September 24, 2011
Westbrook on the 100th anniversary of the first “blue sky” law
Amy Westbrook has posted “Blue Skies for 100 Years: Introduction to the Special Issue on Corporate and Blue Sky Law” on SSRN. Here is the abstract:
Kansas enacted the first state securities law in the United States on March 10, 1911, thereby ushering in a new era of financial regulation. House Bill 906, entitled “An Act to provide for the regulation and supervision of investment companies and providing penalties for the violation thereof” (1911 Act), was the product of disparate forces, including the ongoing struggle over Kansas’ new bank guarantee act, progressive pressures within the Republican Party, strong agricultural markets, the increasing prevalence of traveling securities salesmen, and the work of the charismatic Kansas Commissioner of Banking, Joseph Norman Dolley. This year marks the 100th anniversary of the Kansas “blue sky” law, and this issue of the Washburn Law Journal uses the occasion to look back on the genesis of securities regulation and to think about its future. It is true that the financial markets in 2011 are profoundly different from the markets in 1911. Moreover, the 1911 Act was passed under a specific combination of politics, economics, technology and social forces at work in Kansas in 1911. Although a lot has changed in 100 years, the persistence of the regulatory systems established during the early twentieth century, with respect both to securities and to corporate governance more generally, suggests that era may have more to interest us than “mere” history.
September 23, 2011
Want a Raise? Be Disagreeable.
That's the conclusion of a study by Timothy A. Judge (Mendoza College of Business, University of Notre Dame), Beth A. Livingston (School of Industrial and Labor Relations,Cornell University, and Charlice Hurst (Richard Ivey School of Business, University of Western Ontario). The study, Do Nice Guys – and Gals – Really Finish Last? The Joint Effects of Sex and Agreeableness on Income, is to appear in the Journal of Personality and Social Psychology, and a pdf of the paper is here.
Sex and agreeableness were hypothesized to affect income, such that women and agreeable individuals were hypothesized to earn less than men and less agreeable individuals. Because agreeable men disconfirm (and disagreeable men confirm) conventional gender roles, agreeableness was expected to be more negatively related to income for men (i.e., the pay gap between agreeable men and agreeable women would be smaller than the gap between disagreeable men and disagreeable women). The hypotheses were supported across four studies. Study 1 confirmed the effects of sex and agreeableness on income and that the agreeableness – income relationship was significantly more negative for men than for women. Study 2 replicated these results, controlling for each of the other Big Five traits. Study 3 also replicated the interaction, and explored explanations and paradoxes of the relationship. A fourth study, using an experimental design, yielded evidence for the argument that the joint effects of agreeableness and gender are due to backlash against agreeable men.
This excerpt from the study was especially interesting to me:
Although being disagreeable does not mean that one is more competent or agentic—communion and agency are not opposite ends of the same construct (Wiggins, 1991)—it may imply as much in the minds of employers. People who are low in agreeableness may be perceived as more competent by virtue of their lack of warmth (Benyus, Bremmer, Pujadas, Christakis, Collier, & Warholz, 2009). Amabile and Glazebrook (1982) found that people who were highly critical of others were rated as more competent than those offering favorable evaluations. Furthermore, in an experimental study, Tieden (2001) found that people recommended a higher-status position and higher pay for job applicants who expressed anger—a display that is more likely among disagreeable people (Jensen-Campbell, Knack, Waldrip, & Campbell, 2007; Meier & Robinson, 2004).
I'm hoping this knowledge helps me to think a little more consciously (and carefully) about how I assess current or potential new colleagues.
Harmonizing the Federal Securities Laws’ Treatment of Small Businesses
The Securities Act treats small businesses in a fundamentally different way than the Securities Exchange Act. Harmonizing those two statutes would go a long way towards solving the problem of small business capital formation in the United States.
The Mandatory Disclosure Requirements
Both statutes impose mandatory disclosure requirements on American businesses. The Securities Act requirement is episodic. When a company offers securities, it must file a registration statement with the SEC and make a prospectus available to investors. The mandatory disclosure in the Exchange Act requirement is periodic. Companies must file annual and quarterly reports (Forms 10-K and 10-Q), and also report on certain important events occurring between those regular filings (Form 8-K). The Securities Act disclosure protects investors at the entry level; the Exchange Act disclosure protects existing investors.
Small Business Under the Exchange Act
The two federal statutes treat small businesses very differently. The Exchange Act absolutely and categorically exempts small businesses from the mandatory disclosure requirements. Unless a company’s securities are traded on a national securities exchange or the company has both $10 million in assets and a class of equity securities with more than 500 record holders, it usually doesn’t have to worry about Exchange Act registration.
Small Business Under the Securities Act
The Securities Act does not categorically exempt small business offerings from its registration requirement. In fact, the Securities Act doesn't exempt small business offerings at all. The registration requirement applies regardless of the size of the offering or the size of the company making the offering. (The statute exempts non-public offerings, but the Supreme Court held long ago that the private offering exemption depends primarily on the character of the offerees, not the dollar amount of the offering.)
The Securities Act does authorize the SEC to create exemptions for smaller offerings, and the SEC has adopted several such exemptions, but all of those exemptions add non-trivial restrictions and conditions. There is no unconditional exemption for small offerings or small companies.
It is almost universally recognized that, because of economies of scale, the cost of registering smaller offerings is prohibitive. The Securities Act’s registration requirement therefore imposes a serious burden on small business capital formation.
A Proposal for a Categorical Securities Act Exemption
Why not just follow the approach of the Exchange Act and free all smaller companies from the Securities Act registration requirement as well? The SEC usually points to the higher risk of fraud in small business offerings and argues that registration, or at least some limitations on the offering, are needed to protect investors from that fraud.
It’s true that small businesses are riskier, and that includes a disproportionate risk of fraud. But that risk exists whether the small business is engaged in an offering of securities or just dealing with its existing investors on a day-to-day basis. If the offerees in small business offerings need the protection of one-time mandatory disclosure, then the investors in small businesses equally need the protection of periodic mandatory disclosure. The fraud argument, if you accept it, works for both statutes.
Requiring small companies to file annual and quarterly reports would, of course, be silly. The enormous cost of Exchange Act reporting clearly outweighs any possible gain to the investors. Requiring a company with a total value of only $200,000 to file Exchange Act reports would quickly bankrupt the company.
But the same is true under the Securities Act. Assume that a new business startup wants to raise $100,000 by selling securities. The most that the investors in that offering could possibly lose is $100,000, so the maximum possible benefit of registration is $100,000. (That assumes investors would lose everything without registration and that registration would completely prevent such losses.) Registering that offering would clearly cost more than $100,000, so it doesn’t make economic sense to require registration, no matter how risky the offering is. In short, for the same reason a categorical Exchange Act exemption makes sense, a categorical Securities Act exemption makes sense.
How about adding something like this to the Securities Act:
Section 5 of this Act shall apply only to offerings by an issuer that
(a) has, or will have after the offering, a security traded on a national securities exchange;
(b) has, or will have after the offering, total assets in excess of $10 million.”
September 22, 2011
Is our current system "benefiting the few instead of the many"?
A Reuters column by Peter Apps (here) identifies the widening wealth gap as central to growing discontentment and possible increased political instability. He quotes U.S. counterinsurgency specialist Patricia DeGennaro, a senior fellow at the World Policy Institute and professor at New York University, as seeing a wider "global uprising" or "worldwide insurgency," with the rising wealth gap as key:
"That is at the root of the insurgency. In essence, people are tired of how the system is benefiting the few instead of the many ….”
William Galston, a former policy adviser to President Bill Clinton and now a senior fellow at the Brookings Institution in Washington, is also quoted:
“[W]hen you have a large middle class that is shrinking and where you have alarm and despondency over the future, that is where politics can become very volatile and even dangerous. That's what we saw in Europe in the 1930s.”
Apps cites the rise of the right-wing Tea Party as being “widely seen as part of a trend toward extremes and volatility.”
As I've noted recently (here), whatever rising tide there is left--it appears to no longer be lifting all boats. And, as I've also noted previously (here), it has been written that: "REVOLUTIONS arise from inequalities . . . ."
David Becker Webcast on Ethics at the SEC
David Kotz, the SEC Inspector General, has determined that David Becker, the SEC’s former general counsel, had a conflict of interest with respect to the Bernard Madoff matter. Kotz indicated he is referring the matter to the Justice Department for criminal investigation. A copy of the Inspector General’s report is available here and a New York Times story on the matter is here.
Becker’s mother had an account with Madoff. When she died in 2004, Becker and his brothers inherited the account. They liquidated the account for $2 million, of which $1.5 million was fictitious “profits” generated as part of the Madoff Ponzi scheme. The Inspector General’s report finds that “Becker participated personally and substantially in particular matters in which he had a personal financial interest by virtue of his inheritance of the proceeds of his mother's estate's Madoff account and that the matters on which he advised could have directly impacted his financial position.”
In October 2010, while Becker was still SEC general counsel, he spoke on ethics at the SEC. Becker was a participant in a program at the Case Western Reserve University School of Law on The Changing World of Securities Regulation. In response to an earlier presentation criticizing the “revolving door” at the SEC, Becker set aside his prepared remarks and instead defended the ethics of enforcement personnel at the SEC. The webcast is available here. (Becker’s talk is in the Panel 2 webcast, beginning at about 4:56.) He even speculates (at 11:50) about why Madoff got away with what he did.
September 21, 2011
Will BP Derivative Suit Become the U.K. version of Caremark?
A U.S. District Court has dismissed a BP shareholder derivative suit claiming that BP's directors and officers breached their fiduciary duties to the corporation when they "engaged in a pattern of disregard for the safety of BP's energy exploration operations." The PDF of the opinion is available here. The opinion explains that the basis for the suit is the United Kingdom Companies Act of 2006, "which governs the fiduciary duties that officers and directors owe English companies." Law.com reports that the Act is "a relatively new statute with little case law interpreting it."
So, we'll see how this proceeds in the United Kingdom. If the case were in the United States, it would be an awfully tough one to prove, anyway. As Professor Bainbridge has explained,
Shareholder losses attributable to absent or poorly implemented risk management programs are enormous [and e]fforts to hold corporate boards of directors accountable for these failures likely will focus on so-called Caremark claims. The Caremark decision asserted that a board of directors has a duty to ensure that appropriate "information and reporting systems" are in place to provide the board and top management with "timely and accurate information."
Furthermore, in the Caremark decision, Chancellor Allen explained that such claims are “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” In re Caremark Intern. Inc. Derivative Litigation, 698 A.2d 959, 967 (Del. Ch. 1996). With the law still evolving in the United Kingdom, it should be interesting to see what the U.K. version of Caremark looks like.
September 19, 2011
Academic Economists Aren't Practical Either
I just came across the paper Economists’ Hubris - The Case of Award Winning Finance Literature, by Shahin Shojai and George Feiger. It appears that it is not just Chief Justice Roberts who thinks academics could be doing some more practical work. Here's the abstract:
In this fifth article in the Economists’ Hubris series, we investigate the practical applications of eight papers that won best-article awards in 2008 and 2009 from the Journal of Finance or the Journal of Financial Economics, the two leading journals in finance. We find that these articles are unlikely to help financial executives improve the way they evaluate risk or manage either risk or their institutions. Finance academics appear to live in a parallel universe, completely oblivious to the nature of the financial services sector that they purport to study. Some of the papers do challenge long-held beliefs, which is very encouraging, but academics still need to go much further than that to write articles that are of any practical value.
I happen to believe that there are a lot of excellent law review articles out there with significant practical application. Sometimes, those articles are not at the top journals or winning the top awards (though some are and do). Earlier this year, there were some discussions on the general subject of law reviews and their value and impact. See, e.g., here, here, here, and here. And there is value in academic writing (legal and otherwise) that is not especially practical, but that adds to the discourse in other ways. Perhaps one day we'll figure out how to value (and assess the value of) different kinds of scholarship. Perhaps.
"New" Shareholder Proposal Rule to Take Effect
The SEC has announced that it will allow a previously adopted amendment to Rule 14a-8, the shareholder proposal rule, to become effective as soon as notice is published in the Federal Register. Rule 14a-8 requires public companies to include in their proxy materials certain proposals for shareholder vote submitted by shareholders. The SEC adopted the amendment in August 2010, but it has been in limbo since the Business Roundtable challenged the SEC’s adoption of Rule 14a-11, the rule allowing shareholders to nominate candidates for the board of directors. The SEC stayed the effectiveness of both 14a-11 and the amendment to 14a-8, pending resolution of the Business Roundtable case. even though the amendment to 14a-8 was not challenged. The SEC lost the Business Roundtable case, so Rule 14a-11 is gone, but the amendment to Rule 14a-8 is finally going into effect.
The new amendment relates to proposals concerning elections to the board of directors. Rule 14a-8(i)(8) formerly barred a shareholder proposal that “relates to a nomination or an election for membership on the company’s board of directors or analogous governing body or a procedure for such nomination or election.”
The new rule bars a shareholder proposal only if it
(i) Would disqualify a nominee who is standing for election;
(ii) Would remove a director from office before his or her term expired;
(iii) Questions the competence, business judgment, or character of one or more nominees or directors;
(iv) Seeks to include a specific individual in the company’s proxy materials for election to the board of directors; or
(v) Otherwise could affect the outcome of the upcoming election of directors.
In other words, proposals dealing with specific candidates for election or that will affect the upcoming election are barred. But the rule now allows proposals about election procedures or rules—such as a proposal requiring a majority vote for a director to be elected.
Even after the amendment, the SEC does not have the final word. A proposal could still be excluded under another section of the federal rule [Rule 14a-8(i)(1)] if the proposal is not a proper subject for shareholder action under state law. The new rule only eliminates the federal obstacle to shareholder proposals concerning election procedures.
September 18, 2011
Hoyt on Tax Law
Christopher R. Hoyt has posted Charitable Gifts by S Corporations and Their Shareholders: Two Worlds of Law Collide on SSRN with the following abstract:
This comprehensive article analyzes the rules that apply to, and the tax planning strategies for, a charitable gift of S corporation stock. It describes the interaction of the laws governing S corporations and tax-exempt organizations and describes the best ways to solve the challenges posed by each set of laws. The article also addresses additional challenges that can occur when specific types of tax-exempt organizations own S corporation stock, notably private foundations, donor advised funds, supporting organizations and ESOPs.
From the perspective of both the donor and the charity, three “bad things" happen when S corporation stock is contributed to a charity: (1) the donor's income tax deduction is usually less than the stock’s appraised value; (2) the charity must pay the unrelated business income tax (UBIT) on its share of S corporation income; and (3) the charity must pay UBIT on its gain when it sells the stock. This is much harsher tax treatment than if the charity had received and sold an ownership interest in an identical closely-held business that had been organized as a C corporation, a limited liability company or a partnership. Professor Hoyt suggests specific legal reforms to make the tax treatment more consistent.
The article also identifies the best ways to structure a charitable gift under the existing laws, such as a donation to an intermediary charitable trust. In most cases, though, both the donor and the charity will be better off if the S corporation makes a charitable contribution of some of its assets compared to having a shareholder contribute S corporation stock.
-- Eric C. Chaffee
A rising tide?
The Economic Policy Institute reports (here) that "the richest 5 percent of households obtained roughly 82 percent of all the nation’s gains in wealth between 1983 and 2009." Meanwhile, "[t]he bottom 60 percent of households actually had less wealth in 2009 than in 1983."