Friday, May 22, 2015

The outsourcing of human rights enforcement to corporations- EU-style

I haven’t met Hollywood producer Edward Zwick, who brought the movie and the concept of Blood Diamonds to the world’s attention, but I have had the honor of meeting with medical rock star, and Nobel Prize nominee Dr. Denis Mukwege. Both Zwick and Mukwege had joined numerous NGOs in advocating for a mandatory conflict minerals law in the EU. I met the doctor when I visited Democratic Republic of Congo in 2011 on a fact finding trip for a nonprofit that focuses on maternal and infant health and mortality. Since Mukwege works with mass rape victims, my colleague and I were delighted to have dinner with him to discuss the nonprofit. I also wanted to get his reaction to the Dodd-Frank conflict minerals regulation, which was not yet in effect. I don’t remember him having as strong an opinion on the law as he does now, but I do remember that he adamantly wanted the US to do something to stop the bloodshed that he saw first hand every day.

The success of the Dodd-Frank law is debatable in terms of stemming the mass rape, use of child slaves, and violence against innocent civilians. Indeed, earlier this month, over 100 villagers were raped by armed militia. A 2014 Human Rights Watch report confirms that both rebels and the Congolese military continue to use rape as a weapon of war to deal with ethnic tensions. I know this issue well having co-authored a study on the use of sexual and gender-based violence in DRC with a medical anthropologist. With all due respect to Dr. Mukwege (who clearly know the situation better than I), that research on the causes of rape, but more important, my decade of experience in the supply chain industry have lead me to believe that the US Dodd-Frank law was misguided. The law aims to stem the violence by having US issuers perform due diligence on their supply chains. I have spoken to a number of companies that have told me that  it would have been easier for the US to just ban the use of minerals from Congo because the compliance challenges are too high. Thus it was no surprise that last year’s SEC filings were generally vague and uninformative. It remains to be seen whether the filings due in a few weeks will be any better.

To me Dodd-Frank is a convenient way for the US government to outsource human rights enforcement to multinational corporations. Due diligence and clean supply chains are good, necessary, and in my view nonnegotiable, but they are not nearly enough to deal with the horrors in Congo. Nonetheless, in a surprise move, the EU Parliament voted this week to go even farther than the US law. According to the Parliament’s press release:

Parliament voted by 400 votes to 285, with 7 abstentions, to overturn the Commission's proposal as well as the one adopted by the international trade committee and requested mandatory compliance for "all Union importers" sourcing in conflict areas. In addition, "downstream" companies, that is, the 880, 000 potentially affected EU firms that use tin, tungsten, tantalum and gold in manufacturing consumer products, will be obliged to provide information on the steps they take to identify and address risks in their supply chains for the minerals and metals concerned… The regulation applies to all conflict-affected high risk areas in the world, of which the Democratic Republic of Congo and the Great Lakes area are the most obvious example. The draft law defines 'conflict-affected and high-risk areas' as those in a state of armed conflict, with widespread violence, the collapse of civil infrastructure, fragile post-conflict areas and areas of weak or non-existent governance and security, characterised by "widespread and systematic violations of human rights".

(emphasis mine). I hope this proposed law works for the sake of the Congolese and all of those who live in conflict zones around the world. The EU member states have to sign off on it, so who knows what the final law will look like. Some criticize the law because the list of “conflict-affected areas” is constantly changing. Although that’s true, I don’t think that criticism should affect passage of the law. The bigger flaw in my view is that there are a number of natural resources from conflict-affected zones- palm oil comes to mind- that this regulation does not address. This law, like Dodd-Frank does both too much and not enough. In an upcoming book chapter, I propose that governments use procurement and other incentives and penalties related to executive compensation and clawbacks to drive human rights due diligence and third-party audits (sorry, I'm prohibited from posting a link to it but it's forthcoming from Cambridge University Press).

In the meantime, I will wait for the DC Circuit to rule on constitutional aspects of the Dodd-Frank bill. I will also be revising my most recent law review article on the defects of the disclosure regime to address the EU development. I will post the article next week from Havana, Cuba, where I will spend 10 days learning about the Cuban legal system and culture. Given my scholarship and the recent warming of relations between the US and Cuba, I may sneak a little research in as well, and in two weeks I will post my impressions on the challenges and opportunities that US companies will face in the Cuban market once the embargo is lifted. Adios!

May 22, 2015 in Corporate Governance, Corporations, CSR, Current Affairs, Financial Markets, International Business, Legislation, Marcia Narine, Securities Regulation, Travel | Permalink | Comments (0)

Wednesday, May 20, 2015

Crowdfunding and the Public/Private Divide in U.S. Securities Regulation

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.  

May 20, 2015 in Corporate Finance, Joan Heminway, Securities Regulation | Permalink | Comments (1)

Thursday, May 14, 2015

Did a Slave Make Your Product and Do You Care? The California AG Thinks So

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)

Thursday, May 7, 2015

New Article: Janus Capital in Criminal Cases

Last year, I blogged about a Fourth Circuit case, Prousalis v. Moore, which held that the Janus Capital definition of “maker” in Rule 10b-5 did not apply in criminal cases. For those who are interested, a short article on wrote on that topic, “Make” Means “Make”: Rejecting the Fourth Circuit’s Two-Headed Interpretation of Janus Capital, is now available on SSRN.

The paper is to be included in a symposium honoring the late Alan Bromberg, an outstanding securities scholar, as well as a mentor and friend.

May 7, 2015 in C. Steven Bradford, Case Law, Securities Regulation | Permalink | Comments (0)

Monday, May 4, 2015

Negative Interest Rates and the Definition of Security

In some European countries, bank interest rates have dropped below zero. (See here and here.) That’s right; it actually costs you to put your money in the bank. You put $1,000 in a savings account and the bank promises to pay you, say, $999, in a year.

I came of age in the Gerald Ford/Jimmy Carter years, when annual inflation rates were in the double digits. Whip Inflation Now!  (Yes, children, I’m ancient.) I find it almost unbelievable that nominal interest rate (and bond yields) could drop below zero.

That hasn’t happened in the United States (yet), but what if it did? Set aside the huge macroeconomic issues, and let’s focus on a topic of greater interest to the readers of this blog—the effect on federal securities law, particularly the core notion of what constitutes a security.

The most important case in defining the scope of federal securities law is probably SEC v. W.J. Howey Co., 328 U.S. 293 (1946).  Howey says that an investment is an investment contract, and therefore a security, if people invest money in a common enterprise with an expectation of profits coming from the efforts of others.

The “expectation of profits” part of the Howey test is the problem in a negative-interest-rate economy. Assume, for example, that an entrepreneur asks people for money to start a business and promises to return that money, without interest, in two years. In other words, you put in $1,000 and he’ll pay you back $1,000 in two years.

That investment would not ordinarily be treated as a security because there’s no profit. That’s how the Kiva crowdfunding site,  which is based on no-interest lending, can avoid federal securities law. But, in a negative-interest world, a mere return of your principal is, in effect, profitable. Considering your opportunity cost, you come out ahead.

If we ever have negative interest rates and the courts hold that no-interest investments are securities, remember that you read it here first.

May 4, 2015 in C. Steven Bradford, Financial Markets, Securities Regulation | Permalink | Comments (7)

Friday, May 1, 2015

The New White Collar Whistleblower: Compliance and Audit Professionals as Tipsters

I’ve been thinking a lot about whistleblowers lately. I serve as a “management” representative to the Department of Labor Whistleblower Protection Advisory Committee and last week we presented the DOL with our recommendations for best practices for employers. We are charged with looking at almost two dozen whistleblower laws. I've previously blogged about whistleblower issues here.

Although we spend the bulk of our time on the WPAC discussing the very serious obstacles for those workers who want to report safety violations, at the last meeting we also discussed, among other things, the fact that I and others believed that there could be a rise in SOX claims from attorneys and auditors following the 2014 Lawson decision. In that case, the Supreme Court observed that: “Congress plainly recognized that outside professionals — accountants, law firms, contractors, agents, and the like — were complicit in, if not integral to, the shareholder fraud and subsequent cover-up [Enron] officers … perpetrated.” Thus, the Court ruled, those, including private contractors, who see the wrongdoing but may be too fearful of retaliation to report it should be entitled to SOX whistleblower protection.

We also discussed the SEC's April KBR decision, which is causing hundreds of companies to revise their codes of conduct, policies, NDAs, confidentiality and settlement agreements to ensure there is no language that explicitly or implicitly prevents employees from reporting wrongdoing to the government or seeking an award.

Two weeks ago, I spoke in front of a couple hundred internal auditors and certified fraud examiners about how various developments in whistleblower laws could affect their investigations, focusing mainly on Sarbanes-Oxley and Dodd-Frank Whistleblower. I felt right at home because in my former life as a compliance officer and deputy general counsel, I spent a lot of time with internal and external auditors. Before I joined academia, I testified before Congress on what I thought could be some flaws in the law as written. Specifically, I had some concerns about the facts that: culpable individuals could receive awards; individuals did not have to consider reporting wrongdoing internally even if there was a credible, functioning compliance program; and that those with fiduciary responsibilities were also eligible for awards without reporting first (if possible), which could lead to conflicts of interest. The SEC did make some changes to Dodd-Frank. The agency now weighs the whistleblower’s participation in the firm’s internal compliance program as a factor that may increase the whistleblower’s eventual award and considers interference with internal compliance programs to be a factor that may decrease any award. It also indicated that compliance or internal audit professionals should report internally first and then wait 120 days before going external.

Before I launched into my legal update, I gave the audience some sobering statistics about financial professionals:

  • 23% have seen misconduct firsthand
  • 29% believe they may have to engage in illegal or unethical conduct to be successful
  • 24% would engage in insider trading if they could earn $10 million and get away with it 

I also shared the following awards with them:

  • $875,000 to two individuals for “tips and assistance” relating to fraud in the securities market;
  • $400,000 to a whistleblower who reported fraud to the SEC after the employee’s company failed to address internally certain securities law violations;
  • $300,000 to an employee who reported wrongdoing to the SEC after the company failed to take action when the employee reported it internally first;
  • $14 million- tip about an alleged Chicago-based scheme to defraud foreign investors seeking U.S. residency; and
  • More than $30 million to a tipster living in a foreign country, who would have received more if he hadn't delayed reporting

I also informed them about a number of legal developments that affect those that occupy a position of trust or confidence. These white-collar whistleblowers have received significant paydays recently. Last year the SEC paid  $300,000 to an employee who performed “audit or compliance functions.” I predicted more of these awards, and then to prove me right, just last week, the SEC awarded its second bounty to an audit or compliance professional, this time for approximately 1.4 million.

I asked the auditors to consider how this would affect their working with their peers and their clients, and how companies might react. Will companies redouble their efforts to encourage internal reporting? Although statistics are clear that whistleblowers prefer to report internally if they can and don’t report because they want financial gain, will these awards embolden compliance, audit, and legal personnel to report to the government? Will we see more employees with fiduciary duties coming forward to report wrongdoing? Does this conflict with any ethical duties imposed upon lawyers or compliance officers with legal backgrounds? SOX 307 describes up the ladder reporting requirements, but what happens to the attorney who chooses to go external? Will companies consider self-reporting to get more favorable deferred and nonprosecution agreements to pre-empt the potential whistleblower?

I don’t have answers for any of these questions, but companies and boards should at a minimum look at their internal compliance programs and ensure that their reporting mechanisms allow for reports from outside counsel and auditors. In the meantime, it’s now entirely possible that an auditor, compliance officer, or lawyer could be the next Sherron Watkins.

And by the way, if you were in Busan, South Korea last Wednesday, you may have heard me on the morning show talking about whistleblowers. Drop me a line and let me know how I sounded. 

May 1, 2015 in Case Law, Corporate Governance, Corporations, Current Affairs, Ethics, Financial Markets, Legislation, Marcia Narine, Securities Regulation | Permalink | Comments (0)

Monday, April 27, 2015

Columbia Blue Sky Blog: Institutional Investors’ Appetite for Alternatives

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.

-Anne Tucker

April 27, 2015 in Anne Tucker, Business Associations, Corporate Finance, Corporate Governance, Corporations, Financial Markets, Securities Regulation | Permalink | Comments (0)

Thursday, April 16, 2015

The EU's Conflict over Conflict Minerals

Regular readers know that I have blogged repeatedly about my opposition to the US Dodd-Frank conflict minerals rule, which aims to stop the flow of funds to rebels in the Democratic Republic of Congo. Briefly, the US law does not prohibit the use of conflict minerals, but instead requires certain companies to obtain an independent private sector third-party audit of reports of the facilities used to process the conflict minerals; conduct a reasonable country of origin inquiry; and describe the steps the company used to mitigate the risk, in order to improve its due diligence process. The business world and SEC are awaiting a First Amendment ruling from the DC Circuit Court of Appeals on the “name and shame” portion of the law, which requires companies to indicate whether their products are DRC Conflict Free.” I have argued that it is a well-intentioned but likely ineffective corporate governance disclosure that depends on consumers to pressure corporations to change their behavior.

The proposed EU regulation establishes a voluntary process through which importers of certain minerals into the EU self-certify that they do not contribute to financing in “conflict-affected” or “high risk areas.” Unlike Dodd-Frank, it is not limited to Congo. Taking note of various stakeholder consultations and the US Dodd-Frank law, the EU had originally limited the scope to importers, and chose a voluntary mechanism to avoid any regional boycotts that hurt locals and did not stop armed conflict. Those importers who choose to certify would have to conduct due diligence in accordance with the OECD Guidance, and report their findings to the EU. The EU would then publish a list of “responsible smelters and refiners,” so that the public will hold importers and smelters accountable for conducting appropriate due diligence. The regulation also offers incentives, such as assistance with procurement contracts.

One of the problems with researching and writing on hot topics is that things change quickly. Two days after I submitted my most recent article to law reviews in March criticizing the use of disclosure to mitigate human rights impacts, the EU announced that it was considering a mandatory certification program for conflict minerals. That meant I had to change a whole section of my article. (I’ll blog on that article another time, but it will be out in the Winter issue of the Columbia Human Rights Law Review). Then just yesterday, in a reversal, the European Parliament’s International Trade Committee announced that it would stick with the original voluntary plan after all.The European Parliament votes on the proposal in May.

Reaction from the NGO community was swift. Global Witness explained: 

Today the European Parliament’s Committee on International Trade (INTA) wasted a ground-breaking opportunity to tackle the deadly trade in conflict minerals. […] Under this proposal, responsible sourcing by importers of tin, tantalum, tungsten and gold would be entirely optional. The Commission’s proposed voluntary self-certification scheme would be open to approximately 300-400 companies—just 0.05% of companies using and trading these minerals in the EU, and would have virtually no impact on companies’ sourcing behaviour. The law must be strengthened to make responsible sourcing a legal requirement for all companies that place these minerals on the European market–in any form. This would put the European Union at the forefront of global efforts to create more transparent, responsible and sustainable business practices. It would also better align Europe with existing international standards on responsible sourcing, and complement mandatory requirements in the US and in twelve African countries.

I’m all for due diligence in the supply chain and for forcing companies to minimize their human rights impacts. Corporations should do more than respect human rights-- they must pay when they cause harm. I plan to spend part of my summer researching and writing in Latin America about stronger human rights protections for indigenous peoples and the deleterious actions of some multinationals.

But a mandatory certification scheme on due diligence is not the answer because it won’t solve deep, intractable problems that require much more widespread reform. To be clear, I don't think the EU has the right solution either. Reasonable people can disagree, but perhaps the members of the EU Parliament should look to Dodd-Frank. SEC Chair Mary Jo White disclosed last month that the agency had spent 2.75 million dollars, including legal fees, and 17,000 hours writing and implementing the conflict minerals rule. A number of scholars and activists have argued that the law has in fact harmed the Congolese it meant to help and news reports have attempted to dispel some of the myths that led to the passage of the law.

So let’s see what happens in May when the EU looks at conflict minerals again. Let’s see what happens in June when the second wave of Dodd-Frank conflict minerals filings come in. As I indicated in my last blog post about Dodd-Frank referenced above, the first set of filings was particularly unhelpful. And let’s see what happens in December when parents start the holiday shopping—how many of them will check on the disclosures before buying electronics and toys for the members of their family? Most important, let's see if someone can actually tie the money and time spent on conflict minerals disclosure directly to lower rates of rape, child slavery, kidnapping, and forced labor-- the behaviors these laws intend to stop. 

April 16, 2015 in Corporate Governance, Corporations, CSR, Current Affairs, Ethics, Financial Markets, International Business, Law Reviews, Marcia Narine, Securities Regulation | Permalink | Comments (0)

Wednesday, April 15, 2015

"Best Interest Contracts"--Proposed DOL Regulation of Retirement Brokers

In an earlier BLPB post, I wrote about President Obama's call for greater regulation of retirement investment brokers.  The proposed reforms focused on elevating the current standard that brokers' investment advice must be "suitable" to something closer to an enforceable fiduciary duty to counter financial incentives for some brokers to channel investors into higher-fee investment options.  

Yesterday, the U.S. Department of Labor released new proposed rules (Proposed Rule), which would classify brokers as "fiduciaries" under ERISA but allow them to continue to receive brokerage commissions and fees (a practice that would otherwise violate ERISA conflict-of-interest rules) so long as the brokers and customers enter into a  "Best Interest Contract".

The exemption proposed in this notice (“the Best Interest Contract Exemption”) was developed to promote the provision of investment advice that is in the best interest of retail investors such as plan participants and beneficiaries, IRA owners, and small plans.  Proposed Rule at 4.

In 1975, the DOL issued rules defining investment advice for purposes of triggering fiduciary status under ERISA and the attended duties and conflict-of-interest prohibitions.  That 1975 definition is still in use, is narrow, and excludes much of paid-for investment advice, particularly that provided in the self-directed retirement space (i.e., 401(k) and IRA).  

The narrowness of the 1975 regulation allows advisers, brokers, consultants and valuation firms to play a central role in shaping plan investments, without ensuring the accountability ... [and] allows many advisers to avoid fiduciary status.... As a consequence, under ERISA and the Code, these advisers can steer customers to investments based on their own self-interest, give imprudent advice, and engage in transactions that would otherwise be prohibited by ERISA and the Code. Proposed Rule at 12.

The proposed rule expands the definition of investment advise (see Proposed Rule at 13) making brokers "fiduciaries" under ERISA, but then creates an exemption (which allows  for the continued collection of commissions and fees), requiring: 

the adviser and financial institution to contractually acknowledge fiduciary status, commit to adhere to basic standards of impartial conduct, warrant that they have adopted policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, and disclose basic information on their conflicts of interest and on the cost of their advice. The adviser and firm must commit to fundamental obligations of fair dealing and fiduciary conduct – to give advice that is in the customer’s best interest; avoid misleading statements; receive no more than reasonable compensation; and comply with applicable federal and state laws governing advice. Proposed Rule at 6.

Under the proposed exemption, all participating financial institutions must provide notice to the U.S. DOL of their participation, as well as collect and report certain data. 

As justification for the proposed rules, the DOL asserted that:

In the absence of fiduciary status, the providers of investment advice are neither subject to ERISA’s fundamental fiduciary standards, nor accountable for imprudent, disloyal, or tainted advice under ERISA or the Code, no matter how egregious the misconduct or how substantial the losses. Retirement investors typically are not financial experts and consequently must rely on professional advice to make critical investment decisions. In the years since then, the significance of financial advice has become still greater with increased reliance on participant directed plans and IRAs for the provision of retirement benefits. Proposed Rule at 11.

Critics claim that these rules will limit small investors' access to sophisticated financial advice for investments, while proponents consider this a powerful tool against the eroding effects of high fees on long-term retirement savings.  

I think this is a symbolically important change.  It modernizes the regulatory framework to more closely reflect why many people invest in the stock market (as a tax incentivized alternative to pension plans), the purpose that these investments serves (long-term retirement savings) and the information asymmetries (born of financial illiteracy) confronting the average investor, as well as the changes to the financial services industry.  The enforcement mechanism is placed on the individual investor, who will have limited monitoring resources and and other disincentives to fiercely serve that role, which is why my initial reaction that this is a good "symbolic" measure that has potential to fulfill a more meaningful role.

-Anne Tucker

April 15, 2015 in Anne Tucker, Corporations, Financial Markets, Securities Regulation | Permalink | Comments (0)

Thursday, April 9, 2015

Would the world be a better place if law students were shareholders?

It’s that time of year again where I have my business associations students pretend to be shareholders and draft proposals. I blogged about this topic last semester here. Most of this semester’s proposals related to environmental, social and governance factors. In the real world, a record 433 ESG proposals have been filed this year, and the breakdown as of mid-February was as follows according to As You Sow:

Environment/Climate Change- 27%

Political Activity- 26%

Human Rights/Labor-15%

Sustainability-12%

Diversity-9%

Animals-2%

Summaries of some of the student proposals are below (my apologies if my truncated descriptions make their proposals less clear): 

1) Netflix-follow the UN Guiding Principles on Business and Human Rights and the core standards of the International Labour Organization

2) Luxottica- separate Chair and CEO

3) DineEquity- issue quarterly reports on efforts to combat childhood obesity and the links to financial risks to the company

4) Starbucks- provide additional disclosure of risks related to declines in consumer spending and decreases in wages

5) Chipotle- issue executive compensation/pay disparity report

6) Citrix Systems-add board diversity

7) Dunkin Donuts- eliminate the use of Styrofoam cups

8) Campbell Soup- issue sustainability report

9) Shake Shack- issue sustainability report

10) Starbucks- separate Chair and CEO

11) Hyatt Hotels- institute a tobacco-free workplace

12) Burger King- eliminate GMO in food

13) McDonalds- provide more transparency on menu changes

14) Google-disclose more on political expenditures

15) WWE- institute funding cap

One proposal that generated some discussion in class today related to a consumer products company. As I skimmed the first two lines of the proposal to end animal testing last night, I realized that one of my friends was in-house counsel at the company. I immediately reached out to her telling her that my students noted that the company used to be ”cruelty-free,” but now tested on animals in China.  She responded that the Chinese government required animal testing on these products, and thus they were complying with applicable regulations. My students, however, believed that the company should, like their competitors, work with the Chinese government to change the law or should pull out of China.  Are my students naïve? Do companies actually have the kind of leverage to cause the Chinese government to change their laws? Or would companies fail their shareholders by pulling out of a market with a billion potential customers? This led to a robust debate, which unfortunately we could not finish.

I look forward to Tuesday’s class when we will continue these discussions and I will show them the sobering statistics of how often these proposals tend to fail. Hopefully we can also touch on the Third Circuit decision, which may be out on the Wal-Mart/Trinity Church shareholder proposal issue.These are certainly exciting times to be teaching about business associations and corporate governance.

April 9, 2015 in Business Associations, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Law School, Marcia Narine, Securities Regulation, Teaching | Permalink | Comments (1)

Wednesday, April 8, 2015

Media Coverage of Business Combinations

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.

Continue reading

April 8, 2015 in Business Associations, Corporate Finance, Corporations, Joan Heminway, M&A, Securities Regulation, Teaching | Permalink | Comments (1)

Remote Tippees and *Civil* Insider Trading Liability

In December, 2014 the Second Circuit in US v. Newman addressed liability of remote tippees.  In Newman, a lawyer told a friend who told a roommate information regarding the sale of SPSS Inc. to IBM that found its way into later trades by a cohort of analysts at hedge funds and investment firms. (Op. at 5-7).  The Second Circuit in  Newman  vacated insider trading convictions and narrowed the standard for "improper benefit", reconsideration of which was denied last week, and thus stands pending review by the U.S. Supreme Court.  To qualify as an improper benefit under Newman, there must be proof of a meaningfully close relationship, where the "the personal benefit received in exchange for confidential information must be of some consequence." (Op. at 22).  Newman also made clear that liability standards are the same whether the tippee's liability arises under the classical or the misappropriate theories. (Op. at 11).

Judge Jed S. Rakoff, of Federal District Court in Manhattan, issued an order denying a motion to dismiss the SEC's civil charges against Daryl Payton and Benjamin Durrant III, defendants in Newman who received their information from the roommate of the friend of the lawyer.  This is the first case to examine the impact of the Newman opinion in the civil context.  Judge Rakoff wrote:

Significantly while a person is guilty of criminal insider trading only if that person committed the offense “willfully,” i.e., knowingly and purposely, a person may be civilly liable if that person committed the offense recklessly, that is, in heedless disregard of the probable consequences.  (Op. at 2)

 Judge Rakoff concluded that the SEC's "Amended Complaint more than sufficiently alleges that defendants knew or recklessly disregarded that Martin received a personal benefit in disclosing information to Conradt, and that Martin in doing so breached a duty of trust and confidence to the owner of the information. (Op. at 16).

Peter J. Henning, a professor at Wayne State University Law School, writes in his article in the DealB%k that:

Judge Rakoff’s analysis provides at least some guidance on how to assess the new landscape under the Newman opinion. Courts tend to apply securities law decisions interchangeably in criminal and civil cases, so the Justice Department can cite his opinion as a favorable precedent in other cases involving tippees. 

This and other insider trading enforcement actions by the SEC can be tracked here.

-Anne Tucker

April 8, 2015 in Anne Tucker, Corporate Governance, Securities Regulation | Permalink | Comments (1)

Monday, April 6, 2015

The Crowdfunding Exemption: Three Years and Counting

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.

April 6, 2015 in C. Steven Bradford, Corporate Finance, Entrepreneurship, Securities Regulation | Permalink | Comments (3)

Friday, April 3, 2015

Rose on the SEC's New Whistleblower Program

Amanda Rose (Vanderbilt) was one of the many distinguished speakers at the law and business conference I attended last week. She spoke about her forthcoming article in the Northwestern University Law Review, which focuses on the SEC’s new whistleblower program in relation to Fraud- on-the-Market class action lawsuits. I have added her article to my reading list and the abstract is reproduced below for interested readers.

The SEC’s new whistleblower bounty program has provoked significant controversy. That controversy has centered on the failure of the implementing rules to make internal reporting through corporate compliance departments a prerequisite to recovery. This Article approaches the new program with a broader lens, examining its impact on the longstanding debate over fraud-on-the-market (FOTM) class actions. The Article demonstrates how the bounty program, if successful, will replicate the fraud deterrence benefits of FOTM class actions while simultaneously increasing the costs of such suits — rendering them a pointless yet expensive redundancy. If instead the SEC proves incapable of effectively administering the bounty program, the Article shows how amending it to include a qui tam provision for Rule 10b-5 violations would offer several advantages over retaining FOTM class actions. Either way, the bounty program has important and previously unrecognized implications that policymakers should not ignore.  

April 3, 2015 in Business Associations, Corporations, Haskell Murray, Securities Regulation | Permalink | Comments (0)

Wednesday, April 1, 2015

Regulation A+: facilitating small company access to capital

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.

-Anne Tucker

April 1, 2015 in Anne Tucker, Corporate Finance, Current Affairs, Securities Regulation | Permalink | Comments (0)

Tuesday, March 31, 2015

More Beliefs: Director Primacy and Public and Private Companies

Yesterday, Prof. Bainbridge annotated my "creed" on corporate governance, and I appreciated his take. In fact, many of his chosen sources would have been mine.

In a later footnote, he noted that he was not sure what I meant by my statement: "I believe that public companies should be able to plan like private companies . . . ." I thought I'd try to explain. 

My intent there was to address my perception that there is a prevailing view that private companies and public companies must be run differently.  Although there are different disclosure laws and other regulations for such entities that can impact operations, I'm speaking here about the relationship between shareholders and directors when I'm referencing how public and private companies plan. 

Public companies generally have far more shareholders than private companies, so the goals and expectations of those shareholders will likely be more diverse than in a private entity. Therefore, a public entity may need to keep multiple constituencies happy in a way many private companies do not.  However, that is still about shareholder wishes, and not the public or private nature of the entity itself.  A private company with twenty shareholders could crate similar tensions for a board of directors.

As an example, consider Investopedia's description of Advantages of Privatization in an article called "Why Public Companies Go Private" (emphasis added):

Private-equity firms have varying exit time lines for their investments depending on what they have conveyed to their investors, but holding periods are typically between four and eight years. This horizon frees up management's prioritization on meeting quarterly earnings expectations and allows them to focus on activities that can create and build long-term shareholder wealth. Management typically lays out its business plan to the prospective shareholders and agrees on a go-forward plan. 

This is often a practical reality, but I disagree (or at least believe it should not be the case) that a company must be private to "free up management's prioritization on meeting quarterly earnings expectations and allows them to focus on activities that can create and build long-term shareholder wealth."  

This, I think, connects with Prof. Bainbridge's point in his footnote annotation 4, where he says, "I think too many hedge funds are pressing too many boards to pursue short-term gains at the expense of sustainable long-run shareholder wealth maximization and, accordingly, that boards need more insulation from shareholder pressure." I agree completely with his point there, and that's the kind of issue facing public companies that I was intending to address in my assertion.  

Ultimately, director primacy means ensuring a large measure of director autonomy (or insulation). This works in both directions, whether it relates to short- versus long-term planning or providing workplace benefits (or not). Ensuring a robust business judgment rule as an abstention doctrine preserves director primacy, and in the long run, will benefit corporate governance and shareholder choice.  

March 31, 2015 in Business Associations, Corporations, CSR, Delaware, Joshua P. Fershee, Securities Regulation | Permalink | Comments (3)

Friday, March 27, 2015

Commissioner Dan Gallagher on Twitter

Plenty of valuable information was shared today at Vanderbilt's 17th annual law & business conference, including remarks from Elisse Walter (former-SEC Chairman), Jim Cox (Duke), Bob Thompson (Georgetown)Amanda Rose (Vanderbilt), and others.

The most immediately useful information, however, might be the fact that SEC Commissioner Dan Gallagher, our luncheon speaker, is on Twitter. In academic and other circles, Commissioner Gallagher garnered a great deal of attention due to his controversial article co-authored with Joseph Grundfest (Stanford) entitled "Did Harvard Violate Federal Securities Law? The Campaign Against Classified Boards of Directors."

Below is a recent Tweet from Commissioner Gallagher for those who would like to follow him.

March 27, 2015 in Business Associations, Corporations, Haskell Murray, Securities Regulation | Permalink | Comments (1)

Developing Areas of Capital Market and Federal Securities Regulation at Vanderbilt Law School

Vanderbilt

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.

March 27, 2015 in Business Associations, Conferences, Corporate Finance, Corporations, Haskell Murray, Securities Regulation | Permalink | Comments (0)

Wednesday, March 25, 2015

Flipping Roles in the Securities Regulation Classroom

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!  :>)

March 25, 2015 in Corporate Finance, Joan Heminway, Securities Regulation, Teaching | Permalink | Comments (3)

Monday, March 23, 2015

The Illogic of Crowdfunding Resale Restrictions

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.

Conclusion

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.

March 23, 2015 in C. Steven Bradford, Corporate Finance, Entrepreneurship, Joan Heminway, Securities Regulation | Permalink | Comments (1)