Saturday, June 27, 2015
Chen Chen, Xiumin Martin, Sugata Roychowdhury, and Xin Wang have posted a paper to SSRN that attempts to identify firms that suffer from poor internal information flow by comparing the relative insider trading profits of high level managers and low level managers. They find that when lower level managers make higher profits – suggesting that they have better information than higher level officers – the firm’s external financial reporting suffers.
[More under the cut]
Saturday, June 20, 2015
I’ve just moved down to New Orleans to join the faculty at Tulane Law School (my bio will be updated ... um, eventually), where I’ll be teaching Business Enterprises and Securities Regulation to start. As you can imagine, Louisiana is quite a change from both North Carolina and, before that, NYC. One thing I noticed right off the bat is that most of the banks in Louisiana are local/regional institutions – not many national banks have branches here. Which means that, as a former plaintiffs’ attorney, for the first time in my adult memory I have a bank account with a financial institution I haven’t sued.
(Sidenote: That was actually kind of an issue when I worked for the law firm then-known as Milberg Weiss. I was told we had trouble getting firmwide health insurance because we’d sued all the carriers and they didn’t want to do business with us.)
Anyway, as I procrastinate from unpacking....
*actual representation of my apartment
....the big news that has my attention is the AIG verdict. There have already been conflicting views on what it portends for future bailouts, but what fascinates me is how much of the opinion is devoted to the judge’s moral condemnation of the Fed’s actions, and his moral absolution of AIG, even though the relative good or evil of either player was really not relevant to his ultimate holding.
[More under the jump]
Saturday, June 6, 2015
There have been a few recent articles in the news discussing diversity - or its lack - among lawyers.
First, Deborah Rhode writes in the Washington Post that law is one of the whitest professions. People of color make up one fifth of law school grads but only 7 percent of law firm partners - and those numbers drop to 2 or 3 percent in BigLaw. She argues that among other barriers, unconscious bias still plays a role in hindering the advancement of African American lawyers. She also points out that women, as well, struggle to make partner - perhaps reflecting the difficulty that women have walking the tightrope of being aggressive enough to do their jobs, but not so aggressive that they come off as unfeminine.
Picking up on these themes, the American Lawyer recently published a report on how BigLaw is failing women. Sometimes, these failures are attributed to demanding work schedules that make it difficult for women to shoulder responsibilities for childcare - which is why one law firm was recently profiled in the New York Times for hiring mainly women, and allowing them to adjust their schedules around their parenting responsibilities. But flexible work schedules aren't always a step in the right direction; this article about the lack of women's advancement in consulting makes two important points. First, "family-friendly" policies that allow women to work flexible schedules may undermine their advancement by signaling a lack of commitment to the firm, and second, that many people continue to harbor biases against women - including the assumption that women with children are not fully committed to work - regardless of the hours they keep. The article suggests that instead of adopting flexible work schedules, firms should simply not require long hours of any employees - a suggestion that, not surprisingly, firms are not anxious to adopt.
Based on my law firm experience, these themes resonate. I saw very, very few nonwhite lawyers. There were also far fewer women partners than men partners. (One thing I remember: in group meetings, men routinely talked over and interrupted the women, making it very difficult even for women partners to have their voices heard.)
I don't know what the solution is, but I do think the issues are real ones. And, as Rhode points out, because lawyers often have critical roles in society - in government, and other policymaking roles - it's important that the profession be welcoming to all.
Saturday, May 30, 2015
Section 10(b) of the Securities Exchange Act prohibits anyone from engaging in manipulative or deceptive activities in connection with a securities transaction. Rule 10b-5, promulgated under Section 10(b), prohibits anyone from “mak[ing] any untrue statement of a material fact” or “omit[ting] to state a material fact necessary in order to make the statements made… not misleading" in connection with securities transactions.
Recently, several Section 10(b) lawsuits have been filed alleging that companies hired stock promoters to pen enthusiastic articles about the companies’ prospects. The lawsuits were apparently inspired by an exposé published at Seeking Alpha regarding stock promoter practices. The CEO of one of the companies involved was ultimately arrested on charges of criminal securities fraud, both for hiring promoters, and for more garden variety manipulative practices.
In all of these cases, the promotional articles did not disclose that they were paid promotions, nor did they accurately disclose their authorship. Instead, they were either published under colorful pseudonyms like “Wonderful Wizard,” and “Equity Options Guru,” or under more mundane fictional attributions, such as “James Ratz.” (A name certainly likely to inspire trust….).
These cases raise a number of interesting technical questions regarding the scope of Section 10(b), not the least of which is, can the plaintiffs get around Janus?
[More under the jump]
Saturday, May 23, 2015
Judge Diane Wood of the Seventh Circuit has published an essay in the Yale Law Journal that surveys citations to legal scholarship emerging from the Seventh Circuit. She argues that movements like Legal Realism and its descendants challenge the concept of “judging” as a distinct activity from lawmaking, and as a result, scholarship that emerges from these traditions is not helpful to a sitting judge attempting to identify “what the law is.” She further argues that within the academy, the effect is exacerbated by a norm that values theoretical scholarship over practical “doctrinal” work, and hypothesizes that the type of doctrinal scholarship that judges are most likely to find useful is also more likely to be found in journals that carry less prestige.
Interestingly, Jeffrey Lynch Harrison and Amy Rebecca Mashburn reached similar conclusions. They studied judicial citations and found that judges – far less than academics – do not appear sensitive to the prestige in which an article appears, thus kicking off a debate regarding the purpose and value of legal research (see posts here and here). Among other things, Michael Risch defends legal scholarship on the grounds that its usefulness – to judges, to practitioners – is not the point; it is a good in and of itself.
I’m a recent convert from practice to academia, and that’s a sentiment I’ve frequently heard (usually as I’m being advised to write less like a practitioner). And while I don’t disagree with it, I also can’t help but notice that academics take quite a bit of pride in having their articles cited in judicial opinions – suggesting that their, um, revealed preferences are perhaps more nuanced.
In any event, I was recently thinking about how very often, both in my current research and earlier in my practice, I’ve found that some of the most interesting and helpful law review articles are the most thoroughly doctrinal – the ones that carefully synthesize and explain existing law, regardless of whether they also offer a more abstract theoretical framework, a realist attack on existing precedent, or recommend bold new path for change.
But beyond that, I think the indictment of legal scholarship as too theoretical is at least somewhat unfair. As Deborah Merritt points out, the citation counts actually aren’t all that bad, especially if one assumes a greater number of articles are consulted but not cited. Certainly, there are plenty of highly theoretical works out there that may not be of immediate relevance in a particular dispute, and thus don't end up being cited in judicial opinions, but I also found that when I was practicing, I was able to find a number of more concrete pieces in my area (possibly it’s easier when you practice business law). Sometimes I cited them in my briefing, which I assume increased their chances of being cited by judges (I know of at least one case where that occurred).
In my experience, however, the biggest impediments to citation of legal scholarship from the practice end were twofold: First, in any brief, space is at a premium. I often could not afford to cite a law review article and possibly edge out court decisions that the judges might find more authoritative. (And space may soon become even more scarce)
Second, and relatedly, I often found that legal scholarship was a few years behind the issues in which I was enmeshed. Law review articles were most helpful to me when they dealt with a cutting-edge issue on which precedent had not hardened, but it can take years for an issue to bubble up in judicial opinions to the point where academics notice it. From a practitioner’s perspective, by then it may be too late; the existing judicial opinions are what you want to address. The solution to that, I suppose, is for academics to maintain contact with practitioners, so they can be alerted to new legal developments.
Saturday, May 16, 2015
So the big securities news this week was the “hoax” bid to buy Avon Products.
Apparently, a hoaxster filed a fake offer to take over Avon Products with EDGAR, the SEC’s online database.
The filing caused a brief spike in the price of Avon shares. (As of the drafting of this blog post, Avon shares were still trading slightly higher than they were before the offer was filed). The details of the filing are as yet unknown, but presumably, whoever filed the release profited off the spike.
DealBook points out that this kind of incident may prompt the SEC to conduct some kind of preliminary vetting of filings with EDGAR, but one of the more interesting questions – as Matt Levine argues – concerns the definition of “materiality” for securities laws purposes. Ordinarily, false statements (such as a false representation concerning a takeover bid) are only prohibited to the extent they are “material” to a “reasonable” investors. Most human investors would likely have recognized the dubiousness of the offer (it named a law firm that doesn’t exist, and misspelled the name of the offeror); computerized traders, however, did not. (And perhaps humans then followed on, seeking to capitalize on the chaos caused by computers.) Indeed, a previous spike occurred when Tesla filed an April Fool’s Day press release announcing the release of a (fictional) new product.
Margaret Sachs has previously recognized that courts tend to vary their notion of the “reasonable investor” given the context in which a fraud occurs. Courts tend to assume a very high degree of sophistication for fraud on the market claims concerning widely-traded securities, but when it comes to Ponzi schemes and other frauds aimed at vulnerable populations, courts lower the bar.
Which of course raises the question whether we need a whole new definition of materiality aimed at the computers who do the majority of today’s trading. Tom C.W. Lin has recently published an article on precisely this topic, arguing, among other things, that computerized trading and algorithmic investors should be considered as a type of reasonable investor at whom regulations are aimed.
Saturday, May 9, 2015
In Williams-Yulee v. The Florida Bar (.pdf), the Supreme Court rejected a First Amendment challenge to the Florida Canon of Ethics that bans judicial candidates from personally soliciting campaign contributions. And I realize this is an odd case to discuss on this blog – nothing about it explicitly engages business law issues – but bear with me as I get to the (perhaps, ahem, somewhat attenuated) business-related point.
Saturday, May 2, 2015
It's the story of Tony Menendez, a Halliburton accountant who believed that the company was incorrectly recognizing revenue. When the company wouldn't correct its practices, he went to the SEC. Halliburton learned of the complaint, Menendez was ostracized, and the SEC investigation was dropped. This kicked off a years-long battle in which Menendez sought protection under SOX as a whistleblower, ultimately culminating in a decision from the Fifth Circuit.
What the article does not discuss, though, is the legal issue that dominated the case - namely, what legally qualifies as an adverse action for SOX purposes. Halliburton executives disclosed Menendez's identity to the rest of the accounting department, and his coworkers shunned him; thus, the critical question was, did disclosure of his identity, coupled with ostracism, constitute a materially adverse action? See Halliburton, Inc. v. Administrative Review Bd., 771 F.3d 254 (5th Cir. 2014). Notably, just last month, the Fifth Circuit - in a very closely divided decision - decided not to rehear the case en banc, over the lengthy dissent of Judge Jolly. See Halliburton Co. v. Admin. Review Bd., United States DOL, 596 Fed. Appx. 340 (5th Cir. 2015)).
Anyway, the article presents a rather a riveting David-and-Goliath story that, among other things, highlights the risks inherent in the practice of government agencies relying on internal investigations when deciding whether to take an enforcement action.
Thursday, April 23, 2015
An ongoing issue in many securities cases concerns the precise state of mind necessary to satisfy the element of scienter in a Section 10(b) violation. The basic dispute is about whether the defendant must have intended to harm investors, or whether it is sufficient if the defendant simply intended to mislead them.
One would have thought this issue was settled by the Supreme Court’s decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988). There, the defendants lied to investors by falsely claiming that they were not engaged in merger negotiations. The lie was not intended to harm anyone; if anything, the defendants intended to benefit investors by concealing the talks so as not to prejudice a beneficial deal. The Supreme Court did not weigh in on the definition of scienter per se, but it did emphasize that the defendants’ benign motives would not immunize them from liability. As the Court put it, “[W]e think that creating an exception to a regulatory scheme founded on a prodisclosure legislative philosophy, because complying with the regulation might be ‘bad for business,’ is a role for Congress, not this Court.”
Similarly, in Nakkhumpun v. Taylor, 2015 U.S. App. LEXIS 5547 (10th Cir. Apr. 7, 2015), the Tenth Circuit rejected a defendant’s argument that his false statements – in that case, false characterizations as to why a corporate asset sale had fallen through – were intended to benefit investors by attracting new deal partners. The Tenth Circuit held that whatever the defendant’s ultimate motive, Section 10(b) liability would be imposed if he intentionally or recklessly misled investors.
Nonetheless, courts continue to sporadically define Section 10(b) scienter in a more limited manner.
[More under the jump]
Saturday, April 18, 2015
It was recently announced that the SEC has reached a settlement in its lawsuit against Freddie Mac executives Richard Syron, Patricia Cook, and Donald Bisenius. The basic allegation in the case was that these executives violated Section 17 of the Securities Act and Section 10(b) of the Exchange Act by dramatically understating Freddie Mac’s exposure to subprime mortgages. The executives falsely claimed that Freddie Mac’s portfolio included $2 to $6 billion of subprime loans, when the true figure was closer to $141 billion to $244 billion. Freddie Mac’s exposure to subprime loans ultimately caused it to experience dramatic losses, thus harming investors.
The SEC ran into difficulty because there is no accepted definition of “subprime.” The SEC alleged that investors understood the term to refer to certain loans issued with a high likelihood of default, such as loans with high loan to value and debt to income ratios. The executives, however, claimed that “subprime” was understood by investors only to refer to loans that were designated as subprime by their originators.
The case has now settled, and, under the terms of the settlement, the executives will make payments to a Fair Funds account for the benefit of investors, in the amounts of $250K, $50K, and $10K, respectively.
Unusually, this is not your classic “no admit, no deny” settlement. Instead, it appears to be straight up “no admit,” because after the settlement was reached, Bisenius said that "The dismissal of the case today under these terms vindicates me completely."
Perhaps even more unusually, the payments are characterized as neither fines nor disgorgements. Instead, they are described as “donations.” Meanwhile, the amounts – coincidentally! – were calculated in proportion to the stock and options granted to the defendants during the (alleged) fraud period.
So what gives?
As far as I can tell, the euphemism is because of who’s paying. The settlement amounts will be paid by insurance (which itself is paid for by Freddie Mac). D&O insurance tends to exclude coverage for disgorgement and regulatory fines, see Lawrence J. Trautmana & Kara Altenbaumer-Price, D&O Insurance: A Primer, 1 Am. U. Bus. L. Rev. 337 (2011-12); Jon N. Eisenberg, How Much Protection Do Indemnification and D&O Insurance Provide?, and the SEC has taken the position that contracts to indemnify for Securities Act violations are unenforceable as against public policy. See 17 C.F.R. §229.512.
But I guess the SEC doesn't feel too strongly about it, because by characterizing the payments as donations rather than fines or disgorgement, the defendants are able to get the benefit of insurance and avoid paying out of pocket.
Though the SEC's fair funds statute does contemplate that donations may be included in a fund, see 15 U.S.C. § 7246(b), the settlement is an outlier, by SEC standards. According to Urska Velikonja’s article, Public Compensation for Private Harm: Evidence from the SEC's Fair Fund Distributions, 67 Stan. L. Rev. 331 (2015), executives who pay fines and disgorgement to an SEC fair fund typically pay out of pocket – an important feature, if the SEC is to avoid the criticism that fair fund distributions suffer from the same “circularity” problem that plagues private lawsuits.
Given all of this, one wonders why the SEC even bothered. If they thought they had a case, they could have just taken it to trial, risks be damned. And if they had doubts about the merits of the case, they should have simply dropped the matter.
One possibility is that the SEC believed its legal case was too weak for trial but that the reimbursement to investors was worth it – after all, circularity criticisms notwithstanding, not all investors are diversified, and some may have suffered losses that they did not make up in gains elsewhere. But that's not the motivation here, because the SEC will not establish a new fund to compensate investors for the alleged fraud. Instead, the defendants' donations will be added to an existing fair fund that was set up for the SEC's earlier case against Freddie Mac, brought in 2007, regarding accounting fraud that took place from 1998 through 2002. Which apparently means that the SEC will not even pretend to distribute the funds to the investors who were harmed by the more recent misconduct.
(I suspect this is because the SEC believes it lacks authority to establish a fund consisting solely of donations, with no penalties or disgorgements.)
In any event, $310K is a rather paltry sum if investor compensation was the goal; according to the parallel private lawsuit (dismissed on the pleadings, see Ohio Pub. Emples. Ret. Sys. v. Fed. Home Loan Mortg. Corp., 2014 U.S. Dist. LEXIS 155375 (N.D. Ohio Oct. 31, 2014)), Freddie Mac’s misrepresentation of its subprime exposure resulted in over $6 billion in losses to shareholders.
So the point is, if paid by insurance, the amounts aren’t large enough to deter, and as it stands, they are facially not even intended to compensate. Instead, the settlement seems an exercise in face-saving – the SEC believed it had a weak legal case (though possibly a strong moral one) but didn’t want to exit the field with nothing at all. The whole adventure thus raises the question whether face-saving payments are appropriate for regulators to collect (as well as the question whether much face-saving was actually accomplished).
Saturday, April 11, 2015
In Dura Pharmaceuticals, Inc. v. Broudo, 544 US 336 (2005), the Supreme Court held that to bring a fraud-on-the-market action under Section 10(b), shareholders would have to plead and prove the element of “loss causation,” namely, that disclosure of the fraud caused the company's stock price to drop, resulting in plaintiffs’ losses.
Since Dura was decided, there has been concern that companies might try to avoid liability by strategically disclosing information in a manner that would make it more difficult for plaintiffs to establish stock price effects.
In their new paper, Disclosure Strategies and Shareholder Litigation Risk, Michael Furchtgott and Frank Partnoy take significant steps toward establishing that these fears are well-grounded.
[More under the cut]
Saturday, April 4, 2015
When forum selection bylaws first became a thing, the response from the plaintiffs’ bar was a bit muted. This is because at least some plaintiffs’ firms viewed forum selection bylaws as beneficial, in that they had the potential to cut down on competition among plaintiffs’ firms for control over a given case. No longer would a firm filing a case in Delaware have to fear that a competing firm, filing a case in another jurisdiction, would settle on sweetheart terms – or worse, end up getting dismissed, with collateral estoppel effects – before the Delaware firm had a chance litigate.
Which brings us to the Walmart litigation and a dispute between two plaintiffs’ firms.
[More under the jump]
Saturday, March 28, 2015
On Tuesday, the Supreme Court finally issued its decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund (.pdf), concerning the definition of “opinion falsity” in the context of a lawsuit under Section 11 of the Securities Act.
Joan described the case in more detail here, but the basic issue was, what does it mean for a statement of opinion to be false? Or, to ground it more in the facts of Omnicare, if the company files a registration statement - as Omnicare did - that claims that the company "believes" its contracts are in compliance with the law, is that statement false when the DoJ sues for Medicaid fraud?
The defendants argued that opinion statements - such as a "belief" in legal compliance - can only be false if they falsely represent the speaker’s belief, i.e., if the speaker did not really believe that Omnicare was in compliance. If the speaker did believe in such compliance, then even if that belief was unfounded or turned out to be false, the statement itself would be literally true.
The plaintiffs agreed that statements of opinion may be false if the speaker misrepresents his or her own opinion, but also argued that opinions may be false for other reasons. For example, according to the plaintiffs, an opinion statement is false if the statement has no reasonable basis, regardless of the subjective beliefs of the speaker. So in Omnicare's case, its statement about legal compliance would be false if it did not bother to investigate whether its contracts were in compliance with the law, or if it ignored information that suggested the contracts were not in compliance.
In general, the case was pitched as a dispute about the continuing viability of Section 11 as a strict liability statute. Section 11, 15 U.S.C. §77k, provides that issuers are strictly liable for false statements in registration statements, and signatories of the registration statement are liable unless they demonstrate that they conducted a reasonable investigation of those statements. So, if Omnicare prevailed in its argument that belief statements are only false if the speaker misstates his own belief, it would, as a practical matter, require the plaintiffs to demonstrate that the speaker intentionally misled investors, thus importing a scienter requirement into Section 11. The effect would be particularly pronounced because there is a great deal of slipperiness regarding what counts as an opinion statement in the first place.
Ultimately, the Supreme Court adopted a standard that fit within the framework advocated by the plaintiffs, although the Court used a narrower formulation. The Court agreed with the defendants that statements of opinion can only be false if disbelieved by the speaker – if the speaker misstates his or her own belief – but then went on to hold that such statements may be misleading if they omit material information. Such as, if they omit the fact that the speaker had no basis for the belief he or she purported to hold and failed to conduct any investigation into the matter. It depends on context and delicate inferences yadda yadda yadda, but a registration statement is a formal document and investors are likely to assume that statements of belief contained therein are the product of a reasonable investigation, etc.
But none of this is what the case was really about.
[More under the cut]
Saturday, March 21, 2015
The UAW Retiree Medical Benefits Trust recently won a battle with Gilead and Vertex to have those companies include on their proxy statements proposals to require them to explain to shareholders the risks of their drug pricing decisions.
Basically, both Gilead and Vertex have come under fire recently for charging extremely high prices for new drugs. There's an argument, of course, that this is simply a bad business decision - if your customers can't afford your drugs, they won't buy them. And that's the official basis for the Trust's proposal. The Trust describes, for example, how Sanofi was once forced to dramatically cut drug prices because the initial prices were set unrealistically high.
But I find it very hard to believe that the UAW Retiree Medical Benefits Trust is genuinely concerned about drug pricing in its capacity as a shareholder seeking maximum returns. Instead, it seems far more likely that the Trust's concern is, you know, drug prices. That it has to pay. For its beneficiaries. And it's using its status as shareholder of several pharmaceutical companies to try to influence policy in that regard. The fact that the SEC is allowing the proposal to be included on the companies' proxies suggests that the SEC is not terribly concerned about that possibility (unlike Delaware, which does not want shareholders to pursue their own idiosyncratic agendas).
It reminds me of the AFL-CIO's earlier objection to Wall Street banks' practice of paying deferred compensation to executives to leave to go to government. From a wealth max perspective, you'd think this would be an awesome thing for shareholders - which means the AFL-CIO's objections were not really rooted in concern about the banks' financial performance, but in its broader political concerns about the practice. But the SEC didn't have a problem with that - it refused to allow Goldman to exclude the proposal.
So, I repeatedly threatened that I’d eventually post a summary of my paper on arbitration clauses in corporate governance documents – and well, now you’re all finally being subjected to it.
This post was originally published at CLS Blue Sky blog, but I've made some minor edits and added a new introduction.
For many years, commenters have argued that at least some shareholder disputes can and should be arbitrated, rather than litigated, and that this could be accomplished by amending the corporate “contract” – namely, its charter and/or its bylaws – to require arbitration. The possibility was raised in articles by John Coffee and Richard Shell in the late 1980s, and the idea has resurfaced many times since then, including this year by Adam Pritchard. For almost as long as the idea has been kicked around, there have been warnings that if arbitration clauses are “contractually” binding by virtue of their presence in corporate governance documents, then they may be subject to the Federal Arbitration Act (FAA), which would preempt state attempts to regulate/oversee their use. Coffee discussed that possibility in his 1988 piece on the subject; more recently, Barbara Black and Brian Fitzpatrick have sounded further alarms.
For foes of shareholder litigation, this is a feature, not a bug; though they rarely say so explicitly, whenever anyone relies upon FAA cases to justify the insertion of arbitration clauses in corporate charters and bylaws, they are implicitly advocating the idea that not only are charters and bylaws “contracts” for FAA purposes, but that federal law requires their enforcement, regardless of the preferences of the chartering state. After the Supreme Court decided AT&T Mobility LLC v. Concepcion, the notion was particularly powerful, because it meant that corporations would be free to use arbitration clauses to require that shareholder claims be brought on an individual, rather than class, basis. Given the economics of shareholder litigation, this would almost certainly mean the death of most shareholder lawsuits.
And that’s where my paper comes in.
[More under the cut]
Saturday, March 14, 2015
The Delaware Legislature is set to consider new legislation concerning litigation-limiting bylaws and charter provisions.
As discussed here, the new legislation would, among other things:
(1) Explicitly authorize corporations to include in their charter or bylaws forum selection clauses that designate Delaware courts as the exclusive forum for shareholder litigation;
(2) Explicitly forbid corporations from including in their charters or bylaws forum selection or arbitration clauses that prohibit bringing claims in Delaware courts; and
(3) Prohibit fee-shifting bylaws and charter provisions.
[More under the cut]
Saturday, March 7, 2015
There’s been a lot of controversy recently over the SEC’s use – or perhaps I should say, non-use – of the automatic “bad actor” disqualifications for firms that commit securities violations. The disqualification provisions place certain limits on the activities of firms that are found to have committed securities violations. Dodd Frank added a big stick to the list of penalties: It added an automatic disqualification from participating in private placements under Rule 506 of Regulation D. It’s a severe penalty; private placements are extremely lucrative.
But the SEC can waive the automatic disqualification – and frequently does, even for “recidivist” firms that repeatedly rack up securities violations. It imposes fines, perhaps outside monitoring, but it waives disqualifications – especially the Rule 506 disqualification.
The issue has recently hit the public eye because Democratic Commissioners Luis Aguilar and Kara Stein have been objecting to the grant of waivers to recidivist firms. In their view, waivers are an important tool for deterring securities violations, and the SEC has improperly adopted a policy of granting them “reflexively.”
In light of all of this, the SEC has promised to issue guidelines as to how Rule 506 waiver decisions are made; Commissioner Daniel Gallagher thinks the matter may ultimately have to be resolved by Congress.
Until recently, hasn’t been clear just how often these waivers have been granted, and who has received them. But Urska Velikonja just posted a new paper that gathered data on 201 waivers issued between 2003 and 2014. These waivers involved Regulation D disqualification, Regulation A disqualification, and also disqualification from the use of automatic shelf registration statements to raise capital. Velikonja finds that: (1) large financial firms received over 80% of the waivers; smaller firms and nonfinancial firms rarely receive them even though they are much more likely to be the target of an enforcement action; (2) the SEC typically does not offer any real justifications for its decision to grant or withhold a waiver, but the pattern appears to be that the Commission does not grant waivers for firms accused of offering fraud or issuer disclosure violations; usually, they’re granted for firms accused of unrelated misconduct, such as violations of the broker-dealer and investment adviser rules – presumably because the Commission views the latter firms as presenting a lower recidivism risk; and (3) the number of waivers has declined over time, and the SEC has recently begun utilizing partial waivers.
(More under the jump)
Tuesday, March 3, 2015
I finally got it together and opened an account on SSRN (I know, I know), and posted two of my forthcoming pieces there.
The first, Searching for Market Efficiency, is a very short comment that will be published in the Arizona Law Review, discussing Donald Langevoort's Judgment Day for Fraud-on-the-Market and Geoffrey Miller's The Problem of Reliance in Securities Fraud Class Actions, both of which will be published in the same issue. The comment discusses the Supreme Court's recent decision in Halliburton, and the reasons behind courts' difficulties in defining market efficiency for the purpose of Section 10(b) class actions.
The second, Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws, is a longer article forthcoming in the Georgetown Law Journal, and it deals with the claim that, because corporate governance documents are "contractual," clauses that require arbitration of shareholder disputes must be enforced according to their terms, as required by the Federal Arbitration Act. I've discussed this topic before; the Article spins things out in more depth. I will eventually put up a longer post here summarizing the piece, but if there's anyone who just can't wait for the cliffs notes version, well, you can now download it from SSRN.
Saturday, February 28, 2015
This seems to have been a great week for business stories with a touch of the absurd.
First up, we have Footnoted.org's fantastic catch in Goldman's 10-K. Apparently, Goldman now has a new risk factor:
[O]ur businesses ultimately rely on human beings as our greatest resource, and from time-to-time, they make mistakes that are not always caught immediately by our technological processes or by our other procedures which are intended to prevent and detect such errors. These can include calculation errors, mistakes in addressing emails, errors in software development or implementation, or simple errors in judgment. We strive to eliminate such human errors through training, supervision, technology and by redundant processes and controls. Human errors, even if promptly discovered and remediated, can result in material losses and liabilities for the firm.
We can only speculate as to what specific, as-yet-undisclosed, human error prompted this disclosure, but if I had to make a bet, my money would be on an email address auto-fill mistake that is now the subject of some behind-the-scenes settlement discussions, the details of which will only come to light if negotiations fail and a public lawsuit is filed.
Next up, we have a Hunger-Games inspired video created by Morgan Stanley for its branch managers' meeting. The 10-minute long video depicts branch managers forced to compete to the death to maintain their positions. Apparently, Morgan Stanley shelved the video (which cost $100K to produce) out of concern that it displayed a certain callousness towards the actual real life people who were losing their jobs. So, now, of course, to demonstrate its sensitivity, Morgan Stanley has launched an internal investigation to discover the identity of the person who leaked the video.
Also, the Supreme Court decided Yates v. United States, concerning whether the disposal of undersized fish counted as the destruction of a tangible object intended to impede a federal investigation, in violation of the Sarbanes-Oxley Act. The Court held that it did not. Others have explored the implications of Yates for Obamacare and the case against Dzhokhar Tsarnaev's friends, but I'm far more interested in the headlines the case inspired, including In Overturning Conviction, Supreme Court Says Fish Are Not Always Tangible, Supreme Court: One Fish Two Fish Red Fish Blue Fish (a reference to Justice Kagan's dissent, which cited Dr. Seuss), Fisherman let off the hook in U.S. white-collar crime ruling, High Court SOX Fish Ruling Cuts Hole In Prosecutors’ Net, Supreme Court Throws Prosecutors Overboard in Fisherman Case, Supreme Court tosses ‘fishy’ conviction of Florida fisherman into the drink, and my personal favorite, Cortez case: Small fish, wide net.
Last but not least, the dress may be blue - but it's been nothing but green for the British retailer that sells it. (BuzzFeed didn't do so badly, either; it had to increase its server capacity by 40% to handle dress-related traffic.)
Saturday, February 21, 2015
One of the enduring debates in corporate law concerns whether shareholder empowerment promotes short-termism - i.e., temporary boosts in stock prices that can only be achieved at the expense of longer-term value-building projects, like research and development. Related to this debate is the argument - championed by, among others, Margaret Blair and Lynn Stout - that directors cannot/should not be solely concerned with shareholder wealth maximization; instead, their role is to mediate among various firm stakeholders. This is because a firm cannot thrive unless it offers a credible commitment to its employees and other corporate constituents that they will not be ousted the moment it appears profitable to do so. In other words, in order to induce employees and other stakeholders to invest valuable human capital in the firm, these actors must believe that the firm is committed to them - that shareholders are barred from, for example, insisting on downsizings or outsourcings or what-have-you the moment it appears that doing so will create a share price bump.
Martijn Cremers and Simone Sepe weigh in on this debate in a new paper, Whither Delaware? Limited Commitment and the Financial Value of Corporate Law(summarized here), where they conclude that protections for incumbent management - in the form of strong antitakeover statutes - are associated with higher firm values, in firms where long-term commitment is particularly necessary for profitability. In particular, they classify Delaware as a state where antitakeover protections are not strong, and find that incorporation in Delaware reduces firm value for companies that rely on long-term relationships, as compared to states where antitakeover protections are stronger. The basic idea here is that when management is insulated from shareholder pressures and the market for corporate control, management can more credibly commit to longer term projects and relationships that may not be immediately profitable.
The findings are, of course, extremely interesting and merit further analysis, but I have some difficulty with the premise that underlies their study, namely, that Delaware's antitakeover protections are weaker than those in the comparator states. Most obviously, one of the ways that the study classifies a state as "managerial" is if it has a business combination statute that prohibits transactions between an acquirer and target for 5 years. While it's true that Delaware's antitakeover statute is not quite as draconian - Delaware prohibits combinations for only 3 years as opposed to 5, and can be avoided if the acquirer increases its holdings from under 15% of the target to 85% in a single tender offer - the reality is, as has been documented elsewhere, Delaware's antitakeover law is more than sufficient to block hostile acquisitions.
Given that, antitakeover statutes that are even more extreme than Delaware's because they include a 5 year limitation instead of a 3 year one are gilding the lily; it's not clear why firms incorporated in those states should offer any more of a credible commitment to long-term stakeholders than firms incorporated in Delaware. And by my count, the study classifies 10 states as "managerial" based solely on this criterion, including New York and New Jersey.*
Additionally, the study is based on an analysis of firm value before and after reincorporation - in and out of Delaware, or in and out of the comparator states. But most reincorporations are associated with particular transactions that can be expected to affect firm value (a point which has been used to criticize post-reincorporation-value studies in the past, as Cremers and Sepe acknowledge in their paper). So I have to wonder whether there are some other factors that are driving the reincorporations and the selection of jurisdiction, and those other factors are having the observed effect.
*32 states have business combination statutes along these lines, making it even more unlikely that the 10 states identified as "managerial" according to this criterion (i.e., based on the 5 year rather than 3 year limit) actually offer any special signaling value regarding management's long-term commitments.