March 15, 2008
Plumlee & Plumlee on Financial Reporting
Assurance on XBRL for Financial Reporting, by DAVID PLUMLEE, University of Utah - David Eccles School of Business, and MARLENE PLUMLEE, University of Utah - School of Accounting and Information Systems, was recently posted on SSRN. Here is the abstract:
"Tagging" financial information using eXtensible Business Reporting Language (XBRL) creates documents that are computer readable and searchable. Since 2004, the Securities and Exchange Commission (SEC) has taken steps toward requiring XBRL to be used in its filings, including a voluntary filing program. Once XBRL is required, investors are likely to demand assurance on the tagging process. The PCAOB has issued guidance on attest engagements regarding XBRL financial information furnished under the SEC's current voluntary filer program, which relies on the auditor agreeing a paper version of the XBRL-related documents to the information in the official EDGAR filing. While this process may be adequate for the current paper-oriented reporting paradigm, the power of XBRL is that it allows individual pieces of financial data to be extracted from the SEC's financial database outside the context of the statements as a whole. This article provides some background on the SEC's efforts to incorporate XBRL into its filing process and a brief overview of the technical aspects of XBRL. Its principal focus is on several important questions that assurance guidance must address in a "data centric" reporting environment, such as, what constitutes an error or what does materiality mean when individual pieces of financial data will be used outside the context of the financial statements? It also describes some XBRL-related areas where academic research can and should provide inputs to the process of developing guidance for XBRL-document assurance.
Palmiter & Taha on Mutual Fund Investors
Mutual Fund Investors: Divergent Profiles, by ALAN R. PALMITER, Wake Forest University - School of Law, and AHMED E. TAHA, Wake Forest University - School of Law, was recently posted on SSRN. Here is the abstract:
Mutual funds are owned by almost half of all U.S. households, manage over $12 trillion dollars in assets, and have become a primary vehicle for investment and retirement savings. Who are mutual fund investors? The answer is critical to regulatory policy. Fund investors, by selecting the funds in which they invest, play a central role in determining asset allocation and in controlling the fees funds charge. Thus, the functioning of the mutual fund market turns on the knowledge and financial sophistication of fund investors.
This article examines the profiles of mutual fund investors presented by the mutual fund industry, by the SEC, and by an extensive empirical academic literature produced primarily by finance professors. The industry portrays fund investors as diligent, fairly sophisticated, and guided by professional financial advisers. The industry claims that the result is a competitive mutual fund market as fund investors demand low costs and solid performance. The SEC's regulatory policy paints a more cautious portrait of fund investors. While acknowledging that many investors have limitations, the SEC touts improved disclosure by the industry as a sufficient antidote. The academic literature, however, finds that fund investors are generally ignorant and financially unsophisticated. Most investors are unaware of even the basics of their funds, do not take costs (especially ongoing costs) into account when they invest, and chase past fund performance, despite little evidence that past returns predict future returns. Fund investors who use financial advisers do no better.
The SEC's belief that fund investors can fend for themselves, once armed with adequate disclosure, fails to appreciate the extent of investors' limitations. Instead, the findings of the academic literature suggest that policymakers should rethink the current regulatory approach. Disclosure may not be enough.
Sjostrom on Rule 144A Equity Offerings
The Birth of Rule 144A Equity Offerings, by WILLIAM K. SJOSTROM Jr., Northern Kentucky University - Salmon P. Chase College of Law, was recently posted on SSRN. Here is the abstract:
In a groundbreaking deal closed in May 2007, Oaktree Capital Management LLC, a leading private U.S. hedge fund advisory firm, sold a 15% equity stake in itself for $880 million. The deal is groundbreaking because it was not structured as an initial public offering (IPO), traditionally the only option for an equity offering of this size by a private company. Instead, it was structured as a private placement under Rule 144A of the Securities Act of 1933. Rule 144A enables a company to market and sell securities through an underwriter to institutional investors without registering the offering with the Securities and Exchange Commission as is required for an IPO. Had the Oaktree deal been structured as an IPO, it would have been the sixth largest by a domestic issuer in 2007.
Oaktree's novel use of Rule 144A is driven by two factors. First, passage of the Sarbanes-Oxley Act of 2002 has made it much more expensive to be a public company thereby decreasing the attractiveness of an IPO. Second, the emergence of a centralized trading market for Rule 144A equity securities has improved their liquidity thus increasing the attractiveness of a Rule 144A equity offering. Consequently, a tipping point has been reached where the value of pursuing a Rule 144A equity offering exceeds the value of pursuing an IPO for some firms. The purpose of this article is to explore this development. Specifically, the article analyzes the legal framework of Rule 144A and details the burgeoning Rule 144A trading market. It then compares the costs and benefits of an IPO to those of a Rule 144A equity offering and theorizes about a firm's calculus for choosing one structure over the other. Finally, the article argues that Rule 144A equity offerings are firmly grounded in public policy and thus recommends regulatory reforms to improve their viability.
Leuz & Wysocki on Financial Reporting
Economic Consequences of Financial Reporting and Disclosure Regulation: A Review and Suggestions for Future Research, by CHRISTIAN LEUZ, University of Chicago - Graduate School of Business; European Corporate Governance Institute (ECGI); University of Pennsylvania - Wharton Financial Institutions Center, and PETER D. WYSOCKI, Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA), was recently posted on SSRN. Here is the abstract:
This paper surveys the theoretical and empirical literature on the economic consequences of financial reporting and disclosure regulation. We integrate theoretical and empirical studies from accounting, economics, finance and law in order to contribute to the cross-fertilization of these fields. We provide an organizing framework that identifies firm-specific (micro-level) and market-wide (macro-level) costs and benefits of firms' reporting and disclosure activities and then use this framework to discuss potential costs and benefits of regulating these activities and to organize the key insights from the literature. Our survey highlights important unanswered questions and concludes with numerous suggestions for future research.
"The Dysfunctional Board: Causes and Cures
The Corporate Law Center at the University of Cincinnati College of Law presented its 21st Annual Corporate Law Symposium on March 14 on "The Dysfunctional Board: Causes and Cures," before a packed audience consisting of students, practitioners, and academics. The panelists were of uniformly high quality, and the audience's enthusiastic participation in the Q&A sessions made for lively discussions. The webcast of the program will be shortly posted on the CLC site, and the papers will appear in a forthcoming issue of the University of Cincinnati Law Review. Here is a synopsis of the Program:
Panel I: The Underlying Causes of Dysfunctionality
Franklin A. Gevurtz, McGeorge (The Function of Dysfunctional Boards) started us off with the hard question: what is the board's function? After arguing that none of the models (managing, monitoring, mediating) works, he reviewed the origins of the modern corporate board in English trading companies and medieval councils. From this he argued that the board's purpose is to be a representive body; thus, it is dysfunctional only when it is not an elected body. If a board is divided because the shareholders are divided, it has fulfilled its function.
Jayne W. Barnard, William & Mary (Narcissism, Over-Optimism, Fear, Anger and Depression: The Interior Life of Corporate Leaders) examined common CEO pathologies and how they can lead to recurring behavior, such as overcommitment to previous decisions, overestimation of ability to execute takeovers, overpayment in tender offers, and preoccupation with perquisites and personal myth making. She also proposed some solutions, including the board's awareness of these characteristics in succession planning and expanding the board's monitoring role to take into account these issues.
John S. Stith (Porter Wright & Morris) focused on the Ohio corporation statute, particularly its constituency statute, and noted that the law expects that the board will perform a variety of roles, including mediation.
Panel II: Competing Expectations for Board Performance
Lissa Lamkin Broome and Kimberly D. Krawiec, both from UNC (The Road to Board Diversity: A Case Study from North Carolina) described their empirical study on diversity on public boards, consisting of a series of confidential, semi-structured interviews with corporate directors. For this Symposium, they limited their discussion to an analysis of the rationale for board diversity, in particular, the signaling function. They noted that through board diversity corporations may seek to signal workplace equality, attention to women and minorities in the development in products and services, and, more generally, that they are law-abiding and forward-looking. They could not conclude, however, that board diversity is a stable signal in all cases, since board diversity may not be too costly to fake a signal.
Lawrence A. Cunningham, GW (Rediscovering Board Expertise: Legal Implications of the Empirical Literature) began by noting that despite the fascination with board independence, there is little evidence that it has improved board performance. Accounting expertise, however, has been shown to improve the quality of financial statements, although the SEC's definition of "accounting expertise" is too broad for this purpose. Thus, audit committee members add real value, but may not get greater benefits and may have greater liabilities, than other directors. He argued that the incentives for expertise need to change.
Tamr Frankel, BU (Corporate Boards of Directors: Advisors or Supervisors?) emphasized the importance of culture in the two components of board service: advisory and supervisory. She noted that boards need to strike the appropriate balance between micromanagement and window-dressing. Boards must create a culture where extremes are not allowed. She emphasized the importance of the board's "muddling through" -- to try and if it fails, then try something else.
Gary P. Kreider (Keating, Muething & Klekamp) noted that for shareholders corporate financial performance is what matters. He also predicted that shareholders' access to the corporate ballot for purposes of nominating directors is likely to come soon.
Panel III: The Board as Compliance Officer
Peter J. Henning, Wayne State (Board Dysfunction: Dealing with the Threat of Corporate Criminal Liability) focused on board decisions made in response to reports of alleged misconduct in the context of four recent examples: Enron, Chiquita, United HealthCare and Staples. He recommended the creation of a Zapata committee consisting of directors that are not tainted by the alleged corporate misconduct with the authority to effect real change.
Miriam H. Baer, NYU (Corporate Policing and Corporate Governance: What Can We Learn from Hewlett-Packard's Pretexting Scandal?) first examined Hewlett-Packard's pretexting scandal. She then explained and examined the contradictions between corporate governance principles and corporate policing practices. The government insists on effective corporate compliance programs, and given boards' lack of expertise and limited tools, we should not be surprised if we see more clashes between corporate governance and compliance.
Clifford A. Roe, Jr. (Dinsmore & Shohl) concluded by identifing common themes that had emerged in the course of the day's discussion: the uncertainty about the board's function, the competing expectations for board performance, and the difficulties these present to board members.
March 14, 2008
SEC Trading & Markets Div. on Bear Stearns
The SEC's Division of Trading and Markets today issued the following statement regarding The Bear Stearns Companies:
"The decision by the Federal Reserve Bank of New York to provide The Bear Stearns Companies temporary funding through J.P. Morgan Chase & Co. today followed a significant deterioration in Bear Stearns' liquidity on Thursday. The Division of Trading and Markets has monitored both the capital and the liquidity of the firm on a daily basis in recent weeks. The purpose in doing so on a firm-wide basis has been to consider all potential impacts on the financial health of the two major U.S. registered broker-dealers and the other regulated entities in the Bear Stearns consolidated group.
"As of its most recent capital calculation as of the end of February 2008, Bear Stearns' holding company capital exceeded relevant regulatory standards. According to the information supplied to the SEC by Bear Stearns as of Tuesday, March 11, the holding company had a substantial capital cushion. In addition, as of March 11, the firm had over $17 billion in cash and unencumbered liquid assets.
"Beginning on that day, however, and increasingly throughout the week, lenders and customers of Bear Stearns began to remove funds from the firm, despite its stable capital position. As a result, Bear Stearns' excess liquidity rapidly eroded.
"The Division is continuing to monitor Bear Stearns' condition with a view to the safety of its regulated entities including its registered broker-dealers. The Division believes that Bear Stearns' registered broker-dealers remain in compliance with Commission capital rules.
"The SEC also is working closely with the Department of the Treasury, the Federal Reserve, and the Federal Reserve Bank of New York to ensure that our regulatory actions contribute to orderly and liquid markets."
Former Lason Executives Settle Accounting Fraud Charges
The SEC settled fraud charges against Gary L. Monroe, William J. Rauwerdink, John R. Messinger, and Robert T. Bassman, the former CEO, CFO, COO and Controller, respectively, of Lason, Inc., a document management company based in Troy, Michigan. The Final Judgment against Bassman orders him to pay disgorgement and prejudgment interest of $240,761.70, payment of all but $35,000 of which is waived on the basis of his financial condition. The defendants consented to the entry of the Final Judgments without admitting or denying the allegations against them.
The SEC alleged that during 1998 and 1999, the defendants engaged in a fraudulent scheme to overstate Lason’s earnings in order to meet or exceed Wall Street expectations. The scheme culminated in the third quarter of 1999, when Lason’s earnings were overstated by approximately 65%.
The defendants profited from the scheme through their salaries as well as bonuses, stock options and executive loans that were affected by Lason’s artificially inflated stock price.
In 2007, in a related criminal action, Monroe and Messinger pled guilty to making false statements to a federal agency (the Commission) and Rauwerdink pled guilty to conspiracy and making false statements to a federal agency. Monroe, Messinger and Rauwerdink were sentenced to 15 months, 12 months, and 45 months imprisonment respectively. In addition, Monroe and Messinger were ordered to pay restitution of $20 million, and Rauwerdink was ordered to pay restitution of $285 million.
Bear Stearns Reports Financing Arrangement With JPMorgan Chase
The Bear Stearns Companies Inc. announced today it reached an agreement with JPMorgan Chase & Co. (JPMC) to provide a secured loan facility for an initial period of up to 28 days allowing Bear Stearns to access liquidity as needed. Bear Stearns also announced that it is talking with JPMorgan Chase & Co., regarding permanent financing or other alternatives.
Alan Schwartz, president and chief executive officer of The Bear Stearns Companies Inc., said, "Bear Stearns has been the subject of a multitude of market rumors regarding our liquidity. We have tried to confront and dispel these rumors and parse fact from fiction. Nevertheless, amidst this market chatter, our liquidity position in the last 24 hours had significantly deteriorated. We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations."
The SEC issued the following statement regarding The Bear Stearns Companies:
The Securities and Exchange Commission has been in close contact with the Department of the Treasury, the Federal Reserve, and the Federal Reserve Bank of New York during discussions concerning an agreement by J.P. Morgan Chase & Co. to provide a secured loan facility to The Bear Stearns Companies. We will continue to work closely together in a way that contributes to orderly and liquid markets.
FINRA issued the following statement about Bear Stearns:
FINRA, in coordination with the Securities and Exchange Commission (SEC) and other regulatory authorities, has been monitoring the U.S. broker-dealer subsidiaries of Bear Stearns & Co. Inc. These broker dealers (Bear, Stearns & Co Inc., Bear, Stearns Securities Corp., Bear Wagner Specialists LLC) remain in compliance with the SEC's and FINRA's capital rules.
FINRA Revises Portfolio Margin Risk Disclosure Statements
FINRA has revised the sample portfolio margining risk disclosure and acknowledgment statements that member firms must provide to customers who have been approved for portfolio margin. This replaces the March 2007 sample risk disclosure and acknowledgment statements. Portfolio Margin Release.
March 13, 2008
SEC Suspends Trading in 26 Stocks in Corporate Hijacking Cases
The SEC suspended trading in the securities of 26 companies that appear to have usurped the identity of defunct or inactive publicly-traded corporations using a tactic known as corporate hijacking. The Commission ordered the suspensions because of questions regarding the adequacy and accuracy of information pertaining to their status as publicly-traded companies. The trading suspensions are part of the SEC's stepped-up effort to address fraud involving the securities of non-exchange traded, or microcap, securities. These are the first actions resulting from the recent formation of the Enforcement Division's microcap fraud working group. In March 2007, the Commission suspended trading in the securities of 35 companies as part of the SEC's Anti-Spam Initiative, which targets potentially fraudulent spam e-mail.
SEC Charges Three with Insider Trading in Connection with Eurex Merger with ISE
The SEC filed an insider trading case against three individuals alleging illegal tipping and trading in advance of the April 30, 2007, announcement of Eurex Frankfurt A.G.'s $2.8 billion cash merger agreement with International Securities Exchange Holdings, Inc. The defendants, John F. Marshall, Vice Chairman of ISE, Alan L. Tucker, and Mark R. Larson were all partners in Marshall Tucker & Associates, L.L.C., a New York-based financial consulting partnership. The SEC's complaint alleges that Marshall received detailed and current information regarding the highly confidential ISE-Eurex merger talks, and tipped Tucker and Larson. According to the complaint, Tucker and Larson then purchased ISE securities resulting in illegal profits totaling approximately $1.1 million and $31,000, respectively.
Simultaneous with the filing of the SEC action, the U.S. Attorney's Office for the Southern District of New York announced the filing of a criminal complaint charging the three men with conspiracy to commit securities fraud.
FINRA Issues Notice on Developing New Consolidated Rulebook
Following the consolidation of NASD and NYSE Regulation into FINRA, FINRA established a process to develop a new consolidated rulebook, which is outlined in the attached Notice. The new FINRA Rules will apply to all FINRA members and will be proposed in phases to the SEC. As rules approved by the SEC become effective, they will replace the existing NASD Rules and incorporated New York Stock Exchange (NYSE) Rules.
NASAA Announces 2008 Public Policy Conference
The North American Securities Administrators Association (NASAA) today announced the line-up of speakers and panels for its 2008 Public Policy Conference, which will be held April 1 in Washington, D.C. The conference brings together securities regulators, financial services industry representatives, policy makers, and the media, for an in-depth look at key public policy issues concerning securities regulation and investor protection. Senator Jack Reed (D-RI), a senior member of the Senate Banking Committee and Chairman of the Subcommittee on Securities, Insurance, and Investment, will deliver the conference’s opening keynote address. SEC Chairman Christopher Cox will deliver the luncheon keynote address.
The conference also will feature two panel discussions on current policy issues facing securities regulators and Wall Street. The first panel will outline what is at stake for investors as distinctions blur between investment advisers and brokers and as the SEC continues its ongoing review of how these two financial service providers are regulated. The second panel will delve into the current debate over principles- and rules-based securities regulation, spurred by the U.S. Department of the Treasury’s Review of the Regulatory Structure Associated with Financial Institutions. Panelists will include Roel Campos, former SEC Commissioner, and Lynn E. Turner, former Chief Accountant of the SEC.,Registration information and other details are available on the NASAA website.
Goldman Plans to Underwrite SPAC Offerings
Offerings of blank check companies -- now upgraded to Special Purpose Acquisition Companies (SPACs) -- are hot, comprising almost 25% of all IPOs in the US last year. Goldman Sachs is the last major securities firm that has declined to underwrite SPACs, saying that the typical 20% stake in acquired companies allotted to management is too generous and dilutive of public shareholders' interest. Goldman plans to join the club, but reportedly will underwrite SPACs that cap the management's stake at 10%. WSJ, Goldman to Join the SPAC Field.
Chicago Mercantile and Nymex Near Deal
CME Group, parent of Chicago Mercantile Exchange, the largest US exchange operator, may announce a definitive deal to buy energy exchange operator Nymex Holdings soon. The two have been in exclusive talks since January. If the deal closes, CME would be worth about $35 billion. Last year CME acquired the Chicago Board of Trade. WSJ, Chicago Merc Nears Deal With Nymex.
Electronic Arts Plans Tender Offer for Take-Two
Electronic Arts plans a tender offer for all shares of Take-Two at $26. Take-Two's board previously rejected its unsolicited bid for the same price, which at that time was a 50% premium over the market price, and described the offer as too low and ill-timed. Take-Two is the publisher of Grand Theft Auto. WSJ, EA's Take-Two Saga Turns Hostile.
March 12, 2008
SEC Publishes Text of Proposed Rule on ETFs
The SEC released the text of a proposed new rule under the Investment Company Act of 1940 that would exempt exchange-traded funds (“ETFs”) from certain provisions of that Act and its rules. The rule would permit certain ETFs to begin operating without obtaining an exemptive order from the Commission. According to the SEC, the rule is "designed to eliminate unnecessary regulatory burdens, and to facilitate greater competition and innovation among ETFs." The Commission also is proposing amendments to its disclosure form for open-end investment companies to provide more useful information to investors who purchase and sell ETF shares on national securities exchanges. In addition, the SEC is proposing a new rule to allow mutual funds (and other types of investment companies) to invest in ETFs to a greater extent than currently permitted under the Investment Company Act. Release Nos. 33-8901; IC-28193; File No. S7-07-08; Exchange-Traded Funds.
SEC Trading & Markets Director Testifies on Municipal Bond Turmoil
Erik R. Sirri, Director, Division of Trading and Markets, U.S. Securities and Exchange Commission, testified on Municipal Bond Turmoil: Impact on Cities, Towns and States, before the Committee on Financial Services, U.S. House of Representatives, on March 12, 2008. He describes the current difficulties in the municipal bond market and states:
Due to the severity and immediacy of the auction-rate market decline and implications for investors, Commission staff is developing appropriate guidance to facilitate orderly markets and continue to protect investors. The guidance would be designed to clarify that, with appropriate disclosures, and compliance with certain other conditions, municipal issuers can provide liquidity to investors that want to sell their auction-rate securities without triggering market manipulation concerns. This may also have the secondary effect of easing the substantial financial burden on municipal issuers and conduit borrowers from unusually high interest rates. It also should facilitate an orderly exit from this market by municipal issuers and conduit borrowers who seek to do so.
Spitzer's Legacy on Wall St.
What will be Governor Spitzer's legacy as the crusading Attorney General? Did he accomplish meaningful reforms in the Global Settlement and market-timing investigations, or was it all for show? The Wall St. Journal quotes Professor Tamar Frankel, at Boston University Law School: "Whether for his own purposes or not, he was the one that put the brakes on" and "stopped the slippery slope" that many in the financial-services industry were operating under around the turn of the century. (For my own assessment of the Global Settlement, see Are Retail Investors Better Off Today?) Even many of Spitzer's supporters believe he may have gone too far in his campaigns against NYSE's Dick Grasso and AIG's Maurice Greenberg. And, of course, if you act self-righteous, you actually have to be holier-than-thou. WSJ, Debate Continues on Whether Wall Street Changes Have Aided Investors.
March 11, 2008
Corporate Buyback Programs Are Down
Have buybacks become passe? CFO.com reports that, even when their stock prices could use the boost, corporation are cutting back on stock repurchases, with the exception of IBM, which announced a huge buyback program last month. Corporations may feel they need the cash on hand. CFO.com, Where Have All the Buybacks Gone?