Securities Law Prof Blog

Accounting Firm Liable for Failing to Detect Fraud

A Florida jury has found accounting firm BDO Seidman liable for gross negligence in failing to detect a fraud at E.S. Bankest LLC, a Miami financial services firm.  The accounting firm is potentially liable for investors' losses of $170 million and punitive damages.  See WSJ, BDO Is Found Guilty Of Negligence in Fraud.

ALJ Dismisses Late-Trading Charges Against J.B. Oxford General Counsel

An Administrative Law Judge dismissed the SEC's charges against Scott G. Monson, the General Counsel of J.B. Oxford Holding and its brokerage subsidiary, relating to the firm's permitting favored clients to engage in late trading in violation of Rule 22c-1.  Although the judge found that the evidence that the firm violated Rule 22c-1 was overwhelming, he held that the SEC did not prove that Monson should have known that his conduct would result in late trading violations.  He had no actual knowledge of the Rule and he had no assigned duty or delegated responsibility to research legal implications of a trading deadline.  Thus, he was not a cause of the firm's violations.

SEC Staff Issues Compliance Alerts

The staff of the Securities and Exchange Commission today released its first ComplianceAlert letter to help chief compliance officers of SEC-registered firms learn more about common deficiencies and weaknesses that SEC examiners are finding during compliance examinations. This broader sharing of recent examination findings can benefit compliance officers and help them to proactively fine-tune their compliance and supervisory controls.

The SEC's Office of Compliance Inspections and Examinations conducts compliance examinations of SEC-registered investment advisers, investment companies, broker-dealers, and transfer agents to determine whether firms are in compliance with federal securities laws and rules, and to help correct deficiencies and weaknesses in compliance and supervisory controls. The SEC staff's ComplianceAlert letter, available on the SEC Web site, summarizes select areas that SEC examiners have recently reviewed during examinations, describes issues that were found, and encourages firms to review compliance in these areas and implement improvements as appropriate. SEC staff plans to issue additional ComplianceAlert letters on the SEC Web site.  See New "ComplianceAlerts" to Help SEC-Registered Firms Identify Deficiencies and Improve Compliance Programs, Press Release 2007-116.

NYSE Fines Morgan Stanley for Churning in Guardian Accounts

The NYSE fined Morgan Stanley $500,000 for failing to supervise brokers who engaged in excessivet trading in guardian accounts for the benefit of injured children and elderly clients.  Seven accounts generated over $500,000 in commissions.  See WSJ, Morgan Stanley to Pay Fine in Broker Case.

The Lure and Abuses of Variable Annuities

The Wall St. Journal has a front-page article on the aggressive marketing of variable annuities to the worldwide aging population.  The article focuses primarily on the difficulties insurance companies (because of their insurance component, variable annuities are a hybrid of an insurance product and a security) have in predicting the longevity of their customers and how much in reserves to set aside for these payments.   Midway through the article, however, the dirty little secret of variable annuities is examined.  These are very expensive and very convoluted investments that are being oversold by brokers, frequently to persons for whom they are not a suitable investment.  NASD has brought more than 350 disciplinary actions for improper sales practices in selling variable annuities.  There is currently before the SEC a proposed rule to require advisors to receive training in variable annuities and for managers to review all variable annuity contracts.  See WSJ, As Boomers Retire, Insurers Aim to Cash In.

Broker-Dealer Legal and Compliance Issues

Speech before the SIFMA Conference on Regulatory Focus on Broker-Dealer Legal and Compliance Issues, by Mary Ann Gadziala, Associate Director, Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission, Chicago, Illinois, June 7, 2007.  In her speech, Ms. Gadziala  covered: enhancements to our examination program; examination priorities and challenges; and regulatory coordination.

SEC Sues Former SEC Attorney in Pump & Dump Scheme

The SEC today filed suit against the principals of a micro-cap technology company as well as two securities lawyers for their role in an illegal "pump and dump" scheme. The Commission alleges that Arizona attorney David B. Stocker and Texas attorney Phillip W. Offill, Jr. assisted Michigan-based AVL Global, Inc., in a scheme to dump millions of shares of AVL Global stock into the marketplace without any public disclosure of the company's failing operations. In the same action, the Commission also charged Peter W. Fisher and his son, N. Tyler Fisher, the principals behind AVL Global, for their roles in the scheme.

According to the Commission's complaint, Stocker and Offill, a former enforcement attorney in the Commission's Fort Worth office until 1999, devised a scheme to deliver millions of AVL Global shares to Peter Fisher - an Ontario resident with a criminal record who secretly controlled the company through his son - as well as various family members, business associates and stock promoters. The Commission alleges that, in late 2005, Peter Fisher and Tyler Fisher then caused AVL Global to issue a series of misleading press releases that touted the company's business prospects when, in reality, AVL Global had essentially abandoned its business and ceased operations. Peter Fisher, who controlled the vast majority of the company's stock, dumped his shares and netted approximately $160,000.

The Commission further alleges that Stocker and Offill arranged a series of sham transactions that helped the company avoid registering the stock sales with the Commission and disclosing to the public AVL Global's true financial position. According to the complaint, the defendants caused AVL Global to issue approximately 15 million shares of stock to bogus investment companies controlled by Offill or Stocker. Stocker falsely claimed that these companies had purchased the stock for "investment purposes" and thus the sales were exempt from registration; however, within days of the supposed investments, the Stocker and Offill entities transferred all the stock to Peter Fisher and his associates, who could then commence dumping the stock into the market.

The Commission's complaint, filed in the United States District Court for the Eastern District of Michigan, alleges that the defendants violated the registration provisions of the federal securities laws, and that Peter and Tyler Fisher violated the antifraud provisions as well. The Commission seeks injunctive relief, disgorgement of ill-gotten gains, civil monetary penalties, and other relief.

Without admitting or denying the allegations, AVL Global president Tyler Fisher, of Ontario, Canada, agreed to settle the charges against him. Tyler Fisher agreed to pay a $25,000 civil penalty and consented to an order barring him from serving as an officer or director of a publicly-traded company or participating in penny stock offerings for five years.

NASD-NYSE Proposed Guidance on E-Mail

As mentioned earlier, the NYSE and NASD have released for public comment a Proposed Joint Guidance Regarding the Review and Supervision of Electronic Communications, which sets forth principles for member organizations to consider when developing supervisory systems and procedures for electronic communications that are reasonably designed to achieve compliance with securities laws and SRO rules.  Comments are due by July 13, 2007.

SROs will Issue Guidance on E-Mail

A joint NYSE-NASD committee will issue proposed guidelines on how securities firms should monitor written electronic communications both inside and outside the firm, as well as regulate employees' personal use of cellphones, text-messaging etc.  A concern that the guidelines, while expressed as best practices, will lead to SRO enforcement actions for violations.  See NYTimes, Wall Street to Get Guidelines on E-Mail.

AIG Sues Greenberg, Smith

In response to a shareholders' demand, and after a special investigation, AIG is taking over a litigation filed as a shareholders' derivative suit against its former CEO Maurice "Hank" Greenberg and former-CFO Howard Smith for more than $1 billion in damages resulting from AIG's accounting scandal that was exposed by then- New York Attorney General Spitzer.  Greenberg's lawyer, David Boies, says it's "old news."  See WSJ, AIG Sues Greenberg, Smith For Over $1 Billion in Damages.

Four Big Banks Indicted in Parmalat Scandal

Citigroup, Deutsche Bank, Morgan Stanley, and UBS will go on trial in Italy on charges of market manipulation in connection with the December 2003 collapse of Parmalat, the largest bankruptcy in Europe.  The trial will begin in January.  According to the indictment, the firms secured financing through the sale of bonds knowing that the financials had been falsified and was in financial difficulty.  The firms can be convicted if the prosecutors can prove the firms did not have policies in place to prevent their employees from committing the crimes.  According to the New York Times, the statute of limitations is seven and a half years, which the Times says means that "in most cases, the trial will have to be concluded by the end of 2010 or the charges will be dropped. With the trial not scheduled until January, and with a long appeals process likely if there are convictions, several legal experts said that the statute of limitations might come into play."  In Europe isn't the relevant period for limitations the filing of the charges?  See NYTimes, Trial Ordered in Italy for 4 Big Banks in Parmalat’s Failure, WSJ, Four International BanksTo Face Trial in Milan.

CME Will Increase Its Bid for CBOT

Chicago Mercantile Exchange will increase the value of its $10 billion bid for Chicago Board of Trade by offering a special dividend for CBOT shareholders, in response to the competitive bid by IntercontinentalExchange.  While ICE's offer is valued higher than CME's, the CBOT board has not wavered in its support for CME, and their merger received antitrust clearance this week.  See WSJ, Chicago Mercantile Exchange To Sweeten Bid for CBOT.

Frank on Bush on Scheme Liability

Frankly, I think the flap about the Solicitor General's not following the SEC's request to file an amicus brief on the side of plaintiffs in Stoneridge is the poverbial tempest in a tea pot(does anyone really think this Supreme Court will recognize scheme liability?), but President Bush gave his views and now Barney Frank, Chair of the House Financial Services Committee, finds it "troubling" that the President  expressed an "economic argument." See WPost, Frank Critical Of Bush On Suits.

Richard Breeden, Hedge Fund Owner

A year ago, Richard C. Breeden, former SEC chair and former court-appointed monitor for Worldcom, started his own hedge fund.  How's he doing?  Pretty well, according to the Washington Post.  See Still Keeping An Eye on Trouble in Boardroom.

What a Surprise...

SIFMA opposes extending Rule 10b-5 liability through the "scheme liability" theory.  Here is its press release:

The Securities Industry and Financial Markets Association (SIFMA) today issued the following statement in response to the pending Supreme Court case, Stoneridge Investment Partners v. Scientific-Atlanta and Motorola.  The Court’s ruling in the case could determine whether shareholders can collect damages from investment banks, attorneys, accountants, and other third-parties who did business with a company that engaged in fraud.  Such an outcome would unnecessarily generate significant additional litigation, costing billions of dollars to American businesses, and putting US companies at a competitive disadvantage to their foreign counterparts. 

“Expanding the scope of class action lawsuits to include third-parties would send large ripple effects throughout the US economy,” said Marc Lackritz, SIFMA president and CEO.  “The inclusion of third-parties would cause litigation costs to skyrocket at the expense of the American economy and its workers, by raising the costs for companies in the US and deterring foreign investment in our economy.”

“President Bush got it right yesterday in reiterating the administration’s policy of not expanding the scope of private shareholder litigation against third-parties,” added Lackritz.  “As the President said, this is not a case concerning investor protection; it’s about overzealous litigation.  The SEC already has all the necessary regulatory tools to recoup lost money for investors.” 

Attorney Settles Insider Trading Charges Involving Client's Stock

The SEC today filed a settled civil injunctive  action  against  David  A. Schwinger, an attorney and former managing partner  of  Katten  Muchin Rosenman LLP's (KMR) Washington, D.C. office.  Schwinger  was  charged with engaging in illegal  insider  trading  by  purchasing  shares  of Vastera, Inc. (Vastera).  The complaint alleges that Schwinger purchased Vastera common stock on Nov. 5, 2004, on the basis of material, nonpublic information that  an acquisition of Vastera was imminent.  The  complaint  further  alleges that Schwinger learned of  the  impending  merger  while  interviewing  Vastera's Chief Counsel, who was then seeking to be hired by KMR as  a partner. In responding to Schwinger's inquiries during  the  interview process about the Chief Counsel's reasons  for  leaving  Vastera,  the Chief Counsel allegedly disclosed to Schwinger no later than Oct.  27, 2004, that Vastera's acquisition was imminent. On the  basis  of  that material, nonpublic information, the complaint alleges that  Schwinger purchased 10,000 shares of Vastera common stock on Nov. 5, 2004, at an average price of $1.70 per share. The complaint further  alleges  that Schwinger knew that Vastera was a  KMR  client  at  the  time  of  the purchase.  According to the complaint, Vastera announced on Jan. 7, 2005, that it was being acquired by JP Morgan Chase Bank N.A. The complaint alleges that Schwinger knew,  or  was  reckless  in  not knowing, that he purchased Vastera shares based on material, nonpublic information obtained during the interview process and in breach  of  a fiduciary duty owed to his firm, KMR.  Schwinger  is  alleged  to  have imputed profits of $13,027. Without  admitting  or  denying  the  allegations  in  the  complaint, Schwinger has consented to the entry of a  final  judgment  that:  (i)permanently enjoins him from violating Section 10(b) of  the  Exchange Act and Rule 10b-5 thereunder; (ii) requires him to  disgorge  $13,027 in illicit gains and $1,940 in prejudgment interest thereon; and (iii)orders him to pay a civil penalty of $26,054.

SEC Votes Amendments to Reg SHO

The Securities and Exchange Commission today voted to take additional steps to better safeguard investors and protect the integrity of the markets during short selling transactions by closing loopholes in Regulation SHO and further reducing persistent failures to deliver stock by the end of the standard three-day settlement period for trades. The full text of the detailed releases concerning these items will be posted to the SEC Web site as soon as possible.  For a summary, see SEC Votes on Regulation SHO Amendments and Proposals; Also Votes to Eliminate "Tick" Test.

Proposed NYSE Rule Would Bar Broker Votes in Uncontested Elections

A proposed NYSE rule change currently before the SEC for approval would define even uncontested directors' elections as "non routine" and bar the current practice of brokers' voting shares when their customers do not give them instructions.  Currently, brokers usually vote the shares in favor of management, and in close contests this could make the difference.  The Wall St. Journal discusses the ramifications of the proposed rule change; see 'Broker Votes':Opponents May Win One.

Director/Lawyer Controversy at Topps

A disagreement over a proposed buyout of Topps has revived an old debate -- should a company's outside lawyers sit on the board?  Jack Nusbaum, director and partner at Willkie, Farr & Gallagher, supports the buyout; another director, Arnaud Ajdler, managing director of an investment firm that is a large shareholder, opposes it and criticizes Nusbaum's dual role, saying that Willkie Farr would receive $2 million in legal fees if the deal goes through.  See WSJ, Dual Role of Topps Director Revives Old Conflict Debate.

ICE Continues Fight for CBOT

The Chicago Board of Trade's acquisition by Chicago Mercantile Exchange is moving forward after antitrust clearance, but IntercontintentalExchange has not given up.  It revised its bid, already about $1.1 billion more than CME's, to give CBOT shareholders an oppotunity to receive cash instead of stock and said it would file proxy materials opposing CME's acquisition.  See NYTimes, Suitor Revises Bid for Chicago Board; WSJ, IntercontinentalExchange Upgrades Its Bid for CBOT.

Shareholder Discontent at Yahoo Annual Meeting

About one-third of Yahoo shareholders voted against the re-election of one or more directors, reflecting dissatisfaction with high executive compensation and poor performance under CEO Terry Semel's tenure.  Three proxy advisory firms had recommended no votes against the three members of the compensation committee.  The company announced that all directors were re-elected.  See NYTimes, Dissident Shareholders Send Message to Yahoo; WSJ, Yahoo Holders Send Message.

Atkins on Mutual Fund Board Independence

Excerpts from Remarks at the Fund Governance Forum by SEC Commissioner Paul S. Atkins, New York City, June 7, 2007:

Specifically, I question whether board independence ought to be an end in and of itself. Is it not better to focus on enabling investors to obtain the financial products and services that appropriately fit their investment objectives? Independence may or may not serve that end, but it should not be an end in itself.
Are these rallying cries from putative "investor advocates" on the sidelines reflective of the true concerns of investors? I suspect not. More likely, the average mutual fund investor does not give much thought at all to the degree to which a fund board is independent of the advisor. Prospective investors have many other things to consider in deciding whether and, if so, which mutual fund to purchase.

A recent survey by the Investment Company Institute found that only fifteen percent of mutual fund investors even look at information about the board of directors before investing and only five percent consider this information "very important" to their final investment decision. By contrast, more than three-quarters of investors look at fund fees and expenses and nearly half consider fees and expenses to be a very important factor in their investment decision. Nearly a quarter considered information about the company offering the fund to be very important information to consider before investing. It seems then that investors are not particularly focused on fund boards.

SEC Anounces Agenda and Panelists for Rule 12B-1 Roundtable

The SEC today announced the panelists and final agenda for the June 19th Roundtable on Rule 12b 1 under the Investment Company Act of 1940. Rule 12b-1 permits mutual funds to use fund assets to pay for the sale of fund shares and other distribution-related activities.  The roundtable will consist of panels addressing

the historical circumstances that led to the adoption of Rule 12b-1, and the original intended purpose of the rule;
 
the evolution of the uses of Rule 12b-1 and the rule's current role in fund distribution practices;
 
the costs and benefits of the current use of Rule 12b-1; and
 
the options for reform or rescission of Rule 12b-1.

NASAA Files Brief in Favor of Investors in Scheme Liability Case

North American Securities Administrators Association (NASAA) filed a brief on the side of investors in Stoneridge Investment Partners v. Scientific-Atlanta and Motorola, the case addressing the issue of "scheme liability" under Rule 10b-5.  Its brief is available at its website.

NYSE Censures Member Firm for Sales of Unregistered Securities

NYSE Regulation, Inc. announced on June 11 it has censured and fined J.J.B. Hilliard, W.L. Lyons, Inc. (“Hilliard Lyons”), a member firm, $1 million in connection with the sale of unregistered securities through a private placement that did not qualify for exemption under the federal securities laws.  The firm was also cited for using offering documents that contained material misrepresentations and/or omissions of facts, unsuitable sales to public investors, and supervisory, record-keeping and other violations.  NYSE Regulation also required Hilliard Lyons to make restitution to customers and to enter an undertaking to notify the NYSE of its supervisory systems and controls (that includes a CEO certification) in the event the firm re-enters the private placement business.

US Not Taking Investors' Side in Scheme Liability Case

The Justice Dept. did not meet the Monday midnight deadline for filing an amicus brief in favor of the investors in the case scheduled for argument before the Supreme Court next term on the question of "scheme liability" under Rule 10b-5(Stoneridge Investment Partners v. Scientific-Atlanta and Motorola, 06-43).  The SEC, by a 3-2 vote, requested the Solicitor General to do so; the Treasury Dept., under Secretary Paulson, took the contrary position.  Briefs for the defendants are not due until next month, so it remains unclear whether the Justice Dept. will take a position or remain silent.  See WSJ, U.S. Lets Pass Deadline to Back Shareholders in High Court Case.

Stock-Picking Game Cancelled Because of Cheating

TheStreet.com cancelled a "Beat the Street" stock-picking competition because it said some of the contestants  had “employed trading strategies to achieve returns that could not be duplicated in the real world, thereby depriving other contestants of an equal chance to win.”  The $100,000 prize money will go into the pot for the next contest.  TheStreet reported similar problems with an earlier competition with a $1 million prize.  See NYTimes, Cheating Leads TheStreet.com to Cancel an Investing Contest.

Big Bucks from Blackstone IPO

The Blackstone Group's IPO will take place in the next few weeks; one of the largest private equity firms plans to sell 133.3 million shares at a price expected between $29-31.  In the registration statement filed yesterday with the SEC, the founders' expected returns from the IPO were disclosed, ,and the numbers are mind-boggling.  Stephen Schwartzman will cash out a maximum of $677.2 million and will retain a 24% interest in the company that will be valued at $7.7 billion (assuming an IPO price of $30).  Last year he earned $398.3 million.  Peter Paulson will receive $1.9 billion from the IPO and retain a 4% interest valued at $1.3 billion.  He earned $212.9 million last year.  See NYTimes, Blackstone Founders Prepare to Count Their Billions; WSJ, How Blackstone Will Divvy Up Its IPO Riches.

Nazareth on Hedge Funds

Excerpt from Remarks Before the PLI Hedge Fund Conference, by SEC Commissioner Annette L. Nazareth, New York, New York, June 6, 2007:

As hedge funds' importance to financial markets increases, their potential systemic impact also increases. I'd like to highlight two areas of current concern for regulators. One is whether the transfer of risk from banks and securities firms to hedge funds and other counterparties has been complete and irreversible (or is otherwise covered by adequate collateral) so that banks and securities firms are protected from potential counterparty failure. The second concern is whether any counterparty has grown so large in absolute terms, or accumulated an exposure so significant relative to the overall market, that a destabilizing event forces a broad scale unwinding of positions and otherwise disrupts the markets.

Former Tenet Chief Accounting Officer Consents to Sanctions

On June 8, the SEC issued an Order  Instituting  Administrative Proceedings Pursuant to Rule 102(e)(3)(i) of the Commission's Rules of Practice, Making Findings  and  Imposing  Remedial  Sanctions  (Order)against Raymond L. Mathiasen, CPA.  The Order finds that Mathiasen,  as  the  chief accounting officer for Tenet Healthcare Corporation, participated in a fraudulent scheme , in which Tenet filed misleading  disclosures  with the Commission that failed  to  disclose  the material impact that Tenet's increases in gross charges were having on the company's Medicare outlier revenue, and thereby on  its  earnings.  The Order suspended Mathiasen  from  appearing  or practicing before the Commission as an accountant. Mathiasen consented to the issuance of the Order without admitting or denying any  of  the findings in the Order.  IN THE MATTER OF RAYMOND L. MATHIASEN, CPA.

Shareholder Unhappiness at Yahoo

Yahoo's annual meeting is this Tuesday, and shareholder dissatisfaction is expected over the high compensation package of CEO Terry Semel -- in 2006, it was valued at $71.6 million -- and the poor results in recent years, exacerbated by the success of its rival Google since going public three years ago.  Yahoo requires directors who do not receive a majority vote to submit resignations to the board for its consideration.  Three advisory firms recommend against reelection of the three directors on the compensation committee.  See WPost, Yahoo CEO to Face Shareholder Backlash.

GE, Microsoft Pass On Dow Jones

GE and Microsoft considered making a joint bid for Dow Jones, but discussions with Bancroft family representatives broke down over a week ago, because the economics did not work -- the companies could not see meeting or exceeding Murdoch's $60 per share bid.  See NYTimes, NBC Studied Dow Jones Bid With Microsoft; WSJ, GE, Microsoft Discussed Buying Dow Jones.

Second Circuit Interprets Sections 13(d) and 16(b)

The Second Circuit recently revisited the difficult issue of pleading a "group" for purposes of Section 13(d) in reversing a district court's dismissal of plaintiff's Section 16(b) claim seeking disgorgement of short-swing profits and also examined the final sentence of section 16(b) (which states that the section does not apply if the person is not a beneficial owner at both ends of the transaction).  In dismissing the complaint, the Second Circuit held, the court improperly gave too much weight to defendants' disclaimer of "group" status in their SEC filings and misconstrued the meaning of the final sentence of Section 16(b).  The Second Circuit did agree with the district court that a member of the alleged group could not be held liable under Section 16(b) where there were no allegations that it profited from any stock transactions during the relevant time period. Roth v. Jennings, 2007 WL 1629889, 2d. Cir. June 6, 2007.

EMR had purchased about 14.8% of shares in MMI; shortly thereafter, Jennings purchased about 8.3% of MMI stock with funds borrowed from EMR.  Jennings sold some of his shares in the open market within a six-month period, and, because he was not himself a statutory insider, 16(b) liability turned on whether he and EMR were a group under section 13(d).  SEC filings disclosed the loan agreement and also disclaimed group status. The district court, in granting defendants' motion to dismiss, gave two principal reasons:  (1) Plaintiff did not allege any facts that contradicted defendants' disclaimer, and (2)Defendants' uncontradicted evidence showed that EMR and Jennings were not a group at the time of the sales because Jennings had refused to sell his shares to EMR, instead selling them in the open-market, exactly the opposite, the court said, from what a group member would have done.

The Second Circuit essentially found that the district court overstepped its bounds on dismissing the complaint as to Jennings and improperly resolving issues of facts against the plaintiff at the pleading stage.  Contrary to the district court's reasoning, determination of "group" status depended on the application of the law to the defendants' activities, not on defendants' legal characterization of their activities.  A jury might find that the loan agreement between Jennings and EMR established a "group," notwithstanding the parties' disclaimer.  In addition, the final sentence of Section 16(b) did not require coordinated activity among the group members at both ends of the transactions; thus, the court's analysis of the parties' actions at the time of Jennings' sales was both legally irrelevant and also constituted additional impermissible fact-finding.   

The Second Circuit did agree with the district court that the complaint should be dismissed against EMR since there were no allegations that it sold any of its shares and profited in any way from Jennings' sales.  Under these circumstances, there were no profits for EMR to disgorge.

Hedge Fund Activism and Firm Performance

Hedge Fund Activism, Corporate Governance, and Firm Performance, by ALON BRAV, Duke University - Fuqua School of Business; WEI JIANG, Columbia Business School - Finance and Economics Division; FRANK PARTNOY, University of San Diego - School of Law; and RANDALL S. THOMAS, Vanderbilt University - School of Law; Vanderbilt University - Owen Graduate School of Management, was recently posted on SSRN.  Here is the abstract:
Abstract:      

Using a large hand-collected dataset of hedge fund activism in the U.S. over the period 2001 through 2005, we find that activist hedge funds act both as value investors and shareholder advocates. They target undervalued firms, and propose an array of strategic, operational, and financial remedies. Most tactics are non-confrontational, and attain success or partial success in two-thirds of the cases. However, hedge funds seldom seek control of target companies. The market reacts favorably to hedge fund activism, as the abnormal return upon announcement of potential activism is in the range of 5-7 percent, with no apparent reversal in the subsequent year. We show that this positive market reaction does not reflect anticipated wealth transfers from creditors to shareholders, but instead reflects anticipated improvement in performance. Indeed, target firms see moderate improvement in operational performance and considerably higher CEO turnover after activism. Our analysis provides important new evidence on the mechanisms and effects of informed shareholder monitoring.

A Practitioners' Critique of Bebchuk

Bebchuk's Case for Increasing Shareholder Power: An Opposition, by THEODORE N MIRVIS, PAUL K. ROWE, and WILLIAM SAVITT (all from Wachtell, Lipton, Rosen & Katz), is posted on SSRN.  Here is the abstract:

Abstract:      

This paper sets out the view that Lucian Bebchuk's "case for increasing shareholder power" is exceedingly weak. It demonstrates that Bebchuk's proposed overthrow of core Delaware corporate law principles risks extraordinarily costly disruption without any assurance of corresponding benefit; that Bechuk's case is unsupported by any persuasive empirical data; that Bebchuk's premise that corporate boards cannot be trusted to respect their fiduciary duty finds no resonance in the observed experience of boardroom practitioners (perhaps not surprisingly, as the proposal comes from the height of the ivory tower); and that its obsession with shareholder power is particularly suspect (if not downright dangerous) in light of the palpable practical problems of any shareholder-centric approach.

Gilson and Whitehead on Equity Capital

Deconstructing Equity: Public Ownership, Agency Costs, and Complete Capital Markets, by RONALD J. GILSON, by Stanford Law School; Columbia Law School, and CHARLES K. WHITEHEAD, Boston University School of Law, was recently posted on SSRN.  Here is the abstract:

Abstract:      

The traditional law and finance focus on agency costs presumes, without acknowledgement, that the premise that diversified public shareholders are the cheapest risk-bearers is immutable. In this article, we raise the possibility that changes in the capital markets have called this premise into question, drawn into sharp relief by the recent private equity buying wave in which the size and range of public companies being taken private has expanded significantly.

In brief, we argue that the traditional model's reliance on public shareholders reflects the early stages of corporate risk management and the absence of a liquid market for the transfer of risk. Both have evolved in the last 30 years. In increasingly complete capital markets, private owners can transfer risk in discrete slices to counterparties who, in turn, can manage or otherwise diversify away those risks they choose to forego, arguably becoming a lower cost substitute for traditional risk capital.

If diversified shareholders are no longer the cheapest risk-bearers, then the associated agency costs may now be voluntary; and, if risk management can substitute for risk capital, without requiring a transfer of ownership, then why go public at all? Additionally, in light of the current private equity wave, do more complete capital markets herald (once again) the eclipse of the public corporation? We suggest that, for some, the benefits of public ownership may outweigh the associated agency costs. For others, the ability to transfer risk without transferring ownership may implicate changes in how a firm is (or should be) governed. We offer some preliminary thoughts on the consequences of these changes, suggesting that the line between public and private firms may begin to blur as the traditional balance between agency costs and the benefits of public ownership shift towards a new equilibrium. The article ends with a final question: If, as we anticipate, the opportunity to invest in traditional risk-bearing instruments recedes, by what means will former investors in public equity be able to invest capital?

Prentice on SOX Section 404

Sarbanes-Oxley: The Evidence Regarding the Impact of Section 404, by ROBERT A. PRENTICE, University of Texas at Austin - McCombs School of Business, was recently posted on SSRN.  Here is the abstract:

Abstract:     

Sarbanes-Oxley is the most important securities legislation since the 1930s, and whether it is ultimately considered a success will likely turn on perceptions of its controversial internal controls provision, Section 404. Indeed, whether the law is a success will likely turn on perceptions of 404. SOX 404 has been savagely attacked, especially for its burdensome cost to corporations and its adverse impact on the competitiveness of American capital markets. This article surveys the relevant empirical academic literature. Although that literature does not purport to (and does not) settle the overall question of whether SOX's benefits generally, or SOX 404's specifically, outweigh attendant costs, it does illustrate that the harshest criticisms of SOX are overblown. Importantly, SOX 404 has demonstrably improved corporate financial reporting in the short-term. Its potential for having long-term beneficial impact is largely dependent upon its being perceived as legitimate by capital market participants. At the moment, its legitimacy is being undermined by criticism that ignores much of the important evidence.
 

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Perspective on The Past Week's Stories

Frankly, it was a quiet week.  The theme for the past week must be "waiting," as we wait for further developments in two big news stories: (1) Rupert Murdoch's courting of the Bancroft family, and (2) the prosecution of Milberg Weiss and the announcement that William Lerach might retire from his San Diego firm.  In addition, we continue to wait for news relating to Rule 10b-5 law at the Supreme Court:  the Tellabs opinion and whether the U.S. will take a position, and what it will be, on the Rule 10b-5 "scheme liability" question.