Monday, July 2, 2007
Post-Enron, a number of companies have been established to rate corporations based on their corporate governance. How do they determine a good corporate citizen and does it pay off in stock performance? A Wall St. Journal article looks at three firms: Governance Metrics, Audit Integrity, and Ethisphere. Despite similarity in goals, each ranks corporations according to different variables, and the high scoring corporations on each list are not the same. See WSJ, Finding the Best Measure Of 'Corporate Citizenship.
Sunday, July 1, 2007
A recent Third Circuit decision provides another illustration of the obstacles federal courts impose on investors who allege securities fraud. In DeBenedictis v. Merrill Lynch & Co., 2007 WL 1732254 (3d Cir. June 18, 2007), the court held that the lead plaintiff's class action against his brokerage firm for recommending the purchase of Class B mutual fund shares was time-barred because he was on "inquiry notice" of his claims more than two years before. A significant portion of the opinion is a verbatim recital, from both the mutual fund prospectus and the SAI, of the descriptions of the different classes of mutual fund shares and the compensation structure for sales personnel. (The court does not acknowledge, if indeed it is aware, that most mutual fund investors do not receive the SAI.) In addition, the court took judicial notice of two articles (one from USA Today, one from Time magazine) and a Wall St. Journal article that warned investors about the high costs of Class B shares, as well as several NASD press releases disciplining other brokerage firms for unsuitable recommendations of Class B shares. According to the Third Circuit, these communcations put the plaintiff on inquiry notice because a "reasonable investor of ordinary intelligence would have discovered the information and recognized it as a storm warning." It did not matter, as the plaintiff argued, that the media coverage and the NASD actions did not specifically identify Merrill Lynch as an offender; in fact, the Wall St. Journal referred approvingly to Merrill Lynch's efforts to train its brokers on the different classes of mutual funds. Instead, the court concludes: "even if a mutual fund investor failed to read the Registration Statements when they were initially received and failed to run any independent calculations of the fees that would be incurred on Class B shares [!], the news articles questioning the profitability of such shares and highlighting the possible conflict of interest would urge the reasonable investor to return to the profitability of his or her own investments and investigate their broker's conflict of interest." Thus, apparently, a reasonable investor is expected to follow media coverage of his investments in order to second-guess the recommendation of his trusted "financial consultant."
The Next Epidemic: Bubbles and the Growth and Decay of Securities Regulation, by ERIK F GERDING, University of New Mexico School of Law, was recently posted on SSRN. Here is the abstract:
This article explores how speculative bubbles undermine the effectiveness of securities regulations and spawn epidemics of securities fraud. A brief historical survey demonstrates that stock market bubbles almost invariably coincide with epidemics of securities fraud, and provides a compelling argument that the outbreak of fraud in the Enron era did not stem merely from factors unique to the 1990s, but from the dynamics of an asset price bubble as well.
Drawing on perspectives from securities law practice and economic theory, the article argues that bubbles dilute the deterrent effect of antifraud rules and promote deregulation. Both effects alter the calculus of securities law compliance for public companies and market intermediaries. In turn, diluted regulations and deregulation further fuel a bubble's expansion.
The article creates a basic model for how bubbles promote deregulation. During the formation a bubble, three interrelated cycles – the business cycle, the cycle of investor confidence and the regulatory cycle – generate feedback for each other (by stimulating excessive economic growth, investor trust in the integrity of the market and deregulation). When a bubble bursts, these three cycles reverse and generate negative feedback (through recession, a collapse of investor trust and re-regulation). The interaction of these cycles creates the potential for a perverse pattern of under-regulation or deregulation as bubbles form –the moment when more oversight is needed – and re-regulation in the aftermath of a bubble – once the economy and investor trust have already been damaged.
The article also explores how the dynamics of a bubble can undermine the deterrent effect of anti-fraud rules on securities issuers and market intermediaries by distorting the rational calculus of compliance, potentially exacerbating behavioral biases and raising information and agency costs.
The Myth of the Shareholder Franchise, by LUCIAN ARYE BEBCHUK, Harvard Law School; National Bureau of Economic Research (NBER), was recently posted on SSRN. Here is the abstract:
The power of shareholders to replace the board is a central element in the accepted theory of the modern public corporation with dispersed ownership. This power, however, is largely a myth. I document in this paper that the inci-dence of electoral challenges during the 1996–2005 decade was very low. After presenting this evidence, the paper analyzes why electoral challenges to direc-tors are so rare, and then makes the case for arrangements that would provide shareholders with a viable power to remove directors. Under the proposed de-fault arrangements, companies will have, at least every two years, elections with shareholder access to the corporate ballot, reimbursement of campaign expenses for candidates who receive a sufficiently significant number of votes (for exam-ple, one-third of the votes cast), and the opportunity to replace all the directors; companies will also have secret ballot and majority voting in all directors elec-tions. Furthermore, opting out of default election arrangements through share-holder-approved bylaws should be facilitated, but boards should be constrained from adopting without shareholder approval bylaws that make director removal more difficult. Finally, I examine a wide range of possible objections to the pro-posed reform of corporate elections, and I conclude that they do not undermine the case for such a reform.
The paper, which is based on the Raben Lecture in Corporate Law at Yale and the Uri and Caroline Bauer Lecture at Cardozo, is scheduled to appear in May 2007 in the Virginia Law Review together with responses to it by Martin Lipton and William Savitt, Jonathan Macey, John Olson, Lynn Stout, and E. Norman Veasey.
Multinational Class Actions Under Federal Securities Law: Toward a 'Fraud on the Global Market' Theory?, by HANNAH L. BUXBAUM, Indiana University Bloomington - School of Law, was recently posted on SSRN. Here is the abstract:
This article examines a form of securities class action that is growing increasingly popular in U.S. courts: the “foreign cubed” action, brought against a foreign issuer on behalf of a class that includes foreign investors who purchased securities on a foreign exchange. These cases are becoming an important part of the regulatory landscape (as evidenced by recent high-profile lawsuits involving issuers such as Vivendi, Bayer and Royal Ahold), and they create the potential for particularly severe conflict with other countries on the question of how best to regulate global economic activity. Yet they point out quite clearly that the traditional “conduct” and “effects” tests for subject-matter jurisdiction are inadequate to the task of delimiting the reach of U.S. securities laws in the global capital markets. The article draws on a study of almost 50 “foreign cubed” claims. It analyzes the arguments made by foreign investors seeking to justify the application of U.S. law to their claims – arguments that base an expansive theory of regulatory jurisdiction on the interconnections among the world's capital markets. It then turns to judicial disposition of such claims, examining the various stages of litigation (including class certification) at which courts confront jurisdictional questions and identifying a series of assumptions that courts make in attempting to draw jurisdictional lines. It then uses those assumptions to predict how courts will respond to multinational class actions in the continued absence of legislative guidance regarding subject-matter jurisdiction under the securities laws.