adam Smith’s “free hand” theory, after all, seems to be all many people need to know about economics. This, in turn, reminded me of the introduction Michael Lewis (Moneyball, The Blind Side) wrote as editor to The Real Price of Everything, an enormous compilation of fundamental works in economics from Adam Smith, Thomas Malthus, David Ricardo, Charles Mackay, Thorstein Veblen, and John Maynard Keynes. (For what it’s worth, I have found this to be a great, and daunting, resource.)
Lewis explains that there are (at least) two Smiths – one who believed that self-interest is the primary motivator of how people (and markets) operate and another who believed that there were times when a “visible hand” needed to step in to ensure that markets operate appropriately. So why is the first Smith so well known? Lewis theorizes that the famous “pin factory” example is on page 2; later, and darker, views of the market, including the need for government to play a role in avoiding abuse of the “ordinary worker,” don’t show up for hundreds of pages.
None of this means that the recent regulatory proposals (supported by the President) are the perfect (or even proper) means of providing government oversight, or even that Adam Smith was right on either count. It does mean, though, that when using economics as the basis for new laws and regulations (or repealing old ones), there is real value in going beyond page 2.
March 21, 2010
Thomas and Wells on Executive Compensation
Randall S. Thomas and Harwell Wells have posted Executive Compensation in the Courts: Board Capture, Optimal Contracting and Officer Fiduciary Duties on SSRN with the following abstract:
Article proposes a new approach to monitoring executive compensation.
While the public seems convinced that executives at public corporations
are paid too much, scholars are sharply divided. Advocates of “Board
Capture” theory believe officers so dominate their boards that they can
negotiate their own employment agreements and set their own pay.
“Optimal contracting” theorists doubt this, contending that, given legal
and economic constraints, executive compensation agreements are likely
to be pretty good and benefit shareholders. Disputes about which theory
is correct have hampered efforts to reform executive compensation
Recent developments in corporate law point to a way out of this theoretical impasse. Last year, in Gantler v. Stephens, Delaware’s Supreme Court resolved a major unanswered issue in corporation law when it held that a corporation’s officers owe the same fiduciary duty to the corporation and its shareholders as do its directors. Gantler opens the door for courts to scrutinize rigorously officers’ actions in negotiating their own compensation agreements. The Delaware Chancery Court has taken up this invitation by holding that corporate officers are bound by their duty of loyalty to negotiate employment contracts in an arm’s-length, adversarial manner. If the officers do not do so, but instead try to take advantage of the Board, they will open themselves up to shareholder lawsuits and give courts the opportunity to examine the compensation agreements and their negotiations. This will provide a new level of judicial scrutiny of executive compensation arrangements, and should go far to answer criticisms leveled by Board Capture theorists, who believe the present negotiating system is corrupt, while Optimal Contracting theorists will welcome judicial intervention that improves the present negotiating environment.