Thursday, December 5, 2013
Yesterday was the last day of a fantastic three-day conference at the UN in Geneva on business and human rights, and I will blog about it next week after I fully absorb all that I have heard. As I type this (Wednesday), I am sitting in a session on corporate governance and the UN Guiding Principles on Business and Human Rights moderated by a representative from Rio Tinto. The multi-stakeholder panel consists of representatives from Caux Roundtable Japan (focused on moral capitalism), the Norwegian National Contact Point (the governmental entity responsible for responding to claims between aggrieved parties and companies), Aviva Public Limited (insurance, pensions UK), Cividep (a civil society organization in India), and Petrobas (energy company in Brazil).
If you want to learn more about the conference, I have been tweeting for the past two days at @mlnarine, and you can follow the others who have been posting at #UNForumWatch #unforumwatch or #businessforum. 1700 businesspeople, lawyers, academics, NGOs, state delegates and members of civil society are here. Economist Joseph Stiglitz presented a fiery keynote address. Some of the biggest names in business such as Microsoft, Unilever, Total, Vale and others have represented corporate interests.
Depending on where you are, by the time you read this, I will be in Oslo attending a conference on climate change and global company law and will be speaking on the US perspective on Friday. I will blog on that conference on my Thursday spot in two weeks.
On a completely unrelated note, with Bitcoin appreciating over 5000% in the past year (see here) and reaching $1000 last week, I thought readers would be interested in this article, “Whack-A-Mole: Why Prosecuting Digital Currency Exchanges Won’t Stop Online Money Laundering”by Catherine Martin Christopher. Au revoir from Geneva. Hallo from Norway.
The abstract is below.
Law enforcement efforts to combat money laundering are increasingly misplaced. As money laundering and other underlying crimes shift into cyberspace, U.S. law enforcement focuses on prosecuting financial institutions’ regulatory violations to prevent crime, rather than going after criminals themselves. This article will describe current U.S. anti-money laundering laws, with particular criticism of how attenuated prosecution has become from crime. The article will then describe the use of Bitcoin as a money-laundering vehicle, and analyze the difficulties for law enforcement officials who attempt to choke off Bitcoin transactions in lieu of prosecuting underlying criminal activity. The article concludes with recommendations that law enforcement should look to digital currency exchangers not as criminals, but instead as partners in the effort to eradicate money laundering and — more importantly — the crimes underlying the laundering.
Wednesday, December 4, 2013
Earlier this week the SEC released its 2014 rulemaking agenda and excluded from the list is a proposal for public companies to disclose political spending. In 2011, the Committee on Disclosure of Corporate Political Spending, comprised of 10 leading corporate and securities academics, petitioned the SEC to adopt a political spending disclosure rule. This petition has received a historic number of comments—over 640,000—which can be found here.
The Washington Post reported that after the petition was filed,
A groundswell of support followed, with retail investors, union pension funds and elected officials at the state and federal levels writing to the agency in favor of such a requirement. The idea attracted more than 600,000 mostly favorable written comments from the public — a record response for the agency.
Omitting corporate political spending from the 2014 agenda has received steep criticism from the NYT editorial board in an opinion piece written yesterday declaring the decision unwise “even though the case for disclosure is undeniable.” Proponents of corporate political spending disclosure like Public Citizen are “appalled” and “shocked” by the SEC’s decision, while the Chamber of Commerce declares the SEC’s omission a coup that appropriately avoids campaign finance reform.
Included in the 2014 agenda are Dodd-Frank and JOBS Act measures, as well as a proposal to enhance the fiduciary duties owed by broker-dealers. More on the agenda in future posts….
Sunday, December 1, 2013
- Matteo Tonello on “The Separation of Ownership from Ownership”
The increase in institutional ownership of corporate stock has led to questions about the role of financial intermediaries in the corporate governance process. This post focuses on the issues associated with the so-called “separation of ownership from ownership,” arising from the growth of three types of institutional investors, pensions, mutual funds, and hedge funds.
- Frank Reynolds: “Delaware must fix state takeover law now, law professor warns”
Originally, the anti-takeover law passed its court challenges because the judges accepted faulty data that showed investors could acquire at least 85 percent of the target corporation and satisfy the Williams Act, Subramanian said. But none of the cases used to support the anti-takeover law actually allowed hostile suitors to acquire a controlling 85 percent of a target company, he said, and plaintiffs using research from new studies would be able to convince a judge that the statute is unconstitutionally restrictive.
- Pascal-Emmanuel Gobry: “Let’s Listen to Pope Francis on Economics”
For me, the financial crisis was an eye-opening moment. I’ve long believed in free market economics and believed that the Church would do a lot of good in the world if it embraced it. And I still believe those things. But what the financial crisis has laid bare is that the most conventional version of free market economics was actually dead wrong.
- Martin Lipton: “Some Thoughts for Boards of Directors in 2014”
In many respects, the relentless drive to adopt corporate governance mandates seems to have reached a plateau: essentially all of the prescribed “best practices”—including say-on-pay, the dismantling of takeover defenses, majority voting in the election of directors and the declassification of board structures—have been codified in rules and regulations or voluntarily adopted by a majority of S&P 500 companies…. In other respects, however, the corporate governance landscape continues to evolve in meaningful ways.
Saturday, November 30, 2013
- If you are looking for some books to help you better understand our economic history, try: Timothy Shenk on “The Long Shadow of Mont Pèlerin” – reviewing Angus Burgin’s The Great Persuasion (“[U]ncovering a history where the supposed founders of the American chapter of neoliberalism at the University of Chicago reprimand Hayek’s The Road to Serfdom for overdoing its indictment of the state while Keynes reports himself “in a deeply moved agreement” with the very same text.”).
- I thought I knew what it felt like to be scatterbrained and distracted, then I started spending time on Twitter. Let’s just say my belief that meditation is an integral part of work-life balance was reinvigorated. Relatedly, try: (1) bidushi on “The corporate world’s flirtation with meditation” and (2) “Free Video – ‘3-minute breathing space’ Guided Meditation” from the Oxford Mindfulness Centre.
- For the blogroll: Jennifer Taub’s "perpetual crisis" blog (“a blog on banking, corporate governance, and financial market reform”).
- Finally, you might be interested in Michael Pettis on “When Are Markets ‘Rational’?" (“To me, much of the argument about whether or not markets are efficient misses the point. There are conditions, it seems, under which markets seem to do a great job of managing risk, keeping the cost of capital reasonable, and allocating capital to its most productive use, and there are times when clearly this does not happen. The interesting question, in that case, becomes what are the conditions under which the former seems to occur.”).
Friday, November 29, 2013
In the movie Margin Call, which “[f]ollows the key people at an investment bank, over a 24-hour period, during the early stages of the financial crisis,” one of the main characters says: “There are three ways to make a living in this business: be first, be smarter, or cheat.” Given that only a few folks will be first or smarter, it may not be surprising that a “new report finds 53% of financial services executives say that adhering to ethical standards inhibits career progression at their firm.” In a piece over at The Guardian, Chris Arnade, a former Wall Street trader describes why. What follows is an excerpt from that piece, but you should go read the whole thing here.
After a few years on Wall Street it was clear to me: you could make money by gaming anyone and everything. The more clever you were, the more ingenious your ability to exploit a flaw in a law or regulation, the more lauded and celebrated you became. Nobody seemed to be getting called out. No move was too audacious. It was like driving past the speed limit at 79 MPH, and watching others pass by at 100, or 110, and never seeing anyone pulled over. Wall Street did nod and wave politely to regulators’ attempts to slow things down. Every employee had to complete a yearly compliance training, where he was updated on things like money laundering, collusion, insider trading, and selling our customers only financial products that were suitable to them. By the early 2000s that compliance training had descended into a once-a-year farce, designed to literally just check a box….
As Wall Street grew, fueled by that unchecked culture of risk taking, traders got more and more audacious, and corruption became more and more diffused through the system. By 2006 you could open up almost any major business, look at its inside workings, and find some wrongdoing. After the crash of 2008, regulators finally did exactly that. What has resulted is a wave of scandals with odd names; LIBOR fixing, FX collusion, ISDA Fix. To outsiders they sound like complex acronyms that occupy the darkest corners of Wall Street, easily dismissed as anomalies. They are not. LIBOR, FX, ISDA Fix are at the very center of finance ….
[So,] where is the real responsibility? … [T]he people who really should be held accountable have not. They are the bosses, the managers and CEOs of the businesses. They set the standard, they shaped the culture…. The managers knew what was going on. Ask anyone who works at a bank and they will tell you that. The excuse we have long accepted is ignorance: that these leaders couldn't have known what was happening. That doesn't suffice. If they didn't know, it's an even larger sin.
Thursday, November 28, 2013
On Saturday evening I leave for Geneva to attend the United Nations Forum on Business and Human Rights with 1,000 of my closest friends including NGOs, Fortune 250 Companies, government entities, academics and other stakeholders. I plan to blog from the conference next week. I am excited about the substance but have been dreading the expense because the last time I was in Switzerland everything from the cab fare to the fondue was obscenely expensive, and I remember thinking that everyone in the country must make a very good living. Apparently, according to the New York Times, the Swiss, whom I thought were superrich, "scorn the Superrich," and last March a two-thirds majority voted to ban bonuses, golden handshakes and to require firms to consult with their shareholders on executive compensation. Nonetheless, last week, 65% of voters rejected a measure to limit executive pay to 12 times the lowest paid employee at their company. According to press reports many Swiss supported the measure in principle but did not agree with the government imposing caps on pay.
Meanwhile stateside, next week the SEC closes its comment period on its own pay ratio proposal under Section 953(b) of the Dodd-Frank Act. Among other things, the SEC rule requires companies to disclose: the median of the annual total compensation of all its employees except the CEO; the annual total compensation of its CEO; and the ratio of the two amounts. It does not specify a methodology for calculation but does require the calculation to include all employees (including full-time, part-time, temporary, seasonal and non-U.S. employees), those employed by the company or any of its subsidiaries, and those employed as of the last day of the company’s prior fiscal year. A number of bloggers have criticized the rule (see here for example), business groups generally oppose it, and the agency has been flooded with tens of thousands of comment letters already.
The SEC must take some action because Congress has dictated a mandate through Dodd-Frank. It can’t just listen to the will of the people (many of whom support the rule) like the Swiss government did. It will be interesting to see what the agency does. After all two of the commissioners voted against the rule, and one has publicly spoken out against it. But the SEC does have some discretion. The question is how will it exercise that discretion and will the agency once again face litigation as it has with other Dodd-Frank measures where business groups have challenged its actions (proxy access, resource extraction and conflict minerals, for example). More important, will it achieve the right results? Will investors armed with more information change their nonbinding say-on-pay votes or switch out directors who overpay underperforming or unscrupulous executives? If not, then will this be another well-intentioned rule that does nothing to stop the next financial crisis?
Tuesday, November 26, 2013
Every day MIDAS collects about 1 billion records from the proprietary feeds of each of the 13 national equity exchanges time-stamped to the microsecond. MIDAS allows us to readily perform analyses of thousands of stocks and over periods of six months or even a year, involving 100 billion records at a time.
MIDAS collects posted orders and quotes, modifications/cancellations, and trade executions on national exchanges, as well as off-exchange trade executions.
The methodology for MIDAS is available here.
Happy Thanksgiving BLPB readers!
Sunday, November 24, 2013
The CFA Institute, the Journal of Corporate Finance, and the Schulich School of Business are sponsoring a Conference on Financial Misconduct, April 3-4, 2014, in Toronto, Canada. Deadline for submissions is December 15, 2013. You can go here for all the information. What follows is the stated rationale, along with suggested research questions.
Financial market misconduct erodes investors trust, and in turn influences stock market liquidity and performance, and exacerbates volatility. Financial market misconduct includes but is not limited to fraud. Despite the widespread media attention on market misconduct, the causes and consequences of market misconduct are often misunderstood and under researched around the world. The evolving structure of markets gives rise to new work on topic
This international conference will provide a timely debate on financial market misconduct. The conference also encourages, but does not require, submission to the Journal of Corporate Finance. Papers submitted to the Journal of Corporate Finance would go through the normal review process.
Some research questions that contributors to the conference might address are:
- Is market misconduct more common in different countries or across different exchanges? If so, what types (earnings management, insider trading, market manipulation, dissemination of false and misleading information, other)?
- What are the causes of international differences in expected or detected misconduct?
- What are the consequences of market misconduct, and do they differ across countries or exchanges?
- Can regulation be designed to improve ethical standards and corporate governance?
- Does high frequency trading mitigate or exacerbate market misconduct?
- Does crowdfunding facilitate potential financial market misconduct, and how might such potential misconduct be mitigated through regulation?
- Do intermediaries such as lawyers, auditors, and investment bankers mitigate or exacerbate financial market misconduct?
- Is financial market misconduct exacerbated or mitigated under different types of ownership, such as government, institutional, or family ownership?
- How is market misconduct related to activist investors such as venture capital, private equity, and hedge fund investors?
- How is fraud risk and ethics priced in markets?
- How does the risk of market misconduct affect corporate valuation?
- To what extent has the failure of regulation and reporting standards exacerbated the incidence of market misconduct and the recent financial crisis?
- What encourages the adoption of ethical standards in public firms versus private firms?
- Related research questions on both publicly traded and privately held institutions are welcome.
Tuesday, November 19, 2013
Last week, I had the pleasure of being part of the Second Annual Searle Center Conference on Federalism and Energy in the United States. (I had the good fortune to be part of the first one, too.) The conference covered a wide range of energy issues from electricity transmission siting to hydraulic fracturing to natural gas markets. One paper/presentation struck me as particularly interesting for markets generally (I am told an update version will be available soon at the same site: “The Evolution of the Market for Wholesale Power” by Daniel F. Spulber, Kellogg School of Management, Elinor Hobbs Distinguished Professor of International Business and Professor of Management Strategy & R. Andrew Butters, Kellogg School of Management, Northwestern University.
Here is the conclusion:
A national market for wholesale electric power in the US has emerged following industry restructuring in 2000. Tests for correlation and Granger Causality between trading hubs support the presence of a national market. Going beyond pairwise analysis, we introduce an array of multivariate techniques capable of addressing the national market hypothesis, including the common trend test. Although there is strong evidence of integration between the series, the analysis suggests a division between the eastern and western parts of the market. We also find border connects of 300 miles between the three interconnects.
The absence of transmission between the interconnects and significant border effects suggests that the national market is not yet fully integrated, even within the one-month horizon. Construction of transmission facilities between the interconnects would complete the development of the US wholesale market for electric power. Our analysis suggests that transmission facilities connecting the three regions would result in substantial gains from trade.
This conclusion – that “[a] national market for wholesale electric power in the US has emerged following industry restructuring in 2000 – could have a profound effect for how we view (and FERC views) wholesale electricity markets. The study notably does not control for or otherwise address the price of renewable energy credits (RECs), which are required for compliance with renewable portfolio standards in a majority of states. This may not change the conclusion, but it would be interesting to see how if the RECs have any influence on the market operations.
In addition, it’s possible that more than just the 2000 market restructuring is at play here. Since that time, electricity generation from natural gas has grown dramatically, and there is every reason to believe that will continue. According to the Energy Information Administration, “Nearly 237 GW of natural gas-fired generation capacity was added between 2000 and 2010, representing 81% of total generation capacity additions over that period.” If natural gas really is a major driver in facilitating this market, it would mean that that recent shale gas boom is even broader reaching than some may have expected.
There’s more work to be done here to be certain a national market for electricity really is emerging and if more can be done to facilitate that market. If true, such a market could bode well for the consumers, especially those in higher cost regions. It could also be an indicator that the regulatory structure of the market, even if not ideal, it working efficiently. If so (as I am inclined to believe), it suggests that the Congress and FERC should leave the market-related regulations alone, and focus efforts on things that will further develop the market, such as the study’s finding “that transmission facilities connecting the three regions would result in substantial gains from trade.”
Sunday, November 17, 2013
A quick review of the top 10 Papers for Corporate, Securities & Finance Law eJournals on SSRN for the period of September 18, 2013 to November 17, 2013 (here), led me to Utpal Bhattacharya’s paper “Insider Trading Controversies: A Literature Review.” Here is the abstract:
Using the artifice of a hypothetical trial, this paper presents the case for and against insider trading. Both sides in the trial produce as evidence the salient points made in more than 100 years of literature on insider trading. The early days of the trial focus on the issues raised in the law literature like fiduciary responsibility, the misappropriation theory and the fairness and integrity of markets, but the trial soon focuses on issues like Pareto-optimality, efficient contracting, market efficiency, and predictability raised in the financial economics literature. Open issues are brought up. A jury finally hands out its verdict.
Thursday, November 14, 2013
This week two articles caught my eye. The New York Times’ Room for Debate feature presented conflicting views on the need to “prosecute executives for Wall Street crime.” My former colleague at UMKC Law School, Bill Black, has been a vocal critic of the Obama administration’s failure to prosecute executives for their actions during the most recent financial crisis, and recommended bolstering regulators to build cases that they can win. Professor Ellen Podgor argued that the laws have overcriminalized behavior in a business context, and that the “line between criminal activities and acceptable business judgments can be fuzzy.” She cited the thousands of criminal statutes and regulations and compared them to what she deems to be overbroad statutes such as RICO, mail and wire fraud, and penalties for making false statements. She worried about the potential for prosecutors to abuse their powers when individuals may not understand when they are breaking the law.
Charles Ferguson, director of the film “Inside Job,” likened the activity of some major financial executives to that of mobsters and argued that they have actually done more damage to the economy. He questioned why the government hadn’t used RICO to pursue more criminal cases. Former prosecutor and now private lawyer Allen Goelman pointed out rather bluntly that prosecutors aren’t cozy with Wall Street—they just won’t bring a case when the evidence won’t allow them to win. He also reminded us that greed and stupidity, which he claimed was the cause of the “overwhelming majority of the risky and irresponsible behavior by Wall Street,” are not crimes. Professor Lawrence Friedman wrote that the law “announces the community’s conceptions of right and wrong,” and if we now treat corporations like people under Citizens United then we should likewise make the executives who run them the objects of the community’s condemnation of wrongdoing.
Finally, Senator Elizabeth Warren concluded that if corporations know that they can break the law, pay a large settlement, and not admit any guilt or have any individual prosecuted, they won’t have any incentive to follow the law. She also argued for public disclosure of these settlements including whether there were tax deductions or releases of liability.
This brings me to the second interesting article. Former SEC enforcement chief and now Kirkland & Ellis partner Robert Khuzami recently said, “I didn’t think there was much doubt in most cases that a defendant engaged in wrongdoing when you had a 20-page complaint, you had them writing a big check, you may well have prosecuted an individual in the wrongdoing.” While not endorsing or rejecting current SEC Chair Mary Jo White’s position to require certain companies to admit wrongdoing in settlements, he raised a concern about whether this change in policy would place undue strain on the agency’s limited resources by forcing more cases to go to trial. He also raised a valid point about the legitimate fear that firms should have in that admitting guilt could expose them to lawsuits, criminal prosecution, and potential business losses. Chair White did not set out specific guidelines for the new protocol, but so far this year 22 companies have benefitted from the no admit/no deny policy and have paid $14 million in sanctions. But we don’t know how many executives from these companies lost their jobs. On the other hand, would these same companies have settled if they had to admit liability or would they have demanded their day in court?
Should the desire to preserve agency resources trump the need to protect the investing public—the stated purpose of the SEC? If neither the company nor the executive faces true accountability, what will be the incentive to change? In a post-Citizens United world, will Congressmen strengthen the laws or bolster the power and resources of the regulators to go after the corporations that help fund their campaigns? Have we, as Dostoyevsky asserted, become “used” to the current state of affairs where drug dealers and murderers go to jail, but there aren’t enough resources to pursue financial miscreants?
What will make companies and executives “do the right thing”? Dostoyevksy also wrote “intelligence alone is not nearly enough when it comes to acting wisely,” and he was right. Perhaps the fear of the punishment for clearly enumerated and understood crimes, and the fear of the admission of wrongdoing with the attendant collateral damage that causes will lead to a change in individual and corporate behavior. I agree with Professor Podgor that there is clearly room for prosecutorial abuse of power and that the myriad of laws can lead to a no-mans land for the unwary executive forced to increase margins and earnings per share (while possibly getting a healthy bonus). While I have argued in the past for an affirmative defense for certain kinds of corporate crimial liability, I also agree with Professor Black and Senator Warren. At some point, people and the corporations (made up of people) need more than “intelligence” to act “wisely.” They need the punishment to fit the crime.
Wednesday, November 13, 2013
We live in a world where most working individuals have some retirement savings invested in the stock market. The stock market funds, in part, college educations, and serve as the primary wealth accumulator for post-baby boom generations. My parents—an elementary school teacher and a furniture salesman—lived in Midwestern frugality and invested their savings from the mid-80’s until 2006 when they pulled out of the market. They retired early, comfortably (so I believe), and largely because of consistent gains in the stock market over a 30 year period. The question is whether this story is repeatable as a viable outcome for working investors now.
The Wall Street Journal ran a story on Monday “Stocks Regain Appeal” documenting the number of dollars flowing into markets from retail investors as well as the anecdotal confidence of investors. The WSJ reports that:
“U.S. stock mutual funds have attracted more cash this year than they have in any year since 2004, according to fund-tracker Lipper. Investors have sent $76 billion into U.S. stock funds in 2013. From 2006 through 2012, they withdrew $451 billion.”
This seems indisputably good right? Maybe. The real question for me is why is more money flowing into the markets and confidence high? Is this behavior driven by information, emotion, or herd mentality? Robert Shiller, recent Nobel Prize winner and author of Irrational Exuberance, wrote in March in a column for the NYT that investors were confident, but who knows why. Shiller’s conclusions were based on data from the cyclically adjusted price-earnings ratio, CAPE, of 23 suggesting that the market was priced high, which is interesting when compared with his data that 74% of individual investors did not think that the market was overpriced. Shiller strengthened his cautionary stance on the market last month when the CAPE held at 23.7, and Shiller warned that stocks were the “most expensive relative to earnings in more than five years.”
This is business law blog, not a market blog, yet the role of the market interests me greatly. As corporate law scholars, we teach students and write about the legal limits, obligations and assumptions that establish the market and dictate how individuals and institutions interact with the market and corresponding corporate-level controls. In 2007 the market collapsed (self-corrected if we want to use the economists’ terms) and what was the result? Dodd-Frank and a series of legislation aimed at policing the market. If we are interested in the laws that govern the market, surely some attention must be paid to how and why the market works the way that it does.
Friday, November 8, 2013
The Economist has an interesting piece on how “[a] mutation in the way companies are financed and managed will change the distribution of the wealth they create.” You can read the entire article here. A brief excerpt follows.
The new popularity of the [Master Limited Partnership] is part of a larger shift in the way businesses structure themselves that is changing how American capitalism works…. Collectively, distorporations such as the MLPs have a valuation on American markets in excess of $1 trillion. They represent 9% of the number of listed companies and in 2012 they paid out 10% of the dividends; but they took in 28% of the equity raised…. [The] beneficiaries, though, are a select class. Quirks in various investment and tax laws block or limit investing in pass-through structures by ordinary mutual funds, including the benchmark broad index funds, and by many institutions. The result is confusion and the exclusion of a large swathe of Americans from owning the companies hungriest for the capital the markets can provide, and thus from getting the best returns on offer….
Another booming pass-through structure is that of the “business development company” (BDC). These firms raise public equity and debt much like a leveraged fund.… What they all share is an ability to do bank-like business—lending to companies which need money—without bank-like regulatory compliance costs….
Andrew Morriss, of the University of Alabama law school, sees the shift as an entrepreneurial response to a century’s worth of governmental distortions made through taxation and regulation. At the heart of those actions were the ideas set down in “The Modern Corporation and Private Property”, a landmark 1932 study by Adolf Berle and Gardiner Means. As Berle, a member of Franklin Roosevelt’s “brain trust”, would later write, the shift of “two-thirds of the industrial wealth of the country from individual ownership to ownership by the large, publicly financed corporations vitally changes the lives of property owners, the lives of workers and …almost necessarily involves a new form of economic organisation of society.” … Several minor retreats notwithstanding, the government’s role in the publicly listed company has expanded relentlessly ever since.
November 8, 2013 in Business Associations, Books, Corporate Governance, Corporations, Current Affairs, Financial Markets, LLCs, Partnership, Securities Regulation, Stefan J. Padfield, Unincorporated Entities | Permalink | Comments (0)
Thursday, November 7, 2013
In 2011, I met with members of the SEC and Congressional staffers as part of a coalition of business people and lawyers raising concerns about the proposed Dodd-Frank whistleblower provision. Ten days after leaving my compliance officer position and prior to joining academia, I testified before a Congressional committee about the potential unintended consequences of the law. The so-called “bounty-hunter” law establishes that whistleblowers who provide original information to the SEC related to securities fraud or violations of the Foreign Corrupt Practices Act are eligible for ten to thirty percent of the amount of the recovery in any action in which the SEC levies sanctions in excess of $1 million dollars. The legislation also contains an anti-retaliation clause that expands the reach of Sarbanes-Oxley. Congress enacted the legislation to respond to the Bernard Madoff scandal. The SEC recently awarded $14 million dollars to one whistleblower. To learn more about the program, click here.
I argued, among other things, that the legislation assumed that all companies operate at the lowest levels of ethical behavior and instead provided incentives to bypass existing compliance programs when there are effective incentive structures within the existing Federal Sentencing Guidelines for Organizations. Although they are no longer binding, judges use the Guidelines to sentence corporations that plead guilty or are so adjudicated after trial. Prosecutors use them as guideposts when making deals with companies that enter into nonprosecution and deferred prosecution agreements. I recommended: (1) that there be a presumption that whistleblowers report internally first unless there is no viable, credible internal option; (2) that the SEC inform the company that an anonymous report has been made unless there is legitimate reason not to do so and (3) that those with a fiduciary duty to report be excluded from the bounty provisions of the bill and be required to report upward internally before reporting externally.
Fortunately, the final legislation does make it more difficult for certain people to report externally without first trying to use the compliance program, if one exists. Nonetheless, the Wall Street Journal reported yesterday that a growing number of compliance personnel are blowing the whistle on their own companies, notwithstanding the fact that they must wait 120 days under the rules after reporting internally to go to the SEC. One of the attorneys interviewed in the WSJ article, Gregory Keating, is a shareholder Littler Mendelsohn, a firm that exclusively represents management in labor matters. His firm and others are seeing more claims brought by compliance officers.
This development leads to a number of questions. What about compliance officers who are also lawyers, as I was? NY state has answered the question by excluding lawyers from the awards, and I am sure that many other states are considering it or will now start after reading yesterday’s article. What does this mean for those forward thinking law schools that are training law students to consider careers in compliance? I believe that this is a viable career choice in an oversaturated legal market because the compliance field is exploding, while the world of BigLaw is contracting. Do we advise students considering the compliance field to forego their bar licenses after graduation because one day they could be a whistleblower and face a conflict of interest? I think that’s unwise. What about compliance personnel in foreign countries? Courts have already provided conflicting rulings about their eligibility for whistleblower status under the law.
Most significantly, in many companies compliance officers make at least an annual report to the board on the activities of the compliance program in part to ensure that the board fulfills its Caremark responsibilities. These reports generally do and should involve detailed, frank discussions about current and future risks. Will and should board members become less candid if they worry that their compliance officer may blow the whistle?
Could the Sentencing Commission have avoided the need for compliance officers to blow the whistle externally by recommending that compliance officers report directly to the board as the heads of internal audit typically do? This option was considered and rejected during the last round of revisions to the Sentencing Guidelines in 2010. Compliance officers who do not report to general counsels or others in the C-Suite but have direct access to board members might feel less of a need to report to external agencies. This is why, perhaps, in almost every corporate integrity agreement or deferred prosecution agreement, the government requires the chief compliance officer to report to the board or at least to someone outside of the legal department.
To be clear, I am not opposed to the legislation in principle. And for a compliance officer to report on his or her own organization, the situation internally was probably pretty dire. Gregory Keating and I sit on the Department of Labor’s Whistleblower Protection Advisory Committee, which will examine almost two dozen anti-retaliation laws in the airline, commercial motor carrier, consumer product, environmental, financial reform, food safety, health care reform, nuclear, pipeline, public transportation agency, railroad, maritime and securities fields. During our two-year term we will work with academics, lawyers, government officials, organized labor and members of the public to make the whistleblower laws more effective for both labor and management.
State bars, government agencies, boards, general counsels, plaintiffs’ lawyers and defense lawyers need to watch these developments of the compliance officer as whistleblower closely. I will be watching as well, both as a former compliance officer and for material for a future article.
Wednesday, October 30, 2013
I have a new article, Retirement Revolution: Unmitigated Risks in the Defined Contribution Society, which describes citizen shareholders--individual investors who enter the stock market through defined contribution plans--and examines the overlapping corporate and ERISA laws that govern their investments.
A revolution in the retirement landscape over the last several decades shifted the predominant savings vehicle from traditional pensions (a defined benefit plan) to self-directed accounts like the 401(k) (a defined contribution plan) and has drastically changed how people invest in the stock market and why. The prevalence of self-directed, defined contribution plans has created our defined contribution society and a new class of investors — the citizen shareholders — who enter private securities market through self-directed retirement plans, invest for long-term savings goals and are predominantly indirect shareholders. With 90 million Americans invested in mutual funds, and nearly 75 million who do so through defined contribution plans, citizen shareholders are the fastest growing group of investors. Yet, citizen shareholders have the least protections despite conventional wisdom that corporate law and ERISA protections safeguard both these investors and their investments. As explained in an earlier paper, citizen shareholders do not fit neatly within the traditional corporate law framework because their investment within a defined contribution plan restricts choice and their indirect ownership status dilutes their information and voting rights, as well as exacerbates their rational apathy as diffuse and disempowered “owners.”
Sunday, October 27, 2013
Jennifer Taub has published a new book, “Other People's Houses: How Decades of Bailouts, Captive Regulators, and Toxic Bankers Made Home Mortgages a Thrilling Business.” Here is an excerpt from the Yale University Press description:
Focusing new light on the similarities between the savings and loan debacle of the 1980s and the financial crisis in 2008, Taub reveals that in both cases the same reckless banks, operating under different names, received government bailouts, while the same lax regulators overlooked fraud and abuse. Furthermore, in 2013 the situation is essentially unchanged. The author asserts that the 2008 crisis was not just similar to the S&L scandal, it was a severe relapse of the same underlying disease. And despite modest regulatory reforms, the disease remains uncured: top banks remain too big to manage, too big to regulate, and too big to fail.
UPDATE: The book will be in bookstores in May, but can be pre-ordered now.
Saturday, October 26, 2013
Bill Black takes down claims of a “victory for the government in its aggressive effort to hold banks accountable for their role in the housing crisis.” (HT: naked capitalism.) The full piece is available here, and I highly recommend you go read the whole thing. What follows is a brief excerpt:
The author of the most brilliantly comedic statement ever written about the crisis is Landon Thomas, Jr…. Everything worth reading is in the first sentence, and it should trigger belly laughs nationwide. “Bank of America, one of the nation’s largest banks, was found liable on Wednesday of having sold defective mortgages, a jury decision that will be seen as a victory for the government in its aggressive effort to hold banks accountable for their role in the housing crisis.” … Yes, we have not seen such an aggressive effort since Captain Renault told Rick in the movie Casablanca that he was “shocked” to discover that there was gambling going on (just before being handed his gambling “winnings” which were really a bribe)…. The jurors found that BoA (through its officers) committed an orgy of fraud in order to enrich those officers…. The journalist’s riff is so funny because he portrays DOJ’s refusal to prosecute frauds led by elite BoA officers as “aggressive.” Show the NYT article to friends you have who are Brits and who claim that Americans are incapable of irony…. I’m not sure whether the DOJ consciously deciding not to investigate, bring civil suits, or prosecute the most destructive frauds in history represents “aggressive” or “accountable” to the DOJ. We do know, however, the fantasy that caused DOJ to give these control frauds a free pass. Benjamin Wagner, a U.S. Attorney who is actively prosecuting mortgage fraud cases in Sacramento, Calif., points out that banks lose money when a loan turns out to be fraudulent. “It doesn’t make any sense to me that they would be deliberately defrauding themselves,” Wagner said. “They” refers to the CEO. “Themselves” refers to the bank. “They” are not “defrauding themselves.” … The game being played out in all the corporate settlements, like the JPMorgan deal, is that the controlling officers, even when they grew wealthy by looting the shareholders, use corporate funds to cut deals that protect them from being prosecuted or having to return their fraudulent proceeds. We all know who pays for this – the shareholders. Only a comic genius would have the mastery of irony necessary to call the ability of elite bankers to become wealthy through fraud with immunity “accountability.” … The self-congratulations that DOJ press flacks regularly issue to attempt to con journalists and the public into believing that DOJ is aggressively holding elite bankers accountable for their frauds make “Baghdad Bob” seem credible by comparison.
Thursday, October 24, 2013
Now that juries and the DOJ have spoken, will boards be more active in shaping ethical culture in the C-Suite?
CEOs and executives just can’t get a break in the news lately. A jury found both former Countrywide executive Rebecca Mairone and Bank of America liable for fraud for Countrywide’s “Hustle” loans in 2007 and 2008 (see here). Martha Stewart has had to renegotiate her merchandising agreement with JC Penney to avoid hearing what a judge will say about that side deal in the lawsuit brought against her by Macy’s, with whom she purportedly had an exclusive merchandising deal (see here). JP Morgan Chase is in talks to pay $13 billion to settle with the Department of Justice over various compliance-related failures, but the company still faces billions in claims from angry shareholders. The company isn’t out of the woods yet in terms of potential criminal liability (see here). CEO Jamie Dimon isn’t personally accused of any wrongdoing, and in fact has been instrumental in achieving the proposed settlements. But in the past he has faced questions from institutional shareholders about his dual roles as chair of the board and CEO. Those questions may come up again in the 2014 proxy season.
The Bank of America verdict and the recent JP Morgan Chase settlement may herald a new age of prosecutions and settlements both for institutions and executives for compliance failures and criminal activity. With the recent announcement of a $14 million dollar award for an SEC whistleblower coupled with the SEC's pronouncements about getting its "swagger" back, we can expect more legal actions to come as employees feel incentivized to come forward to report wrongdoing.
So what is the role of the board in directing, managing, and shaping corporate culture? In my former life as a compliance officer this issue occupied much of my time. My peers and I scoured the newspapers looking for cautionary tales like the ones I recounted above so that we could remind our internal clients and board members of what could happen if they didn’t follow the laws and our policies.
Bryan Cave partner Scott Killingsworth has written a white paper on the importance of the board in monitoring the C-Suite. He examines the latest research in behavioral ethics citing Lynne Dallas, Lynn Stout, Krista Llewellyn, Maureen Muller-Kahle, Max Bazerman and Francesca Gino, among others. It’s definitely worth a read by board members in light of recent headlines. The abstract is below:
The C-suite is a unique environment peopled with extraordinary individuals and endowed with the potential to achieve enormous good – or, as recent history has vividly shown, to inflict devastating harm. Given that senior executives operate largely beyond the reach of traditional compliance program controls, a board that aspires to true stewardship must embrace a special responsibility to support and monitor ethics and compliance in the C-suite.
By themselves, the forces at large in the C-suite would challenge the ability of even the most conscientious and rational executives to make consistently irreproachable decisions. The C-suite environment is characterized by the presence of power, strong incentives and huge temptations (financial and other), high ambition, extreme pressure, a fast pace, complex problems and few effective external controls. The problem of C-suite ethics has a deeper dimension, though, than the mere impact of strong pressures upon rational decision-makers. Recent behavioral research brings the unwelcome news that the subversive effects of these pressures are magnified by systematic, predictable human failings that can prompt us to slip our moral moorings and overlook when others do so. We are just beginning to understand the insidious power that such factors as motivated blindness, attentional blindness, conflicts of interest, focused "business-only" framing, time pressure, irrational avoidance of loss, escalating commitment, overconfidence and in-group dynamics can exert below the plane of conscious thought, even over people who have good reason to consider themselves ethically strong. and behaviorally upright.
But we also know that organizational culture can
dramatically affect both ethical conduct and reporting of misconduct, by
establishing workplace norms, harnessing social identity and group loyalty and
increasing the salience of ethical values. How can these learnings inform the
board’s interaction with, and monitoring of, the C-suite? And how can the board
help forge a stronger connection between the C-Suite and the organization’s
compliance and ethics program? This paper suggests several key strategies for
dealing with different aspects of this complex problem.
Saturday, October 19, 2013
Stephen Davidoff recently posted a piece on DealBook entitled “A Push to End Securities Fraud Lawsuits Gains Momentum,” in which he notes that “Halliburton is asking the Supreme Court to confront one of the fundamental tenets of securities fraud litigation: a doctrine known as “’fraud on the market.’” He goes on to provide a lot of interesting additional details, so you should definitely go read the whole thing, but I focused on the following:
In its argument, Halliburton is asking the Supreme Court to confront one of the fundamental tenets of securities fraud litigation: a doctrine known as “fraud on the market.” The doctrine has its origins in the 1986 Supreme Court case Basic v. Levinson. To state a claim for securities fraud, a shareholder must show “reliance,” meaning that the shareholder acted in some way based on the fraudulent conduct of the company. In the Basic case, the Supreme Court held that “eyeball” reliance — a requirement that a shareholder read the actual documents and relied on those statements before buying or selling shares — wasn’t necessary. Instead, the court adopted a presumption, based on the efficient market hypothesis, that all publicly available information about a company is incorporated into its stock price…. A group of former commissioners at the Securities and Exchange Commission and law professors represented by the New York law firm Wachtell, Lipton, Rosen & Katz have also taken up the cause. In an amicus brief, the group argues that, in practice, the Basic case has effectively ended the reliance requirement intended by the statute, something that is not justified. They rely on a forthcoming law review article by an influential professor, Joseph A. Grundfest of Stanford Law School. Professor Grundfest argues that the statute on which most securities fraud is based — Section 10(b) of the Exchange Act — was intended by Congress to mean actual reliance because the statute is similar to another one in the Exchange Act that does specifically state such reliance is required.
This got me to thinking about how I might introduce the fraud-on-the-market reliance presumption to students the next time I teach it. This is what I came up with as a possibility:
Assume you know that a particular weather app is 100% accurate. Assume also that you know all your neighbors check the app regularly. If in deciding whether you need an umbrella you simply look out your window to see whether any of your neighbors are carrying one, rather than checking the weather app, are you not still actually relying on the weather app? The fraud-on-the-market presumption of reliance effectively answers that question in the affirmative. In the securities context it provides that instead of reviewing all publicly available disclosures when deciding to buy or sell securities, it is enough for you to simply “look out your window” at the market price because we assume the market price reflects the consensus equilibrium of all publicly available information.
One might protest that the plaintiff should still have to prove that all the neighbors are in fact checking the weather app, and this is in fact the case when we require plaintiffs seeking the benefits of the FOM presumption to prove the relevant market is efficient. Alternatively, one might protest that the idea that the actions of your neighbors reflect well-enough the information provided by the weather app is questionable, but since Eugene Fama just won the Nobel prize in economics it might be an uphill battle to overturn the presumption on that basis. Another objection might be that we don’t need the presumption because there are enough alternative mechanisms to hold corporate actors accountable for fraud, and it is certainly the case that when the Supreme Court adopted the FOM presumption, a large part of the rationale was the perception that there was a need for the presumption in order to facilitate actions that would otherwise never be brought in any form. What I see as a possible obstacle to this approach is that, while one may debate whether the Roberts Court is in fact pro-business, I do believe it is concerned about appearing overly so – and authoring a decision that states we no longer need the FOM presumption because alternative corporate accountability mechanisms are working so efficiently strikes me as just throwing fuel on that fire when the Court could arguably reach the same result by continuing to tighten up class-action law generally. Finally, one might object that the FOM presumption actually allows folks who just run out of the house without either checking the app or looking out their window to claim the presumption, but at least a partial answer to this objection is that the Basic decision itself provides that: “Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance,” Basic Inc. v. Levinson, 485 U.S. 224, 248 (1988), and this is typically understood to at least include plaintiffs who are, to continue the analogy, rushing out of the house because they don’t have time to grab an umbrella.
Obviously, the issues are ultimately more complicated than the foregoing suggests, but it is just intended to serve as an introduction, which can be expanded to account for more complicated matters as the discussion proceeds. I’d be curious to hear what readers think needs to be added/amended to make this introduction work.
Friday, October 18, 2013
Really great piece by Justin Fox on “What We’ve Learned from the Financial Crisis” over at the Harvard Business Review. What follows is a brief excerpt, but you'll want to go read the whole thing.
Five years ago the global financial system seemed on the verge of collapse. So did prevailing notions about how the economic and financial worlds are supposed to function. The basic idea that had governed economic thinking for decades was that markets work…. In the summer of 2007, though, the markets for some mortgage securities stopped functioning…. [T]he economic downturn was definitely worse than any other since the Great Depression, and the world economy is still struggling to recover…. Five years after the crash of 2008 is still early to be trying to determine its intellectual consequences. Still, one can see signs of change…. To me, three shifts in thinking stand out: (1) Macroeconomists are realizing that it was a mistake to pay so little attention to finance. (2) Financial economists are beginning to wrestle with some of the broader consequences of what they’ve learned over the years about market misbehavior. (3) Economists’ extremely influential grip on a key component of the economic world—the corporation—may be loosening.
Fox goes on to dissect each of these shifts, putting them in historical perspective. As I said, I think it is well worth your time to read his entire piece. A couple of additional noteworthy quotes from his analysis of item (3) above follow:
- [M]ost economic theories also build upon a common foundation of self-interested individuals or companies seeking to maximize something or other (utility, profit) …. Still, one narrow way of looking at the world can’t be the only valid path toward understanding its workings. There’s also a risk that emphasizing individual self-interest above all else may even discourage some of the behaviors and attitudes that make markets work in the first place—because markets need norms and limits to function smoothly.
- I don’t think the shareholder value critics have come up with a coherent alternative. We’re all still waiting for some other framework with which to understand the corporation—and economists may not be able to deliver it. Who will? Sociologists have probably been the most persistent critics of shareholder value, and of the atomized way in which economists view the world. Some, such as Neil Fligstein, of UC Berkeley, and Gerald Davis, of the University of Michigan, have proposed alternative models of the corporation that emphasize stability and cohesion over transaction and value.