Saturday, April 19, 2014
Anita K. Krug has posted Downstream Securities Regulation on SSRN with the following abstract:
Securities regulation wears two hats: Its “upstream” side governs firms in connection with their obtaining financing in the securities markets. That is, it regulates firms’ — issuers’ — offers and sales of securities, whether in public offerings to retail investors or in private offerings to institutional investors. Its “downstream” side, by contrast, governs financial services providers, who assist with investors’ activities in those markets: Their services include providing advice as to securities investments, as investment advisers do; aggregating investors’ assets for purposes of enabling those investors to invest their assets collectively, as mutual funds do; and acting as “middlemen” between buyers and sellers of securities, as broker-dealers do. Yet neither scholars nor policymakers have adequately understood that the regulation of financial services providers under the securities laws is substantively different from the regulation of issuers. They have not, in other words, adequately understood downstream securities regulation.
The problems arising from this oversight are evident in laws and rules designed to protect investors from the excesses of brokerage firms, fraudulent conduct in the mutual fund industry, and hedge-fund managers’ self-interested conduct, as well as in those enacted in the wake of Enron’s bankruptcy and other corporate scandals. Moreover, the harm to investors is real: Brokerage firm customers have struggled for the return of their deposited funds after the firm’s bankruptcy; mutual fund shareholders have suffered from market timing scandals; when tasked with remedying harms to shareholders of financial services firms, the potency of antifraud statutes has been muted. This Article is the first scholarly work to articulate how securities regulation encompasses two distinct spheres of regulation, each of which is based on its own core principles — and, importantly, each of which necessitates its own regulatory approaches. The Article contends that policymakers’ longstanding failure to recognize that securities regulation is bimodal has produced a securities regulatory regime scattershot with flaws and vulnerabilities. Securities regulation could become substantially better with a more complete understanding of how it works — how all parts of it work.
Thomas K. Kick, Enrico Onali, Benedikt Ruprecht, and Klaus Schaeck have posted Wealth Shocks, Credit-Supply Shocks, and Asset Allocation: Evidence from Household and Firm Portfolios on SSRN with the following abstract:
We use a unique dataset with bank clients’ security holdings for all German banks to examine how macroeconomic shocks affect asset allocation preferences of households and non-financial firms. Our analysis focuses on two alternative mechanisms which can influence portfolio choice: wealth shocks, which are represented by the sovereign debt crisis in the Euro area, and credit-supply shocks which arise from reductions in borrowing abilities during bank distress. While households with large holdings of securities from stressed Euro area countries (Greece, Ireland, Italy, Portugal, and Spain) decrease the degree of concentration in their security portfolio as a result of the Euro area crisis, non-financial firms with similar levels of holdings from stressed Euro area countries do not. Credit-supply shocks at the bank level result in lower concentration, for both households and non-financial corporations. Only shocks to corporate credit bear ramifications on bank clients’ portfolio concentration. Our results are robust to falsification tests, and instrumental variables estimation.
Cécile Carpentier and Jean-Marc Suret have posted Business Angels’ Perspectives on Exit by IPO on SSRN with the following abstract:
We analyze exit-related perceptions of the members of a large, well-structured Canadian angel group. Because they invest in high tech deals larger than CAN$1.2 million, together with venture capitalists and a matching fund, these angels should consider the initial public offering (IPO) as a possible exit mode. However, they show a strong preference for the trade sale. This preference is consistent with the economies of scope hypothesis: getting big fast has become more important because large firms can fully and rapidly exploit innovations, resulting in more small firm acquisitions. Securities regulation is also perceived as a major impediment to exiting onto the stock market. Both reasons explain why IPOs are not considered an exit mode. Reluctance to exit through an IPO increases with angels’ experience. Our observations have implications for entrepreneurs, business angels and policy makers.
Friday, April 18, 2014
On April 16, 2014, Commissioner Daniel M. Gallagher delievered Closing Remarks at the SEC's 24th Annual International Institute for Market Development.
The SEC Actions Blog has compiled This Week In Securities Litigation (Week ending April 17, 2014).
Tuesday, April 15, 2014
Li Ong and Fabian Lipinsky have posted Asia's Stock Markets: Are There Crouching Tigers and Hidden Dragons? on SSRN with the following abstract:
Stock markets play a key role in corporate financing in Asia. However, despite their increasing importance in terms of size and cross-border investment activity, the region’s markets are reputed to be more “idiosyncratic” and less reliant on economic and corporate fundamentals in their pricing. Using a model that draws on international asset pricing and economic theory, as well as accounting literature, we find evidence of greater idiosyncratic influences in the pricing of Asia’s stock markets, compared to their G-7 counterparts, beyond the identified systematic factors and local fundamentals. We also show proof of a significant relationship between the strength of implementation of securities regulations and the “noise” in stock pricing, which suggests that improvements in the regulation of securities markets in Asia could enhance the role of stock markets as stable and reliable sources of financing into the future.
Carlos Berdejo has posted Going Public After the JOBS Act on SSRN with the following abstract:
The Jumpstart Our Business Startups Act of 2012 (JOBS Act) represents one of the most comprehensive overhauls of the securities laws in recent years. The principal legislative goal of the JOBS Act is to improve the access to the capital markets for smaller issuers, which are referred to in the act as emerging growth companies, or EGCs. To accomplish this goal, the JOBS Act seeks to reduce the costs of conducting a public offering and complying with the ensuing reporting obligations by making certain disclosure requirements voluntary for EGCs. This Article examines whether these scaled disclosure rules have increased the number of small issuers conducting an initial public offering (IPO) of their equity securities and the extent to which these issuers have taken advantage of the various exemptions available to them under the JOBS Act.
The evidence presented in this Article indicates that EGCs have increasingly taken advantage of several of the scaled disclosure provisions of the JOBS Act during the course of their IPOs. However, the number of EGCs accessing the public capital markets has not increased as a result. The Article explores two explanations for these seemingly contradictory findings. First, the evidence suggests that the direct costs of conducting an IPO have not decreased for EGCs and that some indirect costs may have increased following the enactment of the JOBS Act. Second, certain issuers that qualify for EGC status (particularly the largest ones) may be choosing to pursue private offerings instead. EGCs that take advantage of the scaled financial disclosure available under the JOBS Act are smaller, younger and more likely to belong to R&D-intensive industries, a pattern supporting the adoption of a more flexible securities regulation framework that allows issuers to select from a menu of disclosure regimes.
Jenice J. Prather-Kinsey and Paul Tanyi have posted The Market Reaction to SEC IFRS-Related Announcements: The Case of American Depository Receipt (ADR) Firms in the U.S. on SSRN with the following abstract:
The objective of our study is to test whether the adoption of International Financial Reporting Standards (IFRS) in the United States (U.S.) is perceived positively by American Depository Receipt (ADR) firms’ equity market participants. We conduct our tests by studying market reactions to the Securities and Exchange Commission’s (SEC) IFRS-related press releases between 2007 and 2011 regarding potential adoption of IFRS in the U.S. Using a sample of ADR firms and multivariate regression analyses, we test the 3-day cumulative abnormal returns (CAR) of investors of ADR firms in response to SEC announcements on potential IFRS adoption. We find a significant and positive market reaction to the SEC’s announcements related to the potential adoption of IFRS in the U.S. for ADR firms reporting their financial statements using IFRS, especially in the industry where IFRS is the globally predominant accounting standard. Conversely, we find a significantly negative market reaction to SEC related announcements of potential adoption of IFRS in the U.S. for ADR firms currently reporting their financial statements using U.S. generally accepted accounting principles (GAAP). We conclude that the SEC’s adoption of IFRS may benefit global and U.S. equity market participants relative to Local GAAP reporting (reporting using domestic GAAP that is not IFRS or U.S. GAAP) by providing a common basis for investors, issuers and others to evaluate investment opportunities.
On April 15, 2014 at the North American Trading Architecture Summit in New York, Gregg E. Berman, Associate Director of the SEC's Office of Analytics and Research of the Division of Trading and Markets delivered remarks on What Drives the Complexity and Speed of our Markets.
On April 15, 2014 as part of the MIT Sloan School of Management’s Center for Finance and Policy’s Distinguished Speaker Series, Craig M. Lewis, Chief Economist and Director of the SEC's Division of Economic and Risk Analysis delivered remarks on The Future of Capital Formation.
Monday, April 14, 2014
Omri Y. Marian has posted Reconciling Tax Law and Securities Regulation on SSRN with the following abstract:
Issuers in registered securities offerings are required to disclose, among other tax matters, the expected tax consequences to investors that result from investing in the offered securities (“nonfinancial tax disclosure”). I advance three arguments in this regard. First, nonfinancial tax disclosure practice, as sanctioned by the SEC, does not achieve its intended regulatory purposes. Nonfinancial tax disclosures provide irrelevant information, sometimes fail to provide material information, create unnecessary transactions costs, and divert valuable administrative resources to the enforcement of largely-meaningless requirements. Second, I suggest that the practical reason for this regulatory failure is an unsuccessful attempt by tax practitioners and the SEC to address investors’ heterogeneous tax preferences. Specifically, nonfinancial tax disclosure practice assumes the existence of a “reasonable investor” who is also an “average taxpayer”, and tax disclosures are drafted for the benefit of such average taxpayer. The “average taxpayer”, however, is not a defensible construct. Third, the theoretical reason for the dysfunctionality of the regulatory regime is misapplication of mandatory disclosure theory to tax rules. I argue that given the special nature of tax laws, mandatory disclosure theory — even if accepted at face value — does not support current regulatory framework. To remedy this failure, I describe the types of tax-related disclosures that would be supported by mandatory disclosure theory. Under my suggested regulatory reform, nonfinancial tax disclosure will only include issuer-level tax items, (namely, items at the company level not otherwise disclosed in the financial statements), that affect how “reasonable investors” calculate their own individual tax liabilities. Under such a regime, there is no need to rely on the “average taxpayer” construct.
Robert W. McGee has posted Applying Utilitarian Ethics and Rights Theory to the Regulation of Insider Trading in Transition Economies on SSRN with the following abstract:
The press has given the public the impression that insider trading is evil, unethical and illegal, when in fact such is not always the case. In some cases, insider trading is beneficial to the economy and to shareholders. Whether insider trading is harmful, unethical or illegal depends on many factors.
Policymakers in transition economies are trying to reform their legal and economic systems to more closely reflect those of the developed market economies. However, those policies are often flawed because they tend to outlaw some forms of insider trading that are beneficial to the economy and not unethical in nature. This paper examines recent trends in the regulation of insider trading in transition economies, then applies utilitarian ethics and rights theory to determine which policies are appropriate. More than 35 links to other insider trading articles and World Bank studies are also provided.
Louis R Piccotti has posted An ETF Premium Puzzle and a Market Segmentation Explanation on SSRN with the following abstract:
This paper shows that exchange traded funds (ETFs) persistently trade at a premium to net asset value (NAV) and that market segmentation can explain this puzzling regularity. Tracking error standard deviation is used as the measure of market segmentation. ETFs with larger tracking error standard deviations trade at higher premiums, consistent with the notion that investors are willing to pay a premium to receive liquidity and diversification benefits from holding ETFs rather than the underlying securities directly. These results are robust to investor sentiment effects. Further tests validate that tracking error standard deviation has the desirable properties of a market segmentation measure.
Luca Enriques and Sergio Gilotta have posted Disclosure and Financial Market Regulation on SSRN with the following abstract:
This is a draft chapter for a forthcoming volume, The Oxford Handbook on Financial Regulation, edited by Eilís Ferran, Niamh Moloney, and Jennifer Payne, (Oxford University Press). It provides an overview of the role of mandatory disclosure in financial markets. Focusing mainly on issuer disclosure, we discuss the various goals that academics and policymakers associate to disclosure-based regulatory techniques and the rationales in support of mandatory, as opposed to voluntary, disclosure. We highlight the limits of disclosure as a regulatory technique and the costs – both direct and indirect – it involves. We conclude by addressing a few selected issues that, in our view, are particularly representative of the challenges that today’s policymakers face in the area of mandatory disclosure.
Joan MacLeod Heminway has posted Business Lawyering in the Crowdfunding Era on SSRN with the following abstract:
The advent of crowdfunding (and crowdfund investing, in particular) has put strain on business lawyering. This paper identifies and comments on professional responsibility and professionalism issues in the current rapidly changing business finance and regulatory environment -- an environment in which crowdfunded businesses and projects have become a reality. Traps for the unwary exist in a number of areas ranging from the unlicensed practice of law, through matters of competence and diligence, to compliance with a lawyer's public duties. By appreciating these issues and being attentive to these observations, legal counsel should be better able to engage in productive, valued, ethical lawyering in the crowdfunding era and beyond.
Jerry Brito, Houman B. Shadab, and Andrea Castillo have posted Bitcoin Financial Regulation: Securities, Derivatives, Prediction Markets, & Gambling on SSRN with the following abstract:
The next major wave of Bitcoin regulation will likely be aimed at financial instruments, including securities and derivatives, as well as prediction markets and even gambling. While there are many easily regulated intermediaries when it comes to traditional securities and derivatives, emerging bitcoin-denominated instruments rely much less on traditional intermediaries. Additionally, the block chain technology that Bitcoin introduced for the first time makes completely decentralized markets and exchanges possible, thus eliminating the need for intermediaries in complex financial transactions.
In this article we survey the type of financial instruments and transactions that will most likely be of interest to regulators, including traditional securities and derivatives, new bitcoin-denominated instruments, and completely decentralized markets and exchanges. We find that bitcoin derivatives would likely not be subject to the full scope of regulation under the Commodities and Exchange Act because such derivatives would likely involve physical delivery (as opposed to cash settlement) and would not be capable of being centrally cleared. We also find that some laws, including those aimed at online gambling, do not contemplate a payment method like Bitcoin, thus placing many transactions in a legal gray area.
Following the approach to Bitcoin taken by FinCEN, we conclude that other financial regulators should consider exempting or excluding certain financial transactions denominated in Bitcoin from the full scope of the regulations, much like private securities offerings and forward contracts are treated. We also suggest that to the extent that regulation and enforcement becomes more costly than its benefits, policymakers should consider and pursue strategies consistent with that new reality, such as efforts to encourage resilience and adaptation.
Sunday, April 13, 2014
Urska Velikonja has posted Public Compensation for Private Harm: Evidence from the SEC's Fair Fund Distributions on SSRN with the following abstract:
The SEC’s primary goal is enforcing compliance with securities laws. Almost as important but less visible is the SEC’s rise as a source of compensation for defrauded investors. The Sarbanes-Oxley Act in 2002 expanded the SEC’s ability to compensate investors by allowing the agency to distribute collected civil fines through fair funds.
Based on a couple of well-known cases, fair fund distributions have been derided as a smaller, feebler version of private securities litigation — a waste of the SEC’s resources on repetitive cases. This is the first empirical study to examine the population of 236 fair funds created between 2002 and 2013, through which the SEC will distribute $14.33 billion to defrauded investors. Contrary to conventional wisdom, the study finds that the SEC’s distributions are neither small nor, for the most part, circular transfers from shareholder victims to themselves. Two-thirds of fair funds compensate investors for what can best be described as consumer fraud or anticompetitive behavior by securities markets intermediaries.
Importantly, the study also reveals that private and public compensation for securities fraud are not coextensive. More than half of the time, the SEC compensates investors for losses where a private lawsuit is either unavailable or impractical. The Article thus exposes the limits of private securities litigation as an investors’ remedy. The rise of public compensation, such as the SEC’s distribution funds, fills a void in securities laws, which leaves many victims with no private remedy.
The following law review articles relating to securities regulation are now available in paper format:
Matthew Aglialoro, Note, The New Group Pleading Doctrine, 99 Cornell L. Rev. 457 (2014).
John Arganbright, Comment, No Loss, No Problem: How the Second Circuit Altered Dura and the Concept of Economic Loss in Securities Fraud Cases in ... (Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 2005; Acticon AG v. China North East Petroleum Holdings, Ltd., 692 F.3d 34, 2012.), 44 Seton Hall L. Rev. 279 (2014).
Charles R. Korsmo, High-Frequency Trading: A Regulatory Strategy, 48 U. Rich. L. Rev. 523 (2014).
Jennifer O'Hare, Synthetic CDOs, Conflicts of Interest, and Securities Fraud, 48 U. Rich. L. Rev. 667 (2014).
Junsun Park, Global Expansion of National Securities Laws: Extraterritoriality and Jurisdictional Conflicts, 12 U.N.H. L. Rev. 69 (2014).
Financial Innovation in a Changing World, Keynote by Ethiopis Tafara; articles by Gabriel V. Rauterberg, Andrew Verstein, W. Mark C. Weidemaier, Mitu Gulati, Galit A. Sarfaty, Philip M. Nichols & Richard C. Smith, 54 Va. J. Int'l L. 1-171 (2013).
Friday, April 11, 2014
Eva Micheler has posted Custody Chains and Remoteness - Disconnecting Investors from Issuers on SSRN with the following abstract:
The article shows that the current market infrastructure systemically prevents investors, both shareholders and bondholders, from exercising their rights against issuers. Equity and debt securities are now normally held through a chain of custodians. These custodians are connected with each other through contract law. There also exists legislation determining the relationship between custodians and their clients.
It will be shown in the paper that custody chains have become independent from investors and issuers. Neither issuers nor investors are able to control the length of the chain or the content of the legal arrangements that governs the custody chain. Custodians are connected through a series of bilateral links that are independent of each other. This erodes the rights of investors. The paper will illustrate this by reference to the liability of custodians for their services and by reference to the ability of custodians to contract with sub-custodians on terms that are independent from the terms that they have entered into with their customers.
Custody chains affect securities markets at a very fundamental level. Securities are a bundle of rights that investor have against issuers. Market participants assume that these rights are enforceable against the issuer. There is always a risk that an issuer defaults and becomes unable to meet claims. Otherwise, however, the market is entitled to expect that its infrastructure will make it possible to enforce claims where an investor takes the view that the issuer does not comply with the terms of an issue.
If the enforcement of claims is significantly compromised this can affect the value of securities. Investors will only enforce claims if the cost of enforcement is outweighed by the benefits. If the market infrastructure is set up in way that makes enforcement systematically very expensive investors will refrain from enforcing claims and that has implication for the value of those claims. This can have systemic implications.
Custody chains not only affect securities values in the portfolios of investors. They also cause problems for issuers. They pose a significant hurdle preventing individual and institutional investors from exercising rights against issuers when they wish to do so and as a result deprive issuers of oversight from the shareholders.
This problem cannot be overcome by contract law, corporate law or property law. The thesis of this paper is that structural reform is required to reduce the number of intermediaries that operate between issuers and investors. A central, direct and transparent mechanism should be created through which investors hold securities. The paper observes that in the past incumbent market participants have lobbying intensively to preserve the exiting structure and predicts that they are likely to oppose any change that will be proposed in the future.
Felix B. Chang has posted The Systemic Risk Paradox: Banks and Clearinghouses Under Regulation on SSRN with the following abstract:
Consolidation in the financial industry threatens competition and increases systemic risk. Recently, banks have seen both high-profile mergers and spectacular failures, prompting a flurry of regulatory responses. Yet consolidation has not been as closely scrutinized for clearinghouses, which facilitate trading in securities and derivatives products. These nonbank intermediaries can be thought of as middlemen who collect deposits to ensure that each buyer and seller has the wherewithal to uphold its end of the deal. Clearinghouses mitigate the credit risks that buyers and sellers would face if they dealt directly with each other.
Yet here lies the dilemma: large clearinghouses reduce credit risk, but they heighten systemic risk since the collapse of one such entity threatens the entire financial system. While the systemic risks posed by large banks have been tackled by regulators, the systemic risks of these nonbank intermediaries have received less attention. In fact, clearinghouses have been cloaked with a regulatory mantle which encourages unchecked growth.
This Article examines the paradoxical treatment of regulators toward the systemic risks of clearinghouses and banks. It explores two fundamental questions: Why does the paradox exist, and who benefits from it? Borrowing from antitrust, this Article offers a framework for ensuring that the entities which control a large clearinghouse (the big banks) do not abuse its market dominance.
Nadelle Grossman has posted The Sixth Commissioner on SSRN with the following abstract:
The federal securities laws grant broad rulemaking authority to the Securities and Exchange Commission (SEC). In promulgating rules, the SEC must not only ensure that its rules protect investors and the public interest, but also consider the effects of its rules on efficiency, competition, and capital formation (the ECCF mandate).
However, the SEC’s rulemaking authority has recently been frustrated. In two decisions striking down SEC rules, the D.C. Circuit held that the ECCF mandate requires a quantitative cost-benefit analysis. This contrasts with the SEC’s historic practice of qualitatively assessing the effects of its rules.
While these D.C. Circuit decisions have been criticized for applying an inappropriately high standard of review to SEC rulemaking, this article identifies a more fundamental problem with these decisions: they interfere with the SEC’s power to administer the securities laws. This interference frustrates administrative law principles that lie at the heart of the division of power among the three branches of government.
Requiring the SEC to engage in a quantitative analysis in rulemaking is especially troubling in a context where the SEC must pass numerous rules under the Dodd-Frank and JOBS Acts. These analyses will surely fail to capture the unquantifiable effects of SEC rules, such as their effect on firm wealth-creating strategic management processes. For these reasons, this article urges the SEC to exert its authority under securities laws and issue an explicit interpretation of the ECCF mandate in a way that best captures the full impact of its rules.
Rui A. Albuquerque, Raquel M. Gaspar and Allen Michel have posted Investment Analysis of Autocallable Contingent Income Securities on SSRN with the following abstract:
Autocallable contingent income securities are a relatively new type of structured finance security that gives investors an opportunity to earn high yields in a low interest environment. We collect data on autocallable contingent income securities listed on SEC’s EDGAR from June of 2009 through June of 2013 and describe the properties of autocallable products and of the underlying assets used. We model a typical autocall and show that the unconditional annualized internal rate of return of such a security is often surprisingly low and highly negatively skewed. Our model predicts that by choosing to write the autocall on underlying securities that trade at high prices and display high volatility, the autocall will generate low rates of return for the investor despite the high offered coupons. We provide evidence that underwriting banks design autocalls in a way consistent with our predictions.
Robert W. McGee and Walter E. Block have posted An Ethical Look at Insider Trading on SSRN with the following abstract:
This paper examines the objections that have been raised with regard to insider trading and applies utilitarian ethics and rights theory to determine when insider trading is ethical and when it is not. It also provides a list for further reading, along with links.
Elisabeth de Fontenay has posted Do the Securities Laws Matter? The Rise of the Leveraged Loan Market on SSRN with the following abstract:
One of the enduring principles of federal securities regulation is the mantra that bonds are securities, while commercial loans are not. Yet the corporate bond and loan markets in the U.S. are rapidly converging, putting significant pressure on the disparity in their regulatory treatment. As securities, corporate bonds are subject to onerous public disclosure obligations and liability regimes, which corporate loans avoid entirely. This longstanding regulatory distinction between loans and bonds is based on the traditional conception of a commercial loan as a long-term relationship between the borrowing company and a single bank, in contrast to bonds, which may be issued to widely dispersed retail investors and are traded in a liquid market. Today, however, not only are loans funded by dispersed, non-bank creditors, but the pricing, terms, participants, and liquidity in the two markets are rapidly converging. Logically, securities regulators should respond to this functional convergence by treating loans and bonds as one and the same. While the regulatory disparity persists, however, it provides a rare natural experiment testing the effectiveness of the securities laws. That the loan market has achieved comparable depth and liquidity to the bond market, even in the absence of mandatory disclosure and robust antifraud provisions, suggests that the securities laws are not doing the work for which they were intended.
Barbara G. Katz and Joel Owen have posted An Evaluation of Shareholder Activism on SSRN with the following abstract:
We develop a method to evaluate shareholder activism when an activist targets firms whose shareholders are diversified portfolio holders of possibly correlated firms. Our method of evaluation takes the portfolios of all of the shareholders, including the activist, as its basis of analysis. We model the activist from the time of the acquisition of a foothold in the target firm through the moment when the activist divests the newly acquired shares. We assume that during this period, all exchanges of securities, and their corresponding prices, are achieved in Walrasian markets in which all participants, including the activist, are risk-averse price-takers. Using the derived series of price changes of all the firms in the market, as well as the derived series of changes in all the portfolio holdings over this period, we evaluate the impact of activism on the activist, on the group of other shareholders, and on the combined group. We show that when activism is beneficial to the activist, the group of other investors may not benefit; furthermore, even when the activist benefits from activism, the value of the market may decrease. When the activist benefits from activism, an increase in the value of the market is a necessary but not sufficient condition for the group of other investors to benefit also from activism. In addition, we show that the combined group, the activist plus the group of other investors, benefits if and only if the value of the market increases and, under this condition, either the activist or the group of other investors, but not necessarily both, benefits.
NASAA President Andrea Seidt’s Remarks at the 2014 SIFMA Compliance and Legal Society Annual Meeting
The SEC Actions Blog has compiled This Week In Securities Litigation (Week ending April 11, 2014).
Tuesday, April 8, 2014
Larissa Lee has posted The Ban Has Lifted: Now is the Time to Change the Accredited-Investor Standard on SSRN with the following abstract:
On July 10, 2013, the United States Securities and Exchange Commission lifted an eighty-year ban on general solicitation and general advertising for certain private securities offerings. This was part of a mandate from the Jumpstart Our Business Startups Act ("JOBS Act") in an effort to help small and emerging companies get on their feet. Before, private companies had to rely on private connections or hire an investment bank with those connections in order to raise capital. Now, these companies may solicit or advertise securities through the mail, phone, and online, but only when they are selling to accredited investors. This new rule does not replace the old rule, which allowed a portion of the investors to be unaccredited; it is in addition to the old rule.
The problem with the current accredited-investor standard is that it considers only wealth in determining whether a person may invest. These exempted securities are typically highly risky and because the standard does not take into account investor sophistication or cap the investment amount, it is possible for investors to lose everything on one bad investment. Lifting the general advertising ban creates even more risk that investors may be harmed as issuers can target the elderly and those who are most likely to need protection.
To ameliorate these harms, I therefore propose a new accredited-investor standard involving a mixture of wealth, financial sophistication, and diversification considerations. Additionally, I argue that companies should be required to disclose certain information including the amount of risk and the fact that the securities are unregistered before they may solicit or sell their securities. Finally, I argue that investors should not be allowed to invest all of their income or net worth into one investment; rather investors should only be allowed to invest a certain percentage, to ensure that if the securities fail or are fraudulent, investors won’t lose all of their savings at once.
Larissa Lee has posted Admission of Guilt: Sinking Teeth into the SEC's Sweetheart Deals on SSRN with the following abstract:
Throughout its existence, the Securities and Exchange Commission (SEC) has allowed defendants to settle cases without admitting to the allegations of wrongdoing. This "neither admit nor deny" policy has received heavy criticism by judges, Congress, and the public, especially in the wake of the 2008 financial crisis. On June 18, 2013, SEC Chairman Mary Jo White announced the agency’s intention to require admissions of guilt in certain cases. While Chairman White did not articulate a clear standard of when admissions would be required, she did say that the agency would focus on the egregiousness of the defendant’s conduct and the harm to investors. This Article develops a model to help determine which settlements should require an admission of wrongdoing. This model balances the costs of requiring admissions — in resources and litigation expenses, with the social benefits of requiring admissions — both in ensuring that the defendants are responsible for their actions and allowing the public to distinguish between technical violators and the more culpable offenders.
Yoon-Ho Alex Lee has posted The Efficiency Criterion for Securities Regulation: Investor Welfare or Total Surplus? on SSRN with the following abstract:
Recent regulatory debates have centered on whether independent agencies should be subjected to a more rigorous cost-benefit analysis requirement than their current mandates or should otherwise be required conduct cost-benefit analysis that conforms to the Office of Management and Budget’s guidance under Circular A-4. The Article closely examines the way in which one particular agency--the Securities and Exchange Commission (the “SEC”)--conducts its economic analysis in rulemaking. The SEC’s economic analysis, conducted pursuant only to its statutory mandate to consider the effects on “efficiency, competition, and capital formation,” mainly compares benefits that would accrue to investors against out-of-pocket compliance costs to be incurred by regulated entities. Circular A-4, by contrast, recommends a total surplus approach, whereby benefits and costs are considered from the perspective of all market participants, without making any value judgment as to which parties are inherently more deserving of surpluses. The current debates therefore raise an urgent policy question for the SEC: whether it makes sense to have the agency consider costs and benefits of its rules from the perspective of total surplus, or instead have it consider them from the perspective of investors only. This Article raises three points pertaining to this debate. First, because the two approaches provide conflicting standards for considering whether a rule’s benefits outweigh costs, unless there is first a general consensus regarding the efficiency criterion for SEC rules, no meaningful discussions can take place as to requiring the SEC to conduct more extensive cost-benefit analyses. Second, because Circular A-4 provides a broader perspective of considering costs and benefits, those concerned exclusively with investors’ economic welfare should have reasons to oppose, rather than support, applying Circular A-4’s approach to SEC rules. Third, despite such reasons, there is nevertheless a case for preferring Circular A-4’s approach because a total surplus approach, if used properly, offers several important benefits from policy perspectives.
Vytautas Plečkaitis has posted Rent-Seeking Activities in Hot IPO Allocations: An Analysis from a Law and Economics Perspective on SSRN with the following abstract:
Laddering, spinning and the demanding of premium commissions in exchange for a favourable allocation in hot IPOs were prevalent phenomena during the internet bubble period (1999-2000). An analysis of these practices shows that functioning as trade-based price manipulation laddering boosts the value of the issue. To maximise its profits, a lead-underwriter uses this outcome to increase the offer price and the underpricing level. This, in turn, creates the conditions needed for the other two rent seeking activities, which are considered as separate forms of profit-sharing, to arise. The decreased transparency of the share allocation process and the artificially boosted offer and after-market prices impair stock market development and thus have a negative effect on economic growth in the long-run. Current regulatory regimes in the US and the EU contain different securities law provisions addressing laddering, spinning and the demanding of premium commissions in exchange for a favourable allocation. Despite these numerous regulations, the present legal model contains significant imperfections and, therefore, cannot ensure an efficient outcome. As regards the private enforcement (tort liability) approach, the shortcomings include too complicated pleading requirements, strict issuers’ liability, limits on damage compensation and too short limitation periods for laddering actions. As regards the public enforcement approach they refer to behaviour prohibitions and information disclosure requirements as well as the magnitude and the probability of the imposition of sanctions.
Umakanth Varottil has posted The Protection of Minority Investors and the Compensation of Their Losses: A Case Study of India on SSRN with the following abstract:
Any legal system may potentially deploy two separate but related models to ensure the accuracy of disclosure in the capital markets. First, it may possess legal institutions in the form of regulatory bodies with power to make regulations regarding disclosures and to enforce those regulations through powers of sanction conferred upon them. Second, it may adopt the model that relies upon the courts to grant remedies to investors who are victims of inaccurate or misleading disclosures thereby suffering losses.
This paper tests the efficacy of the two models in their application to India. The exploration of India is interesting and helpful because India’s capital markets have witnessed exponential growth in the last two decades. At first blush, it might be simple to attribute this to India’s legal system through civil liability and its enforcement through the judiciary. Counterintuitively, though, India’s common law legal system operating through the judiciary has not played a vital role in the development of the capital markets through a rigorous civil liability regime. Delays in proceedings due to alarming pendency levels in litigation before Indian courts and skyrocketing costs in initiating litigation are some of the factors that have disincentivized investors from relying upon the civil liability regime for enforcing their compensation claims.
At the same time, other factors have been at play. India’s capital markets regulator, the Securities and Exchange Board of India (SEBI) has been instrumental in formulating policies and regulations governing capital markets, and its actions have been rapid and dynamic to suit the needs of the changing markets, by operating through the power of sanctioning various market players.
The paper concludes with the finding that while the general approach in most common law markets is for courts to play a significant role in the development of the capital markets through the process of compensating investors for losses, the success of India’s capital markets growth has hinged upon the regulatory process rather than the courts.
Alexis Direr and Eric Yayi have posted Portfolio Choice over the Business Cycle and the Life Cycle on SSRN with the following abstract:
Do households holding risky financial securities tend to invest in the stock market, buying at the top and selling at the bottom? Do they reduce their risk exposure with age and especially when approaching retirement? We answer these questions using data on retirement savings contracts from a large French insurer over the period 2002 to 2009. Subscribers can invest their savings in two types of investment vehicles: a euro fund composed primarily of money market securities with almost no risk, and unit-linked funds representing UCITS shares invested in risky securities.
We show that the share of capital invested in unit-linked funds is sensitive to market conditions, but mainly at the date of subscription. Once the initial share has been selected, inertia of portfolio choice is observed as investors rarely revise their position subsequently. We observe a steep procyclicality of investment choices which can be explained by extrapolation of recent market performance. New subscribers buy risky assets when the stock market rises and stop buying them when it drops. This leads them to hold a minimum share of risky assets in 2004, a beginning of a 4-year rising phase and a maximum share in 2008 at the beginning of a fall market.
We also find that the risky share declines with age once time effects are controlled for and cohort effects are excluded. The age profile also declines in the reverse configuration (taking into account cohort effects and excluding time effects) but the decline is less pronounced. After a discussion of the plausibility of the different effects, we estimate a probability of unit-linked detention which decreases by about 12 percentage points with age between ages 40 and 60, and a conditional equity share which decreases by about 6 percentage points with age between 40 and 60 years. This decrease is too small to bring the invested share to zero when approaching retirement.
On April 8, 2014 at the North American Securities Administrators Association Annual NASAA/SEC 19(d) Conference in Washington, D.C., Commissioner Luis A. Aguilar offered remarks on NASAA and the SEC: Presenting a United Front to Protect Investors.
Monday, April 7, 2014
Ryan Kantor has posted Why Venture Capital Will Not Be Crowded Out by Crowdfunding on SSRN with the following abstract:
As the recovery period from one of the worst recessions in our history continues on, life for the fledgling and even, often times, experienced entrepreneur has been tough. Indeed, President Obama remarked “[c]redit’s been tight, and no matter how good their ideas are, if an entrepreneur can’t get a loan from a bank or backing from investors, it’s always impossible to get their businesses off the ground.” In response to this ever-present need for business funding, and in an attempt to stimulate the economy and job growth, Obama signed the Jumpstart Our Business Startups Act (“JOBS Act”) into law on April 5, 2012. The Act, among other things, increases a business’s access to capital by enabling them to sell securities to both accredited and non-accredited investors without registering or completing the full disclosure requirements typically required for public offerings.
The overarching purposes of this paper will be to: 1) explain and analyze the relationship and overall dynamic that will exist between crowdfunding and VCs; 2) elucidate why investors should avoid or, at the very least, be wary of investing money through the crowdfunding medium; and 3) expound reasons as to why crowdfunding as a means of financing should be used as a last resort for a budding entrepreneur.
Taylor J. Phillips has posted The Federal Common Law of Successor Liability and the Foreign Corrupt Practices Act on SSRN with the following abstract:
Although successor liability is a key aspect of the government’s FCPA enforcement policy, the Department of Justice and the Securities and Exchange Commission have not distinguished clearly between the contexts of mergers, stock purchases, and asset acquisitions. As demonstrated by this article, asset purchases should be recognized as an acquisition structure that minimizes the risk of FCPA liability. That is because the law that should be applicable to such transactions is not a relatively broad federal common law of successor liability. Instead, it is state common law, which traditionally concedes only very narrow exceptions to the general rule of successor nonliability. Furthermore, given the remedial foundations of most successor liability doctrines, it is not obvious that traditional state common law encompasses punitive — much less criminal — successor liability theories.
Kevin S. Haeberle has posted on SSRN with the following abstract:
It is well understood that society is better off when public companies’ stock prices are more accurate. But those who make stock prices more accurate are unable to capture the full social benefits of their efforts, so market forces alone will produce only a sub-optimal level of stock-price accuracy. Scholars and policymakers have therefore examined the extent to which securities law can be used to spur the production of accurate stock prices. However, their work has overwhelmingly focused on the traditional core of securities law — that is, the disclosure, fraud, and insider-trading rules that mainly regulate the firms that issue stock — and has overlooked what I refer to as “stock-market law” — that is, the law that governs the market in which stocks are traded.
This Article theorizes that central aspects of stock-market law are resulting in society generating a lower level of stock-price accuracy than it otherwise might. Accordingly, the Article identifies new ways in which securities law may be modified to increase the accuracy of public firms’ stock prices and the social benefits to which that enhanced accuracy leads — and offers a framework for lawmakers to determine whether those alterations are socially desirable.
Lars Hornuf and Armin Schwienbacher have posted Which Securities Regulation Promotes Crowdinvesting? on SSRN with the following abstract:
In this paper, we show that too strong investor protection may harm small firms and, thus, entrepreneurial initiatives. This situation is particularly relevant in crowdinvesting, which refers to a recent financial innovation originating on the Internet. In general, securities regulation offers exemptions to prospectus and registration requirements. From an analysis of selected countries, we offer first evidence that portals shape the securities contracts they provide to startups based on these exemptions. This, in turn, can limit the amount of capital raised by the firms as well as the type of investors participating in the campaigns. Finally, we offer a ‘law and finance’ analysis of recent reforms of securities regulation in different countries that have been initiated as a means to encourage crowdinvesting.
Rutheford B. Campbell Jr. has posted Proposed Crowdfunding Regulations Under the Jobs Act: Please, SEC, Revise Your Proposed Regulations in Order to Promote Small Business Capital Formation on SSRN with the following abstract:
The Jobs Act was enacted to promote efficient access to external capital by small businesses. Title III of the Jobs Act offers small businesses the chance of efficient financial intermediation through crowdfunding. The crowdfunding exemption is not self-executing but, instead, requires regulatory implementation by the SEC.
The Commission’s first iteration of its crowdfunding rules fails to offer small businesses efficient access to external capital. Principally, this is because the proposed crowdfunding rules: (1) require excessive disclosures, especially regarding smaller crowdfunding offerings; (2) fail to offer small businesses relying on the crowdfunding exemption two-way safe harbor integration protection; and (3) fail to protect small businesses from the loss of the crowdfunding exemption as the result of the financial intermediary’s failure to meet its statutory and regulatory obligations.
The problems can be fixed by the Commission by revising its proposed crowdfunding regulations, thereby fulfilling its broad and ubiquitous obligation to balance capital formation and investor protection.
Usha Rodrigues has posted The Effect of the JOBS Act on Underwriting Spreads on SSRN with the following abstract:
U.S. underwriting fees, or spreads, have somewhat inexplicably clustered around 7% for years, a phenomenon that some have suggested evidences implicit collusion. The goal of Title I the JOBS Act of 2012 was to make going public easier for smaller firms; certain provisions specifically should make the underwriters’ task less risky, and thus less expensive. Presuming these provisions are effective, then one would predict that underwriting spreads would decrease as the costs to the underwriter for a public offering declined. Admittedly the prior presumption is a big one: it may be that the JOBS Act reforms were largely ineffective, and thus could be expected to have little effect on underwriter cost. This article is the first to examine post-JOBS Act underwriting spreads to determine whether spreads have in fact declined. A finding that underwriting costs stayed constant might be evidence of either collusion or that the JOBS Act was ineffective at reducing the cost of going public. I find that one provision has lowering the spread, thus suggesting elasticity in the spread and offering at least some evidence of the Act’s effectiveness.
Christine Hurt has posted Pricing Disintermediation: Crowdfunding and Online Auction IPOs on SSRN with the following abstract:
Recently, the concept of crowdfunding has reignited a desire among both entrepreneurs and investors to harness technology to assist smaller issuers in the funding of their business ventures. Like the online auction IPO of the previous decade, equity crowdfunding promises both to disintermediate capital raising and democratize retail investing. In addition, crowdfunding could make capital raising more accessible to small issuers than any type of IPO or private offering. Until the passage of the Jumpstart Our Business Startups Act (“JOBS” Act) in 2012, however, crowdfunding sites operated in a netherworld of uncertain regulation. In this crowdfunding Wild West, various types of entrepreneurs raised monies in various ways, some in obvious violation of the Securities Act. For entrepreneurs looking to raise start-up capital, crowdfunding was attractive but dangerous. Some investor crowdfunding portals, such as ProFounder, Prosper and Lending Club, purported to give entrepreneurs an easy and legal way to crowdfund equity capital or interest-bearing loans; however, regulatory scrutiny caught up with those skirting securities laws.
The passage of Title III of the JOBS Act, the Capital Raising Online While Deterring Fraud and Unethical Non-disclosure Act (“CROWDFUND” Act) seemed to bless the attempts of crowdfunding pioneers in the area of capital raising, at least in theory. However, the statutory language does not exempt early entrants’ efforts; instead, it provides a mechanism for future attempts to qualify for an exemption. The proposed Regulation Crowdfunding leaves little doubt that crowdfunding will not be easy: disclosure requirements, portal registration, and capital limitations are just a few of costly burdens added to this would-be alternative. The most optimistic commentators hope that crowdfunding eases access to capital markets for promising for-profit ventures, creating a new step in the life cycle of a startup: friends and family funding, crowdfunding, angel investing, venture capital, IPO. On the other hand, critics predict that crowdfunding goes the way of the online auction, an unnecessarily complicated mechanism that stigmatizes those issuers who try to sidestep traditional Wall Street intermediaries.
However, even if crowdfunding may not be the optimal path for start-ups with an ultimate goal of a successful IPO, crowdfunding may be useful for other types of for-profit ventures. Regardless of the future of the SEC regulations, the legal charitable crowdfunding of donations will be unaffected and will continue to increase in popularity and acceptance. With the growth of charitable crowdfunding, for-profit social entrepreneurship may find equity crowdfunding both appealing and available. For-profit social entrepreneurs may be able to use the crowdfunding vehicle to brand themselves as pro-social, attracting individual and institutional cause investors who may operate outside of traditional capital markets and may look for intangible returns. Just as charitable crowdfunders rebut the conventional wisdom that donors expect tax-deductibility, prosocial equity crowdfunders may rebut the conventional wisdom that early equity investors expect high returns or an exit mechanism. This avenue may be an attractive alternative to private equity financing, which may be tempting but may also lead to mission drift and loss of founder control.
Saturday, April 5, 2014