Wednesday, May 27, 2015
This week I have found myself reading the co-authored, empirical piece by C.N.V. Krishnan, Frank Partnoy, and Randall Thomas titled, Top Hedge Funds and Shareholder Activism. Through their sample they observe that top hedge funds have repetitional capital in that the market responds more positively to announcements by certain hedge funds with certain features, like a longer track record, larger assets under management and management participation through board of director seats. Its an interesting and insightful article on the role, and value, of hedge funds. The authors conclude that
The market appears to anticipate the superior performance of these top hedge funds even before announcement of intervention. Moreover, post-intervention target-firm operating performance associated with these top hedge funds is significantly superior to that of other hedge fund activists.
The focus on reputation reminded of Elisabeth de Fontenay's good work on reputation in private equity. Her article, Private Equity Firms as Gatekeepers, 33 Review of Banking & Financial Law 115-189 (2014). de Fontenay argues in her piece that:
private equity firms act as gatekeepers in the debt markets. As repeat players, private equity firms use their reputations with creditors to mitigate the problems of borrower adverse selection and moral hazard in the companies that they manage, thereby reducing creditors’ costs of lending to these companies. Private equity-owned companies are thus able to borrow money on more favorable terms than standalone companies, all else being equal. By acting as gatekeepers, private equity firms render the debt markets more efficient and provide their portfolio companies with an increasingly valuable borrowing advantage.
Updated to add: Frank Partnoy informed me that he and Elisabeth presented these 2 papers collaboratively to the Duke law faculty with each commenting on the other. This either proves once again that I have no original ideas OR this validates my insights about the overlapping observations in these papers.
Wednesday, May 20, 2015
Some of you may recall that I blogged last summer about a SEALS (Southeastern Association of Law Schools) discussion group on "publicness." That post can be found here. My contribution to the discussion group was part of a paper that then was a work-in-process for the University of Cincinnati Law Review that I earlier had blogged about here.
That paper now has been released in electronic and hard-copy format. I just uploaded the final version to SSRN. The abstract for the paper reads as follows:
Conceptions of publicness and privateness have been central to U.S. federal securities regulation since its inception. The regulatory boundary between public offerings and private placement transactions is a basic building block among the varied legal aspects of corporate finance. Along the same lines, the distinction between public companies and private companies is fundamental to U.S. federal securities regulation.
The CROWDFUND Act, Title III of the JOBS Act, adds a new exemption from registration to the the Securities Act of 1933. In the process, the CROWDFUND Act also creates a new type of financial intermediary regulated under the Securities Exchange Act of 1934 and amends the 1934 Act in other ways. Important among these additional changes is a provision exempting holders of securities sold in crowdfunded offerings from the calculation of shareholders that requires securities issuers to become reporting companies under the 1934 Act.
This article attempts to shed more light on the way in which the CROWDFUND Act, as yet unimplemented (due to a delay in necessary SEC rulemaking), interacts with public offering status under the 1933 Act and public company status under the 1934 Act. Using the analytical framework offered by Don Langevoort and Bob Thompson, along with insights provided in Hillary Sale’s work, the article briefly explores how the CROWDFUND Act impacts and is impacted by the public/private divide in U.S. securities regulation. The article also offers related broad-based observations about U.S. securities regulation at the public/private divide.
I hope that you are motivated to read the article--and that you get something out of it if you do read it. The thinking involved in creating the article was often challenging (even if the expressed ideas may not reflect or meet that challenge). Yet, writing the article, in light of the super work already done by Don Langevoort, Bob Thompson, and Hillary Sale, was joyful and illuminating for me in many ways.
I often say that I stand on the shoulders of giants in my teaching and scholarship. That was transparently true in this case. If only all academic research and writing could be so rewarding.
Thursday, May 14, 2015
Last week, I looked lovingly at a picture of a Starbucks old-fashioned grilled cheese sandwich. It had 580 calories. I thought about getting the sandwich and then reconsidered and made another more “virtuous” choice. These calorie disclosures, while annoying, are effective for people like me. I see the disclosure, make a choice (sometimes the “wrong” one), and move on.
Regular readers of this blog know that I spend a lot of time thinking about human rights from a corporate governance perspective. I thought about that uneaten sandwich as I consulted with a client last week about the California Transparency in Supply Chains Act. The law went into effect in 2012 and requires retailers, sellers, and manufacturers that exceed $100 million in global revenue that do business in California to publicly disclose the degree to which they verify, audit, and certify their direct suppliers as it relates to human trafficking and slavery. Companies must also disclose whether or not they maintain internal accountability standards, and provide training on the issue in their direct supply chains. The disclosure must appear prominently on a company’s website, but apparently many companies, undeterred by the threat of injunctive action by the state Attorney General, have failed to comply. In April, the California Department of Justice sent letters to a number of companies stating in part:
If your company has posted the required disclosures on its Internet website or, alternatively, takes the position that it is not required to comply with the Act, we request that – within 30 days of this letter’s date – you complete the form accessible at http://oag.ca.gov/sb657 and provide this office with (1) the web links (URLs) to both your company’s Transparency in Supply Chains Act disclosures and its homepage containing a link to the disclosures; and/or (2) information demonstrating your company is not covered by the Act.
There are no financial penalties for noncompliance. Rather, companies can face reputational damage and/or an order from the Attorney General to post something on their websites. A company complies even if that disclosure states that the company does no training, auditing, certification, monitoring or anything else related to human trafficking or slavery. The client I spoke to last week is very specialized and all of its customers are other businesses. Based on their business profiles, those “consumers” are not likely to make purchasing decisions based on human rights due diligence. I will be talking to another client in a few weeks on the California law. That client is business to consumer but its consumers specifically focus on low cost—that’s the competitive advantage for that client. Neither company-- the B2B nor the B2 (cost conscious)C-- is likely to lose significant, if any business merely because they don’t do extensive due diligence on their supply chains. Similarly, Apple, which has done a great job on due diligence for the conflict minerals law will not set records with the sale of the Apple Watch because of its human rights record. I bet that if I walked into an Apple Store and asked how many had seen or heard of Apple’s state of the art conflict minerals disclosure, the answer would be less than 1% (and that would be high).
People buy products because they want them. The majority of people won’t bother to look for what’s in or behind the product, although that information is readily available through apps or websites. If that information stares the consumer in the face (thanks Starbucks), then the consumer may make a different choice. But that assumes that (1) the consumer cares and (2) there is an equally viable choice.
To be clear, I believe that companies must know what happens with their suppliers, and that there is no excuse for using trafficked or forced labor. But I don’t know that the use of disclosures is the way to go. Some boards will engage in the cost benefit analysis of reputational damage and likelihood of enforcement vs cost of compliance rather than having a conversation about what kind of company they want to be. Many board members will logically ask themselves, “should we care if our customers don’t care?”
My most recent law review article covers this topic in detail. I’ll post it in the next couple of weeks because I need to revise it to cover the April development on the California law, and the EU’s vote on May 19 on their own version of the conflict minerals law. In the meantime, ignorance is bliss. I’m staying out of Starbucks and any other restaurant that posts calories- at least during the stressful time of grading exams.
May 14, 2015 in Corporate Finance, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, International Business, Law Reviews, Marcia Narine, Securities Regulation | Permalink | Comments (3)
Wednesday, May 6, 2015
Monday, I had the privilege of moderating a discussion on structuring merger and acquisition transactions that I had organized as part of a continuing legal education program for the Tennessee Bar Association. Rather than doing the typical comparison/contrast of different business combination structures (with charts, etc.), I organized the hour-long discussion around the banter that corporate/securities and tax folks have in structuring a transaction. We used the terms of a proposed transaction (an LLC business being acquired by a public corporation) as a jumping-off point.
The idea for the format came from a water cooler conversation--literally--among me (in the role of a corporate/securities lawyer), one of my property lawyer colleagues, and one of my tax lawyer colleagues. The conversation started with a question my property law colleague had about the conveyance of assets in a merger. I told him that mergers are not asset conveyance transactions but, rather, statutory transactions that have the effects provided for in the statute, which include a vesting of assets in the surviving corporation. I told him that I call this "merger magic." I showed him Section 259(a) of the Delaware General Corporation Law:
When any merger or consolidation shall have become effective under this chapter, . . . all property, real, personal and mixed, and all debts due to any of said constituent corporations on whatever account, as well for stock subscriptions as all other things in action or belonging to each of such corporations shall be vested in the corporation surviving or resulting from such merger or consolidation . . . .
We discussed the possibility of an assignment/transfer of assets by operation of law under that provision and more generally under Delaware law in connection with different types of mergers, including recent case law regarding reverse triangular mergers. Ultimately, my property law colleague decided that a direct merger involved an asset sale by the target entity and a purchase transaction by the surviving corporation, as a matter of property law, notwithstanding my "merger magic" explanation I was forwarding as a descriptor under state corporate law.
The tax guy thought all this (both descriptions of a merger) was balderdash. These descriptions were too complex and stilted for his taste. Not to be outdone, he offered that all merger and acquisition transactions are either asset sales or sales of equity. At least, he allowed, that's how federal income tax law looks at them . . . . I told him that asset and equity sale transactions are joined by mergers (direct, reverse triangular, and forward triangular) and share exchange transactions (which are also statutory transactions, available in Tennessee and other Model Business Corporation Act states, but not available in Delaware) in the corporate lawyer's business combination toolkit. I also noted that federal securities law voting and reporting requirements work off these different corporate law descriptors.
Fascinating! Three lawyers, three different conceptions of business combination transactions. The moderated discussion on Monday was, in effect, an attempt by me to recreate, albeit in a different form, parts of that conversation. The discussion was, in my view, decently successful in achieving its limited purpose in the program. Nevertheless, I really wish I had a transcription of that original conversation by the water cooler. That was truly priceless . . . .
Wednesday, April 29, 2015
Perhaps this post would have been timelier before the spring submission cycle, but hopefully it will be helpful in framing title options for pieces being developed this summer. One of the many benefits of co-authorship is learning substantive and procedural knowledge from your collaborators. On a recent article, I worked with three economists who have different skill sets, perspectives, and discipline standards. When we were trying to finalize our title, we came up with several different categories or types of article titles—a framework that I will utilize again in the future and which I am sharing with you today. We selected the “themed” based title for our article, Institutional Investing When Shareholders Are Not Supreme, and a play on words, Institutional Investors’ Appetite for Alternatives, for a shorter piece appearing on Columbia Blue Sky Blog.
SOBER: Institutional Investing after Constituency Statutes
QUESTION: Does Changing Shareholder Value Maximization Standards Change Institutional Investors’ Behavior?
CONTRAST: Institutional Investors Behavior Before and After Constituency Statutes
PLAY ON WORDS: Appetite for Alternatives: Institutional Investors’ Behavior in the Fact of Shareholder Value Maximization Pressures
FORWARD THINKING: What Does Institutional Investors Behavior after Constituency Statutes Tell Us Regarding Benefit Corporations?
HISTORICAL: The Changing Landscape of Directorial Duties: Constituency States to Alternative Purpose Firms
SLATE/OP-ED: Who’s Afraid of Alternative Purpose Firms?
THEME: Agency Investing When Shareholders Are Not Supreme
For those interested and perhaps to put the title options in perspective, here is a little background on our article, Institutional Investing When Shareholders Are Not Supreme. In an earlier BLPB post, I linked to our short piece appearing in Columbia Blue Sky Blog. Our article examines institutional investors’ response to corporate director duty changes embodied in constituency statutes and links our findings to current questions of institutional investors’ potential acceptance of alternative business entities. Our paper surveys the 30+ year literature debate on directors’ duties to maximize shareholder value, a case law analysis of constituency statute litigation, and an empirical study (utilizing a difference-in-differences approach) of institutional investors’ divestment of stock held in companies incorporated in constituency statute jurisdictions. We first verified that courts enforced constituency statutes, or in other words, that constituency statutes represented at least a small change to directors’ legal duties. In our empirical section, we found no statistically significant departure of institutional investors after the passage of constituency statutes, focusing specifically on institutions with high fiduciary duties. If institutional investors had fled constituency statute investments, which are subject to lower director duties changes than with say benefit corporations, then there would be grounds to think that institutional investors would not invest in alternative purpose firms. Finding no such negative reaction to constituency statutes does not conclusively indicate institutional investor’s acceptance of alternative purposes firms, especially given the greater deviation from shareholder value maximization by requiring (rather than permitting) directors to consider nonshareholder interests codified in benefit corporation statutes. It does suggest, however, some latitude for institutional investors to consider alternative purpose firm investments without running afoul of fiduciary duties. If I were explaining the results to a student, I would say that our study could have produced strong evidence shutting the door on this possibility, but instead the findings leave the door open. This paper is valuable in the absence of direct information on the question, and will certainly give way to findings utilizing empirical data directly on point with publicly-traded benefit corporations and/or B Corporations.
Monday, April 27, 2015
The following guest blog post on my recent article, Institutional Investing When Shareholders Are Not Supreme, is available at Columbia's Blue Sky Blog discussing institutional investors' attitudes towards alternative business forms and similar issues raised by Etsy's IPO.
Wednesday, April 8, 2015
For thirty years, I have had a pet peeve about the media's routine reporting on mergers and acquisitions. I have kept this to myself, for the most part, other than scattered comments to law practice colleagues and law students over the years. Today, I go public with this veritable thorn in my side.
From many press reports (which commonly characterize business combinations as mergers), you would think that every business combination is structured as a merger. I know I am being picky here (since there are both legal and non-legal common parlance definitions of the verb "merge"). But a merger, to a business lawyer, is a particular form of business combination, to be distinguished from a stock purchase, asset purchase, consolidation, or statutory share exchange transaction.
The distinction is meaningful to business lawyers for whom the implications of deal type are well known. However, imho, it also can be meaningful to others with an interest in the transaction, assuming the implications of the deal structure are understood by the journalist and conveyed accurately to readers. For instance, the existence (or lack) of shareholder approval requirements and appraisal rights, the need for contractual consents, permit or license transfers or applications, or regulatory approvals, the tax treatment, etc. may differ based on the transaction structure.
Monday, April 6, 2015
Yesterday was the third anniversary of the JOBS Act. President Obama signed it into law on April 5, 2012. The JOBS Act, as regular readers of this blog know, requires the SEC to adopt rules to enact an exemption for crowdfunded securities offerings. The statutory deadline for the SEC to do so was December 31, 2012. The SEC proposed the required rules on October 23, 2013, but it still has not adopted them.
It is now
- 1096 days since Congress passed the JOBS Act
- 826 days since the deadline for the SEC to adopt the required rules
- 530 days since the SEC proposed the rules
. . . and still no crowdfunding exemption.
If I treated my tax returns like the SEC has treated the crowdfunding rules, I would be in jail.
SEC Chair Mary Schapiro has recently said that the SEC hopes to finalize the rules by the end of the year. I certainly hope so.
Thursday, April 2, 2015
In connection with the current legislative debate on benefit corporations in Tennessee (which has been gathering momentum since I last wrote on the topic), I have repeatedly asked about the impetus for the bill. Of course, there is the obvious "push" for benefit corporation legislation by the B Lab folks, who have gotten the ear of folks at the Chamber, convincing them that the legislation is needed in Tennessee to protect social enterprise entities from the application of a narrow version of the shareholder wealth maximization norm (a conclusion that I dispute in my earlier post). But what else? What real parties in interest in Tennessee, if any, have expressed a desire that Tennessee adopt this form of business entity?
There is anecdotal information from one venture attorney that some Tennessee entrepreneurs have indicated a preference for the benefit corporation form and have specifically requested that their business be organized as a Delaware benefit corporation. Leaving aside the Delaware versus Tennessee question, why are these entrepreneurs looking to organize their businesses as benefit corporations? Where does this idea come from?
Earlier this week I went to a really useful workshop conducted by the Venture Law Project and David Salmon entitled "Key Legal Docs Every Entrepreneur Needs." I decided to attend because I wanted to make sure that I’m on target with what I am teaching in Business Associations, and because I am on the pro bono list to assist small businesses. I am sure that the entrepreneurs learned quite a bit because I surely did, especially from the questions that the audience members asked. My best moment, though was when a speaker asked who knew the term "right of first refusal" and the only two people who raised their hands were yours truly and my former law student, who turned to me and gave me the thumbs up.
Their list of the “key” documents is below:
1) Operating Agreement (for an LLC)- the checklist included identity, economics, capital structure, management, transfer restrictions, consent for approval of amendments, and miscellaneous.
2) NDA- Salmon advised that asking for an NDA was often considered a “rookie mistake” and that venture capitalists will often refuse to sign them. I have heard this from a number of legal advisors over the past few years, and Ycombinator specifically says they won't sign one.
3) Term Sheets- the seminar used an example for a Series AA Preferred Stock Financing, which addressed capitalization, proposed private placement, etc.
4) Independent Contractor Agreement- the seminar creators also provided an IRS checklist.
6) Employment Agreement- as a former employment lawyer, I would likely make a lot of tweaks to the document, and vey few people have employment contracts in any event. But it did have good information about equity grants.
7) Convertible Promissory Note Purchase Agreement- here's where the audience members probably all said, "I need an attorney" and can't do this from some online form generator or service like Legal Zoom or Rocket Lawyer.
8) Stock Purchase Agreement- the sample dealt with Series AA preferred stock.
9) IRS 83(b) form- for those who worry that they may have to pay taxes on "phantom income" if the value of their stock rises.
10) A detailed checklist dealing with basic incorporation, personnel/employee matters, intellectual property, and tax/finance/administration with a list of whether the responsible party should be the founders, attorney, officers, insurance agent, accountant, or other outside personnel.
What’s missing in your view? The speakers warned repeatedly that business people should not cut and paste from these forms, but we know that many will. So my final question- how do we train future lawyers so that these form generators and workshops don't make attorneys obsolete to potential business clients?
Wednesday, April 1, 2015
On March 25, 2015, the SEC Commissioners unanimously adopted final rules amending Regulation A, effective in 60 days, extending an existing exemptions for smaller issues as required under Title IV of the Jumpstart Our Business Startups (JOBS) Act. SEC information on the new regulations are available here and commentary is available here.
The SEC Release states that:
The updated exemption will enable smaller companies to offer and sell up to $50 million of securities in a 12-month period, subject to eligibility, disclosure and reporting requirements.
The final rules, often referred to as Regulation A+, provide for two tiers of offerings: Tier 1, for offerings of securities of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer; and Tier 2, for offerings of securities of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer. Both Tiers are subject to certain basic requirements while Tier 2 offerings are also subject to additional disclosure and ongoing reporting requirements.
The final rules pre-empt states from reviewing and approving Tier 2 offerings to "qualified purchasers." For a further discussion on merit review and preemption, see The SEC's New 'Regulation A+' and the States' 'M' Word, posted on JDSupra.
Supporters have commended the change as decreasing reliance on costly gate keepers to capital such as investment bankers, and facilitating an easier path to raise capital by allowing qualifying companies to offer their stock directly to the public. Initial reaction quotes in the alternative finance world are available here.
Friday, March 27, 2015
After teaching my early morning classes, I will spend the rest of the day at Vanderbilt Law School for their Developing Areas of Capital Market and Federal Securities Regulation Conference.
This is Vanderbilt's 17th Annual Law and Business Conference and they have quite the impressive lineup, including Commissioner Daniel Gallagher, Jr. of the U.S. Securities and Exchange Commission.
I am grateful to the Vanderbilt faculty members who invited me to this event and others like it. Vanderbilt is only about 1 mile from Belmont and I have truly enjoyed getting to know some of the Vanderbilt faculty members and their guest speakers.
Wednesday, March 25, 2015
Today, part of the assignment for my Securities Regulation students was to read a chapter in our casebook and, as assigned by me, come to class prepared to teach in a three-to-five-minute segment a part of the assigned reading. The casebook is Securities Regulation: Cases and Materials by Jim Cox, Bob Hillman, and Don Langevoort. The chapter (Chapter 7, entitled "Recapitalization, Reorganizations, and Acquisitions") covers the way in which various typical corporate finance transactions are, are not, or may be offers or sales of securities that trigger registration under Section 5 of the Securities Act of 1933, as amended (the "1933 Act"). I have used this technique for teaching this material before (and also use a student teaching method for part of my Corporate Finance course), and I really enjoy the class each time.
I find that the students understand the assigned material well (having already been through a lot of registration and exemption material in the preceding weeks) and embrace the responsibility of teaching me and each other. I am convinced that they learn the material better and are more engaged with it because they have had to read it with a different intent driven by a distinct objective. For their brief teaching experience, each student needs to understand both the transaction at issue and the way in which it implicates, does not implicate, or may implicate 1933 Act registration requirements. They do not disappoint in either respect, and I admit to being interested in their presentations and proud of them.
I also find that changing my role principally to that of a listener and questioner refreshes me. I organize and orchestrate the general structure of the class meeting and come to class prepared with the knowledge of what needs to be brought out during the session. But since I cannot control exactly what is said, I must listen and react and help create logical transitions and other links between the topics covered. In addition, I can create visuals on the board to illustrate aspects of the "mini-lectures" (as I did today when a student was explaining a spin-off transaction). I honestly have a lot of fun teaching this way.
There are, no doubt, many ways in which we can engage students in teaching course material in the classroom that may have similar benefits. What are yours? When and how do you use them to make them most effective? Teach me! :>)
Monday, March 23, 2015
The JOBS Act requires the SEC to create an exemption for small, crowdfunded offerings of securities. That exemption, if the SEC ever enacts it, will allow issuers to raise up to $1 million a year in sales of securities to the general public. (Don’t confuse this exemption with Rule 506(c) sales to accredited investors, which is sometimes called crowdfunding, but really isn’t.)
The crowdfunding exemption restricts resales of the crowdfunded securities. Crowdfunding purchasers may not, with limited exceptions, resell the securities they purchase for a year. Securities Act sec. 4A(e); Proposed Rule 501, in SEC, Crowdfunding, Securities Act Release No. 9470 (Oct. 23, 2013). Unlike the resale restrictions in some of the other federal registration exemptions, the crowdfunding resale restriction serves no useful purpose. All it does is to increase the risk of what is already a very risky investment by reducing the liquidity of that investment.
Enforcing the “Come to Rest” Idea
Some of the resale restrictions in other exemptions are designed to enforce the requirement that the securities sold “come to rest” in the hands of purchasers who qualify for the exemption.
Rule 147, the safe harbor for the intrastate offering exemption in section 3(a)(11) of the Securities Act, is a good example. To qualify for the intrastate offering exemption, the securities must be offered and sold only to purchasers who reside in the same state as the issuer. Securities Act sec. 3(a)(11); Rule 147(d). This requirement would be totally illusory if an issuer could sell to a resident of its state and that resident could immediately resell outside the state. Therefore, Rule 147(e) prohibits resales outside the state for nine months.
The resale restrictions applicable to the Rule 505 and 506 exemptions have a similar effect. Rule 506 only allows sales to accredited investors or, in the case of Rule 506(b), non-accredited, sophisticated investors. Rules 506(b)(2)(ii), 506(c)(2)(i). These requirements would be eviscerated if an accredited or sophisticated purchaser could immediately resell to someone who does not qualify.
Rule 505 does not limit who may purchase but, like Rule 506, it does limit the number of non-accredited investors to 35. Rules 505(b)(2)(ii), 501(e)(1)(iv). If an issuer could sell to a single purchaser who immediately resold to dozens of others, the 35-purchaser limitation would be meaningless.
To enforce the requirements of the Rule 505 and 506 exemptions, Rule 502(d) restricts resales in both types of offering.
Preventing an Information-less Resale Market
Rule 504 also includes a resale restriction, Rule 502(d), even though it does not impose any restrictions on the nature or number of purchasers. A resale would not, therefore, be inconsistent with any restrictions imposed on the issuer’s offering.
However, Rule 504 does not impose any disclosure requirements on issuers. See Rule 502(b)(1). Because of that, people purchasing in a resale market would not have ready access to information about the issuer. But the Rule 504 resale restriction does not apply if the offering is registered in states that require the public filing and delivery to investors of a disclosure document. Rules 502(d), 504(b)(1). In that case, information about the issuer is publicly available and there’s no need to restrict resales. People purchasing in the resale market would have access to information to inform their purchases.
The resale restrictions in Rule 505 and 506 offerings could also be justified in part on this basis. If issuers sell only to accredited investors in those offerings, there is no disclosure requirement. If they sell to non-accredited investors, disclosure is mandated, but even then there’s no obligation to make that disclosure public. See Rule 502(b). People purchasing in the resale market therefore would not have ready access to public information about the issuer.
This lack-of-information justification is consistent with the lack of resale restrictions in Regulation A. To use the Regulation A exemption, an issuer must file with the SEC and furnish to investors a detailed disclosure document. Rules 251(d), 252. Because of that, information about the issuer and the security will be publicly available to purchasers in the resale market.
The Crowdfunding Exemption
Neither of these justifications for resale restrictions applies to offerings pursuant to the forthcoming (some day?) crowdfunding exemption.
The come-to-rest rationale does not apply. The crowdfunding exemption does not limit the type or number of purchasers. An issuer may offer and sell to anyone, anywhere, so no resale restriction is necessary to avoid circumvention of the requirements of the exemption.
The information argument also does not apply. A crowdfunding issuer is required to provide a great deal of disclosure about the company and the offering—as I have argued elsewhere, probably too much to make the exemption viable. See Securities Act sec. 4A(b)(1); Proposed Rule 201 and Form C. The issuer is also obligated to file annual reports with updated information. Securities Act sec. 4A(b)(4); Proposed Rule 202. All of that information will be publicly available. Even if one contends that the information required to be disclosed is inadequate, it will be no more adequate a year after the offering, when crowdfunding purchasers are free to resell. Securities Act sec. 4A(e); Proposed Rule 501.
Some people, including Tom Hazen and my co-blogger Joan Heminway, have argued that resale restrictions may be necessary to avoid a repeat of the pump-and-dump frauds that occurred under Rule 504 when Rule 504 was not subject to any resale restrictions. As I have explained, Rule 504, which requires no public disclosure of information, fits within the information rationale. Such fraud is much less likely where detailed disclosure is required. There will undoubtedly be some fraud in the resale market no matter what the rules are, but public crowdfunding will be much less susceptible to such fraud than the private Rule 504 sales in which the pump-and-dump frauds occurred.
The resale restrictions are consistent with neither the come-to-rest rationale nor the information rationale for resale restrictions Forcing crowdfunding purchasers to wait a year before reselling therefore serves no real purpose. The only real effect of those resale restrictions is to make an already-risky investment even riskier by reducing liquidity.
Friday, March 20, 2015
Bernard Sharfman has posted a new article entitled “Activist Hedge Funds in a World of Board Independence: Long-Term Value Creators or Destroyers?" In the paper he makes the argument that hedge fund activism contributes to long-term value creation if it can be assumed that the typical board of a public company has an adequate amount of independence to act as an arbitrator between executive management and the activist hedge fund. He also discusses these funds’ focus on disinvestment and attempts to challenge those in the Marty Lipton camp, who view these funds less charitably. In fact, Lipton recently called 2014 “the year of the wolf pack.” The debate on the merits of activist hedge funds has been heating up. Last month Forbes magazine outlined “The Seven Deadly Sins of Activist Hedge Funds,” including their promotion of share buybacks, aka “corporate cocaine.” Forbes was responding to a more favorable view of these funds by The Economist in its February 7, 2015 cover story.
Whether you agree with Sharfman or Lipton, the article is clearly timely and worth a read. The abstract is below:
Numerous empirical studies have shown that hedge fund activism has led to enhanced returns to investors and increased firm performance. Nevertheless, leading figures in the corporate governance world have taken issue with these studies and have argued that hedge fund activism leads to long-term value destruction.
In this article, it is argued that an activist hedge fund creates long-term value by sending affirming signals to the board of directors (Board) that its executive management team may be making inefficient decisions and providing recommendations on how the company should proceed in light of these inefficiencies. These recommendations require the Board to review and question the direction executive management is taking the company and then choosing which path the company should take, the one recommended by executive management, the one recommended by the activist hedge fund or a combination of both. Critical to this argument is the existence of a Board that can act as an independent arbitrator in deciding whose recommendations should be followed.
In addition, an explanation is given for why activist hedge funds do not provide recommendations that involve long-term investment. There are two reasons for this. First, the cognitive limitations and skill sets of those individuals who participate as activist hedge funds. Second, and most importantly, the stock market signals provided by value investors voting with their feet are telling the rest of the stock market that a particular public company is poorly managed and that it either needs to be replaced or given less assets to manage. These are the kind of signals and information that activist hedge funds are responding to when buying significant amounts of company stock and then making their recommendations for change. Therefore, it is not surprising that the recommendations of activist hedge funds will focus on trying to reduce the amount of assets under current management.
Wednesday, March 18, 2015
Avantages de Participation à des Conférences Internationales Interdisciplinaires (Benefits of Attending Interdisciplinary International Conferences)
Greetings from Lyon, France, where I am presenting a work-in-process at an international conference on microfinance and crowdfunding organized by the Groupe ESC Dijon Borgogne (Burgundy School of Business) Chaire Banque Populaire en Microfinance. As the only legal scholar, the only U.S. researcher, and the only presenter with an orange-casted arm (!), I stand out in the crowd. So what is a one-armed U.S. law professor like me, with limited French language skills, doing in a place like this on my spring break? Among other things, I am:
- Broadening my academic and practical view of the world of business finance;
- Making new connections, personally and substantively;
- Getting different, pointed feedback on my ongoing crowdfunding work;
- Offering assistance and new perspectives (U.S.-centric, legal, regulatory, etc.) to scholars and industry participants from a spectrum of countries; and
- Securing potential partners and resources for future projects.
Although most of the participants speak English, I am still living at the edge of my socio-lingual comfort zone. It helps that I am an off-the-charts extrovert. Regardless, however, the benefits of attendance have been immediate and meaningful.
Questions for our readers:
Do you participate in interdisciplinary research conferences?
If not, why not?
If so, what scholarly traditions were emphasized? What did you find most beneficial . . . or most difficult?
Have you attended international research conferences?
If not, is it because of cost, personal discomfort, or another reason?
If so, how (if at all) have you benefitted from your attendance? What insights can you offer those considering doing the same?
Friday, March 6, 2015
It’s always nice to be validated. Day two into torturing my business associations students with basic accounting and corporate finance, I was able to post the results of a recent study about what they were learning and why. "Torture" is a strong word-- I try to break up the lessons by showing up to the minute video clips about companies that they know to illustrate how their concepts apply to real life settings. But for some students it remains a foreign language no matter how many background YouTube videos I suggest, or how interesting the debate is about McDonalds and Shake Shack on CNBC.
My alma mater Harvard Law School surveyed a number of BigLaw graduates about the essential skills and coursework for both transactional and litigation practitioners. As I explained in an earlier post, most of my students will likely practice solo or in small firms. But I have always believed that the skills sets are inherently the same regardless of the size of the practice or resources of the client. My future litigators need to know what documents to ask for in discovery and what questions to ask during the deposition of a financial expert. My family law and trust and estates hopefuls must understand the basics of a business structure if they wish to advise on certain assets. My criminal law aficionados may have to defend or prosecute criminal enterprises that are as sophisticated as any multinational corporation. Those who want to be legislative aides or go into government must understand how to close loopholes in regulations.
What are the top courses students should take? The abstract is below:
We report the results of an online survey, conducted on behalf of Harvard Law School, of 124 practicing attorneys at major law firms. The survey had two main objectives: (1) to assist students in selecting courses by providing them with data about the relative importance of courses; and (2) to provide faculty with information about how to improve the curriculum and best advise students. The most salient result is that students were strongly advised to study accounting and financial statement analysis, as well as corporate finance. These subject areas were viewed as particularly valuable, not only for corporate/transactional lawyers, but also for litigators. Intriguingly, non-traditional courses and skills, such as business strategy and teamwork, are seen as more important than many traditional courses and skills.
Did you take these courses? Has your school started adding more of this type of coursework and does your faculty see the value? Do you agree with the results of this survey? Let me know in the comments or email me at email@example.com.
March 6, 2015 in Business Associations, Corporate Finance, Corporate Governance, Corporations, Current Affairs, Jobs, Law School, Marcia Narine, Securities Regulation, Teaching | Permalink | Comments (2)
Monday, March 2, 2015
As many of you know, both I and my co-blogger Joan Heminway have written several articles on crowdfunding. My articles are available here and Joan’s are available here. I think that a properly structured crowdfunding exemption (unfortunately, not the exemption Congress authorized in Title III of the JOBS Act) could revolutionize the finance of very small businesses.
Professor Darian M. Ibrahim, of William & Mary Law School, has posted an interesting and important new paper on crowdfunding, Equity Crowdfunding: A Market for Lemons? It’s available here.
Professor Ibrahim discusses two types of “crowdfunding” approved by the JOBS Act: (1) sales to accredited investors pursuant to SEC Rule 506(c), adopted pursuant to Title II of the JOBS Act; and (2) sales to any investors pursuant to the crowdfunding exemption authorized by Title III of the JOBS Act, but not yet implemented by the SEC. I don’t think the former should be called crowdfunding, but many people call it that, so I’ll excuse Professor Ibrahim.
Title II “Crowdfunding”
Professor Ibrahim points out that traditional investing by venture capitalists and angel investors is characterized by contractual controls and direct personal attention to the business by the investors. This allows the investors to monitor the investment and control misbehavior, and the investors’ participation and advice also provides a benefit to the business.
Ibrahim argues that Title II (506(c)) “crowdfunding” has been successful because it mimics what angel investors have been doing all along. It’s not really revolutionary, just making the existing model of angel investing more efficient by moving it to the Internet.
Title III Crowdfunding
Title III crowdfunding, on the other hand, is revolutionary; it doesn’t resemble anything that currently exists in the United States. If the SEC ever adopts the required rules, issuers will be selling to unaccredited investors who lack the knowledge and sophistication of venture capitalists and angel investors. It’s less obvious how they will judge among the various offerings and protect themselves from misbehavior by the entrepreneur.
Some have argued that the new crowdfunding exemption will appeal only to those companies that are too low quality to obtain traditional VC or angel funding, leaving unaccredited investors with the bottom of the barrel. Ibrahim disagrees, arguing that Title III crowdfunding will appeal to some high-quality entrepreneurs—those who need less cash for their businesses or are unwilling to share control with VCs or angel investors.
But how are we to avoid a “lemons” problem if the unsophisticated investors likely to participate in crowdfunding cannot distinguish good companies from bad? Ibrahim poses two possible answers. The first is the “wisdom of crowds,” the idea that the collective decision-making of a large crowd can approximate or even exceed expert judgments. Possibly, although I’m not completely sure. Collective judgments by non-experts can equal or surpass the judgments of experts, but I'm still unsure that the necessary conditions for that to happen are met on crowdfunding platforms. At best, I think the wisdom of the crowd is only a partial answer.
Ibrahim’s second answer is for the funding portals who host crowdfunding offers to curate the offerings—investigate the quality of the offerings and either provide ratings or limit their sites to higher-quality offerings. I think this is a good idea, but, unfortunately, the SEC’s proposed regulations would prohibit funding portals from doing this. Funding portals required to check for fraud, but that’s all they can do. Any attempt to exclude entrepreneurs for reasons other thanfraud or to provide ratings would go beyond what the proposed regulations allow and subject the portals to regulation under the Investment Advisers Act. Ibrahim has the right solution, but it’s going to require congressional action to get there.
Abstract of the Paper
Here’s the full abstract of Professor Ibrahim’s article:
Angel investors and venture capitalists (VCs) have funded Google, Facebook, and virtually every technological success of the last thirty years. These investors operate in tight geographic networks which mitigates uncertainty, information asymmetry, and agency costs both pre- and post-investment. It follows, then, that a major concern with equity crowdfunding is that the very thing touted about it – the democratization of investing through the Internet – also eliminates the tight knit geographic communities that have made angels and VCs successful.
Despite this foundational concern, entrepreneurial finance’s move to cyberspace is inevitable. This Article examines online investing both descriptively and normatively by tackling Titles II and III of the JOBS Act of 2012 in turn. Title II allows startups to generally solicit accredited investors for the first time; Title III will allow for full-blown equity crowdfunding to unaccredited investors when implemented.
I first show that Title II is proving successful because it more closely resembles traditional angel investing than some new paradigm of entrepreneurial finance. Title II platforms are simply taking advantage of the Internet to reduce the transaction costs of traditional angel operations and add passive angels to their networks at a low cost.
Title III, on the other hand, will represent a true equity crowdfunding situation and thus a paradigm shift in entrepreneurial finance. Despite initial concerns that only low-quality startups and investors will use Title III, I argue that there are good reasons why Title III could attract high-quality participants as well. The key question will be whether high-quality startups can signal themselves as such to avoid the classic “lemons” problem. I contend that harnessing the wisdom of crowds and redefining Title III”s “funding portals” to serve as reputational intermediaries are two ways to avoid the lemons problem.
It’s definitely worth reading.
Andrew Schwartz at the University of Colorado is also working on a paper that addresses the problems of uncertainty, information asymmetry, and agency costs in Title III crowdfunding. I have read the draft and it’s also very good, but it’s not yet publicly available. I will let you know when it is.
Monday, February 23, 2015
I serve on the Tennessee Bar Association Business Entity Study Committee (BESC) and Business Law Section Executive Committee (mouthfuls, but accurately descriptive). The BESC was originated to vet proposed changes to business entity statutes in Tennessee. It was initially populated by members of the Business Law Section and the Tax Law Section, although it's evolved to mostly include members of the former with help from the latter. The Executive Committee of the Business Law Section reviews the work of the BESC before Tennessee Bar Association leadership takes action.
Just about every legislative session of late, these committees of the Tennessee Bar Association have been asked to review proposed legislation on benefit corporations (termed variously depending on the sponsors). A review request for a bill proposed for adoption for this session recently came in. Since I serve on both committees, I get to see these proposed bills all the time. So far, the proposals have pretty much tracked the B Lab model from a substantive perspective, as tailored to Tennessee law. To date, we have advised the Tennessee Bar Association that we do not favor this proposed legislation. Set forth below is a summary of the rationale I usually give.
February 23, 2015 in Business Associations, Corporate Finance, Corporate Governance, Corporations, Current Affairs, Entrepreneurship, Haskell Murray, Joan Heminway, Social Enterprise | Permalink | Comments (18)
Thursday, February 5, 2015
Many corporate governance professionals have been scratching their heads lately. In November, a federal judge in Delaware ruled that Wal-Mart had wrongfully excluded a shareholder proposal by Trinity Wall Street Church regarding the sale of guns and other products. Specifically, the proposal requested amendment of one of the Board Committee Charters to:
27. Provid[e] oversight concerning the formulation and implementation of, and the public reporting of the formulation and implementation of, policies and standards that determine whether or not the Company [i.e., Wal-Mart] should sell a product that:
1) especially endangers public safety and wellbeing;
2) has the substantial potential to impair the reputation of the Company; and/or
3) would reasonably be considered by many offensive to the family and community values integral to the Company's promotion of its brand.
Wal-Mart filed with the SEC under Rule 14a-8 indicating that it planned to exclude the proposal under the ordinary business operations exclusion. The SEC agreed that there was a basis for exclusion under 14a-8(i)(7), but the District Court thought otherwise because the proposal related to a “sufficiently significant social policy.” In mid-January Wal-Mart appealed to the Third Circuit arguing among other things that the district court should have deferred to the SEC’s precedents and guidance over the past forty years on these issues.
In an unrelated but relevant matter in December 2014, the SEC issued a no action letter to Whole Foods stating:
You represent that matters to be voted on at the upcoming stockholders' meeting include a proposal sponsored by Whole Foods Market to amend Whole Foods Market's bylaws to allow any shareholder owning 9% or more of Whole Foods Market's common stock for five years to nominate candidates for election to the board and require Whole Foods Market to list such nominees with the board's nominees in Whole Foods Market's proxy statement. You indicate that the proposal and the proposal sponsored by Whole Foods Market directly conflict. You also indicate that inclusion of both proposals would present alternative and conflicting decisions for the stockholders and would create the potential for inconsistent and ambiguous results. Accordingly, we will not recommend enforcement action to the Commission if Whole Foods Market omits the proposal from its proxy materials in reliance on rule 14a-8(i)(9).
In a startling turn of events, the SEC withdrew its no action letter on January 16, 2015 after a January 9th letter from the Council of Institutional Investors questioning the reasoning in the Whole Foods and similar no action letters. The withdrawal of the no action letter came on the same day as the release an official SEC statement declining “to express a view on the application of Rule 14a-8(i)(9) during the current proxy season” due to questions about the scope and application of the rule.
This announcement, a contradictory departure from a decision made just weeks earlier, benefits neither issuers nor investors and introduces an additional layer of uncertainty into an already complicated set of rules. The CCMC believes this reversal underscores why corporate governance policies must provide certainty for all stakeholders, not just to advance the goals of a small minority of special interest activists….[t]he January 16 announcement places many issuers in an untenable position, and presents them with a series of questions for which there may be no good answers. For those issuers wishing to present their own alternative proposal to shareholders for consideration, do they exclude a shareholder proposal in favor of their own and face the heightened risk of litigation with the proponent or the Commission? Do they risk shareholder confusion by including both their own proposal and a competing one from a proponent? Do they incur the added expense and distraction to management of seeking declaratory relief in federal district court? Are shareholders deprived of their right to include a proposal that is omitted because of the absence of SEC action? Far from encouraging private ordering, the recent announcement will only serve to stymie it.
The CCMC also recommends a review of the entire 14a-8 process because, as the letter claims, “it is well-known that the shareholder proposal process has been dominated by a small group of special interest activists, including groups affiliated with organized labor, certain religious orders, social and public policy advocates, and a handful of serial activists. These special interests use the shareholder proposal process to pursue their own idiosyncratic agendas, often far removed from the mainstream, as evidenced by the overall low approval rates of many shareholder proposals that are put to a vote. Indeed, mainstream institutional investors account for only one percent of shareholder proposals at the Fortune 250.”
Reasonable people may disagree on how the CCMC characterizes the motives behind the shareholder proposals, but there can be no disagreement that the current SEC silence doesn't serve any constituency. Steve Bainbridge also has an informative post on this topic. Proxy season is coming up and shareholders and companies alike are awaiting a decision from the Third Circuit in the Wal-Mart action that could dramatically alter the landscape for shareholder proposals, possibly flooding the courts with expensive, protracted litigation. The timing couldn’t be worse for the SEC’s lack of action on no action letters.
February 5, 2015 in Corporate Finance, Corporate Governance, Corporations, Current Affairs, Delaware, Financial Markets, Marcia Narine, Securities Regulation, Social Enterprise | Permalink | Comments (0)