Saturday, February 23, 2008
At long last, President Bush may send nominations to the Senate to fill the vacancies on the SEC. There are currently two vacancies that must be filled by Democrats, to replace Annette Nazareth and Raul Campos. In addition, there will be a Republican vacancy when Paul Atkins' term expires this summer. Among the names mentioned to replace Atkins is Professor Troy Paredes of the Washington University at St. Louis Law School. The names that have been floated as the Democratic vacancies for some time are Atlanta lawyer Luis Aguilar and Elisse Walter, senior official at FINRA. WSJ, White House Selects
Candidates for SEC Openings.
The SEC, Corporate Governance, and Shareholder Access to the Board Room, by J. ROBERT BROWN Jr., University of Denver Sturm College of Law, was recently posted on SSRN. Here is the abstract:
In the shareholder governance area, one of the most contentious issues concerns the right of shareholders to nominate directors and include the nominees in management's proxy statement.
This article examines the conflict in the context of the growing importance of independent directors. State law and the Securities and Exchange Commission (SEC) have increasingly relied upon independent directors to protect shareholders and ensure the integrity of the financial disclosure process. Yet because of weak definitions and problems of enforcement, these directors are often not truly independent.
One method of addressing these concerns is to allow shareholders to nominate and elect their own candidates. They have the power to nominate under state law but the authority has largely been emasculated by the need to solicit proxies, an expensive and time consuming process.
The SEC has from time to time sought, always unsuccessfully, to amend the rules to allow shareholders some access to the company's proxy statement for their nominees, with the first effort taking place in 1942. The article contains a comprehensive analysis of these efforts, including the most recent iteration in 2007 when the Commission reaffirmed its traditional position that shareholders should not have access to the company's proxy statement for nominees.
The article takes the position that in an era of activist shareholders, pressure on the SEC to reform its rules will continue to grow. Moreover, continued denial of access will make things worse, leading to efforts by activist shareholders that are more intrusive and more likely to result in contests for the board of directors. The denial of access also leaves in place a serious gap in the disclosure regime for proxy contests. Finally, as the SEC becomes increasingly involved in the corporate governance process, a role it has not historically had to consider, the denial of access raises questions about the agency's willingness to protect the interests of shareholders.
Shareholder Protection and Stock Market Development: An Empirical Test of the Legal Origins Hypothesis, by JOHN ARMOUR, University of Oxford - Faculty of Law; University of Cambridge - Centre for Business Research (CBR); European Corporate Governance Institute (ECGI); SIMON DEAKIN, University of Cambridge - Centre for Business Research (CBR); European Corporate Governance Institute (ECGI); PRABIRJIT SARKAR, Jadavpur University; University of Cambridge - Centre for Business Research (CBR); MATHIAS M. SIEMS, University of Edinburgh - School of Law; University of Cambridge - Centre for Business Research (CBR); and AJIT SINGH, University of Cambridge, was recently posted on SSRN. Here is the abstract:
We test the 'law matters' and 'legal origin' claims using a newly created panel dataset measuring legal change over time in a sample of developed and developing countries. Our dataset improves on previous ones by avoiding country-specific variables in favour of functional and generic descriptors, by taking into account a wider range of legal data, and by considering the effects of weighting variables in different ways, thereby ensuring greater consistency of coding. Our analysis shows that legal origin explains part of the pattern of change in the adoption of shareholder protection measures over the period from the mid-1990s to the present day: in both developed and developing countries, common law systems were more protective of shareholder interests than civil law ones. We explain this result on the basis of the head start common law systems had in adjusting to an emerging 'global' standard based mainly on Anglo-American practice. Our analysis also shows, however, that civil law origin was not much of an obstacle to convergence around this model, since civilian systems were catching up with their counterparts in the common law. We then investigate whether there was a link in this period between increased shareholder protection and stock market development, using a number of measures such as stock market capitalisation, the value of stock-trading and the number of listed firms, after controlling for legal origin, the state of economic development of particular countries, and their position on the World Bank rule of law index. We find no evidence of a long-run impact of legal change on stock market development. This finding is incompatible with the claim that legal origin affects the efficiency of legal rules and ultimately economic development. Possible explanations for our result are that laws have been overly protective of shareholders; transplanted laws have not worked as expected; and, more generally, the exogenous legal origin effect is not as strong as widely supposed.
Sovereign Wealth Funds and Corporate Governance: A Minimalist Response to the New Merchantilism, by RONALD J. GILSON, Stanford Law School; Columbia Law School, and CURTIS J. MILHAUPT, Columbia Law School, was recently posted on SSRN. Here is the abstract:
Sovereign wealth funds (SWFs) have increased dramatically in size as a result of increased commodity prices and the increase in the foreign currency reserves of Asian trading countries. SWF assets now roughly equal those in hedge and private equity funds combined. This growth, and the shift of SWF investment strategy toward equities and increasingly high profile investments like capital infusions into U.S. financial institutions following the subprime mortgage problem, have generated calls for domestic and international regulation. The U.S. and other western economies already regulate the foreign acquisition of control of domestic corporations. However, acquisitions of significant but non-controlling positions are not regulated. The danger is that new regulation will compromise the beneficial recycling of trade surpluses accomplished by SWF investments.
In this paper, we situate the controversy over SWF investments in the increasing global trend toward direct governmental involvement in corporate activity, a phenomenon we label the New Merchantilism. We explain why increased transparency of SWF investment portfolios and strategy, the most commonly advanced policy recommendation, does not respond to the chief concern that SWF investments have engendered. We offer a regulatory minimalist response to fears that SWFs will make portfolio investments for strategic rather than economic reasons. Under our proposal, voting rights of SWF equity investments in U.S. corporations would be suspended but reinstated on sale. Thus, SWFs would buy and sell fully voting rights, thereby assuring that the incentives to make non-strategic investments would be unaffected, while the capacity to exercise influence for strategic motives would be constrained. The paper concludes by assessing the extent to which even a regulatory minimalist response remains both over and under inclusive; however, the limited imprecision does not undermine the effectiveness of the response.
Friday, February 22, 2008
The SEC announced today that it settled its enforcement action with Vencent A. Donlan ("Donlan"), former stock options administrator at Wireless Facilities, Inc. ("WFI") (now Kratos Defense & Security Solutions, Inc.) for his violations of the federal securities laws in fraudulently obtaining stock and stock options from WFI. The SEC also settled with Donlan's wife, Robin D. Colls Donlan ("Colls"), who was named as a relief defendant to recover proceeds from the fraud. The SEC alleged that between November 2002 and November 2003, Donlan abused his position as WFI's stock options administrator to issue and transfer over 700,000 shares of WFI stock and stock options to a brokerage account, which he sold for a net gain of approximately $6.3 million.
The federal district court for the Southern District of California entered a permanent injunction against Donlan and ordered him to pay disgorgement in the amount of $6,252,715.42, plus prejudgment interest thereon in the amount of $153,611.23, but payment was waived for the amount exceeding $5.5 million and civil penalties were not imposed against Donlan based on his sworn representation of his financial condition. Colls was held jointly and severally liable for the disgorgement and prejudgment interest, and she also made a sworn representation of financial condition. On October 26, 2007, Donlan began serving a forty-six month prison sentence for federal wire fraud and tax evasion violations related to his fraudulent scheme.
The Chicago Mercantile Exchange, the largest U.S. exchange operator, is moving forward with plans to acquire Nymex Holdings, an energy exchange operator, even though the DOJ recently expressed concerns about the exchange business. The acquisition would cost about $10 billion, in both cash and CME shares. Last year CME acquired the Chicago Board of Trade. WSJ, CME to Press On With Nymex Bid.
Nasdaq announcced it will seek SEC approval of a rule change to list special purpose acquisition companies (SPACs)and subject them both to NASDAQ's initial listing requirements as well as additional criteria developed specifically for this type of entity. No other market has yet adopted such criteria, although the Wall St. Journal reports that the NYSE is considering a similar move.
In addition to having to satisfy all applicable initial listing standards, NASDAQ will require that acquisition vehicles also meet the following criteria:
Gross proceeds from the initial public offering (IPO) must be
deposited in an escrow account maintained by an insured depository
institution as defined by the Federal Deposit Insurance Act or in a
separate bank account established by a registered broker or dealer.
Within 36 months of the effectiveness of its IPO registration
statement, the company must complete one or more business
combinations using aggregate cash consideration equal to at least
80% of the value of the escrow account at the time of the initial
So long as the company is in the acquisition stage, each business
combination must be approved both by the company's shareholders and
by a majority of the company's independent directors. Following each
business combination, the combined company must meet all of the
requirements for initial listing.
Thursday, February 21, 2008
David Kotz, the SEC's new Inspector General, announced reforms to improve the agency's investigations in a letter to Senate Finance Committee ranking member Charles Grassley. The letter is apparently a response to Congressional criticism of the SEC's handling of an insider trading investigation that led to the dismissal of SEC attorney Gary Aguirre. InvNews, New SEC inspector general vows reform.
Would you buy stock in a distributor of "self-cleaning toilet seats"? The SEC alleges that Clean Care Technologies, Inc. ("CCT"), its former president and principal owner, Edward Klein, and two salespeople, Al Nazon and Anil Varughese, orchestrated a fraudulent unregistered offering of CCT securities, through which they raised approximately $2.2 million from at least 26 unsuspecting investors. CCT purported to be the exclusive North American Distributor of a self-cleaning toilet seat (which, in fact, it wasn't).
The Commission's complaint, filed in the Southern District of New York, charges that the defendants violated securitles laws by conducting an unregistered offering of securities and making material misrepresentations and omissions to investors. The Commission's complaint seeks a final judgment assessing civil penalties, permanently enjoining defendants from further securities law violations and trading of penny stocks, and ordering the defendants to disgorge their ill-gotten gains. Securities and Exchange Commission v. Clean Care Technologies, Inc., et al., 08 CIV 01719 [HB] (S.D.N.Y.)
FINRA announced today that Oppenheimer & Co. will pay a fine of $250,000 for supervisory and other failures in connection with improper market timing of mutual fund shares from January through September 2003. The firm will also pay $4.25 million in restitution to more than 60 mutual fund companies.
FINRA found that Oppenheimer failed to prevent a group of five traders' improper, short-term trading of mutual funds on behalf of hedge fund customers - activity that yielded about $9 million in gross revenue for the firm. Oppenheimer also failed to establish, maintain or enforce supervisory systems and written procedures to detect and prevent improper market timing activities, or to maintain required books and records of the short-term trading of mutual funds through other firms' trading platforms. During the relevant period, the group maintained about 580 accounts for 15 hedge fund customers in an attempt to circumvent market timing trading blocks put in place by the mutual funds.
FINRA also found that the group used 51 different registered representative numbers to create the appearance that the trades were coming from registered representatives who had not previously been blocked from trading.
FINRA further found that the group sold variable annuity contracts to its hedge fund clients to allow them to use the annuity sub-accounts as yet another vehicle for market timing mutual funds. During the relevant period, the group - with the approval of at least some senior managers - purchased 159 variable annuity contracts on behalf of their hedge fund clients. Oppenheimer settled this action without admitting or denying the charges, but consented to the entry of FINRA's findings.
According to the latest Research Quarterly released by SIFMA, the 2007 full-year issuance total, $6.44 trillion, was virtually unchanged from the $6.47 trillion in securities issued in 2006. On the strength of a strong first half of the year, 2007 corporate and municipal bond issuance set records. In the second half of 2007, the weaker housing market, risk repricing and diminished credit market liquidity contributed to a much more volatile U.S. capital market environment. As a result, second half issuance slowed to $2.70 trillion compared to $3.74 trillion in the first half, and the fourth quarter volume was $1.36 trillion compared to $1.72 trillion in the fourth quarter of 2006
A poll by a political consulting firm shows that Americans are distrustful of foreign-government investment in U.S. firms, especially investments by Saudi Arabia, China, Abu Dhabi, Russia, Kuwait, Hong Kong, and Singapore. The poll also showed that those polled did not have much specific information about SWFs. WSJ, Americans See Little to Like In Sovereign-Wealth Funds.
Tuesday, February 19, 2008
Hedge Fund Activism in the Enforcement of Bondholder Rights, by MARCEL KAHAN, New York University - School of Law, and EDWARD B. ROCK, University of Pennsylvania Law School, was recently posted on SSRN. Here is the abstract:
Activist hedge funds have transformed how bondholders respond to violations of their contractual rights. Insurance companies and mutual funds, the traditional investors in bonds, often slept on their rights and turned active only little and late. Hedge funds, by contrast, seek out opportunities for activism in order to make profits. In the wake of their activism, hedge funds have not only benefitted themselves, but their fellow bondholders as well.
Alas, the remedy scheme for violations of bondholders rights - in particular, the centrality of the acceleration remedy - introduces its own set of imperfections. When treasury interest rates have increased or the stock price of a company that has issued convertible bonds has declined, acceleration generates a windfall: bondholders receive compensation in excess of the harm associated with the violation. In these cases, activists will spend excessive resources in detecting and pursuing potential claims and companies have excessive incentives to stave off potential violations. When treasury rates have declined, the tables are turned, and bondholder rights are underenforced.
Whether this selective enforcement has generated aggregate benefits for bondholders and companies in the short term is unclear. Over the long term, however, the market will adjust to hedge fund activism by changing other terms in corporate bond indentures. In particular, we suggest that the contractual remedy scheme be revised by giving companies an expanded defeasance option and offering bondholders a make-whole premium upon acceleration, which would reduce, respectively, the incentives for overenforcement and underenforcement.
The SEC has published, and solicited public comment on, amendments to Rule 12g3-2(b), which exempts foreign private issuers from section 12(g) if they meet certain requirements. Once the foreign private issuer (FPI) obtains the Rule 12g3-2(b) exemption, its shares may trade on a limited basis in the U.S. OTC market.
Currently, in order to obtain the exemption under Rule 12g3-2(b), a non-reporting FPI must submit certain materials to the SEC in paper copies, including a list of information that the issuer has to disclose publicly in its home jurisdiction, along with paper copies of the documents. In addition, at the time of the initial submission, the FPI must provide the SEC with information about the number of U.S. security holders, the percentage held by them, and how they acquired the securities.
Under the proposed amendments, the FPI can claim the Rule 12g3-2(b) exemption automatically if: it is not otherwise subject to Exchange Act reporting, meets the foreign listing condition, has 20 percent or less of its worldwide trading market in the United States, and electronically publishes the specified non-U.S. disclosure documents,as required under the proposed amendments.
The release explains that "by requiring the electronic publication in English of specified non-U.S. disclosure documents for an issuer claiming the Rule 12g3-2(b) exemption, the proposed amendments should make it easier for U.S. investors to gain access to a foreign private issuer’s material non-U.S. disclosure documents, and make better informed decisions regarding whether to invest in that issuer’s equity securities through the over-the-counter market in the United States or otherwise. Thus, the proposed amendments should foster increased efficiency in the trading of the issuer's securities for U.S. investors." SEC Rel. 34-57350, Exemption from Registration under section 12(g) for Foreign Private Issuers.
Last week Philip Bennett, former CEO of Refco, the failed commodities firm, pleaded guilty to twenty counts of conspiracy, securities fraud, false filings with the SEC, wire fraud, false statements to Refco's auditors, bank fraud, and money laundering. It is likely that Mr. Bennett will spend the rest of his life in prison. Today, the SEC filed a civil injunctive action against Bennett. The complaint seeks a permanent injunction enjoining Bennett from future violations and also seeks payment by Bennett of unjust enrichment that he received as a result of his actions, with prejudgment interest thereon, and imposition of civil money penalties. Perhaps the SEC thinks that Bennett has funds that can be returned to defrauded investors, since additional deterence seems unnecessary.
Monday, February 18, 2008
In Rich v. Spartis (2d Cir. Feb. 8, 2008), the Second Circuit affirmed the district court's vacatur of a securities arbitration award in favor of customers, but instructed the the district court to order the NASD panel that issued the award to clarify it. In its opinion the Second Circuit directs some critical words to the panel, two of whom (including the Chair), it notes, were lawyers and presumably should have known better. The problem was that the customers, a married couple, suffered losses because of their brokers' "exercise and hold plan" for Worldcom stock options that the wife had received through her employment. The customers, however, had not opted out of the Worldcom Securities class action, which barred them from arbitrating the Worldcom claims. Although this was called to the attention of the panel before the conclusion of the hearing, the Chair determined to go ahead with the arbitration and leave it to the respondents to go to court to void the arbitration award. The Chair also said that it would break out any damages awarded into Worldcom and non-Worldcom securities. The award, however, entered a lump sum damages award. At the hearing, the customers conceded that they could not enforce any portion of the award related to their Worldcom securities. Accordingly, the district court issued an injunction that nevertheless permitted the panel to clarify whether any portion of the award relates to non-Worldcom claims. However, the panel, without explanation, denied the motion to clarify the award. The Second Circuit found that some, indeed all, of the damages could relate to non-Worldcom securities and that the customers were entitled to the benefit of the burden of proof that the FAA imposes on the challengers of the award to establish that the panel exceeded its authority. Accordingly, the Second Circuit instructed the district court to order the panel to clarify the award and specify the amount of the award, if any, attributable to the Worldcom losses.
Philip Bennett, former CEO of failed commodities broker Refco, pleaded guilty to securities fraud weeks before his trial was set to start. The charges stem from a decade-long scheme to conceal the firm's true financial condition from the public. The trial is scheduled to continue against two other Refco executives. WSJ, Bennett, Refco's Former CEO, Avoids Trial With Guilty Plea.
Bond insurers are scrambling to find ways to improve their triple-A rating. On Friday Governor Spitzer told Congress that they had 3-5 days to find solutions or the regulators would step in. On the same day, FGIC, the holding company for the third-largest bond insurer, notified the New York Insurance Dept. that it would split its business between the safe municipal bonds and the risky subprime debt. Other bond insurers, like MBIA and Ambac, are raising capital or seeking other rescue plans. WSJ, Bond Insurer Seeks to Split Itself, Roiling Some Banks.
Buyer's remorse is not our problem, says Clear Channel Communications, as it filed a complaint against a subsidiary of Providence Equity Partners to complete a $1.2 billion purchase of 56 television stations. Clear Channel is being acquired by private equity firms for close to $20 billion; this is a separate deal. NYTimes, Broadcaster Sues to Force Buyout Deal.
SPACs (Special Purpose Acquisition Companies, f/k/a blank check companies) are hot, even though, as former SEC Chair Arthur Levitt puts it, they are "the ultimate in terms of lack of transparency." Since 2003, SPACs have raised about $20 billion in IPOs. They generally have 18-24 months to find an acquisition (which must be approved by shareholders) or return investors' money. The Washington Post highlights one that has raised $215 million from investors like Jack Kemp, Mario Cuomo and Hank Aaron to buy sports teams and stadiums. WPost, The New Way To Make Deals: Blank Checks.