March 24, 2008
JPMorgan-Bear Stearns Merger May be Renegotiated
The New York Times reports that JPMorgan Chase is negotiating to increase its offer for Bear Stearns stock to $10, up from the $2 agreed upon last weekend, as unhappy Bear Stearns shareholders threaten to vote down the merger agreement. The Fed, however, is resisting any increase, since Treasury Secretary Paulson has emphasized that the government's involvement was necessary to provide stability to the marketplace, and paying the Bear Stearns shareholders any more would make the merger look more like a bailout of the firm and its shareholders. The Bear Stearns board reportedly is also considering selling a block of stock to JPMorgan Chase to reduce the percentage of Bear Stearns shares needed to approve the merger.
Because of the haste in which the merger was negotiated, the document may contain drafting errors. One provision commits JPMorgan Chase to guarantee Bear Stearns trades even if the shareholders vote down the deal. NYTimes, JPMorgan in Negotiations to Raise Bear Stearns Bid.
March 23, 2008
Schwarcz on Systemic Risk
Systemic Risk, by STEVEN L. SCHWARCZ, Duke University School of Law, was recently posted on SSRN. Here is the abstract:
This article is the first major work of legal scholarship on systemic risk, under which the world's financial system can collapse like a row of dominos. There is widespread confusion about the causes and even the definition of systemic risk, and uncertainty how to control it. This article attempts to provide a conceptual framework for examining what risks are truly "systemic," what causes those risks, and how, if at all, those risks should be regulated.
It begins by carefully examining what systemic risk really means, cutting through the confusion and ambiguity to establish basic parameters. Economists and other scholars historically have tended to think of systemic risk primarily in terms of financial institutions such as banks. However with the growth of disintermediation, in which companies can access capital market funding without going through banks or other intermediary-institutions, greater focus should be devoted to financial markets and the relationship between markets and institutions.
Using this integrated perspective, the article derives a working definition of systemic risk. It then uses this definition to examine whether systemic risk should be regulated. To that end, the article examines how risk itself - in particular, financial risk - should be regulated and then inquires how that regulatory framework should change by reason of the financial risk being systemic.
A threshold question is whether regulatory solutions are appropriate for systemic risk. The article argues they are because, like a tragedy of the commons, no individual market participant has an incentive, absent regulation, to limit its risk taking in order to reduce the systemic danger to other participants and third parties.
Verret on Hedge Fund Regulation
Dr. Jones and the Raiders of Lost Capital: Hedge Fund Regulation, Part II, a Self-Regulation Proposal, by J.W. VERRET, George Mason University - School of Law; Delaware Court of Chancery, was recently posted on SSRN. Here is the abstract:
Hedge funds are a fairly new asset class utilized by institutional investors and wealthy individuals. These funds can sometimes achieve remarkable returns. However, the market practice for fund managers is to charge performance fees that greatly exceed any other investment type in the financial services sector, leading some hedge fund managers to engage in illicit behavior, including fraud, that violates their duty to their investors and tempts institutional investors to violate their fiduciary duty to their principals.
This exploration examines a registration requirement, previously instituted by the Securities and Exchange Commission (SEC) to combat instances of hedge fund fraud, which was struck down during the summer of 2006. This study relies on a survey of general literature on financial regulation, specific commentary on the hedge fund regulatory reforms instituted, models of self-regulation, and analogous examples in other areas of financial regulation that have been successful. The result is a critique of the previous regulatory regime and proposals that will make it more effective.
The rapid expansion of hedge fund investments is transforming the price discovery function of the securities markets, resulting in more efficient valuation and robust flows of capital. However, these innovative strategies morph so rapidly and operationally they are so much leaner, that the simple regulatory strategies of the Securities Acts of 1933, 1934, and 1940 do not lend themselves to cookie cutter application. Further, the decision makers are sharply divided. The Administration has taken a firm stance in not supporting hedge fund regulation. Congress, under Democratic control, has signaled that it is clearly interested in advancing regulation. The SEC, under its previous chairman, was 3-2 in favor of added regulation, though the United States Court of Appeals for the District of Columbia subsequently overturned the form as it was adopted. The current chairman does not support hedge fund registration.
The future consequences of this market shift are far from certain. The challenge is crafting a lasting and expensive governmental administrative structure with justification that must rest, in part, on faith in a particular regulatory philosophy or market efficiency theory. The present incarnation of the market dynamic is entirely novel. Maybe we will institute a regime that will constrain the benefits hedge funds offer. Maybe we will continue to fly blind across a cliff that will make previous financial disasters look like child's play. Risk is part of the financial regulatory game just as much as it is the essence of finance itself. The only reasonable response is to learn from what worked in the past and attempt to model the variables that will persist in the future. Therefore, I am proposing a mean between the thus far advanced regulatory philosophies, using principles we find by analogy in other areas of financial regulation.
A self-regulatory model that utilizes the inherent advantage of firms regulating each other is a major theme of the policy recommendations presented. Crafting regulatory safe harbors, permissive information access, and designing legal defenses that encourage the operation of a self-regulatory entity to monitor this industry can help to overcome the severe disadvantage that bureaucratic regulators face in this field.
Int'l Bar Assoc. Report on Extraterritorial Jurisdiction
Draft Report of the Securities Law Subcommittee of the Task Force on Extraterritorial Jurisdiction of the International Bar Association, by MARGARET E. TAHYAR, Davis Polk & Wardwell; JAAP WILLEUMIER, Stibbe, ERIC J. PAN, Yeshiva University - Benjamin N. Cardozo School of Law; HOWELL E. JACKSON, Harvard Law School, and EILIS FERRAN, University of Cambridge - Faculty of Law; European Corporate Governance Institute (ECGI), was recently posted on SSRN. Here is the abstract:
The International Bar Association's Securities Law Subcommittee of the Task Force on Extraterritorial Jurisdiction, comprised of a panel of academics, practitioners, senior in-house counsel at financial institutions and former regulators, has produced this draft report examining the need for reform of the regulation of the global securities markets. The report reviews approaches to addressing problems such as mutual recognition, regulatory convergence and disparities in enforcement intensity and makes a series of recommendations. The Subcommittee urges reform of domestic regulatory systems with a view towards its international impact and argues that such reform should be an urgent priority for legislative and regulatory bodies in major financial centers.
Piotrosk & Srinivasan on SOX's Effect on Int'l Listings
Regulation and Bonding: The Sarbanes-Oxley Act and the Flow of International Listings, by JOSEPH D. PIOTROSK, Stanford University; University of Chicago - Graduate School of Business, and SURAJ SRINIVASAN, University of Chicago - Graduate School of Business, was recently posted on SSRN. Here is the abstract:
In this paper, we examine the economic impact of the Sarbanes-Oxley Act (SOX) by analyzing foreign listing behavior onto U.S. and U.K. stock exchanges before and after the enactment of SOX in 2002. Using a sample of all listing events onto U.S. and U.K. exchanges from 1995-2006, we develop an exchange choice model that captures firm-level, industry-level, exchange-level, and country-level listing incentives, and test whether these listing preferences changed following the enactment of SOX. After controlling for firm characteristics and other economic determinants of these firms' exchange choice, we find that the listing preferences of large foreign firms choosing between U.S. exchanges and the London Stock Exchange's (LSE) Main Market did not change following the enactment of SOX. In contrast, we find that the likelihood of a U.S. listing among small foreign firms choosing between the NASDAQ and LSE's Alternative Investment Market decreased following the enactment of SOX. The negative effect among small firms is consistent with these marginal companies being less able to absorb the incremental costs associated with SOX compliance. The screening of smaller firms with weaker governance attributes from U.S. exchanges is consistent with the heightened governance costs imposed by SOX
Wang, Winton & Yu on IPO Fraud
Corporate Fraud and Business Conditions: Evidence from IPOs, by TRACY YUE WANG, University of Minnesota - Twin Cities - Carlson School of Management, ANDREW WINTON, University of Minnesota - Twin Cities - Carlson School of Management, and XIAOYUN YU, Indiana University Bloomington - Department of Finance, was recently posted on SSRN. Here is the abstract:
Using a sample of firms that went public between 1995 and 2002, we examine whether a firm's incentive to commit fraud when raising external capital varies with investor beliefs about industry business conditions as predicted by Povel, Singh and Winton (2007). We document a concave relationship between fraud propensity and optimism in investor beliefs. A firm is more likely to commit fraud when investors are more optimistic about the firm's industry prospect. Nevertheless, the probability of fraud decreases in the presence of extreme investor optimism, as the firm is able to obtain funding without misrepresenting information to outside investors. We also find evidence that venture capitalists and underwriters have different monitoring incentives. When venture capitalists are present, fraud is less likely for low investor beliefs but more likely for high investor beliefs; this suggests that venture capitalists primarily monitor to seek good returns for their investment and thus take investor beliefs into account. By contrast, underwriters' monitoring choices appear to be more concerned with preventing fraud per se so as to protect their reputations. These findings are consistent with the predictions from Povel, Singh and Winton (2007). Our results suggest that regulators and auditors should be especially vigilant during booms.