Business Law Prof Blog

Westbrook on the 100th anniversary of the first “blue sky” law

Amy Westbrook has posted “Blue Skies for 100 Years: Introduction to the Special Issue on Corporate and Blue Sky Law” on SSRN.  Here is the abstract:

Kansas enacted the first state securities law in the United States on March 10, 1911, thereby ushering in a new era of financial regulation. House Bill 906, entitled “An Act to provide for the regulation and supervision of investment companies and providing penalties for the violation thereof” (1911 Act), was the product of disparate forces, including the ongoing struggle over Kansas’ new bank guarantee act, progressive pressures within the Republican Party, strong agricultural markets, the increasing prevalence of traveling securities salesmen, and the work of the charismatic Kansas Commissioner of Banking, Joseph Norman Dolley. This year marks the 100th anniversary of the Kansas “blue sky” law, and this issue of the Washburn Law Journal uses the occasion to look back on the genesis of securities regulation and to think about its future. It is true that the financial markets in 2011 are profoundly different from the markets in 1911. Moreover, the 1911 Act was passed under a specific combination of politics, economics, technology and social forces at work in Kansas in 1911. Although a lot has changed in 100 years, the persistence of the regulatory systems established during the early twentieth century, with respect both to securities and to corporate governance more generally, suggests that era may have more to interest us than “mere” history.

SJP

Facebook, Happiness, and the Stock Market

Color me skeptical, but I haven't looked at it that closely.  Yigitcan Karabulut has. Here is his abstract for a draft paper, Can Facebook Predict Stock Market Activity?: 

This paper revisits the relation between investor sentiment and stock market activity using a novel and direct measure for sentiment. Specifically, I use Facebook's Gross National Happiness which captures investor sentiment on a daily basis using content from the individual status updates of almost 100 million Facebook users in the US. I document that Facebook sentiment has the ability to predict statistically significant and economically meaningful changes in the daily returns and trading volume in the US equity market. For instance, a one-standard deviation increase in Facebook sentiment predicts an increase in market returns equal to 12 basis points over the next day. Moreover, I also find an incremental ability of Facebook sentiment to forecast returns among small-cap and growth stocks that is consistent with the noise trader models.

Of course, I can't look at it very closely, because the paper is not available on SSRN (just the abstract), but an overview of the paper is available here, via CXO Advisory Group, LLC.  CXO runs their own, simplified test, concluding that

evidence from simple tests on available data indicates little or no power for changes in Facebook Gross National Happiness for the U.S. to predict U.S. stock market returns.

Either way, given the enormous influence of social networking, it would seem something could be learned. I'm more interested in the micro-level impacts.  I'd be curious to see the impact of key corporate information being disseminated via Facebook or Twitter. And whether a company have any effect on the market response to key information releases by controlling some aspect of social networking and related discussions. I'm sure some companies are looking into, but I suspect they aren't going to share what they find.  

--JPF

Movie Trailer: "The Flaw"

 

SJP

This is news?

From The Guardian: Ratings agencies suffer 'conflict of interest', says former Moody's boss

SJP

A Market Cure for Too-Big-to-Fail?

Over at DealBook, Jesse Eisinger writes:

One of the most remarkable aspects of the debate about overhauling the financial system after the great crisis was the absence of serious contemplation of breaking up the largest banks…. Lawmakers and regulators have failed to remake our system with smaller, safer institutions. What about investors? Big bank stocks have been persistently weak, making breakups that seemed politically impossible no longer unthinkable…. [However, e]ven in the face of investor pressure, there are forces that would hold bank breakups back. Mainly pay. “The biggest motivation for not breaking up is that top managers would earn less,” Mr. [Mike Mayo, an analyst with CLSA] said. “That is part of the breakdown in the owner/manager relationship. That’s a breakdown in capitalism.” Institutional investors — the major owners of the banks — are passive and conflicted. They don’t like to go public with complaints. They have extensive business ties with the banks. The few hedge fund activist investors who aren’t cowed would most likely balk at taking on such an enormous target.

You can read the full post here.

SJP

Coates on Citizens United

John Coates has posted "Corporate Governance and Corporate Political Activity: What Effect Will Citizens United Have on Shareholder Wealth?" on SSRN.  Here is the abstract:

In Citizens United, the Supreme Court relaxed the ability of corporations to spend money on elections, rejecting a shareholder-protection rationale for restrictions on spending. Little research has focused on the relationship between corporate governance – shareholder rights and power – and corporate political activity. This paper explores that relationship in the S&P 500 to predict the effect of Citizens United on shareholder wealth. The paper finds that in the period 1998-2004 shareholder-friendly governance was consistently and strongly negatively related to observable political activity before and after controlling for established correlates of that activity, even in a firm fixed effects model. Political activity, in turn, is strongly negatively correlated with firm value. These findings – together with the likelihood that unobservable political activity is even more harmful to shareholder interests – imply that laws that replace the shareholder protections removed by Citizens United would be valuable to shareholders.

SJP

Bushee, Jung, and Miller on Selective Investor Access to Management

Brian Bushee, Michael Jung, and Gregory Miller have posted “Do Investors Benefit from Selective Access to Management?” on SSRN.  Here is the abstract:

We examine whether investors benefit from “selective access” to corporate managers, which we define as the opportunity for investors to meet privately with management in individual or small-group settings. We focus on two potential opportunities for selective access advantages at invitation-only investor conferences: formal “off-line” meetings outside of the webcast presentation and CEO attendance at the conference. We find significant increases in trade sizes during the hours when firms provide off-line access to investors and after the presentation when the CEO is present, consistent with selective access providing investors with information that they perceive to be valuable enough to trade upon. We also find significant potential trading gains over three- to 30-day horizons after the conference for firms providing formal off-line access, suggesting that selective access can lead to profitable trading opportunities. While we cannot conclusively determine that managers are providing selective disclosure in these off-line settings, our evidence does suggest that selective access to management conveys more benefits to investors than public access even in the post-Reg FD period.

SJP

D.C. Court Strikes Down Proxy Access

Stephen Bainbridge pulls together some of the blogosphere reaction here.  I highlight the following from that post:

Mike Scarcella at The BLT:

The appeals court sided with the business groups’ lawyers, who argued that investors with special interests, including unions and state and local governments, would be likely to put the maximization of shareholder value second to other interests. “By ducking serious evaluation of the costs that could be imposed upon companies from use of the rule by shareholders representing special interests, particularly union and government pension funds, we think the Commission acted arbitrarily,” Judge Douglas Ginsburg said in the ruling, joined by Chief Judge David Sentelle and Judge Janice Rogers Brown.

Gordon Smith:

The opinion is a rather limited indictment of the proxy access proposal, relying on the lack of sufficient justification. The SEC is considering its options. While it might challenge the ruling, I suspect that the agency is more likely to produce a newly justified rule in the near future.

Brett McDonnell:

[L]et me briefly lament the D.C. Circuit's vacating of the proxy access rule....  The SEC's documents proposing and finalizing the rule are about extensive as I have ever seen from that agency, and they had voluminous comments from all sides to help guide them.  The D.C. Circuit cherrypicks areas where it asserts the SEC didn't do enough.  It will almost always be possible to do that with any agency rulemaking.  Requiring that level of deliberation could well make the task of rule-writing for Dodd-Frank more daunting still.  This opinion is little more than the judges ignoring the proper judicial rule of deference to an agency involved in notice-and-comment rulemaking and asserting their own naked political preferences.  Talk about judicial activism.

SJP

Still Figuring Out Twitter in the Financial Sector

The Dealbook reports that the Financial Regulatory Authority (Finra), recently announced the one-year suspension of broker (plus a $10,000 fine) who sent “misrepresentative and unbalanced” messages on Twitter.  This case sounds like it had a lot more going on, including the broker failing to disclose a number of significant things to the employer, but it once again points out that we still have a lot to figure out with social media in the financial sector (and most other places, for that matter).

It seems to me that it should be pretty clear that any financial advice obtained via Twitter is going to lack some disclosures.  If someone is using a post on Twitter as the only reason to buy or sell a stock, I'm not sure there is a whole lot we can do for that investor.  That doesn't mean we don't need some ground rules, but people don't need to freak out, either.  It's not Twitter that makes brokers play fast and loose any more than it does politicians. It simply provides quick and accessible evidence, and perhaps we should appreciate that more than we do.

H/T Compliance Building for the link to Daniel Schwartz, at Connecticut Employment Law Blog, who says  it well when he explains that post on Twitter can cause problems for employers,

[b]ut so can a letter to an editor in your local newspaper, or a notable call to a radio talk show or causing a scene at a presentation.

You don’t see advice that we ought to cut off mail service, or remove phones from employees’ offices, or stop allowing employees to attend seminars and presentations.  Rather, we outline a set of expectations as to what is proper business behavior and what is expected by the employer.

And yet, cutting off access to Twitter is exactly what some have suggested.  Such a blanket suggestion ignores the usefulness of this internet tool and is not consistent with the approach that companies use for other, more established forms of communication.  (Can you imagine a company now that required letters to be faxed instead of e-mailed?)

Now, perhaps using faxes would have helped protect Congressman Weiner from himself, but I rather doubt it.  The same is true for employer and investors. 

In the meantime, Finra provides this Guide to the Internet for Registered Representatives.  It is not especially clear how one should use social media, and it seems to group a number of social media together in a way that doesn't appreciate the different powers of the varying options, but these are the rules. And even when rules are dumb, if it relates to your livelihood, it's best to follow them. 

--JPF

Splitting Oil Companies Could Be A Good Thing for Investors and Business

ConocoPhillips recently announced that it would be splitting its company into two separate entities, one that explores for and produces oil, and another that refines the oil.  Back in January, Marathon Oil announced a similar move.  Marathon's spin-off, Marathon Petroleum Corp., which is the refining company, starting trading July 1 of this year.  

In this recent era of consolidation, the separation of these operations into separate companies could be a good thing.  The executives of these entities will now have a more focused business model, and the concerns of each part of the business are now less likely to compete.  I will be particularly interested to see how the new refining entities operate.  Obviously, as independent, publicly traded companies, the refining entities may have interests in working with other oil producers.  This could create some real opportunities for synergies, geographically and otherwise, that were less likely to occur under the old model.  

I'm also curious just how independent the new entities will look and act out of the gate.  

--JPF

A Thought on Say on Pay

As my colleague Steve Bradford noted, the SEC say-on-pay rule led to a 98.5% approval of executive compensation packages.  Steve Bainbridge answered Steve Bradford's question, "Is the 98.5% approval rate a strong argument against requiring companies to go through this exercise?," with "a resounding YES."

In addition to providing for the shareholder advisory vote on pay, the SEC rules also require shareholders (also in an advisory capacity) to vote on how often executive pay will be submitted to the shareholders for consideration.  

Personally, I think  this second vote has the idea right.  That is, there was a better rule that would provide shareholders options, without unduly wasting company and shareholder time:  the SEC should have simply required that companies subject to the rule ask their shareholders if they want an advisory vote on executive pay.  If the shareholders want it, then great.  If not, then the company doesn't have to deal with a regular process its shareholders don't want.  

I know a lot of people hate the entire concept, and that's reasonable, too.  But I think the SEC does add value from time to time, so I'm okay with some proposed rules to help shareholders particpate more in the process to the extent they are willing.  I just think that in some cases, it makes sense to ask shareholders what they want, rather than telling them.

-JPF  

Does retail investor trust and confidence in the market matter?

That's a question that popped into my head while reading Jason Zweig's recent "Intelligent Investor" column: Why You Shouldn't Buy Those Quarterly Earnings Surprises.  Zweig writes that we should expect to see a number of upcoming positive earnings "surprises" because "[t]hey are predetermined in a cynical tango-clinch between companies and the analysts who cover them."  He quotes James A. Bianco, president of Bianco Research, as saying that "All the numbers are gamed at this point."  Why?  Because companies have an incentive to "guide" analysts to projections they can beat and analysts have an incentive to provide close but conservative projections that result in "surprises" that spur trading--thereby creating bank profits.  Zweig concludes that "the smartest investors realize the surprise is a staged event" and won't "believe anyone who tries to tell you that these fake surprises mean nothing but good times are ahead for the economy and the stock market."

SJP

Verstein on P2P Lending

If the recent posts here and here haven’t sated you, Andrew Verstein, the Executive Director at the Yale Law School Center for the Study of Corporate Law, has written an interesting article on peer-to-peer lending. It is available here. Here’s the abstract:

Amid a financial crisis and credit crunch, retail investors have lent a billion dollars over the Internet, on an unsecured basis, to total strangers. Technological and financial innovation has allowed person-to-person lending to connect lenders and borrowers in ways never before imagined. However, all is not well with person-to-person lending. The entire industry is threatened by the SEC, which asserted jurisdiction in a fundamental misunderstanding of person-to-person lending. This Article argues that the SEC lacked adequate basis for regulating this market. More importantly, it shows that the SEC has made this industry less safe and more costly than ever, threatening its very existence. This Article takes the SEC’s misregulation as  an opportunity to theorize about regulation in a rapidly disintermediating world. A preferable regulatory scheme is then proposed, designed to preserve and discipline person-to-person lending’s innovative mix of social finance, microlending and disintermediation: regulation by the new Consumer Financial Protection Bureau.

Verstein focuses on two of the biggest P2P sites, Prosper.com and LendingClub  and considers their treatment under federal securities law. In an interesting digression, he also takes the revered Kiva.com site down a notch or two.

Verstein discusses how the P2P platforms changed in response to SEC pressure and argues that those changes have actually made them less safe for investors. Verstein's analysis is very good.I disagree with a couple of minor points he makes about whether P2P investments are securities, but, in his defense, he’s merely posing possible counterarguments to the SEC’s position.

I'm not so sure about Verstein's conclusion. I can't imagine that putting things in the hands of Elizabeth Warren at the CFPB is going to make things any better for P2P sites.

Well worth reading.

-Steve Bradford

Natural Gas Bubble or Not? Either Way, It Matters

There is no consensus on whether there is a natural gas bubble about to burst; it depends on who you ask. Personally, I am starting to think much of the recent natural gas investment and deals are over valued, but I'm not sure it means a bad bubble burst is on the way. More on this soon, but try these as some example of what some are saying on the issue:

There's No Bubble In Natural Gas

Report: Federal Officials Fear Fracking Industry Bubble

A Big Bet on Exco and Natural Gas

--JPF

Peer-to-Peer Lending: Who Is the Issuer?

Today's Wall Street Journal contains an article about the growth of peer-to-peer (P2P) lending.  However, there are still a number of states that have concluded that the P2P business model does not satisfy their securities laws.  Back in October, I was part of a panel discussing P2P lending at the Ohio Securities Conference, and Mark Heuerman, Registration Chief Council of the Ohio Securities Division, gave a great explanation for why Ohio is one of those state.  At least one of the problems, as far as Ohio is concerned, is that while the trading platform (for example, Lending Club) is the one filing the prospectus, Ohio views the actual issuer of the notes as being the individual or entity seeking the loan.  This creates a problem because under Ohio's merit review guidelines the Securities Division must conclude that "the business of the issuer is not fraudulently conducted," while the lending platform lacks the requisite information on the actual issuers to allow for such a finding.  In fact, Prosper Marketplace apparently disclosed as part of its 2009 prospectus amendment that "[i]nformation supplied by borrowers may be inaccurate or intentionally false."  You can view more details from Mark's presentation here.  P2P lending should be in the news some more before the end of the summer because the Dodd-Frank Act calls for the Government Accountability Office to issue a report on the subject by July 21.

SJP

Dueling Views on Money Market Funds

Today’s  Wall Street Journal contains a point/counterpoint from two law professors on whether investors should worry about money market funds. Jeff Gordon  argues that they should. Jonathan Macey  argues to the contrary.

Gordon argues that, if a single fund “breaks the buck,” all money market funds risk runs. Even if the fund is run by a strong financial institution, there’s no guarantee the institution will support the fund, as some did in the last recession. Gordon also argues that fund investors can’t count on the government bailing them out next time.

Macey argues that investments in money market funds are much safer structurally than bank deposits. According to Macey, stronger regulation of money market funds would drive money back into banks, where the return is lower and the risk to the system is greater. Macey argues that the problem in the last recession was due, at least in part, to the SEC’s laxity in letting poorly run funds invest in highly risky commercial paper.

Ironically, both Gordon and Macey conclude by endorsing the extension of government deposit insurance to mutual funds.

Definitely worth reading.

-Steve Bradford

Jay Brown on "The Consequences of the NYSE-Deutsche Combination on Listing Standards"

Over at The Race to the Bottom, Jay Brown has an interesting 8-part (to this point) series on the impact of the NYSE-Deutsche combination on listing standards.  Here are the topics:

• Introduction / Overview
  

• Ensuring Regulatory Independence

• Part 3 [Conflicts of Interest]
  

• The Issue of Funding

• Changes to the Definition of Director Independence

• Limits of Regulatory Independence

• SEC Review and German Ownership

• Regulatory Alternatives

SJP

Shareholder Perspective on Hostile Takeover Numbers

The New York Times Dealbook provides a brief excerpt from an article at efinancialnews.com (registration, which I have yet to do, for a free trial is required to access the full article): 

JPMorgan Chase successfully defended clients against hostile takeover approaches 64.4 percent of the time — the best among the top advisory banks, according to an analysis by Financial News. Morgan Stanley, meanwhile, got clients it advised 15.9 percent more in price when hostile takeovers were successful, another best, according to the analysis.

First thought:  How many companies that hire JPMorgan Chase would be better off if the takeover were successful?  That's obviously not JPMorgan's problem, but it is a potential concern for shareholders. 

Second thought:  As a shareholder, based on this report, which firm would I rather see my board hire? Pretty clear for most of us, I suspect:  Morgan Stanley. Most of the time, I'd rather see 15.9% more for my shares in a takeover than see my company's management team stay the course.  Not always, I suppose. But almost.

--JPF

Citizens United and the Power of "Corporate Democracy"

Over at the Race to the Bottom, Jay Brown has commented on a recent shareholder proposal involving Home Depot that is seeking to get a shareholder vote on corporate "electioneering contributions."  The proposal is expressly in response to Citizens United, but Prof. Brown views it as evidence of "a central flaw in the Supreme Court's analysis in Citizens United."  Writes Brown:

The Court made it seem like broad dissemination of information about campaign contributions was sufficient.  Apparently this was because shareholders could, with the disclosure, effect the company's practices with respect to the contributions.  In fact, this is probably not the case.  As CA v. AFSME shows, the Delaware courts are highly protective of board discretion and willing to strike down almost any effort by shareholders to tie the hands of directors.  As a result, a proposal calling for mandatory limits on campaign contributions would likely be invalidated under state law.

I think the extent to which one views the Citizens United majority's reliance on "corporate democracy" (See, e.g., 130 S. Ct. at 911: "There is ... little evidence of abuse that cannot be corrected by shareholders 'through the procedures of corporate democracy.'") to be sound turns in large part on what one understands the justices to mean by corporate democracy.  If one understands them to be arguing that shareholders could force a board of directors to take certain actions vis-a-vis electioneering, then I agree with Jay that the Court was likely wrong.  If, on the other hand, one understands the Court to be relying on the ability of shareholders to "vote with their feet" in an effective way, then I'm inclined to not be as critical of the opinion (at least on that particular point).  I believe we've already seen one example of that in the case of Target.

Citizens United: the gift that just keeps on giving.

SJP

LinkedIn's IPO: Debating the Corporate Governance Structure

Following up on Josh's post about the teaching opportunities presented by the Ed Shultz lawsuit, I thought I'd summarize some of what Steven Davidoff and John Carney have recently written about the planned LinkedIn IPO, which also has the potential to serve as a useful teaching case study.

Davidoff has posted a couple of pieces over at DealBook discussing what he sees as a number of management-friendly governance structure provisions.  In the first, he focuses on the proposed dual-class structure, which would essentially allow co-founder Reid Hoffman to retain control of the business even if his ownership stake drops significantly below a majority.  This is so because he will own Class B shares that carry 10 votes as opposed to the one-vote Class A shares being offered to the public.  Notes Davidoff:

In 1988, the Securities and Exchange Commission responded to shareholder complaints by trying to outlaw dual-class stock, but the rule was struck down a year later by a federal court. The stock exchanges then adopted their own rules forbidding a company from adopting dual shares after it listed. This ended the ability of management to adopt this structure to fight off a hostile bid. The exchanges, however, allowed a big exception: a company can go public with a dual-class share structure.

The tension here, of course, is between (a) the benefits of allowing those who have successfully managed the business to the point of making it IPO-worthy to continue to exercise control even after significantly reducing their equity stake, and (b) effectively disenfranchising public shareholders in a way that creates opportunities for value-destroying self-dealing.  Here, Davidoff points out that:

A study in 2008 by Paul A. Gompers, Joy L. Ishii and Andrew Metrick found evidence of this self-interest. The authors found that dual-class stock could destroy value where the holders had a much more significant voting interest than an economic one.

One obvious response to the criticism of dual-class stock is that the market will take the structure into account in valuing the offering.  In making this point, Carney points out that the market may actually have some good reasons to favor such a structure:

[W]hat Davidoff and the governance types don't see is that "good" corporate governance may be too costly for its alleged benefits. And government policy is constantly making it costlier. Consider, for instance, recently proposed changes in proxy access rules and "say on pay." These increase the ability of special interest groups, including union-controlled pension funds, to cut deals with management to the detriment of outside shareholders. Dual class companies may avoid this problem.  Similarly, dual class companies can better avoid the short term "beat the quarter" thinking that debilitates so much of corporate America.

Davidoff notes, however, that there may be reason to question the market's efficiency on this point:

Why is LinkedIn adopting these mechanisms? The most likely reason is that it can get away with it, particularly since this will be a hot I.P.O. Institutional Shareholder Services, the influential proxy advisory service, does not provide a rating of corporate governance until the company is public. The reason is that many of I.S.S.’s customers — institutional shareholders — are going to flip shares acquired in an I.P.O., and therefore do not scrutinize the company’s corporate governance provisions at the going-public stage.

In my opinion, this is just another area where we likely need more empirical evidence of investor behavior.  I imagine behavioral economists would be able to identify a number of cognitive biases that set up investors to undervalue the risk of a variety of corporate governance structures.

In his second piece, Davidoff goes on to examine a number of other potentially problematic features of LinkedIn's corporate governance structure, including the presence of a staggered board (which Davidoff notes is effectively permanent in light of the dual-class structure and relevant voting requirements), bylaw notice / choice of forum provisions, and acceptance of Delaware's anti-takeover statute protections.

All in all, there is easily enough here to fill an entire review session at the end of a Corporations class.

SJP