July 10, 2010
Scienter Versus the Intent to Violate Accounting Rules
The Wall Street Journal has an article today headlined "BofA Admits Hiding Debt." In the light of my first reading of the article, it sounds like Bank of America engaged in transactions similar to Lehman's "Repo 105" transactions. The bank apparently admits that it engaged in these transactions in order to "reduce the specific business unit's balance sheet to meet [the bank's] internal quarter-end limits for balance sheet capacity." However, it sounds like what made the accounting for these transactions incorrect was that the bank received back substantially the same type of securities that it originally "sold". The bank apparently claims it made an error in failing to recognize that this required accounting for the transactions as loans rather than a sales.
But even if one accepts this explanation, it can still sound like little more than "we didn't intend to get caught." The question of whether there is enough here to make a showing of scienter (an intent to defraud) under the securities laws remains.
While there is certainly an argument to be made here that the transactions were of relatively minor amounts ($10.7B out of $2.3T in assets), and entered into for purely internal record-keeping practices, I am reminded of a comment an investment advisor friend made to me in the wake of the recent financial crisis: "How can I ever trust anything that comes out of the mouths of these guys again?"
July 9, 2010
Aronson on Corporate Governance
Bruce E. Aronson has posted Learning from Toyota’s Troubles: Board Oversight and the Debate on Board Structure and Director Independence in Japan on SSRN with the following abstract:This Article considers the potential significance of Toyota’s recent troubles for Japanese corporate governance by examining two sets of issues. First, it looks at the relevant fiduciary duty of Toyota’s directors, i.e., the general duty of oversight in Japan as set forth in case law in the Daiwa Bank shareholder derivative litigation (2000) and the related subsequent statutory duty to establish a system of internal controls provided in the Companies Act (2005). Potential director liability would depend on the filing of a shareholders derivative suit and the discovery of facts which show director’s negligence in devising, implementing, and monitoring specific measures to carry out the board’s existing overall policy on internal controls.
Second, it considers the Toyota case in light of the ongoing debate in Japan during the last decade between competing board structures: the traditional company auditor (kansayaku) structure with no required outside directors and the newer alternative board committee structure with a required majority of outside directors. The potential role of independent directors remains controversial and is currently the hottest topic in Japanese corporate governance. The recent failures of Toyota, a highly successful champion of the traditional Japanese governance system, might help make Japan more receptive to calls by international and domestic institutional investors to take measures to increase board independence.
Kerhuel on Corporate Acquisitions
Anne-Julie Kerhuel has posted Conflict-of-Law Rules in Conflict and Competition with Substantive Law Rules: The Case of Corporate Acquisitions (La Cession De Contrôle En Droit International Privé) on SSRN with the following abstract:
that a citizen of UK and a citizen of France meet in Italy and sign a
contract to be performed in Germany. If a legal issue arises regarding
the interpretation of the contract, which national law
should apply? Conflict-of-law rules exist to resolve
this question. Among the criteria used to determine which law
applies (in the case when the parties to the contract did not choose
it) are the country where the contract is signed, the country where the
contract is performed, and in the case of corporate law,
the country in which the corporation in question is registered.
Conflict-of-law rules are for the most
part a product of national law and a court before
which the dispute is brought will apply the conflict-of-law
rule of the country of which it is part.
Nevertheless, a court may find that conflict-of-law rules that it applies are themselves in conflict. For example, a legal dispute may involve issues about contract law and corporate law and a conflict-of-law rule applicable to contract law may require a different result than the conflict-of-law rules applicable to corporate law. One way to resolve this conflict of conflict-of law-rules is to apply different conflict-of-law rules to various aspects of the disputed matter. But this differential application of the conflict-of law rules to the same issue avoids consideration of the matter in question as a whole, introduces complexity, and may produce incoherent results. Another way to resolve the conflict of conflict-of-law rules is to weigh the different interests at stake in light of the underlying purposes of the substantive law. This method has been applied by courts in some instances. But with both approaches, the viability of traditional conflict-of-law methods is called into question. Moreover, the problem becomes even more complicated when substantive rules on international (rather than national) law are involved. This study describes the different conflicts that may occur and analyzes the different solutions for resolving them through the example of corporate acquisitions.
The More Ruthless Rich
The New York Times reports that one in seven homes with mortgages of $1 million or more is in default, while that is true of only one in twelve homes with mortgages of less than $1 million. Because of this data, according to Sam Khater a senior economist for CoreLogic, the group that collected the data, “The rich are different: they are more ruthless.”
Wow, where to start. First, I suppose he is saying that we're all ruthless, but the rich are more ruthless. Some ruthlessness is okay, it appears, but there's a line (and the rich have crossed it).
Second, the article says that it is hard to know for sure from the data (I assume they are hinting at the difference between correlation and causation here), but they think the data "suggest" that the wealthy are dumping their underwater homes "just as they would any sour investment." Okay, that sounds like a business tactic, but is it ruthless? I mean, the data don't suggest that the rich kick puppies on their way out the door or take candy from babies.
I don't mean to give people a pass for walking away from homes they bought and can afford. But "ruthless," based on this data alone, still seems like a pretty extreme statement. Perhaps the rich are more ruthless, but I'd like a little more explanation of why the one act (default) is necessarily linked to the characteristic (ruthlessness). Then again, perhaps I missed something. Maybe "ruthless" is defined somewhere as "one who defaults on a very large loan they could afford just because they don't feel like paying it."
July 8, 2010
Pasquale on "The End of the Free Market"
Frank Pasquale reviews Ian Bremmer's book, "The End of the Free Market: Who Wins the War Between States and Corporations?," here. Scandalously, Pasquale suggests we may be able to learn something from the way China runs its economy.
Will BP and Bankers Love LeBron?
How can they not love anyone who distances them from "Public Enemy Number One" status?
Truth on the Market has more here.
July 7, 2010
Bainbridge on Insider Trading
Stephen M. Bainbridge has published Insider Trading Inside the Beltway on SSRN with the following abstract:
study of the results of stock trading by United States Senators during
the 1990s found that that Senators on average beat the market by 12% a
year. In sharp contrast, U.S. households on average underperformed the
market by 1.4% a year and even corporate insiders on average beat the
market by only about 6% a year during that period. A reasonable
inference is that some Senators had access to – and were using –
material nonpublic information about the companies in whose stock they
Under current law, it is unlikely that Members of Congress can be held liable for insider trading. The proposed Stop Trading on Congressional Knowledge Act addresses that problem by instructing the Securities and Exchange Commission to adopt rules intended to prohibit such trading.
This article analyzes present law to determine whether Members of Congress, Congressional employees, and other federal government employees can be held liable for trading on the basis of material nonpublic information. It argues that there is no public policy rationale for permitting such trading and that doing so creates perverse legislative incentives and opens the door to corruption. The article explains that the Speech or Debate Clause of the U.S. Constitution is no barrier to legislative and regulatory restrictions on Congressional insider trading. Finally, the article critiques the current version of the STOCK Act, proposing several improvements.
Markham on the Financial Crisis
Jesse W. Markham Jr. has published Lessons for Competition Law from the Economic Crisis: The Prospect for Antitrust Responses to the 'Too-Big-To-Fail' Phenomenon on SSRN with the following abstract:
This article explores the failure of antitrust law to prevent or intercede to remedy any of the aspects of the too-big-to-fail phenomenon.
Anderson on Financial Regulatory Reform
Kenneth Anderson has published Do Lawyers and Law Professors Have Any Comparative Advantages in Opining on Financial Regulation Reform? A Brief Essay on SSRN with the following abstract:
short (4,500 word) essay addresses a worry sometimes at the back of the
minds of financial lawyers and law-and-finance scholars
seeking to intervene in the debate over financial regulation reform in
the wake of the financial crisis of 2007-09. As lawyers and law
professors, what - if anything - do we have to contribute to the
debate? Are the fundamental questions of the financial crisis not
economic in a professional and disciplinary sense? Questions that
require formal disciplinary skills and training in economics in order to
be able formulate positions on the fundamental issues, in which the
skills of the lawyer and law professor are, at most,
those of scribe seeking clearly to write down policy positions
necessarily reached elsewhere? Framed in this way, these questions aim
gently to provoke a bit, and exaggerate a bit, in order to ask the
still-sensible question: what, if any, is the comparative advantage of
lawyers and law professors in arguments
over financial regulation reform?
This essay began as a talk to law students, and it remains an informal, discursive, and meditative consideration of professional and disciplinary roles. It seeks in a very short space to identify several areas in which lawyers and law professors bring particular insights to the regulatory table. They include not just the ability to read closely and formulate complicated ideas in words that form statutes and regulations - and a professional ability to see unintended consequences in the form of words - but also a particular disciplinary appreciation in the law for the "thick" relationships of agency, fiduciary, loyalty, and care that bind together institutions far more than the simplification of "nexus of contracts" can capture.
Moreover, regarding financial markets and instruments, lawyers have a better appreciation than other disciplines of the ways in which financial instruments used in markets as though they were economic equivalents are not actually legal equivalents, if one reads, so to speak, the fine print - fine print that matters particularly when their equivalence is challenged as a matter, unsurprisingly, of law. Additionally, lawyers have a greater sensitivity to the contingencies of processes such as bankruptcy - even when "rule-base" - and the uncertainties that, on efficient market theory, are priced into financial instruments, but - at least the lawyers will wonder - how so and on what actual, rational valuation method, if, after all, the lawyer-experts are themselves are uncertain.
Pricing the (Maybe) Biggest IPO, Plus KKR Goes Public
The Agricultural Bank of China is now public. The bank raised more than $19 billion from stock sales and could earn more than $22 billion, which would make it the largest IPO ever completed. (The largest to date is the IPO for Industrial & Commercial Bank of China at $21.9 billion.)
Apparently, many experts on the Chinese economy expect the Chinese banks will suffer because lending practices over the past two years are likely to lead to a significant number of defaults. Of course, investors can read, too, so they know all of this.
Nonetheless, the New York Times explains that the
Agricultural Bank I.P.O., like the ones preceding it, has been heavily subscribed, in part because virtually everyone believes the government is locked into ensuring the bank’s success. Major government-controlled corporations are among the early subscribers to the issue.
Odds are it is a good bet that the Chinese government will help ensure success, but it doesn't mean the government must or even will do that. Presumably, though, purchasers have calculated into the price the risk that the government might choose not to back the debt. (I say "presumably," because I tend to buy into the semi-strong form efficient market hypothesis that stock prices adjust efficiently "to information that is obviously publicly available.")
July 6, 2010
A need for wiretaps?
At a 1989 training conference sponsored by the SEC, we young NYSE regulators were advised by one speaker to "ask the ultimate question." Young, green, and overly optimistic about the coercive power of a formal investigation, we were thus encouraged to conclude testimony by looking the subject in the eye and asking, "Sir, did you trade on inside information?"
The anecdote (and the related, unproductive strategy) serve foremost to remind me how much such investigations ultimately rely on purely circumstantial evidence. Simply put, defendants at contested trials often forget the specific content of telephone conversations; witnesses with better memories have often concluded deals for leniency. It thus becomes necessary for SEC attorneys and their co-champions in the war on insider trading to pile interlocking facts and inferences so high that the conclusion is inescapable that a violation took place.
A big chunk of the pile is often comprised of telephone records. While data indicating merely the date, time and duration of a telephone call may seem porous, when combined with facts on trades and profits, the phone records become vital. See, e.g., United States v. Reed, 601 F.Supp. 685, 690 (S.D.N.Y. 200 ), rev'd on other grounds, 773 F.2d 477 ("The purchase was made shortly after Reed had participated in a telephone conversation with his father.") and SEC v. Sekhri, 333 F. Supp. 2d 222,223 (S.D.N.Y. 2004)(noting, without discussion of content, the existence of 7 phone calls between alleged tipper and tippee over a 2-day period).
But a recent SDNY decision eschewed conclusions premised upon phone call data. In the Rorech case from late last month, the court ruled against the Commission on charges of insider trading, opining on the telephone calls between alleged tipper and tippee that “While the SEC attempts to attribute nefarious content to those calls through circumstantial evidence, there is, in fact, no evidence to support this inference.”
Such a dismissive judicial view of the import of phone data is no doubt significant to the pending Galleon Case. The SEC seemingly "upped its game" last year when it brought charges against a hedge fund manager reliant in large part upon federally authorized wiretaps of the accused's cellphone. See generally Peter Henning, The Next Step in Catching Insider Trading?, New York Times DealBook, May 27, 2010. In May of this year, attorneys for the defendant moved to exclude the wiretaps (arguing that their authorization violated the applicable statute). That motion is pending.
The aggressive investigative tactics are now all the more interesting in light of a court's discrediting of the Commission's traditional approach of leaving the trier of fact to surmise the dramatic content of conversations. On the one hand, "criminal" surveillance tactics (like wiretapping) may erect procedural limits traditionally irrelevant to the SEC's civil proceedings. However, if it becomes clear that federal courts are not going to perfunctorily join in the SEC's estimation as to what was discussed at key parts of a time line, then the telephone conversations themselves may need to be more frequently gathered and produced, whatever the cost in terms of time, effort, and legal debate. Thus, in a larger sense, the recent SEC loss may simply prove to be a trigger to a much uglier and hotly contested war over who said what to whom at what time.
July 5, 2010
Top Job Salaries
With all the talk about say on pay for public companies and salaries at large investment banks, executive salaries have been getting a fair amount of scrutiny in the recent past. But what about top politicians? The Economist has an interesting chart listing the salaries of twenty-two world political leaders compared to their country's GDP per person. Tops on the list: Singapore's Lee Hsien Loong makes $2,183,516, which is more than 40 times the GDP per person. At the bottom: India's Manmohan Singh, $4,106, about 3 times the per person GDP.If you're curious, President Barack Obama earns $400,000, which is around 7 or 8 times the U.S. GDP per person. This ranks him below France and New Zealand, but above the U.K. and Japan.
I'm not sure I have concluded what (if anything) all of this tells us, but it is still an interesting comparison.
Of Market Brakes, Large and Small
The current SEC emphasis on stock-by-stock circuit breakers seems to have rendered obsolete the false sense of security from that much-publicized remedy of the 1980s, the exchange-wide circuit breaker. For a summary of the rules governing the new, individual stock "time outs," see http://www.sec.gov/news/press/2010/2010-117.htm.
Meanwhile, the futility of the exchange-wide circuit breaker was a hot topic at a symposium hosted by Chapman Law School last Halloween weekend. For the symposium summary (including a post by yours truly on such market halts), see http://www.lawschoolblog.org/blog/.
July 4, 2010
Feinberg on the Legal Profession in China
Gary Feinberg has posted The Professional Model of Law vs. The Business Model of Law: A Critical View of Opposing Trends in the United States and the People's Republic of China on SSRN with the following abstract:
This study begins by reflecting on the literature characterizing the nature and function of a profession qua profession. It continues by arguing that based upon commonly used indicia of a profession that the practice of law in the US is de-professionalizing in significant ways and morphing towards a functioning business model. The related advantages of such a development for American society, its lawyers and their clients, including especially criminal defendants are critically discussed. It then traces the emergence and ascendancy of the rule of law in China and corresponding quest to institutionalize the practice of law in China as a profession. The study concludes by exploring the alternative advantages of applying the business model to the Chinese legal practice. It recommends that embracing a paradigm shift away from the professional model towards a business model comparable to what is happening in the US would be to the greater advantage of Chinese lawyers in terms of enhanced authority, increased self- regulation, as well as greater leverage in advocating client interests.