Business Law Prof Blog

Where’s the Data?: The Speculative Debate over High-Frequency Trading Regulation

Over the last few years, the SEC and the EU have toyed with the idea of regulating flash trading. They’ve floated a few tentative thoughts and proposals for public digestion, see, e.g., http://www.sec.gov/rules/proposed/2009/34-60684.pdf, but because of vigorous debate over the unquantified benefits and harms of high-frequency trades (and the sheer volume of trades and the proprietary automated programs such reforms may affect), it has been difficult for regulators to be decisive.

 

Many of the reforms thus far have been informational---aimed at facilitating transparency and gathering data for after-the-fact analysis, rather than banning any particular activity.  For example, in response to the May 6, 2010, flash crash, which many blamed on flash traders dropping out of the market and creating a liquidity vacuum, the SEC adopted a large trader rule earlier this year requiring broker-dealers to maintain records of transactions available for easy reconstruction of market activity and investigation into manipulative activity. http://www.sec.gov/news/press/2011/2011-154.htm. (It is currently trying to push for a consolidated audit trail for tracking orders across securities markets.)

 

Recently, with the EU’s October proposal for putting a financial transaction tax on stock and bond purchases, http://dealbook.nytimes.com/2011/09/27/europe-readies-plan-for-tax-on-financial-transactions/, the focus has turned back to substantive measures for discouraging high-frequency traders. Although anticipated to reduce the GDP, proponents seem to think it’s worth the cost to deter speculative transactions that allegedly do not contribute positive value to markets. The small tax percentage would be designed to curb the profitability of high-frequency traders, who would have to pay the transaction costs more often to pay for the volatility their activities may introduce into the market. Opponents express concern that without an all-or-nothing agreement between the major world markets, the tax would simply mean that the EU would scare away investors to other markets without such regulation. The regulation would have the potential effect of turning away trade volume without shielding their market from the volatility that may exist in other markets that still encourage high-frequency trading.

 

Despite the liquidity arguments in favor of high-frequency trading, both sides of the debate have to at least admit that whatever benefits that come from HFT are incidental---a product of historical coincidences rather than the intended effects of reasoned policy. According to the SEC, Regulation NMS’s Rule 602 exception, which permits this nonpublic flash-trading side market to exist, employs language that has remained unaltered since 1978. http://www.sec.gov/rules/proposed/2009/34-60684.pdf. Its original intent was to facilitate manual trading on exchange floors and to exclude “ephemeral” exchanges and cancellations because it would be impractical to include these deals in the consolidated quotation data. But these assumptions have changed with a highly automated trading environment, and there is a concern that the flash trading market is a significant enough one to elicit fears that we are creating a two-tiered market where the public does not have access to information on the best prices. And it doesn’t seem quite right to characterize one approach as pro-market or pro-innovation, as opposed to another, merely because of one’s unease with further regulation or upsetting the large amounts invested in proprietary trading algorithms based on the status quo. The advantages of the flash traders do not come from new insights into market value; it is a product of innovators taking advantage of carveouts in the current public price reporting regime, arbitraging the advantages of the unregulated at the expense of the regulated.

 

But despite calls for prompt action, perhaps the sluggish regulatory response isn’t such a bad thing for now, given the absence of consensus or data. There are a lot of proposals on the table, and part of the difficulty of creating a good response to all of the claimed ills of flash trading is the “black-box” nature of the proprietary algorithms and the difficulty of reverse engineering how any particular algorithm functions to create liquidity advantages or volatility crises. And aside from the actual logical effects of such trading, how should we measure causality when it comes to perceptions: loss of public confidence or the discouragement of small-time investors at what they believe to be a rigged system? I’ve been rummaging around the Internet for data to back up conclusions about causality, but such data seems quite elusive. And furthermore, even discussion of methodology---how we should begin to gather useful data separating out confounding variables and establishing useful comparison points---seems hard to come by. (The CFTC Commissioner suggested getting high-frequency traders to register and cooperate in disclosing information to the government to help regulators evaluate the effect of their activities http://www.cftc.gov/PressRoom/SpeechesTestimony/opachilton-53.)

 

In the absence of governmental regulation, various exchanges are experimenting with their own rules of minimizing the volatility effects of flash trading (e.g., circuit breaker rules, clerical error checks, and even outright bans of flash trading). Perhaps the lack of uniformity, for now is a good thing, allowing for regulatory experimentation that could lead to comparative data. (For example, if we took a sample basket of stocks and banned flash trading in those stocks, would we see a noticeable market preference in those stocks? Over time, would we see a difference in liquidity in some types of trades over others?)  This problem, itself, was created by unanticipated effects of regulation; we might as well take a studied approach the second time around before unsettling a market that has adapted to the rule.

 

HC

 

More Citigroup Settlement Musings

I'm continuing my email interview with a journalist regarding Judge Rakoff's Citigroup settlement decision (see my prior post on this here), and among other things I was asked whether I was surprised by the SEC's decision to appeal the ruling.  Here is part of my response:

I was not surprised by the appeal, but it does set up an interesting conflict.  On the one hand, the SEC is likely correct that requiring an admission of facts in order for a settlement to be approved in these types of cases is unprecedented.  On the other hand, Judge Rakoff seems to be stating an obvious truth when he asserts that he cannot carry out his duty of determining whether the settlement is "fair, reasonable, adequate, and in the public interest" without some facts upon which to render this decision.  I think the following quote from Judge Rakoff's opinion is right on point:

"Here, the S.E.C.'s long-standing policy—hallowed by history, but not by reason—of allowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations, deprives the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact…. The S.E.C., by contrast, took the position that, because Citigroup did not expressly deny the allegations, the Court, and the public, somehow knew the truth of the allegations. This is wrong as a matter of law and unpersuasive as a matter of fact."

I think the Second Circuit will feel a great deal of pressure to overturn Judge Rakoff's decision, but it will be interesting to see how it resolves this issue if in fact it does reverse.

12/18 UPDATE: Prof. Bainbridge is surprised by the appeal.

SJP

A Note to the SEC: Don't Just Take Some Case and Hope

On Dec. 14, 2011, a reporter for ProPublica, Jesse Eisenger, wrote the following article for New York Times Dealbook: In Hunt for Securities Fraud, a Timid S.E.C. Misses the Big Game.  In it, he argues:

Does the Securities and Exchange Commission suffer from trialphobia?

Ever since Judge Jed S. Rakoff rejected the S.E.C.’s settlement with Citigroup over a malignant mortgage securities deal, the agency has been defending its policy to settle securities fraud cases. But the public wants a “Law & Order” moment, and who can blame them?

. . . .

But so far, there’s been no civil trial in a major case directly related to the biggest economic fiasco of our time: the financial crisis.

Two days later, the Dealbook, from authors Azam Ahmed and Ben Protess, provides this: S.E.C. Sues 6 Former Top Fannie and Freddie Executives, which reports that the SEC seems to have answered Mr. Eisenger's call:

The Securities and Exchange Commission has brought civil actions against six former top executives at the mortgage giants Fannie Mae and Freddie Mac, saying that the executives did not adequately disclose their firms’ exposure to risky mortgages in the run-up to the financial crisis.

The case is one of the most significant federal actions taken against top executives at the center of the housing bust and ensuing financial crisis. 

Obviously, this case would have been in works long before last Wednesday, so the timing is something of a coincidence, and it's not as though Mr. Eisenger is the first person to question where the SEC is on this. But I sure hope that this case is proceeding because the SEC thinks it's proper to move forward, and not because they think they need to bring a case, any case, forward.

I bristle at the idea that an agency, law enforcement or regulatory, would purse a case simply because "the public wants a 'Law & Order' moment."  I know, of course, that many prosecutors seek cases primarily to raise their profile and send a message, but that doesn't mean it's right.  I undertand what he's saying, but I don't care for Mr. Eisenger's recommended use of authority.  He explains:

To overcome its greatest fear, the S.E.C needs to realize that it can win even if it loses. A trial against a big bank could be helpful regardless of the outcome. It would generate public interest. It would put a face on complex transactions that often are known only by abbreviations or acronyms. Litigation would cost the bank money, too. And it could cast the way Wall Street does business in such an unflattering light that even if the bank won, it might bring about better behavior.

A trial would show boldness. And when the S.E.C. found itself at the negotiating table again, it would feel a new respect.

You don't earn respect by being a bully, by making people jump through hoops, or by making them expend resources just because you can. You may earn fear and you will almost certainly earn disdain, but that's not the same thing. 

I agree that the SEC shouldn't seek only cases it can win or settle. In fact, I think a lot of relatively "little guys" are getting forced into SEC fines and settlements right now, not because they necessarily did something wrong, but because they can't afford the fight. The SEC gets to report the settlements, which go down as wins over "corruption and fraud."  

And I think there may be value in pursuing some of the big guys for fraud because some of them probably committed fraud.  But you need to facts before you go hauling people into court.  I'm all for pursuing fraud vigorously, but I'm not willing to let any regulator decide to mess with people's lives just because the public thinks someone needs to pay.  Law enforcement and regulation only work if the right people pay for the wrongs they committed. So, SEC, don't just take some case and hope for it. Put together the right case, and then go for it.

--JPF

 

Former Fannie Mae and Freddie Mac Executives Indicted for Securities Fraud

The SEC has indicted former Fannie Mae and Freddie Mac Excutives for Securities Fraud based on the subprime loan debacle.  This case will be one to watch in 2012.  The complaint is here.

-- Eric C. Chaffee

Buell on the Potentially Perverse Effects of Corporate Civil Liability

Samuel W. Buell has posted "Potentially Perverse Effects of Corporate Civil Liability" on SSRN.  Here is the abstract:

Inadequate civil regulatory liability can be an incentive for public enforcers to pursue criminal cases against firms. This incentive is undesirable in a scheme with overlapping forms of liability that is meant to treat most cases of wrongdoing civilly and to reserve the criminal remedy for the few most serious institutional delicts. This effect appears to exist in the current scheme of liability for securities law violations, and may be present in other regulatory structures as well. In this chapter for a volume on "Prosecutors in the Boardroom," I argue that enhancements of the SEC's enforcement processes likely would reduce the frequency of DOJ criminal enforcement against firms, an objective shared by many. Among other enforcement features, I address problems with the practice of accepting "neither admit nor deny" settlements in enforcement actions, a subject that has drawn greater attention since this chapter was published.

SJP

Quick Review of Rudolph H. Weingartner's Fitting Form to Function

As a new Associate Dean for Academic Affairs & Research, I've taken on a number of administative functions this year. I'm still not at all clear that the administrative life is the one for me, especially at this point in my academic career. Having had a career before becoming a lawyer, I'm probably more comfortable with budgets, hiring and firing, and office politics than some. Of course, that doesn't mean I necessarily like it.  After all, I did leave that career to go to law school.  

Nonetheless, I agreed to take the position for a little while, and I'm committed to doing it as well as I can. Part of that has meant learning as much as I can about academic leadership and how academic institutions work. This is no easy task. Schools have very different sizes, characters, and resources, and this can have a significant impact on how to interpret even some of the "universal truths" of academic life.  

Further, while I have found real value in reading some of the materials from leaders in academic adminstration, I also sometimes find the tone and tenor of how administrators describe faculty both patronizing and unnecesarily polarizing, even if the description is largely correct. (See, e.g., Stanley Fish). Some of this may be "youthful" idealism on my part, but I don't think the relationship between faculty and administration needs to adversarial.  At least, not most of the time. I know that there are some faculty members who act like petulant children, but treating all faculty members as though they act that way means you are likely to facilitate similar behavior from others less inclined to do so. 

Recently, I've been reading Rudolph H. Weingartner's Fitting Form to Function.  It's a managable read that provides an nice "Primer on the Organization of Academic Insititutions."  There's not a lot groundbreaking here, and yet I notice that an awful lot of people (from educators to administrators to legislators) could use the information contained in the book. Even if it's all elementary information, it's clear that information is not being put to good use in a number of settings.  

The book also nicely provides a list of maxims to distill and "elevate[]" some "general truths" derived from the author's experience.  Here are some that I find useful:

Maxim 6: If the organizational chart is the right one, and micromanagement exists, either the supervisor or the supervised is the wrong person for the slot. 

Maxim 11: Committees whose mission is to perform routine and ongoing functions are ill suited to tasks that require them to move outside the framework within which they normally operate. 

Maxim 15: An office that lacks goals of its own will tend to give priority to getting the process right over getting the job done.

Maxim 21: Refrain from making rules that make normal business more cumbersome merely in order to prevent offense that might be committed on rare occasions. 

Whether you are an administator, looking for ways to help make a law (or other) school a little more efficient, or curious about why some things in academics work the way they do, this book is worth a look.

--JPF

One More Thought -- Does Anyone Own the Packers?

Professor Bainbridge reasonably asked what I actually thought about whether the Green Bay Packers stock is a security. I said it's not under federal securities law, but that I think it should be.  Then I had one other thought -- who really "owns" the Packers?  Professor Bainbridge noted in his post Owning the Green Bay Packers, that his first weekend went well. Of course, as he has said, he really is the "proud owner of 1 share of stock in Green Bay Packers, Inc."  By his own standards, anyway, the good professor is not actually an owner of the Packers.  

Back in March of 2010, Professor Bainbridge let me know: Once more with feeling: Shareholders Don't Own the Corporation.  As he explained: 

There is no entity or thing capable of being owned. Granted, because the shareholders hold the residual claim on the corporation's assets, their deal with the corporation has certain ownership-like rights. But they have only those rights specified by their contract, as that contract is embodied in state corporate law and the firm's organic documents. 

So, to recap, the Packers sale of stock provides neither a security nor ownership of the Packers. So what is it?  The stock grants the right to attend an annual meeting and vote on a few things, but provides very few "ownership-like rights."  Is it really just an expensive piece of paper?  It must be a little more than that, because even though people feel good about a donation to Goodwill and other such groups, they don't frame the receipt. (Maybe some people do, I guess, but I'm assuming not.) 

Ultimately, then, it is this simple: Packers "stock" is a contract that provides the right to vote for the members of the Board of Directors, amendments to the Article of Incorporation, certain mergers or sales, and dissolution, at a price of $250 per vote.  

With that settled, on to the next issue:  With the Delaware Chancery Court having filled Chancellor Chandler's seat, when does Professor Bainbridge join the Packers board, as permitted under the bylaws? Assuming he'd accept such a nomination, consider that campaign launched.  Their quarterback is a West Coast guy.  Why not add a similarly situated director?

--JPF 

A Reason People Hate Corporate Lawyers or Why the Packers Should Be an LLC

On Friday, I asked whether the sale of Green Bay Packers stock should be considered a security.  A few people asked whether I really think the Packers stock could be a security. The answer, under Wisconsin law, is almost certainly no, especially given that that Green Bay Packers, Inc., "is organized as a Wisconsin nonprofit stock corporation." And that's probably the case for almost any other state, too, and under federal law.  

But just because the outcome is pretty clear, it doesn't mean that there aren't policy implications that are worth thinking about. I think the biggest one is this: lawyers and business people should say what they mean. Mixing marketing and corporate law is not always a good idea. I find it more than a little silly that the cover of the Packers offering documents says: 

Green Bay Packers, Inc.

Common Stock Offering Document

COMMON STOCK DOES NOT CONSTITUTE AN INVESTMENT IN “STOCK” IN THE COMMON SENSE OF THE TERM. PURCHASERS SHOULD NOT PURCHASE COMMON STOCK WITH THE PURPOSE OF MAKING A PROFIT.

So, you see, the word stock without quotes is different than stock with quotes.  In my view, you shouldn't call something stock if it's not stock, even if you can under securities laws.  There's no doubt that the Landreth court, interpreting Forman, said that stock is not a security just because the company said it issued stock:

[I]n Forman we eschewed a "literal" approach that would invoke the [Securities] Acts' coverage simply because the instrument carried the label "stock." Forman does not, however, eliminate the Court's ability to hold that an instrument is covered when its characteristics bear out the label. 

Now, before these cases, one could argue that something labeled "stock" is always a security, as per § 2(1) of the 1933 Act:

"The term `security' means any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, . . . investment contract, voting-trust certificate,. . . or, in general, any interest or instrument commonly known as a `security.' " 15 U. S. C. § 77b(1).

In Landreth, the court cited Louis Loss, Fundamentals of Securities Regulation 211-212 (1983), providing the following excerpt:

It is one thing to say that the typical cooperative apartment dweller has bought a home, not a security; or that not every installment purchase `note' is a security; or that a person who charges a restaurant meal by signing his credit card slip is not selling a security even though his signature is an `evidence of indebtedness.' But stock (except for the residential wrinkle) is so quintessentially a security as to foreclose further analysis." 

And, in fact, before Landreth, SEC v. C. M. Joiner Leasing Corp., 320 U. S. 344 (1943) indicated that notes or bonds could possibly be deemed securities "by proving [only] the document itself."  The Forman court said that interpretation was dictum as to stock, and the Landreth confirmed that was not true for stock (leaving that question as to notes and bonds "until another day"). Thus, the Supreme Court said, we must look to the economic realities to determine whether stock is a security.  

Which bring me back to this: If the Packers are really just selling a $250 (plus handling) certificate (suitable for framing), they shouldn't call it stock.  And they shouldn't start their offering letter: "Dear Future Owner of the World Champion Green Bay Packers." It should say: "Dear Future Owner of a Certificate saying 'World Champion Green Bay Packers.'"

 In my view, the Packers are using the sense of ownership to secure investors and people who have a connection with the team.  I think that's fine; I actually rather like the idea.  But I don't like the idea that they can use the term stock, the sense of ownership, provide voting rights and the opportunity to attend Annual Meetings, restrict gifting or sales, and then disclaim that what they are selling is a security simply because the primary upside is that past purchases helped "ensure the team survived and remained in Green Bay" and the new purchases will fund an "expansion [that] has been designed to keep the crowd noise in the stadium and maximize our home-field advantage."  

So, I admit my argument is largely academic (a luxury I have), but I do think there is value in not allowing people to muddy the waters.  Suppose, for the sake of argument, the Packers committed a massive fraud and used the money to invest in Greek debt. The debt tanks, the Packers can't have a stadium upgrade, and the home field advantage begins to fade.  The team suffers, and shareholders sue under 10b-5.  The court says, nope, you didn't buy a security because you only had voting rights, without ecomomic rights. The court would probably be right under Landreth (notice my continuing, apparently unavoidable, hedge).  And it would be reasonable under the actual terms of the offering document, if you read it. But it would still make a bunch of lawyers and judges look like jerks.   

To me, this would all be better done as an LLC, with a granting of an owership unit clearly defining the terms.  Then it's plainly (or should be) contractual, and it's not stock, and we have very little problem with confusion with traditional stock or other securities. Frankly, isn't that confusion the main reason the Packers are calling it stock?  I think so.  This is just one more reason we should start respecting and using the LLC for creative entities, and leave the off-the-rack stuff for corporations.

[Update: Professor Bainbridge wanted an answer to the real question of whether Packers stock is a security.  My answer is that I don't think a federal court would find this to be a security, especially with the appropriate disclaimers that have been made. But I reserve my right to think they should.  In the interest of full disclosure, I am a life-long Lions fan.]

--JPF

Observations from Recent 14a-8 No-Action Letters

In keeping with my earlier post on shareholder activism, I became curious about the sorts of 14a-8 proposals that companies have been receiving lately. Conveniently, the SEC keeps a chronological list of all of the no-action letters it issues in response to company inquiries on omitting 14a-8 proposals, available here: http://www.sec.gov/divisions/corpfin/cf-noaction/2011_14a-8.shtml#chrono. Although the list may not reflect all of the proposals that a company may receive (e.g., the proposals it includes without dispute or in some negotiated form), the SEC’s response letters suggest the involvement of a wide diversity of companies, shareholders, issues, and approaches to handling disputes.

The companies involved in the last month of no-action letters span across several industries: Disney, Hewlett Packard, Starbucks, Capital Bancorp, Deere & Company (of John Deere fame), and Hormel Foods, to name some of the more recognizable household names. The shareholders submitting the proposals, also, come in an assortment of shapes and sizes: a union (Unite Here), retirement funds (various New York City public employee retirement funds, the United Brotherhood pension fund), funds committed to socially responsible investing (Walden Asset Management, Tides Foundation), a nonprofit (the Humane Society), and even profit-minded individual investors who believe that tighter corporate governance will increase their returns.

But surprisingly, the subject matter of the proposals aren’t all that different from the sort of demands you might see scrawled on a handwritten sign in a populist street protest. For example, the individual stockholders, whose only apparent purpose in submitting the proposals was to increase profit, submitted several proposals aimed at increase corporate oversight and accountability measures. The proposals ranged from proposals seeking greater shareholder input, such as eliminating supermajority voting requirements and allowing larger shareholders to call their own shareholder meetings, to trying to implement checks against what the shareholder believed to be risky behavior (i.e., a proposal demanding that the company retain a threshold cash balance). And other proposals by the individual shareholders appeared to attack perceived cronyism and accountability problems: demanding that the company shorten director terms, appoint an independent director to serve as chairman of the board (instead of the CEO), and preventing employees of the company from being part of the board of directors of a peer group used to benchmark executive compensation, and audit a subsidiary to ensure that it conforms to law and the company’s corporate governance documents.

The institutional investors made similar demands, requesting auditor rotation, shareholder approval prior to golden-parachute agreements exceeding a certain percentage of the senior executive’s salary, and even regular reports disclosing company political contributions and expenditures and the names of the people involved in making such decisions on behalf of the company. The perceived problems targeted in these proposals strike me as rather reminiscent of the more vague public dissatisfaction against corporate greed, lack of decisionmaker accountability, high-risk strategy, and (a hot-button issue since Citizens United even among members of the non-stockholding public) corporate political speech. And curiously, it was the institutional investor, rather than the renegade individual shareholder with a personal agenda, that proposed the less ostensibly profit-oriented proposals. For example, the New York City retirement funds demanded that Hewlett Packard work toward encouraging the publication of an annual sustainability report and monitoring the protection of workers’ rights and human rights throughout its supply chain. The Humane Society, though not a traditional institutional investor, used its ownership in Hormel Foods stock to demand a report on Hormel’s use of sows in gestation crates. Each of these more social-reform-minded proposals were framed in profit-seeking terms, expressing concern about the company’s failure to keep up with industry standards or match peer companies’ commitments, or failure to realize the profits that may be captured from adopting a new way of business that also happens to coincide with efficiency, reputational gains, and profit-maximizing strategy. Perhaps shareholders and discontented non-shareowner members of the public have more in common than commonly assumed, such that there isn’t always such a clean-cut dichotomy between the interests of those who make up a corporation and those who do not.

A survey of the companies’ responses and the SEC’s no-action letters reveal that these proposals have enjoyed varying levels of success in accomplishing their objectives. The less remarkable no-action letters appear to concern outcomes that followed naturally from the SEC’s interpretation of the SEC’s rules (e.g., denials based on personal grievance, ordinary business operations, substantial similarity, and share ownership requirement grounds).

But three of the proposals, in particular, caught my interest as good illustrations of how parties seem to negotiate in reaction to the rules that define the landscape. For example, the parties seem to use the SEC review process to communicate with one another and to equalize informational gaps about the other’s preferences and concerns. Unite Here withdrew its proposal on executive compensation before the SEC could weigh in, once Disney submitted its belief that it could exclude on vagueness grounds (i.e., even if passed, the company would not be able to assess exactly what concrete policy would implement the shareholders’ consensus view). http://www.sec.gov/divisions/corpfin/cf-noaction/14a-8/2011/unitehere120611-14a8.pdf. This seems to be an example where the proposer benefited from hearing the potential critiques to the proposal early on and getting an opportunity to revise the proposal and to anticipate concerns that may come up at the annual meeting itself. (After all, the cost of a failed proposal, whether because of poor drafting, poor campaigning, or lack of interest, is to be locked out of submitting proposals on roughly the same subject matter for a period of time. So, it is helpful to get things right the first time.)

When Hewlett Packard learned of the New York City retirement funds’ desire to require the publication of annual sustainability reports, it negotiated with the proposers and voluntarily agreed to implement published, independently verifiable reports, where previously they only reported internally on such benchmarks in response to internal requests. The NYC retirements funds withdrew their proposal, seeing this concession as achieving the same effect as what they requested. http://www.sec.gov/divisions/corpfin/cf-noaction/14a-8/2011/unitedbrotherhoodofcarpentershewlett111811-14a8.pdf. HP, in turn, appeared to benefit from these informal negotiations; they are not formally required by shareholder resolution to take a particular course of action, and the informal understanding between the parties allowed greater flexibility on the company’s part to decide on their own terms how they would address the parties’ concerns. And they gained another possible side benefit: avoiding company-wide discussion on an idea that hasn’t reached its time or doesn’t interest all shareholders, and possibly gaining a “substantially implemented” defense against future proposals that take a more aggressive stance on sustainability and human rights issues.

And then there are company challenges that take a less cooperative stance. When an individual shareholder submitted a proposal to Piedmont Natural Gas on changing an 80% supermajority vote to a simple majority, the company submitted its own counterproposal reducing the supermajority requirement to a two-thirds majority. The company then challenged the proposal contending that they should not be required to distribute the shareholder’s proposal because it contradicted their own. What is especially interesting is the history behind the proposal: apparently, an earlier vote to reduce three-year director terms to one-year terms failed because only 79% voted in favor, just shy of the 80% requirement. http://www.sec.gov/divisions/corpfin/cf-noaction/14a-8/2011/geraldarmstrong111711-14a8.pdf. This seems to be another example of where a company undercuts a proposal by submitting what is essentially a compromise position. This may not immediately appear as a win for the shareholder that wanted to campaign for the more aggressive stance, but in essence, he was successful in pushing the company itself to espouse a position that may permit the director term vote to prevail the next time it is proposed. A company-backed proposal can be viewed as a win in itself, given the number of passive shareholders that may simply vote as recommended by the company.

*****

And finally… The last series of proposals of note might not be particularly instructive on any useful aspect of the proposal review process, but is interesting nonetheless. They all involve Deere, and its strategy of denying proposals on the basis of discrepancies between the postmarked date and the date of the letter asserting proof of share ownership. In essence, the company takes the shareholder’s statement of one-year continuous ownership of $2,000 worth of stock, which is a prerequisite to submitting proposals under Rule 14a-8, and challenges, and decides to exclude the proposal when the postmark on the letter is later than the end date of the one-year period for which the statement vouches for the proposer’s share ownership. See, for example, http://www.sec.gov/divisions/corpfin/cf-noaction/14a-8/2011/waldenasset111611-14a8.pdf. For example, Deere successfully procured a no-action letter where Walden Asset Management encloses a proof of ownership letter dated September 12, and the FedEx stamp reveals a mailing date of September 15. The idea, ostensibly, is that the proposer might have fallen under the requirement between September 12 and 15, even though it is required to vouch for its intent to maintain its ownership in the company until the annual meeting. But while these technicalities appear to be successful in fending off proposal distribution requests, for now, I wonder whether cutting off this valuable informational pipeline between shareholders and management will prove a pyrrhic strategy in the long run. And, aside from the informational advantages, perhaps there are some loyalty incentives to negotiating with certain shareholders (e.g., those not of the day-trading variety) and giving them a greater sense of participation and personal attachment to the company to encourage increased investment and confidence in the company.

But for now, I guess the lesson-of-the-moment to be learned, if you happen to be a Deere shareholder, is to make sure you mail your proposals on the same day as the date of your proof of ownership letter.

HC

Beneish, Marshall & Yang on Collusive Directors

Messod Daniel Beneish, Cassandra D. Marshall, and Jun Yang have posted "Why Do CEOs Survive Corporate Storms? Collusive Directors, Costly Replacement, and Legal Jeopardy" on SSRN.  Here is the abstract:

We use an observable action (non-executive directors’ insider trading) and an observable outcome (the market assessment of a board-ratified merger) to infer collusion between a firm’s executive and non-executive directors. We show that CEOs are more likely to be retained when both directors and CEOs sell abnormal amounts of equity before the delinquent accounting is revealed, and when directors ratify one or more value-destroying mergers. We also show that a good track record, higher innate managerial ability, and the absence of a succession plan make replacement more costly. We find retention is less likely when the misreporting is severe and directors fear greater litigation penalties from owners, lenders, and the SEC. Our results are robust to controlling for traditional explanations based on performance, founder status, corporate governance, and CFOs as scapegoats. Overall, our analyses increase our understanding of the retention decision by about a third; they suggest that financial economists consider collusive trading and merger ratification as additional means of assessing the monitoring effectiveness of non-executive directors.

SJP