Wednesday, July 15, 2015
I read with interest the recently released opinion of the U.S. Court of Appeals for the Third Circuit in Trinity Wall Street v. Walmart Stores, Inc. The Wall Street Journal covered the publication of the opinion earlier in the month, and co-blogger Ann Lipton wrote a comprehensive post sharing her analysis on the substance of the decision over the weekend. (I commented, and Ann responded.) Of course, like Ann, as a securities lawyer, I was interested in the court's long-form statement of its holding and reasoning in the case. But I admit that what pleased me most about the opinion was its use of legal scholarship written by my securities regulation scholar colleagues.
Tom Hazen's Treatise on the Law of Securities Regulation is cited frequently for general principles. This is, as many of you likely already know, an amazing securities regulation resource. I also will note that many of my students find Tom's hornbook helpful when they are having trouble grappling with securities regulation concepts covered in the assigned readings in my class.
Donna Nagy's excellent article on no-action letters (Judicial Reliance on Regulatory Interpretation in S.E.C. No-Action Letters: Current Problems and a Proposed Framework, 83 Cornell L. Rev. 921 (1998)) also is cited by the court. This piece is not praised enough, imho, for the work it does in the administrative process area of securities law. I see the citations in the opinion as an element of needed praise.
And finally, Alan Palmiter's scholarship also is cited numerous times in the opinion. Specifically, the court quotes from and otherwise cites to The Shareholder Proposal Rule: A Failed Experiment in Merit Regulation, 45 Ala. L. Rev. 879 (1994). Again, this work represents an important, under-appreciated scholarly resource in securities law.
At least one other law review article is cited once in the opinion.
[Note: Alison Frankel also points out that Vice Chancellor Laster cites formatively to a paper co-authored by Jill Fisch, Sean Griffith, and Steve Davidoff Solomon in a recent opinion. More evidence that our work matters, at least to the judiciary.]
As Ann's post notes, the Trinity opinion also is worth reading for its substance. In addition to the matters Ann mentions, the opinion includes, for example, a lengthy, yet helpful, history of the ordinary business exclusion under Rule 14a-8. And the analysis is instructive, even if unavailing (unclear in its moorings and effect in individual cases).
Finally, it's worth noting that the opinion is drafted with a healthy, yet (imv) professional, dose of humor. The opinion begins, for example, as follows:
“[T]he secret of successful retailing is to give your customers what they want.” Sam Walton, SAM WALTON: MADE IN AMERICA 173 (1993). This case involves one shareholder’s attempt to affect how Wal-Mart goes about doing that.
And the conclusion of the opinion includes the following passage that made me smile:
Although a core business of courts is to interpret statutes and rules, our job is made difficult where agencies, after notice and comment, have hard-to-define exclusions to their rules and exceptions to those exclusions. For those who labor with the ordinary business exclusion and a social-policy exception that requires not only significance but “transcendence,” we empathize.
(This is part of the "scolding" Ann references in her post.)
Read the concurring opinion of Judge Shwartz, too. It is thoughtful (even if not entirely helpful, as Ann notes) in making some nice additional points worth considering.
Saturday, July 11, 2015
I noted with favor the other day (to myself, privately) the helpful and interesting commentary on The Glom of our trusted colleague and co-blogger, Usha Rodrigues, regarding the recent press reports on Mylan N.V.'s related-party disclosures. As the story goes, a firm managed and owned in part by the Vice Chair of Mylan's board of directors sold some land to an entity owned by one of the Vice Chair's business associates for $1, and that entity turned around the same day and sold the property to Mylan for its new headquarters for $2.9 million. Usha's post focuses on both the mandatory disclosure rules for related-party transactions and the mandatory disclosure rules on codes of ethics. Two great areas for exploration.
A reporter from the Pittsburgh Tribune-Review called me Thursday to talk about the Mylan matter and some related disclosure issues. He and I spoke at some length yesterday. That press contact resulted in this story, published online late last night. The reporter was, as the story indicates, interested in prior related-party disclosures made by Mylan involving transactions with family members of directors. This led to a more wide-ranging discussion about the status of family members for various different securities regulation purposes. It is from this discussion that my quote in the article is drawn. But our conversation covered many other interesting, related issues.
Monday, July 6, 2015
I have been reading Paul Mahoney’s brilliant new book, Wasting a Crisis: Why Securities Regulation Fails (University of Chicago Press 2015). You should too.
Mahoney attacks the traditional market failure rationale for our federal securities laws. He argues that contrary to the traditional narrative, market manipulation was not rampant prior to 1933 and the securities markets were operating reasonably well. Mahoney concludes that “‘lax’ regulation was not a substantial cause of the financial problems accompanying the Great Depression and . . . most (although not all) of the subsequent regulatory changes were largely ineffective and in some cases counterproductive.”
Mahoney looks at state blue sky laws, the Securities Act, the Exchange Act, the Public Utility Holding Company Act, and, regrettably only briefly, the Investment Company Act. He concludes by discussing the Sarbanes-Oxley and Dodd-Frank Acts. He discusses the rationales for each regulation and whether those rationales are supported by the facts. Mahoney backs up his argument with a great deal of empirical research, some of which has appeared in earlier articles. Warning: Some of that discussion may be a little difficult for those without a background in regression analysis or financial economics, but you can follow Mahoney’s conclusions without understanding all of the analytical detail.
Mahoney’s work is a nice counterpoint to the narrative that prevails in most securities treatises and casebooks. Every law library should have a copy. Everyone interested in securities regulation policy, and certainly everyone who teaches a securities law course, should read this book. Whether or not you ultimately agree with Mahoney (as it happens, I generally do), his arguments must be dealt with.
Wednesday, July 1, 2015
As I earlier noted, on June 23rd, I moderated a teleconference on proposals to shorten the Section 13(d) reporting period, currently fixed by statute and regulation at 10 days. If you don't mind registering with Proxy Mosaic, you can listen to the program. The link is here.
The discussion was lively--as you might well imagine, given that one of the participants represents activist shareholders and the other represents public companies. A number of interesting things emerged in the discussion, many (most) of which also have been raised in other public forums on Schedule 13D, including those referenced and summarized here, here, and here, among other places.
- Exactly how does the Section 1d(d) reporting requirement protect investors or maintain market integrity or encourage capital formation? Or is it just a hat-tipping system to warn issuers about potential hostile changes of control, chilling the potential for the market for corporate control to run its natural course? Of course, the answer to many questions about Section 13(d) depends on our understanding of the policy interests being served. It's hard to tinker with the reporting system if we cannot agree on the objectives it seeks to achieve . . . . (Read the remaining bullets with this in mind.)
- We're not in the 1960s, 1970s, or 1980s any more. If market accumulations are deemed to present dangers to investors today (and that case needs to be made), why are they not just an accepted risk of public market participation? Shouldn't every investor know that market accumulations are a risk of owning publicly traded securities? And how does the reporting requirement really protect them from harm? Is this just over-regulation that treats investors as nitwits?
- Not all activist investors are the same. Some act or desire to act as a Section 13(d) group; others don't. Some seek effective or actual control of an issuer; some don't.
- Provisions within the Section 13(d) filing requirements interact. So, can we really talk about decreasing disclosure time periods without also talking about triggering thresholds and mandatory disclosure requirements?
- Why is 5% beneficial ownership the triggering threshold for reporting? What's the magic in that number--and if it were to be changed, should it be lower or higher?
- Schedule 13D is a disclosure form fraught with complexity. Many important judgment calls may have to be made in completing the required disclosures accurately and completely, depending on the circumstances. Is all this complexity needed? In particular, can the Item 4 disclosure requirement be simplified? And is the group concept necessary?
- What is the value, if any, in looking at the issue from a comparative global regulatory viewpoint? Toward the end of the call, international comparisons were increasingly being made and used as evidence that a change in U.S. regulation is needed or desirable. But are other markets and systems of regulation enough like ours for these comparisons to work? E.g., although other countries require Schedule 13D-like filings fewer days after attainment of a triggering threshold of ownership, does that mean we also should reduce the time period for mandatory disclosure here in the U.S.?
Lots of questions; I am beginning to think through answers. Regardless there's much food for thought here. Any reactions? What do you think, and why?
Tuesday, June 30, 2015
Last week, S.E.C Commissioner Daniel M. Gallagher, gave a speech, Activism, Short-Termism, and the SEC: Remarks at the 21st Annual Stanford Directors’ College. I agree with many of Commissioner Gallagher's views on short-termism, and (I will semi-shamelessly note) he cited one of my earlier posts about the role of activists on board decision making. In his remarks, he said, with regard to short-termsim (i.e., companies operating for short term rather than long-term gains):
The current picture is bleak . . .
Clearly, there’s a way for all the parties . . . to co-exist peacefully. The SEC sets a level playing field; companies manage themselves for the long-term with the vigorous oversight of the board; and activists put pressure on those companies that fall short of that ideal. Unfortunately, we are not in that happy place. Rather, there seems to be a predominance of short-term thinking at the expense of long-term investing. Some activists are swooping in, making a lot of noise, and demanding one of a number of ways to drive a short-term pop in value: spinning off a profitable division, beginning a share buy-back program, or slashing capital expenditures or research and development expenses. Having inflated current returns by eliminating corporate investments for the future, these activists can exit their investment and move on.
. . . .
 See, e.g., Joshua Fershee, Shareholder Activists Can Add Value and Still Be Wrong (Apr. 28, 2015) (positing that activists can signal to boards when the company’s strategy may be inefficient; it is then the board’s responsibility to “use the tools before it to make decisions in the best interests of the entity” — that shareholder activists can improve long-term value even if following their recommendations blindly would not).
I absolutely agree with the Commissioner that too many companies are using a short-term philosophy to guide their decision making and that directors are allowing non-controlling institutional investors too much influence in the boardroom. But, as a believer in director primacy, I see that as a director failure, not an S.E.C. failure or an institutional investor/activist failure. Directors need to make the decisions for the entity based on their view of what is best for the entity, not on someone else's view.
Commissioner Gallagher is spot on when he notes his concern "that some institutional investors are paying insufficient attention to their fiduciary obligations to their clients when they determine whether to support a particular activist’s activity."
That concern, though, has nothing to do with how the board of a company responds to its activist institutional investors that urge short-termist actions. The institutional investor activist in that case should be held accountable to its clients, and perhaps it should not be urging such behavior, but that is not relevant to how a board of a company in which an institutional investors owns stock responds to such pressure.
It could be that some boards really believe that short-termism is how best to run a company. The level of complaining about activists suggests otherwise, but then it is up to boards to reject the activist's requests. If boards are being unduly influenced by non-controlling outside forces, then shareholders need to take a break from their rational apathy, and do something. If controlling shareholders are pushing short termism to the detriment of non-controlling shareholders, boards should not follow the controlling shareholder's request or (again) non-controlling shareholders need to push back to ensure the board and the controlling shareholders are honoring their fiduciary obligations.
If it's just that directors like short termism as a strategy, though, and it's not a decision made for any other reason than directors think it's the right one, I believe those directors are wrong. But that's not my call. I'm not on the board.
Thursday, June 18, 2015
Last week I posted the first of three posts regarding doing business in Cuba. In my initial post I discussed some concerns that observers have regarding Cuba’s readiness for investors, the lack of infrastructure, and the rule of law issues, particularly as it relates to Cuba’s respect for contracts and debts. Indeed today, Congress heard testimony on the future of property rights in Cuba and the claims for US parties who have had billions in property confiscated by the Castro government- a sticking point for lifting the embargo. (In 1959, Americans and US businesses owned or controlled an estimated 75-80% of Cuban land and resources). Clearly there is quite a bit to be done before US businesses can rush back in, even if the embargo were lifted tomorrow. This evening, PBS speculated about what life would be like post-embargo for both countries. Today I will briefly discuss the Cuban legal system and then focus the potential compliance and ethical challenges for companies considering doing business on the island.
Cuba, like many countries, does not have a jury system. Cuba’s court system has a number of levels but they have both professional judges with legal training, and non-professional judges who are lay people nominated by trade unions and others. Cubans have compulsory service to the country, including military service for males. Many law graduates serve part of their compulsory service as judges (or prosecutors) and then step down when they are able. The lay judges serve for five years and receive a full month off from their employer to serve at full pay. Although there is a commercial court, only businesses may litigate there and are then they are at the mercy of the lay judges, who have equal power to the professional jurists. This lay judge system exists even at the appellate level. Most lawyers and law firms are controlled by the Cuban government, unless they work for a non agcricultural cooperative. More important, although I have received differing opinions from counsel, it is possible that hiring and paying a local lawyer there could violate US law related to doing business in Cuba. Notwithstanding these obstacles, many companies are trying to get an OFAC license to do business in Cuba right away or are planning for the eventual life of the embargo. In my view, getting there is the easy part. The hard part will be complying with US law, not because Cuba is in a nascent state of legal and economic development, but because of the sheer complexity of doing business with a foreign government.
The first challenge that immediately comes to mind is compliance with the Foreign Corrupt Practices Act, which makes it illegal for a person or company to make “corrupt payments” or provide “anything of value” to a foreign official in order to obtain or retain business. Since almost everything is a state-owned enterprise or a joint venture with a state owned enterprise, US firms take a real risk entering into contracts or trying to get permits. There is no de minimis exception and facilitation payments- otherwise known as grease payments to speed things along- while customary in many countries- are illegal too. Legal fees and fines for FCPA violations are prohibitively expensive, and those companies doing business in Cuba will surely be targets.
Another concern for publicly-traded US companies is compliance with the Sarbanes-Oxley and Dodd-Frank whistleblower rules. Unless the law changes, most US companies will have to follow the model of Canadian and EU companies and enter into joint ventures or some contractual relationship with the Cuban government or a Cuban company (which may be controlled by the government). Most US employees are afraid to report on their own private employers in the US. How comfortable will a Cuban employee be using a hotline or some other mechanism to report wrongdoing when his employer is in some measure controlled by or affiliated with the Cuban government? As I will discuss next week, the biggest criticism of Cuba is its human rights record related to those who dissent. I have personally dealt with the challenge establishing and working with hotlines in China and in other countries where speaking out and reporting wrongdoing is not the cultural norm. I can imagine that in Cuba this could be a herculean task.
The last concern I will raise in this post relates to compliance with a company’s own code of conduct. If a company has a supplier code of conduct that mirrors its own, and those codes discuss freedom of association and workers’ rights that may be out of step with the Cuban law or culture, should the US firm conform to local rules? Even if that is legal, is it ethical? Google's code is famous for its “don’t be evil”credo and it has received criticism in the past from NGOs who question how it can do business in China. But Google was in Cuba last week testing the waters. Perhaps if Google is able to broaden access to the internet and the outside world, this will be a huge step for Cubans. (Of note, Cubans do not see the same TV as the tourists in their hotels and there are no TV commercials or billboards for advertisements).
There are a number of other compliance and ethics challenges but I will save that for my law review article. Next week’s post will deal with the role of foreign direct investment in spurring human rights reform or perpetuating the status quo in Cuba.
Wednesday, June 17, 2015
In response to one of my posts last week, co-blogger Josh Fershee raised concern about making minor changes to securities regulation--in that case, in the context of the tender offer rules. Specifically, after raising some good questions about the teaser questions in a marketing flyer regarding a program I am moderating, he adds:
This reflects my ever-growing sense that maybe we should just take a break from tweaking securities laws and focus on enforcing rules and sniffing out fraud. A constantly changing securities regime is increasingly costly, complex, and potentially counterproductive.
Admittedly, I am not that close to this, so perhaps I am missing something big, but I’m thinking maybe we should just get out of the way (or, probably better stated, keep the obstacles we have in place, because at least everyone knows the course).
Although I pushed back a bit, I generally agree with his premise (and I told him so). I will leave the niceties regarding the tender offer rule at issue for another day--perhaps blogging on this after the moderated program takes place. But in the mean time, I want to think a bit more out loud here about Josh's idea that, e.g., mandatory disclosure and substantive regulation should be minimal and fraud regulation should be paramount. Not, of course, a new idea, but a consideration that all of us who are honest securities policy-makers and scholars must address.
SEC Commissioner Kara M. Stein provided remarks at the Brookings Institute's 75th Anniversary of the Investment Company Act on Monday, June 15th. Now if that isn't an exciting introduction to a post, I just don't know what is. She addressed a topic that is of great interest to me and a focus of my research: retail/retirement investors. I tend to call them Citizen Shareholders in my writing, and it is sentiment shared by Commissioner Stein:
"By retail investor, I mean the everyday citizen or household that is investing – not institutional investors or pension funds. Eighty-nine percent of mutual fund assets are attributable to retail investors." (emphasis added).
In her remarks she detailed several troubling aspects of the mutual fund industry--a primary investment source for retail investors-- liquidity, leverage and disclosure. She also highlighted future SEC rule making initiatives related to these issues. For example, the Commission recently proposed new rules to enhance data reported to the Commission by registered funds. The proposed rule is available here (Download SEC proposed disclosure rules) and received comments can be tracked on the SEC's website here.
Noting that a major function of the 1940 Investment Act was transparency and accuracy through disclosures, she lamented the mission drift in the mutual fund industry which she described as:
"[T]he liquidity of registered funds is one area where it seems that regulation has drifted into “buyer beware.” A retail investor looks at a mutual fund and expects that he or she will be able to get money out of a fund very quickly if needed. A retail investor is generally not performing cash flow analyses on mutual funds to test their true liquidity."
SEC rules require redemption within 7 days and only 15% of mutual fund assets can be invested in illiquid funds. Bank loans and ETF funds, increasingly dramatically in popularity since 2009 (by over 400%) take over one month to settle and thus threaten the redemption rights and liquidity of funds in times of financial stress.
Additional "drift" comes from interpretation that the 15% threshold is at the time of purchase, not at the time of settlement so there is no true 15% threshold.
Promising high liquidity, which all mutual funds must do, on illiquid assets, that have not traditionally been a part of mutual funds, does not seem in keeping with the intent of the Investment Company Act.
Commissioner Stein identified a second problem: leverage. Another cornerstone principle in mutual fund regulation has been the requirement for relatively low leverage, as mandated by Section 18 of the Investment Company Act. Section 18 of the Investment Company Act requires low leverage with senior securities mandating a coverage ratio of 3:1 (300% asset coverage for senior securities). Commissioner Stein described the SEC's enforcement on leverage restrictions as "ad hoc" beginning in 1970 through the 30 subsequent no-action letters issued by the Commission.
Additionally Commissioner Stein addressed the rapid evolution and popularity of alternative mutual funds that attempt to mimic hedge fund returns based on mutual fund liquidity: propositions that she finds troubling.
Assets under management in alternative mutual funds have exploded in recent years. In 2008, there were approximately $46 billion in assets under management for these funds. By the end of 2014, the number had surged to over $311 billion in assets under management. This is an increase of over 575%.
[T]oday, alternative mutual funds promising the upside of hedge fund investments with the liquidity of traditional mutual funds are all the rage. I think that this trend should give everyone pause, and regulators and the public need to be asking questions about this development. ..... Should we consider regulating these funds differently than plain vanilla, traditional mutual funds?
Commissioner Stein's remarks highlight several areas in the mutual fund industry that are being reevaluated by the SEC and should be interested developments to watch if you are an attorney representing mutual fund companies and investment advisers, an academic or simply an average "retail" investor.
Wednesday, June 10, 2015
Courtesy of AALS Section on Securities Regulation Chair Christine Hurt:
Call for Papers
AALS Section on Securities Regulation - 2016 AALS Annual Meeting
January 6-10, 2016 New York, NY
The AALS Section on Securities Regulation invites papers for its program on “The Future of Securities Regulation: Innovation, Regulation and Enforcement.”
TOPIC DESCRIPTION: This panel discussion will explore the current trends and future implications in the securities regulation field including transactional and financial innovation, the regulation of investment funds, the intersection of the First Amendment and securities law, the debate over fee-shifting bylaws, the ever-expanding transactional exemptions including under Regulation D, and judicial interpretations of insider trading laws. The Executive Committee welcomes papers (theoretical, doctrinal, policy-oriented, empirical) on both the transactional and litigation sides of securities law and practice.
ELIGIBILITY: Full-time faculty members of AALS member law schools are eligible to submit papers. Pursuant to AALS rules, faculty at fee-paid law schools, foreign faculty, adjunct and visiting faculty (without a full-time position at an AALS member law school), graduate students, fellows, and non-law school faculty are not eligible to submit. Please note that all faculty members presenting at the program are responsible for paying their own annual meeting registration fee and travel expenses. NOTE FURTHER, AALS has announced reduced registration fees for junior faculty for the 2016 conference.
PAPER SUBMISSION PROCEDURE: Up to four papers may be selected from this call for papers. There is no formal requirement as to the form or length of proposals. However, more complete drafts will be given priority over abstracts, and presenters are expected to have a draft for commentators two weeks prior to the beginning of the AALS conference.
Papers will be selected by the Section's Executive Committee in a double-blind review. Please submit only anonymous papers by redacting from the submission the author's name and any references to the identity of the author. The title of the email submission should read: "Submission - 2016 AALS Section on Securities Regulation."
Please email submissions to the Section Chair Christine Hurt at: firstname.lastname@example.org on or before August 21, 2015.
Monday, June 8, 2015
I was reading an article on securities crowdfunding in China and came across this description of Chinese practice:
Generally, in China, equity-based crowdfunding capital-seekers rely on the strength of experienced, leading investors to advise “follow-up” investors in locating investment projects. Leading investors are usually professionals with rich experience in private offerings and label themselves as holding innovative techniques in investment strategies and possessing sound insights. On the contrary, follow-up investors usually do not have even basic financial skills, but they do ordinarily control certain financial resources for investment. When a leading investor selects a target investment project through an equity-based crowdfunding platform, the leading investor usually invests personal funds into the project. Crowdfunding capital- seekers then take advantage of the leading investor’s funds to market the project to follow-up investors.
(This is from a recent article by Tianlong Hu and Dong Yang, The People’s Funding of China: Legal Developments of Equity Crowdfunding-Progress, Proposals, and Prospects, 83 U. CIN. L. REV. 445 (2014).)
This is not unique to China. Private offerings to accredited investors in the United States often follow a similar path. Smaller investors are more likely to commit once a well-known, sophisticated investor has made a commitment. But the article made me wonder if we could use that structure to create a new securities offering exemption—one that responds to some of the policy concerns people have about the existing exemptions.
Most unregistered primary offerings of securities in the United States are pursuant to Rule 506 of Regulation D, the regulatory safe harbor for the private offering exemption in the Securities Act. Offerings pursuant to Rule 506, either by law [Rule 506(c)] or for practical reasons [Rule 506(b)], are limited to “accredited investors,” a defined term.
Many people have argued that the definition of accredited investor in Regulation D is too broad. Some of the investors covered by the definition are sophisticated institutional investors who clearly can fend for themselves. But the definition also includes many unsophisticated individuals who meet relatively low net worth and income requirements. Many of these investors, it is argued, cannot adequately evaluate the merits and risks of Rule 506 private offerings.
On the other hand, some people have complained that limiting these offerings to accredited investors privileges wealthy people at the expense of “ordinary” investors. Rich people have the opportunity to participate in these sometimes-lucrative offerings, but the rest of us cannot. That was one of the arguments for the not-yet-implemented section 4(a)(6) crowdfunding exemption added by the JOBS Act.
One way to resolve the tension between these two arguments, and deal with both concerns, would be to allow unsophisticated investors to invest in an offering only after a sophisticated investor has made a commitment. Ordinary investors might not be able to protect themselves, but they could free ride on the sophisticated investor’s evaluation of the offering.
We could create a new category of super-accredited investors, consisting only of institutions or individuals who clearly have the sophistication to protect themselves. Once one of those investors purchases a significant stake in an offering, other investors could purchase on the same terms.
For example, if Startup Corporation wanted to raise $50 million in an unregistered offering, it could first sell $10 million of the securities to a large venture capital firm. After that, it would be free to sell the remaining $40 million on the same terms to any investor, accredited or non-accredited, wealthy or not.
The lead investor’s evaluation of the offering wouldn’t completely protect the other investors. In particular, the lead investor’s tolerance for risk might be much higher than most ordinary investors’. But lead investor's evaluation would help protect against fraud and overreaching by the issuer.
The exemption would have to include some additional requirements to make sure that the other investors can reasonably rely on the lead investor’s decision to invest:
1. No conflicts of interest. The lead investor could not have a relationship to the issuer. Otherwise, the lead investor’s decision to invest might be due to that relationship, not because it believes the investment is a good one.
2. Minimum Investment. There should be a minimum investment requirement for the lead investor, to give the lead investor sufficient incentive to review the deal. To take an extreme example, a lead investor’s decision to invest $1 in a $50 million offering tells us little about the quality of the deal.
3. Same Terms. The lead investor must be investing on the same terms as the subsequent investors. The lead investor’s decision that an investment is worthwhile offers no protection at all to subsequent investors if those subsequent investors are getting a materially different deal.
4. Exit. If the lead investor’s decision to invest provides a signal to the other investors, so does the lead investor’s decision to exit the investment. At a minimum, the lead investor should have to disclose to the other investors when it sells. And, if the issuer is repurchasing the lead investor’s securities, we might want to impose a requirement that the issuer also offer to repurchase the securities of the other investors who purchased in the exempted offering.
This is just a sketch of what such an exemption would look like, about as far as one can go in a blog post. The proposed exemption would not be perfect. It wouldn’t guarantee that investors were getting a good deal, or even that the offering was not fraudulent. But even registration can’t do that. And I think the proposal is a nice compromise between investor protection and capital formation concerns.
Friday, May 29, 2015
A while ago, I noted a New York Times article about the effect of SEC Chair Mary Jo White's recusals from cases because of her husband's work at Cravath. The Times has a follow-up today. Apparently, the 2-2 split that results when Ms. White recuses herself is causing some real enforcement headaches, including missing a statute-of-limitations deadline.
Wednesday, May 27, 2015
CRN: #46 Corporate and Securities Law in Society
LSA 2015 Schedule
THURSDAY, MAY 28
2:45 PM - 4:30 PM
3319—Roundtable: Shareholders, Stewardship & Accountability
FRIDAY, MAY 29
9:30 AM - 11:15 AM
3321—Corporations and Their Constituencies: Employees, Customers, Creditors, and the Public
1:30 PM - 3:15 PM
3322—Banking, Securities, and Beyond: Evaluating Financial Regulation in Varied Contexts
3:30 PM - 5:15 PM
3325—Business Decisionmaking and Business Law: Exploring Implications for Constituencies and Communities
5:30 PM - 7:15 PM
3326—New Insights on Law and Regulation’s Evolution and Efficacy
SATURDAY, MAY 30
8:15 AM - 10:00 AM
3320—Ownership and Control: New Considerations on Litigation, Governance Structures, and Shareholder Activism
Friday, May 22, 2015
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
Some of you may recall that I blogged last summer about a SEALS (Southeastern Association of Law Schools) discussion group on "publicness." That post can be found here. My contribution to the discussion group was part of a paper that then was a work-in-process for the University of Cincinnati Law Review that I earlier had blogged about here.
That paper now has been released in electronic and hard-copy format. I just uploaded the final version to SSRN. The abstract for the paper reads as follows:
Conceptions of publicness and privateness have been central to U.S. federal securities regulation since its inception. The regulatory boundary between public offerings and private placement transactions is a basic building block among the varied legal aspects of corporate finance. Along the same lines, the distinction between public companies and private companies is fundamental to U.S. federal securities regulation.
The CROWDFUND Act, Title III of the JOBS Act, adds a new exemption from registration to the the Securities Act of 1933. In the process, the CROWDFUND Act also creates a new type of financial intermediary regulated under the Securities Exchange Act of 1934 and amends the 1934 Act in other ways. Important among these additional changes is a provision exempting holders of securities sold in crowdfunded offerings from the calculation of shareholders that requires securities issuers to become reporting companies under the 1934 Act.
This article attempts to shed more light on the way in which the CROWDFUND Act, as yet unimplemented (due to a delay in necessary SEC rulemaking), interacts with public offering status under the 1933 Act and public company status under the 1934 Act. Using the analytical framework offered by Don Langevoort and Bob Thompson, along with insights provided in Hillary Sale’s work, the article briefly explores how the CROWDFUND Act impacts and is impacted by the public/private divide in U.S. securities regulation. The article also offers related broad-based observations about U.S. securities regulation at the public/private divide.
I hope that you are motivated to read the article--and that you get something out of it if you do read it. The thinking involved in creating the article was often challenging (even if the expressed ideas may not reflect or meet that challenge). Yet, writing the article, in light of the super work already done by Don Langevoort, Bob Thompson, and Hillary Sale, was joyful and illuminating for me in many ways.
I often say that I stand on the shoulders of giants in my teaching and scholarship. That was transparently true in this case. If only all academic research and writing could be so rewarding.
Thursday, May 14, 2015
Last week, I looked lovingly at a picture of a Starbucks old-fashioned grilled cheese sandwich. It had 580 calories. I thought about getting the sandwich and then reconsidered and made another more “virtuous” choice. These calorie disclosures, while annoying, are effective for people like me. I see the disclosure, make a choice (sometimes the “wrong” one), and move on.
Regular readers of this blog know that I spend a lot of time thinking about human rights from a corporate governance perspective. I thought about that uneaten sandwich as I consulted with a client last week about the California Transparency in Supply Chains Act. The law went into effect in 2012 and requires retailers, sellers, and manufacturers that exceed $100 million in global revenue that do business in California to publicly disclose the degree to which they verify, audit, and certify their direct suppliers as it relates to human trafficking and slavery. Companies must also disclose whether or not they maintain internal accountability standards, and provide training on the issue in their direct supply chains. The disclosure must appear prominently on a company’s website, but apparently many companies, undeterred by the threat of injunctive action by the state Attorney General, have failed to comply. In April, the California Department of Justice sent letters to a number of companies stating in part:
If your company has posted the required disclosures on its Internet website or, alternatively, takes the position that it is not required to comply with the Act, we request that – within 30 days of this letter’s date – you complete the form accessible at http://oag.ca.gov/sb657 and provide this office with (1) the web links (URLs) to both your company’s Transparency in Supply Chains Act disclosures and its homepage containing a link to the disclosures; and/or (2) information demonstrating your company is not covered by the Act.
There are no financial penalties for noncompliance. Rather, companies can face reputational damage and/or an order from the Attorney General to post something on their websites. A company complies even if that disclosure states that the company does no training, auditing, certification, monitoring or anything else related to human trafficking or slavery. The client I spoke to last week is very specialized and all of its customers are other businesses. Based on their business profiles, those “consumers” are not likely to make purchasing decisions based on human rights due diligence. I will be talking to another client in a few weeks on the California law. That client is business to consumer but its consumers specifically focus on low cost—that’s the competitive advantage for that client. Neither company-- the B2B nor the B2 (cost conscious)C-- is likely to lose significant, if any business merely because they don’t do extensive due diligence on their supply chains. Similarly, Apple, which has done a great job on due diligence for the conflict minerals law will not set records with the sale of the Apple Watch because of its human rights record. I bet that if I walked into an Apple Store and asked how many had seen or heard of Apple’s state of the art conflict minerals disclosure, the answer would be less than 1% (and that would be high).
People buy products because they want them. The majority of people won’t bother to look for what’s in or behind the product, although that information is readily available through apps or websites. If that information stares the consumer in the face (thanks Starbucks), then the consumer may make a different choice. But that assumes that (1) the consumer cares and (2) there is an equally viable choice.
To be clear, I believe that companies must know what happens with their suppliers, and that there is no excuse for using trafficked or forced labor. But I don’t know that the use of disclosures is the way to go. Some boards will engage in the cost benefit analysis of reputational damage and likelihood of enforcement vs cost of compliance rather than having a conversation about what kind of company they want to be. Many board members will logically ask themselves, “should we care if our customers don’t care?”
My most recent law review article covers this topic in detail. I’ll post it in the next couple of weeks because I need to revise it to cover the April development on the California law, and the EU’s vote on May 19 on their own version of the conflict minerals law. In the meantime, ignorance is bliss. I’m staying out of Starbucks and any other restaurant that posts calories- at least during the stressful time of grading exams.
May 14, 2015 in Corporate Finance, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, International Business, Law Reviews, Marcia Narine, Securities Regulation | Permalink | Comments (3)
Thursday, May 7, 2015
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.
Monday, May 4, 2015
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.
Friday, May 1, 2015
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.
Monday, April 27, 2015
The following guest blog post on my recent article, Institutional Investing When Shareholders Are Not Supreme, is available at Columbia's Blue Sky Blog discussing institutional investors' attitudes towards alternative business forms and similar issues raised by Etsy's IPO.
Thursday, April 16, 2015
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)