Monday, March 23, 2015
The JOBS Act requires the SEC to create an exemption for small, crowdfunded offerings of securities. That exemption, if the SEC ever enacts it, will allow issuers to raise up to $1 million a year in sales of securities to the general public. (Don’t confuse this exemption with Rule 506(c) sales to accredited investors, which is sometimes called crowdfunding, but really isn’t.)
The crowdfunding exemption restricts resales of the crowdfunded securities. Crowdfunding purchasers may not, with limited exceptions, resell the securities they purchase for a year. Securities Act sec. 4A(e); Proposed Rule 501, in SEC, Crowdfunding, Securities Act Release No. 9470 (Oct. 23, 2013). Unlike the resale restrictions in some of the other federal registration exemptions, the crowdfunding resale restriction serves no useful purpose. All it does is to increase the risk of what is already a very risky investment by reducing the liquidity of that investment.
Enforcing the “Come to Rest” Idea
Some of the resale restrictions in other exemptions are designed to enforce the requirement that the securities sold “come to rest” in the hands of purchasers who qualify for the exemption.
Rule 147, the safe harbor for the intrastate offering exemption in section 3(a)(11) of the Securities Act, is a good example. To qualify for the intrastate offering exemption, the securities must be offered and sold only to purchasers who reside in the same state as the issuer. Securities Act sec. 3(a)(11); Rule 147(d). This requirement would be totally illusory if an issuer could sell to a resident of its state and that resident could immediately resell outside the state. Therefore, Rule 147(e) prohibits resales outside the state for nine months.
The resale restrictions applicable to the Rule 505 and 506 exemptions have a similar effect. Rule 506 only allows sales to accredited investors or, in the case of Rule 506(b), non-accredited, sophisticated investors. Rules 506(b)(2)(ii), 506(c)(2)(i). These requirements would be eviscerated if an accredited or sophisticated purchaser could immediately resell to someone who does not qualify.
Rule 505 does not limit who may purchase but, like Rule 506, it does limit the number of non-accredited investors to 35. Rules 505(b)(2)(ii), 501(e)(1)(iv). If an issuer could sell to a single purchaser who immediately resold to dozens of others, the 35-purchaser limitation would be meaningless.
To enforce the requirements of the Rule 505 and 506 exemptions, Rule 502(d) restricts resales in both types of offering.
Preventing an Information-less Resale Market
Rule 504 also includes a resale restriction, Rule 502(d), even though it does not impose any restrictions on the nature or number of purchasers. A resale would not, therefore, be inconsistent with any restrictions imposed on the issuer’s offering.
However, Rule 504 does not impose any disclosure requirements on issuers. See Rule 502(b)(1). Because of that, people purchasing in a resale market would not have ready access to information about the issuer. But the Rule 504 resale restriction does not apply if the offering is registered in states that require the public filing and delivery to investors of a disclosure document. Rules 502(d), 504(b)(1). In that case, information about the issuer is publicly available and there’s no need to restrict resales. People purchasing in the resale market would have access to information to inform their purchases.
The resale restrictions in Rule 505 and 506 offerings could also be justified in part on this basis. If issuers sell only to accredited investors in those offerings, there is no disclosure requirement. If they sell to non-accredited investors, disclosure is mandated, but even then there’s no obligation to make that disclosure public. See Rule 502(b). People purchasing in the resale market therefore would not have ready access to public information about the issuer.
This lack-of-information justification is consistent with the lack of resale restrictions in Regulation A. To use the Regulation A exemption, an issuer must file with the SEC and furnish to investors a detailed disclosure document. Rules 251(d), 252. Because of that, information about the issuer and the security will be publicly available to purchasers in the resale market.
The Crowdfunding Exemption
Neither of these justifications for resale restrictions applies to offerings pursuant to the forthcoming (some day?) crowdfunding exemption.
The come-to-rest rationale does not apply. The crowdfunding exemption does not limit the type or number of purchasers. An issuer may offer and sell to anyone, anywhere, so no resale restriction is necessary to avoid circumvention of the requirements of the exemption.
The information argument also does not apply. A crowdfunding issuer is required to provide a great deal of disclosure about the company and the offering—as I have argued elsewhere, probably too much to make the exemption viable. See Securities Act sec. 4A(b)(1); Proposed Rule 201 and Form C. The issuer is also obligated to file annual reports with updated information. Securities Act sec. 4A(b)(4); Proposed Rule 202. All of that information will be publicly available. Even if one contends that the information required to be disclosed is inadequate, it will be no more adequate a year after the offering, when crowdfunding purchasers are free to resell. Securities Act sec. 4A(e); Proposed Rule 501.
Some people, including Tom Hazen and my co-blogger Joan Heminway, have argued that resale restrictions may be necessary to avoid a repeat of the pump-and-dump frauds that occurred under Rule 504 when Rule 504 was not subject to any resale restrictions. As I have explained, Rule 504, which requires no public disclosure of information, fits within the information rationale. Such fraud is much less likely where detailed disclosure is required. There will undoubtedly be some fraud in the resale market no matter what the rules are, but public crowdfunding will be much less susceptible to such fraud than the private Rule 504 sales in which the pump-and-dump frauds occurred.
The resale restrictions are consistent with neither the come-to-rest rationale nor the information rationale for resale restrictions Forcing crowdfunding purchasers to wait a year before reselling therefore serves no real purpose. The only real effect of those resale restrictions is to make an already-risky investment even riskier by reducing liquidity.
Friday, March 20, 2015
Bernard Sharfman has posted a new article entitled “Activist Hedge Funds in a World of Board Independence: Long-Term Value Creators or Destroyers?" In the paper he makes the argument that hedge fund activism contributes to long-term value creation if it can be assumed that the typical board of a public company has an adequate amount of independence to act as an arbitrator between executive management and the activist hedge fund. He also discusses these funds’ focus on disinvestment and attempts to challenge those in the Marty Lipton camp, who view these funds less charitably. In fact, Lipton recently called 2014 “the year of the wolf pack.” The debate on the merits of activist hedge funds has been heating up. Last month Forbes magazine outlined “The Seven Deadly Sins of Activist Hedge Funds,” including their promotion of share buybacks, aka “corporate cocaine.” Forbes was responding to a more favorable view of these funds by The Economist in its February 7, 2015 cover story.
Whether you agree with Sharfman or Lipton, the article is clearly timely and worth a read. The abstract is below:
Numerous empirical studies have shown that hedge fund activism has led to enhanced returns to investors and increased firm performance. Nevertheless, leading figures in the corporate governance world have taken issue with these studies and have argued that hedge fund activism leads to long-term value destruction.
In this article, it is argued that an activist hedge fund creates long-term value by sending affirming signals to the board of directors (Board) that its executive management team may be making inefficient decisions and providing recommendations on how the company should proceed in light of these inefficiencies. These recommendations require the Board to review and question the direction executive management is taking the company and then choosing which path the company should take, the one recommended by executive management, the one recommended by the activist hedge fund or a combination of both. Critical to this argument is the existence of a Board that can act as an independent arbitrator in deciding whose recommendations should be followed.
In addition, an explanation is given for why activist hedge funds do not provide recommendations that involve long-term investment. There are two reasons for this. First, the cognitive limitations and skill sets of those individuals who participate as activist hedge funds. Second, and most importantly, the stock market signals provided by value investors voting with their feet are telling the rest of the stock market that a particular public company is poorly managed and that it either needs to be replaced or given less assets to manage. These are the kind of signals and information that activist hedge funds are responding to when buying significant amounts of company stock and then making their recommendations for change. Therefore, it is not surprising that the recommendations of activist hedge funds will focus on trying to reduce the amount of assets under current management.
Friday, March 6, 2015
It’s always nice to be validated. Day two into torturing my business associations students with basic accounting and corporate finance, I was able to post the results of a recent study about what they were learning and why. "Torture" is a strong word-- I try to break up the lessons by showing up to the minute video clips about companies that they know to illustrate how their concepts apply to real life settings. But for some students it remains a foreign language no matter how many background YouTube videos I suggest, or how interesting the debate is about McDonalds and Shake Shack on CNBC.
My alma mater Harvard Law School surveyed a number of BigLaw graduates about the essential skills and coursework for both transactional and litigation practitioners. As I explained in an earlier post, most of my students will likely practice solo or in small firms. But I have always believed that the skills sets are inherently the same regardless of the size of the practice or resources of the client. My future litigators need to know what documents to ask for in discovery and what questions to ask during the deposition of a financial expert. My family law and trust and estates hopefuls must understand the basics of a business structure if they wish to advise on certain assets. My criminal law aficionados may have to defend or prosecute criminal enterprises that are as sophisticated as any multinational corporation. Those who want to be legislative aides or go into government must understand how to close loopholes in regulations.
What are the top courses students should take? The abstract is below:
We report the results of an online survey, conducted on behalf of Harvard Law School, of 124 practicing attorneys at major law firms. The survey had two main objectives: (1) to assist students in selecting courses by providing them with data about the relative importance of courses; and (2) to provide faculty with information about how to improve the curriculum and best advise students. The most salient result is that students were strongly advised to study accounting and financial statement analysis, as well as corporate finance. These subject areas were viewed as particularly valuable, not only for corporate/transactional lawyers, but also for litigators. Intriguingly, non-traditional courses and skills, such as business strategy and teamwork, are seen as more important than many traditional courses and skills.
Did you take these courses? Has your school started adding more of this type of coursework and does your faculty see the value? Do you agree with the results of this survey? Let me know in the comments or email me at firstname.lastname@example.org.
March 6, 2015 in Business Associations, Corporate Finance, Corporate Governance, Corporations, Current Affairs, Jobs, Law School, Marcia Narine, Securities Regulation, Teaching | Permalink | Comments (2)
Monday, March 2, 2015
As many of you know, both I and my co-blogger Joan Heminway have written several articles on crowdfunding. My articles are available here and Joan’s are available here. I think that a properly structured crowdfunding exemption (unfortunately, not the exemption Congress authorized in Title III of the JOBS Act) could revolutionize the finance of very small businesses.
Professor Darian M. Ibrahim, of William & Mary Law School, has posted an interesting and important new paper on crowdfunding, Equity Crowdfunding: A Market for Lemons? It’s available here.
Professor Ibrahim discusses two types of “crowdfunding” approved by the JOBS Act: (1) sales to accredited investors pursuant to SEC Rule 506(c), adopted pursuant to Title II of the JOBS Act; and (2) sales to any investors pursuant to the crowdfunding exemption authorized by Title III of the JOBS Act, but not yet implemented by the SEC. I don’t think the former should be called crowdfunding, but many people call it that, so I’ll excuse Professor Ibrahim.
Title II “Crowdfunding”
Professor Ibrahim points out that traditional investing by venture capitalists and angel investors is characterized by contractual controls and direct personal attention to the business by the investors. This allows the investors to monitor the investment and control misbehavior, and the investors’ participation and advice also provides a benefit to the business.
Ibrahim argues that Title II (506(c)) “crowdfunding” has been successful because it mimics what angel investors have been doing all along. It’s not really revolutionary, just making the existing model of angel investing more efficient by moving it to the Internet.
Title III Crowdfunding
Title III crowdfunding, on the other hand, is revolutionary; it doesn’t resemble anything that currently exists in the United States. If the SEC ever adopts the required rules, issuers will be selling to unaccredited investors who lack the knowledge and sophistication of venture capitalists and angel investors. It’s less obvious how they will judge among the various offerings and protect themselves from misbehavior by the entrepreneur.
Some have argued that the new crowdfunding exemption will appeal only to those companies that are too low quality to obtain traditional VC or angel funding, leaving unaccredited investors with the bottom of the barrel. Ibrahim disagrees, arguing that Title III crowdfunding will appeal to some high-quality entrepreneurs—those who need less cash for their businesses or are unwilling to share control with VCs or angel investors.
But how are we to avoid a “lemons” problem if the unsophisticated investors likely to participate in crowdfunding cannot distinguish good companies from bad? Ibrahim poses two possible answers. The first is the “wisdom of crowds,” the idea that the collective decision-making of a large crowd can approximate or even exceed expert judgments. Possibly, although I’m not completely sure. Collective judgments by non-experts can equal or surpass the judgments of experts, but I'm still unsure that the necessary conditions for that to happen are met on crowdfunding platforms. At best, I think the wisdom of the crowd is only a partial answer.
Ibrahim’s second answer is for the funding portals who host crowdfunding offers to curate the offerings—investigate the quality of the offerings and either provide ratings or limit their sites to higher-quality offerings. I think this is a good idea, but, unfortunately, the SEC’s proposed regulations would prohibit funding portals from doing this. Funding portals required to check for fraud, but that’s all they can do. Any attempt to exclude entrepreneurs for reasons other thanfraud or to provide ratings would go beyond what the proposed regulations allow and subject the portals to regulation under the Investment Advisers Act. Ibrahim has the right solution, but it’s going to require congressional action to get there.
Abstract of the Paper
Here’s the full abstract of Professor Ibrahim’s article:
Angel investors and venture capitalists (VCs) have funded Google, Facebook, and virtually every technological success of the last thirty years. These investors operate in tight geographic networks which mitigates uncertainty, information asymmetry, and agency costs both pre- and post-investment. It follows, then, that a major concern with equity crowdfunding is that the very thing touted about it – the democratization of investing through the Internet – also eliminates the tight knit geographic communities that have made angels and VCs successful.
Despite this foundational concern, entrepreneurial finance’s move to cyberspace is inevitable. This Article examines online investing both descriptively and normatively by tackling Titles II and III of the JOBS Act of 2012 in turn. Title II allows startups to generally solicit accredited investors for the first time; Title III will allow for full-blown equity crowdfunding to unaccredited investors when implemented.
I first show that Title II is proving successful because it more closely resembles traditional angel investing than some new paradigm of entrepreneurial finance. Title II platforms are simply taking advantage of the Internet to reduce the transaction costs of traditional angel operations and add passive angels to their networks at a low cost.
Title III, on the other hand, will represent a true equity crowdfunding situation and thus a paradigm shift in entrepreneurial finance. Despite initial concerns that only low-quality startups and investors will use Title III, I argue that there are good reasons why Title III could attract high-quality participants as well. The key question will be whether high-quality startups can signal themselves as such to avoid the classic “lemons” problem. I contend that harnessing the wisdom of crowds and redefining Title III”s “funding portals” to serve as reputational intermediaries are two ways to avoid the lemons problem.
It’s definitely worth reading.
Andrew Schwartz at the University of Colorado is also working on a paper that addresses the problems of uncertainty, information asymmetry, and agency costs in Title III crowdfunding. I have read the draft and it’s also very good, but it’s not yet publicly available. I will let you know when it is.
Thursday, February 26, 2015
Last week, I posted about Walmart’s ballyhooed wage hike and asked whether boycotts and activism actually work. Apparently, the President was so impressed that he called the company’s CEO to thank him. Some Walmart workers, however, aren’t as pleased because without more hours, they still can’t make ends meet. Nonetheless, TJX, the parent company of retailers TJ Maxx and Home Goods announced yesterday that its employees would also receive a pay raise. Is this altruism? Have the retail giants caved to pressure?
As some commented on the blog last week and to me privately, it’s more likely that these megaretailers have implemented these “pro-employee” moves to reduce turnover, raise morale, and most important compete in a tightening job market. But one LinkedIn commenter from Australia believes that boycotts in general can work, stating:
My experience with having organised boycotts is that they work, but they take time. They create the conditions for public awareness of corporate activities, and put pressure on the company to change. They are effectively the 'bad cop' of civil society pressure. Consequently, they do not work on their own, requiring also the 'good cop' - civil society organisations and market conditions that allow the subject of the boycott to shift behaviour. Market conditions include a broader 'meta boycott' in which companies needing access to supply chains must change because supply chains have changed, only accepting product that is acceptable to CSOs (the 'good' CSOs, who have certification programmes, and other initiatives for the company to opt for. If you are looking for a case study of these conditions, I suggest you follow the Tasmanian forest industry debate in Australia. Here, an entire industry was worn down after years of boycotts, market campaigns, and demands from purchasers for FSC certified product only. The fascinating addendum to this case study is the state government (and the Federal government, unsuccessfully), are still advocating behaviours that not even the companies want. They want to sign the 'peace deal' and the government(s) are trying to prolong the 'war' - for political, election-related issues. All this indicates that boycotts do not work in isolation, and if they do they are less likely to work.
Investors too are putting pressure on companies. Just yesterday, a group of 60 investors with four trillion in assets under management called for companies to do more for workers' human rights, including wages. Because I study business and human rights with a special emphasis on labor issues, I will wait to see what happens with all of this pressure. I will also monitor the share price, shareholder proposals, and whether there is any evidence that consumers reward Walmart and TJX for their better treatment of workers.
Tuesday, February 24, 2015
The New York Times has an interesting article today about SEC Chair Mary Jo White. Her husband is a partner at Cravath, Swaine, & Moore, so she has to recuse herself from any cases, enforcement actions, or investigations involving the firm's clients. The Times claims that the resulting 2-2 split has given the Republican commissioners a little more control over some settlements than they otherwise would have had.
Thursday, February 5, 2015
Many corporate governance professionals have been scratching their heads lately. In November, a federal judge in Delaware ruled that Wal-Mart had wrongfully excluded a shareholder proposal by Trinity Wall Street Church regarding the sale of guns and other products. Specifically, the proposal requested amendment of one of the Board Committee Charters to:
27. Provid[e] oversight concerning the formulation and implementation of, and the public reporting of the formulation and implementation of, policies and standards that determine whether or not the Company [i.e., Wal-Mart] should sell a product that:
1) especially endangers public safety and wellbeing;
2) has the substantial potential to impair the reputation of the Company; and/or
3) would reasonably be considered by many offensive to the family and community values integral to the Company's promotion of its brand.
Wal-Mart filed with the SEC under Rule 14a-8 indicating that it planned to exclude the proposal under the ordinary business operations exclusion. The SEC agreed that there was a basis for exclusion under 14a-8(i)(7), but the District Court thought otherwise because the proposal related to a “sufficiently significant social policy.” In mid-January Wal-Mart appealed to the Third Circuit arguing among other things that the district court should have deferred to the SEC’s precedents and guidance over the past forty years on these issues.
In an unrelated but relevant matter in December 2014, the SEC issued a no action letter to Whole Foods stating:
You represent that matters to be voted on at the upcoming stockholders' meeting include a proposal sponsored by Whole Foods Market to amend Whole Foods Market's bylaws to allow any shareholder owning 9% or more of Whole Foods Market's common stock for five years to nominate candidates for election to the board and require Whole Foods Market to list such nominees with the board's nominees in Whole Foods Market's proxy statement. You indicate that the proposal and the proposal sponsored by Whole Foods Market directly conflict. You also indicate that inclusion of both proposals would present alternative and conflicting decisions for the stockholders and would create the potential for inconsistent and ambiguous results. Accordingly, we will not recommend enforcement action to the Commission if Whole Foods Market omits the proposal from its proxy materials in reliance on rule 14a-8(i)(9).
In a startling turn of events, the SEC withdrew its no action letter on January 16, 2015 after a January 9th letter from the Council of Institutional Investors questioning the reasoning in the Whole Foods and similar no action letters. The withdrawal of the no action letter came on the same day as the release an official SEC statement declining “to express a view on the application of Rule 14a-8(i)(9) during the current proxy season” due to questions about the scope and application of the rule.
This announcement, a contradictory departure from a decision made just weeks earlier, benefits neither issuers nor investors and introduces an additional layer of uncertainty into an already complicated set of rules. The CCMC believes this reversal underscores why corporate governance policies must provide certainty for all stakeholders, not just to advance the goals of a small minority of special interest activists….[t]he January 16 announcement places many issuers in an untenable position, and presents them with a series of questions for which there may be no good answers. For those issuers wishing to present their own alternative proposal to shareholders for consideration, do they exclude a shareholder proposal in favor of their own and face the heightened risk of litigation with the proponent or the Commission? Do they risk shareholder confusion by including both their own proposal and a competing one from a proponent? Do they incur the added expense and distraction to management of seeking declaratory relief in federal district court? Are shareholders deprived of their right to include a proposal that is omitted because of the absence of SEC action? Far from encouraging private ordering, the recent announcement will only serve to stymie it.
The CCMC also recommends a review of the entire 14a-8 process because, as the letter claims, “it is well-known that the shareholder proposal process has been dominated by a small group of special interest activists, including groups affiliated with organized labor, certain religious orders, social and public policy advocates, and a handful of serial activists. These special interests use the shareholder proposal process to pursue their own idiosyncratic agendas, often far removed from the mainstream, as evidenced by the overall low approval rates of many shareholder proposals that are put to a vote. Indeed, mainstream institutional investors account for only one percent of shareholder proposals at the Fortune 250.”
Reasonable people may disagree on how the CCMC characterizes the motives behind the shareholder proposals, but there can be no disagreement that the current SEC silence doesn't serve any constituency. Steve Bainbridge also has an informative post on this topic. Proxy season is coming up and shareholders and companies alike are awaiting a decision from the Third Circuit in the Wal-Mart action that could dramatically alter the landscape for shareholder proposals, possibly flooding the courts with expensive, protracted litigation. The timing couldn’t be worse for the SEC’s lack of action on no action letters.
February 5, 2015 in Corporate Finance, Corporate Governance, Corporations, Current Affairs, Delaware, Financial Markets, Marcia Narine, Securities Regulation, Social Enterprise | Permalink | Comments (0)
Wednesday, February 4, 2015
I am a list maker. I make daily to do lists, grocery lists, research plans, workout schedules (that quickly get jettisoned) and complicated child care matrices necessary in two-career families. How else am I supposed to remember and keep on my radar all of the things that I am supposed to be doing now, or doing when I have time, or things that I can't forget to do in the future? One area where I feel deficient is in planning my conference travel/attendance. It always feels either a little ad hoc (ohh I got an invitation and I never say no to those!) or a little out habit (once you have presented at a conference it is easier to be asked to participate in future panels). Rarely does it feel like a part of an intentional plan for the year where I set out to prioritize conference A or break into conference B.
Realizing that this year there are 3 corporate law events within 10 days of each other is seriously making me reconsider my approach. I need a conference list-- a way to plan for the coming year, prioritize opportunities and frankly, schedule grandparent visits (read: child care) when I need to travel for more than a night or two.
Below is my running list of annual or nearly annual events, but I know that I am missing big pieces of the conference puzzle. Please contribute in the comments so we can create a list of some standard corporate law events (great for new teachers, great for those looking to expand their research circles, etc.). Updated to reflect suggestions in comments & put in approximate order of timing.
- AALS Annual (and Mid-year) Meeting (January; call for papers and/or invited participation spring & summer)
- Society for the Advancement of Behavioral Economics "SABE" (January; call for papers summer/fall)
- C-LEAF Junior Faculty Workshop (Feb. 27-28, 2015, a call for papers in the summer)
- Law and Entrepreneurship Retreat (UGA, March 21, 2015, a call for papers was released late 2014)
- Tulane Corporate Law Institute (March 2015 workshop; paid attendance & invited participation)
- Institute of Law & Economic Policy (ILEP) symposium (in April, by invitation)
- Annual Transactional Clinical Conference (occurs annually; April 24, 2015; call for paper circulated fall 2014)
- Law and Society Association "LSA" (late May 2015; calls for papers & coordinated panel submissions and round tables Fall 2014)
- National Business Law Scholars ( June 2015; call for papers available Dec. 2014)
- Berle Center Symposium at Seattle University (schedule varies; invited papers & attendance)
- Emory Teaching Transactional Law & Skills Conference (every 2 years usually in summer; call for papers announced)
- American Law & Economics Association (May 15, 2015; call for papers late fall terminated January 2015)
- Southeastern Association of Law Schools "SEALS" (July/August 2015; call for papers in the fall & coordinated panel submissions; papers due in spring)
- Midwestern Law and Economics Association "MLEA" (usually in the fall; call for papers late summer)
- Canadian Law and Economics Association Annual Meeting (Toronto, Fall 2015, a call for papers in the spring)
- ABA LLC Institute (usually October conference; workshop attendance & invited participation)
- Conference on Empirical Legal Studies (Wash U, October 30-31, 2015, a call for papers in the late spring)
- Corporate and Securities Litigation Workshop (Boston University, early November, expect a call for papers in the spring)
- Henry G. Manne Programs at George Mason ( programs occur throughout the year; workshop attendance)
- Various Harvard Law Corporate Governance Round Tables (programs occur throughout the year; invited attendance/ participation)
Tuesday, February 3, 2015
Last Wednesday, I reported on a New York Times story that, prior to Alibaba's registered public offering this fall, a Chinese government agency secretly contacted Alibaba about allegedly illegal practices on its shopping web sites. Not surprisingly, the U.S. securities litigation industry has swung into action and filed a securities class action lawsuit against Alibaba. Details here. Welcome to America!
Monday, February 2, 2015
On December 22 and again on January 9, I posted the first two installments of a three-part series featuring the wit and wisdom of my former student, Brandon Whiteley, who successfully organized a student group to draft, propose, and instigate passage of Invest Tennessee, a state crowdfunding bill in Tennessee. The first post featured Brandon's observations on the legislative process, and the second post addressed key influences on the bill-that-became-law. This post, as earlier promised, includes Brandon's description of the important role that communication played in the Invest Tennessee endeavor. Here's what he related to me in that regard (as before, slightly edited for republication here).
Thursday, January 29, 2015
I oppose the Dodd-Frank conflict minerals rule, which requires companies to conduct due diligence and report on their sourcing of certain minerals from the war-ravaged Democratic Republic of Congo and surrounding countries. As I have written before repeatedly on this blog, a law review article, and an amicus brief, it is a flawed “name and shame law” that assumes that consumers and investors will change their purchasing decisions based upon a corporate disclosure, which they may not read, understand, or care about. The name and shame portion of the law was struck down on First Amendment grounds, and the business lobby, the SEC, and the NGO community are eagerly awaiting a decision by the full DC Circuit Court of Appeals.
A disclosure law that does not take into account the true causes for the violence that has killed millions is not the most effective way to have a meaningful impact for the Congolese people. The Democratic Republic of Congo needs outside governments to provide more aid on security sector, criminal justice, education, and judicial reform at the very least. Indeed, the Congolese government is still trying to defeat the rebels that this law was meant to weaken (see here for example). I have strong feelings about the law as a former supply chain professional and an advisory board member of an NGO that operates in eastern DRC.
I am currently working on an article about the defects in disclosure laws that attempt to address human rights impacts, and the conflict minerals rule is one of them. In that context, I was excited to read a recent draft article entitled The Conflict Minerals Experiment by Professor Jeff Schwartz. Although I don't agree with his conclusion that the best way to fix the law is, among other things, to employ a disclose or explain approach and greater transparency (which I also discuss in my article), I do agree that reform and not necessarily repeal is in order. Schwartz’ article is particularly useful because he provides empirical evidence of the relative uselessness of the first round of corporate disclosures. I look forward to citing it in my upcoming piece. The abstract is below:
In Section 1502 of Dodd-Frank, Congress instructed the SEC to draft rules that would require public companies to report annually on whether their products contain certain Congolese minerals. This unprecedented legislation and the SEC rulemaking that followed have inspired an impassioned and ongoing debate between those who view these efforts as a costly blunder and those who view them as a measured response to human-rights abuses committed by the armed groups that control many mines in the Congo.
This Article for the first time brings empirical evidence to bear on this controversy. I present data on the inaugural disclosures that companies submitted to the SEC. Based on a quantitative and qualitative analysis of these submissions, I argue that Congress’s hope of supply-chain transparency goes unfulfilled, but amendments to the rules could yield useful information without increasing compliance costs. The SEC filings expose key loopholes in the regulatory structure and illustrate the importance of fledgling institutional initiatives that trace and verify corporate supply chains. This Article’s proposal would eliminate the loopholes and refocus the transparency mandate on disclosure of the supply-chain information that has come to exist thanks to these institutional efforts.
Wednesday, January 21, 2015
One week after the SEC levied the largest dark pool trading violation fine against USB, a group of nine banks (including Fidelity, JP Morgan, BlackRock, etc.) introduced a new dark pool platform, an independent venture called Luminex Trading & Analytics. Dark trading pools are linked to the role of high frequency trading and the notion that certain buyers and sellers should not jump the queue and shouldn't be the first to buy or sell in the face of a large order. The financial backers of Luminex were quoted in a Bloomberg article describing it as a platform "where the original purpose of dark pools, letting investors buy and sell shares without showing their hand to others, will go on without interference."
The announcement raises public scrutiny about dark pools, but among financial circles (like those at ZeroHedge, it is being touted as a smart self-regulatory move by the major mutual funds to prevent the money leach to HFT's, which some seeing as the beginning of the end for HFTs.
If you are looking for more resources on dark pools and HFTs-- there are two brand new SSRN postings on the subject:
- Chris Brummer's Disruptive Technology and Securities Regulation
- Andreas M. Fleckner, Regulating Trading Practices
Tuesday, January 20, 2015
I was watching the Michigan State-Iowa basketball game a couple weeks ago, and commentator Jay Bilas noted his view (which he has stated previously) that the lane violation rule is wrong. I am teaching Sports Law and an Energy Law Seminar this semester, so (naturally) I linked his comments to a broader framework.
So start, here's the current rule. Basketball for dummies explains:
Lane violation: This rule applies to both offense and defense. When a player attempts a free throw, none of the players lined up along the free throw lane may enter the lane until the ball leaves the shooter's hands. If a defensive player jumps into the lane early, the shooter receives another shot if his shot misses. An offensive player entering the lane too early nullifies the shot if it is made.
Bilas argues that a defensive lane violation should result in the ball being awarded to shooter's team instead of another attempt at the free throw for the shooter. His rationale is, "The advantage to be gained going in early is on the rebound, not the shot. Give the ball to the non-violating team." This is probably right, though a player might enter the lane early to distract the shooter, too. I suppose one could award a reshot for a lane violation if the ball is not live (e.g., the violation occurs on the first freethrow of a two-shot foul), and award the ball to the shooter's team on a missed live ball.
I think there is some merit to Bilas's argument, but I think there's a practical reason the rule remains as it is: the penalty is not too harsh, making it something referees are willing to call. A favorite quote of mine comes from Ben Franklin, who once warned, "Laws too gentle are seldom obeyed; too severe, seldom executed."
Here, I think Bilas is probably right on the penalty-incentive link, but the rule he proposes may prove too severe for lane violations to be called as willingly as they are today. In addition, practically speaking, if the shooter makes the free throw anyway, the shooter's team would still need to get the ball after a lane violation, if the punishment is really about discincentivizing cheating for a rebound. This could be the rule, and it might be right, too, but that would make the penalty even more severe, making referees even less likely to make the call. (You could, I suppose, give the shooter's team a choice -- the the point or the ball -- but that gets messy.)
I used the Ben Franklin quote in my article from a few years back, Choosing a Better Path: The Misguided Appeal of Increased Criminal Liability after Deepwater Horizon, which was published in the William & Mary Environmental Law and Policy Review (available here). In the article, I argued that increased criminal liability for energy company employees was not likely to be any more effective in preventing disasters like the blowout of BP oil well in the Gulf of Mexico because the likelihood of actually sending people to jail is highly unlikely.
I still believe this is true in a many contexts. It's not to say we should not have harsh penalties for certain behaviors, but we need to be sure the laws or rules are more than justifiable. We also need to be sure they will be executed in a manner that the laws or rules serve the actual purpose for which they were designed.
To be clear, we also need to be sure that the penalties are not so gentle that no one will follow the rule. In the energy and business sector, I am of the mind that we regularly err on both sides -- some rules are too gentle and others too severe. Sports can be that way, too, though we often don't even know the penalty for certain acts like, say, allegedly deflating a few footballs.
As for lane violations, though, I think the rule has the balance right, even if there is a justification for a harsher rule.
Monday, January 19, 2015
Every U.S. law school, or at least every law school I’m aware of, offers a securities regulation course. But those courses usually focus on the Securities Act of 1933 and the Securities Exchange Act of 1934. A typical securities regulation course covers the definition of security, materiality, the registration of securities offerings under the Securities Act, and liability issues under both the Securities Act and the Exchange Act. If the professor is ambitious, those courses may also cover the regulation of securities markets and broker-dealers.
Almost none of those basic securities regulation courses spends any significant time on the 1940 Acts—the Investment Company Act and the Investment Advisers Act. It’s not because those two statutes are unimportant. A good proportion of American investment is through mutual funds and other regulated investment companies, not to mention hedge funds which depend upon Investment Company Act exemptions. And the investment advisory business is booming. When I attend gatherings of securities lawyers, I’m always amazed at how many of the lawyers present are dealing with issues under the 1940 Acts.
The lack of coverage of the 1940 Acts in the basic securities law course would be acceptable if law schools offered separate, stand-alone courses dealing with those issues, but many of them do not. I began teaching a course on the 1940 Acts in 1997. (I subsequently expanded the course to include a segment on the regulation of brokers.) At that time, you could count the number of law schools offering 1940 Act courses on one hand. Since then, more law schools have begun to offer such courses, but many law schools still do not.
Why are law schools not offering such an important business law course? One problem may be staffing. Many schools, including my own, have only one securities law professor. That person often also has to teach Business Associations, Mergers and Acquisitions, and other such courses, leaving no time for a second securities course. I have been able to offer my course only by rotating it with Mergers and Acquisitions on a biennial basis.
The lack of 1940 Act courses may also be due to the backgrounds of people teaching securities law. Some (certainly not all) securities law professors come from the litigation side of practice. Securities litigation centers on the 1933 and 1934 Acts. Litigation is a less important part of practice under the 1940 Acts, so many securities litigators aren’t exposed to it much.
A third problem is a lack of teaching materials. There isn’t much available on the 1940 Acts. I was lucky when I began teaching the course to discover a set of materials put together by Larry Barnett at Widener University. Those materials, supplemented with my own handouts and problems, have worked well. Unfortunately, Larry just retired and will no longer be updating his materials, so I’m not sure what I’m going to do now. I suspect more people would teach the course if more books were available, but there’s a chicken-and-egg problem. The major publishers aren’t interested in offering materials for a course that few schools teach.
Whatever the reason, the lack of such courses is a serious deficiency at any school preparing students for a securities law practice.
I'm interested to hear from commenters: are there any other courses law schools aren't teaching that are crucial to business law practice?
Thursday, January 15, 2015
Greetings from Dublin. Between the Guinness tour, the champagne afternoon tea, and the jet lag, I don’t have the mental energy to do the blog I planned to write with a deep analysis of the AALS conference in DC. I live tweeted for several days and here my top 25 tweets from the conference. I have also added some that I re-tweeted from sessions I did not attend. I apologize for any misspellings and for the potentially misleading title of this post:
Posner: judges ought to give reasons for rulings but shouldn't pretend they're interpreting intention of the statute drafters #AALS2015— Dalie Jimenez (@daliejimenez) January 5, 2015
Studies show that scholars are more productive if they write 15-30 minutes every day- more so if they are accountable for time #AALS2015— Marcia Narine (@mlnarine) January 4, 2015
#AALS2015 Judge Rosenthal-lots of questions are so practical re access to courts that academics haven't focused on them.— Marcia Narine (@mlnarine) January 3, 2015
Next week I will write about the reason I'm in Dublin.
January 15, 2015 in Business Associations, Conferences, Corporate Finance, Corporate Governance, Corporate Personality, Corporations, CSR, Delaware, Financial Markets, Marcia Narine, Securities Regulation, Travel | Permalink | Comments (0)
Friday, January 9, 2015
A few weeks ago, I described to you a really special extracurricular project undertaken by one of my students, Brandon Whiteley, now an alum, this past year. The project? Proposing and securing legislative passage of Invest Tennessee, a Tennessee state securities law exemption for intrastate offerings that incorporates key features of crowdfunding. The legislation became effective on January 1.
In that first post, I described the project and Brandon's observations on the legislative process. This post highlights his description of the influences on the bill that became law. Here they are, with a few slight edits (and hyperlink inserts) from me.
Monday, December 22, 2014
Effective as of January 1. 2015, Tennessee will allow Tennessee corporations to engage in intrastate offerings of securities to Tennessee residents over the internet without registration. The new law, adopted earlier this year, is the direct result of a law-student-led movement. The key student leader was one of my students, and he kept me informed about the effort as it moved along. (I was called upon for advice and commentary from time to time, but the bill is all their work.)
In my experience, this kind of effort--a student-initiated, non-credit, extracurricular engagement in business law reform--is almost unheard of. I was intrigued by the enterprise and impressed by its success. As a result, I asked the student leader, Brandon Whiteley, now an alumnus, to send me some of his perceptions about drafting and proposing the bill and getting it passed.
This is the first in a series of three posts that feature Brandon's observations on the legislative process, the key influences on the bill, and the importance of communication. This post highlights his commentary on the legislative process (which I have edited minimally with his consent). I think you'll agree that his wisdom and humor both shine through in this first installment (as well as the others). His organizational capabilities also are evident throughout.
Monday, December 15, 2014
On December 10, the press reported the Second Circuit's decision in the insider trading prosecution of Todd Newman and Anthony Chiasson (two of multiple defendants in the original case). In its opinion, the court reaffirms that tippee liability for insider trading is predicated on a breach of fiduciary duty based on the receipt of a personal benefit by the tipper and clarifies that insider trading liability will not result unless the tippee has knowledge of the facts constituting the breach (i.e., "knew that the insider disclosed confidential information in exchange for a personal benefit"). The court summarized its opinion, which addresses these matters in the context of the Newman case, a criminal case, as follows:
[W]e conclude that, in order to sustain a conviction for insider trading, the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit. Moreover, we hold that the evidence was insufficient to sustain a guilty verdict against Newman and Chiasson for two reasons. First, the Government’s evidence of any personal benefit received by the alleged insiders was insufficient to establish the tipper liability from which defendants’ purported tippee liability would derive. Second, even assuming that the scant evidence offered on the issue of personal benefit was sufficient, which we conclude it was not, the Government presented no evidence that Newman and Chiasson knew that they were trading on information obtained from insiders in violation of those insiders’ fiduciary duties.
Thursday, December 11, 2014
In many companies, executives and employees alike will give a blank stare if you discuss “human rights.” They understand the terms “supply chain” and “labor” but don’t always make the leap to the potentially loaded term “human rights.” But business and human rights is all encompassing and leads to a number of uncomfortable questions for firms. When an extractive company wants to get to the coal, the minerals, or the oil, what rights do the indigenous peoples have to their land? If there is a human right to “water” or “food,” do Kellogg’s, Coca Cola, and General Mills have a special duty to protect the environment and safeguard the rights of women, children and human rights defenders? Oxfam’s Behind the Brands Campaign says yes, and provides a scorecard. How should companies operating in dangerous lands provide security for their property and personnel? Are they responsible if the host country’s security forces commit massacres while protecting their corporate property? What actions make companies complicit with state abuses and not merely bystanders? What about the digital domain and state surveillance? What rights should companies protect and how do they balance those with government requests for information?
The disconnect between “business” and “human rights” has been slowly eroding over the past few years, and especially since the 2011 release of the UN Guiding Principles on Business and Human Rights. Businesses, law firms, and financial institutions have started to pay attention in part because of the Principles but also because of NGO pressures to act. The Principles operationalize a "protect, respect, and remedy" framework, which indicates that: (i) states have a duty to protect against human rights abuses by third parties, including businesses; (ii) businesses have a responsibility to comply with applicable laws and respect human rights; and (iii) victims of human rights abuses should have access to judicial and non-judicial grievance mechanisms from both the state and businesses.
Many think that the states aren’t acting quickly enough in their obligations to create National Action Plans to address their duty to protect human rights, and that in fact businesses are doing most of the legwork (albeit very slowly themselves). The UK, Netherlands, Spain, Italy and Denmark have already started and the US announced its intentions to create its Plan in September 2014. A number of other states announced that they too will work on National Action Plans at the recent UN Forum on Business and Human Rights that I attended in Geneva in early December. For a great blog post on the event see ICAR director Amol Mehra's Huffington Post piece.
What would a US National Action plan contain? Some believe that it would involve more disclosure regulation similar to the Dodd-Frank Conflict Minerals Rule, the Ending Trafficking in Government Contracting Act, Trafficking Victims Protection Act, the Burma Reporting Requirements on Responsible Investment, and others. Some hope that it will provide additional redress mechanisms after the Supreme Court’s decision in Kiobel significantly limited access to US courts on jurisdictional grounds for foreign human rights litigants suing foreign companies for actions that took place outside of the United States.
But what about the role of business? Here are five observations from my trip to Geneva:
1) It's not all about large Western multinationals: As the Chair of the Forum Mo Ibrahim pointed out, it was fantastic to hear from the CEOs of Nestle and Unilever, but the vast majority of people in China, Sudan and Latin American countries with human rights abuses don’t work for large multinationals. John Ruggie, the architect of the Principles reminded the audience that most of the largest companies in the world right now aren’t even from Western nations. These include Saudi Aromco (world’s largest oil company), Foxconn (largest electronics company), and India’s Tata Group (the UK’s largest manufacturing company).
2) It’s not all about maximization of shareholder value: Unilever CEO Paul Pollman gave an impassioned speech about the need for businesses to do their part to protect human rights. He was followed by the CEO of Nestle. (The opening session with both speeches as well as others from labor and civil society was approximately two hours long and is here). In separate sessions, representatives from Michelin, Chevron, Heinekin, Statoil, Rio Tinto, Barrick, and dozens of other businesses discussed how they are implementing human rights due diligence and practices into their operations and metrics, often working with the NGOs that in the past have been their largest critics such as Amnesty International, Human Rights Watch and Oxfam. The US Council for International Business, USCIB, also played a prominent role speaking on behalf of US and international business interests.
3) Investors and lenders are watching: Calvert; the Office of Investment Policy at OPIC, the US government’s development finance institution; the Peruvian Financial Authority; the Supervision Office of the Banco Central do Brasil; the Vice Chair of the Banking Association of Colombia; the European Investment Bank; and Swedfund, among others discussed how and why financial institutions are scrutinizing human rights practices and monitoring them as contractual terms. This has real world impact as development institutions weigh choices about whether to lend to a company in a country that does not allow women to own land, but that will provide other economic opportunities to those women (the lender made the investment). OPIC, which has an 18 billion dollar portfolio in 100 countries, indicated that they see a large trend in impact investing.
4) Integrated reporting is here to stay: Among other things, Calvert, which manages 14 billion in 40 mutual funds, focused on their commitment to companies with solid track records on environmental, social, and governance factors and discussed the benefits of stand alone or integrated reporting. Lawyers from some of the largest law firms in the world indicated that they are working with their clients to prepare for additional non-financial reporting, in part because of countries like the UK that will mandate more in 2016, and an EU disclosure directive that will affect 6,000 firms.
5) Is an International Arbitration Tribunal on the way?: A number of prominent lawyers, retired judges and academics from around the world are working on a proposal for an international arbitration tribunal for human rights abuses. Spearheaded by lawyers for better business, this would either supplement or possibly replace in some people’s view a binding treaty on business and human rights. Having served as a compliance officer who dealt extensively with global supply chains, I have doubts as to how many suppliers will willingly contract to appear before an international tribunal when their workers or members of indigenous communities are harmed. I also wonder about the incentives for corporations, the governing law, the consent of third parties, and a host of other sticking points. Some raised valid concerns about whether privatizing remedies takes the pressure off of states to do their part. But it’s a start down an inevitable road as companies operate around the world and want some level of certainty as to their rights and obligations.
On another note, I attended several panels in which business executives, law firm partners, and members of NGOs decried the lack of training on business and human rights in law schools. Even though professors struggle to cover the required content, I see this area as akin to the compliance conversations that are happening now in law schools. There is legal work in this field and there will be more. I look forward to integrating some of this information into an upcoming seminar.
In the meantime, I tried to include some observations that might be of interest to this audience. If you want to learn more about the conference generally you can look to the twitter feed on #bizhumanrights or #unforumwatch, which has great links. I also recommend the newly released Top 10 Business and Human Rights Issues Whitepaper.
December 11, 2014 in Business Associations, Conferences, Corporate Finance, Corporate Governance, Corporations, CSR, Current Affairs, Financial Markets, International Business, Jobs, Law School, Marcia Narine, Securities Regulation, Teaching | Permalink | Comments (0)
Monday, December 8, 2014
Many of you may have seen this already, but this past week's news brought with it an update to JPMorgan Chase CEO Jamie Dimon's health situation--positive news on his cancer treatment results, for which we all can be grateful. I posted here about Dimon's earlier public disclosure that he was undergoing treatment for this cancer. Based on publicly available information, I give Dimon my (very unofficial) "Power T for Transparency" cheer for 2014. (The "Power T" is The University of Tennessee's key--and now almost exclusive--branding symbol. See my earlier posts on UT's related branding decisions regarding the Lady Volunteers here and here.)
As many of you know, I have written about securities law and corporate law disclosure issues relating to private facts about key executives (which include questions relating to the physical health of these important corporate officers). I do not plan to rehash all that here. But I will note that I think friend and Glom blogger David Zaring gets it just right in his brief report on the recent Dimon announcement (with one small typo corrected and a hyperlink omitted):
Not to pile on, but there's the slightly unsettling trend of CEOs talking, or not, about their health. Surely material information a real investor would want to know about when deciding whether to buy or sell a stock in these days of the imperial CEO. But deeply unprivate. . . . The stock is up 2% on the day. It will be interesting to see whether this email makes its way into a securities filing.
Love that post. Thanks, David.
Sadly, as I was drafting this post, I learned that Kansas City Chiefs safety and former Tennessee Volunteer football standout Eric Berry has been diagnosed with Hodgkin's lymphoma. This obviously is not a matter of public company business disclosure regulation (given that the Kansas City Chiefs franchise, while incorporated, apparently is privately held). But I know I join many in and outside Vol Country in wishing Eric the same success in his cancer treatment that Dimon appears to have had to date with his.