Sunday, October 21, 2007
Lemon Signaling in Cross-Listing, by MICHAL BARZUZA, University of Virginia - School of Law, was recently posted on SSRN. Here is the abstract:
This paper develops a model of signaling of private benefits of control and applies it to the decision to cross-list. It suggests that cross-listing signals that a manager or a controlling shareholder can not extract large amounts of private benefits.
This signaling effect creates opposite incentives for managers and controlling shareholders. While the opportunity to bond and signal limited extraction encourages managers to cross-list, it discourages controlling shareholders from cross-listing, since such a signal decreases the control premium they receive if they sell their control block.
The paper derives implications for the cross-listing market, the desirability of international regulation and the likelihood of international convergence of corporate law and structures.
Since this paper is the first to develop a signaling model of private benefits, it also has implications for other issues in corporate law and corporate finance such as the desirability of mandatory corporate law and dividend distribution.
Regulatory Monitoring Under the Sarbanes-Oxley Act , by CINDY R. ALEXANDER and KATHLEEN WEISS HANLEY, both from the SEC, was recently posted on SSRN. Here is the abstract:
This paper examines the economic relevance of the factors set forth under Section 408 of the Sarbanes-Oxley Act to guide the enhanced regulatory scrutiny of public company financial disclosures, as required under the Act. We interpret two of the factors, volatility and firm size, as predictors of a public company's relative risk of non-compliance or the prospective loss to investors, conditional upon non-compliance. We use disclosures of material weaknesses in internal controls under Section 404 as indicators of the potential for non-compliance. Our evidence is that the Section 408 factors that we associate with a relatively high risk of non-compliance – high stock-price volatility, and whether a company is emerging with a disparate PE ratio – are good predictors of reported material weaknesses in internal controls. In addition, while Section 408 calls for enhanced review of large firms – those with high market capitalization and a material affect on the economy – we find that relatively few large firms have disclosed material weaknesses in internal controls. The large firms that have disclosed material weaknesses, however, comprise 92% of the market capitalization of all companies disclosing a material weakness. In contrast with the focus of the public debate on the compliance problems of smaller public companies, our evidence points to high volatility as a stronger predictor of compliance problems under the Act than small firm size. Finally, we discuss alternate explanations for our findings and the potential for unintended consequences for shareholders.
Shareholder Primacy's Corporatist Origins: Adolf Berle and 'The Modern Corporation,' by WILLIAM W. BRATTON, Georgetown University Law Center; European Corporate Governance Institute (ECGI), and MICHAEL L. WACHTER, University of Pennsylvania Law School, was recently posted on SSRN. Here is the abstract:
Many corporate law discussants think of themselves as picking up where Adolf Berle and E. Merrick Dodd left off in a famous, precedent-setting debate in the 1930s. The generally accepted historical picture puts Berle in the position of the original ancestor of today's shareholder primacy position while Dodd is cast as the original ancestor of today's corporate social responsibility (CSR). This Article shows that both categorizations amount to mistaken readings of old material outside of its original context. The Article corrects the mistakes, offering new readings of some of corporate law's fundamental texts, texts that recently reached their 75th anniversaries and include Berle's famous book with Gardiner C. Means, The Modern Corporation and Private Property. Seventy-five years ago the normative issue of the day was the appropriate policy response to the crisis of the Great Depression. Both Berle and Dodd addressed the issue from a corporatist perspective which views the corporation as an entity that operates as an organ of the state and assumes social responsibilities. In so doing Berle took on the fundamental question “for whom is the corporation managed” at a time when the answer had crucial implications for social welfare. In answering the question, Berle articulated a political economy that integrated a theory of corporate law within a theory of social welfare maximization. It was a great accomplishment, but it was in a context very different from today's debates about corporate management and responsibility. Accordingly, Berle was not advocating shareholder primacy as we understand it today. Nor is there a strong claim that Berle was a CSR advocate; he never did make the final jump of advocating reorganization of the legal firm as a social welfare maximizer. His unqualified statements on the subject all presupposed a strong regulatory state and a public consensus against a corporate profit maximand. Dodd does not present a clear picture either. Dodd's Depression-era writing, once contextualized, offers only indirect support to today's CSR advocates. He is most plausibly read as a managerialist, and social responsibility within management's discretion is not what CSR tends to be about. The biggest lesson from this analysis is that the shareholder primacy school impairs its own position by making a claim on Berle.
Stoneridge Investment Partners v. Scientific-Atlanta (8th Cir. 2006) What Makes it the Most Important Securities Case in a Decade?, by BARBARA BLACK, University of Cincinnati - College of Law, was recently posted on SSRN. Here is the abstract:
Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. is scheduled for oral argument before the U.S. Supreme Court on October 9, 2007. It has been described as “arguably the most important securities law case to reach the Court in a decade” and as securities lawyers' “Roe v. Wade.” What is the legal issue that has occasioned this much attention? Phrased as a technical legal argument, plaintiff asserts that it may establish that outside actors committed a Rule 10b-5 violation on a theory of “scheme liability;” in contrast, defendants assert that Central Bank of Denver v. First Interstate Bank of Denver, which found no statutory basis for aiding and abetting liability, precludes plaintiff's theory of liability.
What is on trial before the Supreme Court, however, may be the future of private securities fraud litigation. Beyond the legal issue, the parties' positions reflect the differing views in the ongoing debate on the value of private securities fraud litigation. Does scheme liability enhance the compensatory and deterrent functions of private litigation or does it contribute to abusive private litigation that jeopardizes the US markets' competitive position? Thirty one amicus briefs have been filed in the case, about equally divided between the plaintiff's and the defendant's position. There was disagreement within the executive branch as to which side the Solicitor General should support. Most recently, the SEC announced that it would hold a spring 2008 roundtable to debate the various positions on private securities litigation.
This paper will first analyze the legal issue in Stoneridge, describe the policy issues from the perspective of the amicus briefs and then provide some commentary on the case's significance to the law and policy of private securities fraud litigation. This paper is a work-in-progress, to be continued upon the Court's opinion.
The Corporate Monitor: The New Corporate Czar?, by VIKRAMADITYA S. KHANNA, University of Michigan at Ann Arbor - Law School, and TIMOTHY DICKINSON, Paul, Hastings, Janofsky & Walker, LLP - Washington, DC, was recently posted on SSRN. Here is the abstract:
Following the recent spate of corporate scandals, government enforcement authorities have increasingly relied upon corporate monitors to help ensure law compliance and reduce the number of future violations. These monitors also permit enforcement authorities, such as the Securities & Exchange Commission and others, to leverage their enforcement resources in overseeing corporate behavior. However, there are few descriptive or normative analyses of the role and scope of corporate monitors. This paper provides such an analysis. After sketching out the historical development of corporate monitors, the paper examines the most common features of the current set of monitor appointments supplemented by interviews with monitors. This is followed by a normative analysis that examines when it is desirable to appoint monitors and what powers and obligations they should have. Based on this analysis, we provide a number of recommendations for enhancing the potential of corporate monitors to serve a useful deterrent and law enforcement function without being unduly burdensome on corporations. This involves, among other things, discussion of the kinds of powers monitors should have and the fiduciary duties monitors should owe to the shareholders whose businesses they are monitoring.
Friday, October 19, 2007
Criminal charges were filed in federal court against six individuals, including a securities lawyer, alleging securities fraud in connection with PIPEs tranactions by Xybernaut Corp. and Ramp Corp. WSJ, Ex-Xybernaut Executives, Lawyer Indicted in PIPEs Case.
The SEC today announced that $356 million is being paid to investors harmed by the financial fraud at Fannie Mae (Federal National Mortgage Association) between 1998 and 2004. With today's payments, the SEC has distributed more than $3 billion overall since the agency was given authority to send financial penalties from SEC enforcement actions to the victims of financial fraud.
Today's $356,128,500 going to individual investors, pension plans and other victims represents the entirety of the money Fannie Mae paid to settle the SEC's fraud charges last year, plus interest. The Fair Fund for Fannie Mae victims resulted from an enforcement action in May 2006 in which Fannie Mae paid $350 million to settle SEC charges that it issued materially false and misleading financial statements in SEC filings and in various reports disseminated to investors. Final judgment was entered in August 2006, and the U.S. District Court of the District of Columbia approved the establishment of the Fair Fund in April 2007.
A panel of state securities regulators representing the North American Securities Administrators Association (NASAA) reported on developments at the PIABA Annual Meeting. A few themes were emphasized. First, fraud among senior investors is increasing and is expected to continue to increase with the aging population. Second, a significant number of their complaints relate to annuities, which they also expect will increase. Indeed, one regulator called equity-indexed annuities a "scourge" and urged the SEC to resolve whether they are securities. Third, as to arbitration, they recommend making it non-mandatory and eliminating the industry arbitrator. Rex Staples, the GC of NASAA, referred to the industry arbitrator as the "Achilles' heel" of securities arbitration and unnecessary, given the prevalence of expert testimony on industry practices.
One of the hot topics at this year's Public Investors Arbitration Bar Association (PIABA) Annual Meeting is FINRA's proposed rule that is intended to reduce the number of pre-hearing motions to dismiss. Although FINRA has not yet filed the text of the rule with the SEC, it took the unusual step of issuing a Notice to Parties describing the proposed rule, as well as sending an e-mail blast to its arbitrators immediately after the FINRA Board approved the proposal. George Friedman, Executive Vice President, made it clear that this proposed rule was in response to complaints from claimants' attorneys that too many pre-hearing dispositive motions were being filed in arbitration. The proposed rule will restrict pre-hearing motions to dismiss to three ground -- prior written settlement, "factual impossibility," and the 6-year eligibility rule and require a panel that grants a dispositive motion to give an explanation. Of course, as with the expungement procedure, much will depend upon the competence and commitment of the arbitrators to understand and follow the procedures.
MetroPCS Communications filed suit in Texas state court charging that its broker, Merrill Lynch, acted improperly in investing about $134 million in risky CDO securities, in violation of its objective to maintain low-risk, liquid investments for its spare cash. Apparently the customer did not sign a predispute arbitration agreement. WSJ, MetroPCS Sues Merrill Over Risky Investment.
Is Bear Stearns in trouble again? The Massachusetts securities regulator is investigating whether the firm engaged in undisclosed principal trading with two inhouse hedge funds that collapsed this summer. The federal prosecutors and the SEC are already investigating the circumstances surrounding the collapse. WSJ, Bear Stearns Draws Probe On Fund Trades.
Thursday, October 18, 2007
The convoluted and troubled criminal trial against three former KPMG executives and a former Sidley Austin attorney was delayed, after Judge Kaplan disqualified Steven Bauer, lead counsel for ex-KPMG senior tax manager John Larson for potential conflicts of interest. Last month the government asked the judge to explore possible conflicts. WSJ, Judge Delays KPMG Trial After Barring Defense Lawyer.
I have the honor of being a speaker at the Public Investors Arbitration Bar Association (PIABA) Annual Meeting currently underway on Amelia Island, Florida. This morning George Friedman, Executive Vice President, FINRA Dispute Resolution, reported on recent developments and answered a number of questions put to him by PIABA attorneys. Of particular interest is the track record on motions to expunge from the CRD records of arbitration claims filed by customers against registered representatives. A recent PIABA study examined all settled customer awards issued by FINRA panels in 2006 that were subject to the restrictions on expungement under NASD Rule 2130. It found that in over 71% of the stipulated awards arbitration panels recommended expungement of customer complaints without any evidence that an evidentiary hearing had been conducted, and that expungements were granted in more than 98% of the stipulated or settled awards where the expungement relief had been requested.
Mr. Friedman began his remarks by stating that clearly something needs to be done to address the problem and that he expects (without giving specifics) that something will be done soon. He did note that expungements have gone down since the new rule took effect, from 907 in 2005 to 516 in 2006 and, for the first half of 2007, 166. Since the rule has taken effect, NASD/FINRA has been named a defendant in 69 post-award judicial expungement proceedings and has opposed expungement in 56 of those instances. The SRO has received 440 requests for waiver of the rule's requirement that the SRO be named as a defendant, and it has granted 386 waivers. Mr. Friedman also noted that the rule does not require that the arbitrators conduct an evidentiary hearing on the grounds for expungement, although FINRA does encourage hearings. He also noted that all arbitrators were required to receive training on the operation of the new rule. He acknowledged that there have been disagreements between FINRA and NASAA about the expungement process-- a topic that a later NASAA panel addressed in greater detail. Finally, Mr. Friedman said that failure was not an option for this rule.
During its panel session, NASAA, for its part, noted that NASAA and FINRA were interpreting the three findings of the rule differently. NASAA reviews all requests for expungement and transmits the information to all states where the registered representative is registered. Some states are fighting expungement proceedings aggressively; the New York AG, for example, is opposing expungement in every case. NASAA's website has further information on the cases.
I will report in later posts on other "hot" topics addressed at the meeting, including FINRA's proposed rule limiting motions to dismiss.
Millbrook Capital, an activist hedge fund, wants Brnk's to split its armored-truck and security provider units into two separate companies. To that end, it plans a proxy contest for four seats on the board of directors. Another hedge fund, Pirate Capital, is also pressing for corporate governance changes; it wants to eliminate the staggered board and to separate the offices of chair and CEO. NYTimes, Millbrook Plans Proxy Contest for Seats on Brink’s Board
Unisystems Inc. filed a putative class action against State Street Corp. over losses in fixed-income funds held in workplace retirement plans. The complaint alleges that the funds were misrepresented as conservative investments and did not disclose their investments in high-risk and mortgage-backed securities. Prudential previously filed suit against State St. with similar allegations, and several State Attorneys General are investigating State Street in connection with losses in state retirement plans. WSJ, State Street Is Sued Over Fund Losses.
The big banks' reporting of third quarter results continues to reflect this summer's difficulties. JPMorganChase was able to report a 2.3% increase in earnings, even as it took nearly $2 billion in write-downs and increases to consumer loss reserves that reflect the difficulties in its retail and investment banking units. JPMorgan Chase's performance is in sharp contrast to Citigroup's dismal 57% drop in earnings for the third quarter. NYTimes, JPMorgan Chase Posts a Profit, but Takes $2 Billion Write-Down ; WSJ, J.P. Morgan's Time to Grin.
The New York Times Co. is one of the best examples of a dual-class share structure that allows a public company to vest perpetual control in a shareholder group, in this case, the Ochs-Sulzberger family. For two years, Morgan Stanley, a 7% shareholder, waged a campaign to change the structure, but no more. It has sold its block of New York Times stock. The stock price closed yesterday at its lowest since January 1997. NYTimes, Big Holder Sells Stake in Times Co.; WSJ, Sign of Times:Don't Fight The Family?
Wednesday, October 17, 2007
Somehow we knew this was coming -- the SEC is conducting an informal investigation into the stock sales by Countrywide Financial Corp. CEO Angelo Mozilo, who reportedly sold $130.6 million worth of shares in the first half of the year under a Rule 10b5-1 plan. WSJ, SEC Investigating Mozilo Stock Sales.
You will recall that Dow Chemical fired two officers when JPMorganChase told the company that they had participated in secret talks to buy the company. The firing resulted in litigation between the company and the officers. Now Romeo Kreinberg, one of the officers, is suing JPMorganChase, calling it a "Judas" that implicated him in the negotiations to get back into Dow's good graces. The complaint also asserts that the bank should be held accountable for its share of the harm to Dow. (huh?) NYTimes, Fired Dow Chemical Officer Sues JPMorgan