Monday, January 11, 2010
A number of organizations, including the Consumer Federation of America, the Financial Planning Association, and NASAA, have written a joint letter to Senators Dodd and Shelby in support of the provision of the Senate version of the Restoring American Financial Stability Act that eliminates the broker-dealer exclusion from the definition of "investment adviser" in the Investment Advisers Act. The letter concludes:
For too long, brokers have been free to market themselves as trusted advisers and offer extensive advisory services without having to meet the fiduciary standard appropriate to that role. Section 913 of the “Restoring American Financial Stability Act of 2009” eliminates the legislative loophole that has allowed this dual standard to persist. Investors will only benefit, however, if Congress resists efforts to scale back and water down critical protections provided by the legislation, efforts that have been advanced through a campaign of misinformation and mischaracterization. We urge you to stand up for investors by standing up to those who would undermine these important investor protections.
The Financial Crisis Inquiry Commission, a 10-member bipartisan panel established by Congress to examine the causes of the financial crisis, will conduct its first public hearing and hear testimony from public- and private-sector leaders on January 13 and 14. The Commission is required to submit its final report by the end of 2010.
The Huffington Post has the complete list of witnesses. The Commission does not yet have a website.
Sunday, January 10, 2010
Dangerous Liaisons: Collective Scienter in SEC Enforcement Actions, by Bradley J. Bondi, Securities and Exchange Commission (SEC); Georgetown University - Law Center; George Mason University - School of Law, was recently posted on SSRN. Here is the abstract:
Scienter is an essential element of a securities-fraud action brought by the Securities and Exchange Commission (“SEC”) or private plaintiffs. Scienter generally refers to intent or knowledge of wrongdoing. Establishing scienter in a case against an individual is accomplished by pleading and proving the requisite mental state of the individual at the time he or she committed the wrongful act, usually a material misstatement or omission. Establishing scienter for a corporation, however, is more complex. A corporation is a legal artifice that does not think and cannot act on its own, although it has a legal status distinct from its shareholders and agents. A corporation acts solely through its agents. As a result, doctrines such as respondeat superior have evolved to impute the knowledge of an agent-wrongdoer to the corporation in order to hold a corporation liable for securities fraud.
Courts agree that a corporate defendant acted with scienter if the authorized corporate agent making a false statement acted with scienter. The more difficult question is whether a corporation can be held liable for securities fraud when the person responsible for the misstatement was not aware of the truth but some other corporate employee was aware, or when no single corporate employee knew the truth, but the collective knowledge of several employees would have exposed the truth. For example, if a corporate officer makes a statement and only an entry-level employee knows the statement is false, has the corporation acted with fraudulent intent? Furthermore, if a corporate officer makes a statement and no individual knows the statement is false, but by piecing together the collective knowledge of employees it becomes apparent that the statement is false, has the corporation acted with fraudulent intent?
In recent years, some private plaintiffs have resorted to a theory known as “collective scienter” to attach corporate liability on the basis of the collective knowledge of the corporation’s employees, regardless of whether those employees had any role in making the alleged false statements. While most courts have rejected the collective scienter theory, a handful of courts have permitted some derivation of collective scienter.
All of the judicial decisions in the area of collective scienter involve private securities litigation. Because it is extremely rare for a corporation to litigate with the SEC, the question of whether the SEC can and should utilize the theory of collective scienter in its enforcement actions against public companies remains unanswered. Although the SEC has never explicitly asserted a collective scienter theory, some commentators have opined that the theory may have been contemplated, if not utilized, by the agency in one SEC enforcement action.
This Article initially describes the development of the concept of corporate liability from the theory of respondent superior to collective scienter, and explains the various views espoused by courts. The Article then examines SEC enforcement actions that implicitly may have used collective scienter in reaching a settlement with a company. Finally, the Article highlights some legal and policy considerations associated with utilizing the concept of collective scienter in SEC enforcement actions. As discussed below, the SEC should avoid resorting to collective scienter in its enforcement actions because collective scienter would impose a negligence standard in conflict with other laws, chill corporations from voluntarily disclosing information, create inefficient deterrence and misplaced incentives, and would not provide sufficient notice and predictability to corporations regarding charges or penalties.
Is the Bankruptcy Code an Adequate Mechanism for Resolving the Distress of Systemically Important Institutions?, by Edward R. Morrison, Columbia University - Law School, was recently posted on SSRN. Here is the abstract:
Lehman’s bankruptcy has triggered calls for new approaches to rescuing systemically important institutions. This essay assesses and confirms the need for a new approach. It identifies the inadequacies of the Bankruptcy Code and advocates an approach modeled on the current regime governing commercial banks. That regime includes both close monitoring when a bank is healthy and aggressive intervention when it is distressed. The two tasks - monitoring and intervention - are closely tied, ensuring that intervention occurs only when there is a well-established need for it. The same approach should be applied to all systemically important institutions. President Obama and the Congress are now considering such an approach, though it is unclear whether it will establish a sufficiently close connection between the power to intervene and the duty to monitor. The proposed legislation is unwise if it gives the government power to seize an institution regardless of whether it was previously subject to monitoring and other regulations.
Cleaning the Murky Safe Harbor for Forward-Looking Statements: An Inquiry into Whether Actual Knowledge of Falsity Precludes the Meaningful Cautionary Statement Defense, by Allan Horwich, Schiff Hardin LLP; Northwestern University - School of Law, was recently posted on SSRN. Here is the abstract:
Congress included a safe harbor for forward-looking statements in the 1995 Private Securities Litigation Reform Act. This affords certain issuers and other specified persons limited protection from civil liability for damages under the Securities Act of 1933 and the Securities Exchange Act of 1934 when the projections or objectives in a forward-looking statement are not realized, i.e., turn out to be false. The safe harbor contains two principal elements, in addition to protection for “immaterial” statements: One prong where projections are accompanied by “meaningful cautionary statements,” the second prong where the plaintiff fails to prove that the speaker made the statement with “actual knowledge” that it is false or misleading. This article reviews the legislative history of the safe harbor, the divergent lines of case law interpreting it and extensive commentary on how the safe harbor should be applied. The conclusion of this analysis is that the first prong is available as a complete defense without regard to the state of mind or intent of the speaker, so that (1) the second prong does not apply when the first prong is satisfied and (2) statements are not deemed not “meaningful” because a risk factor that rendered the forward-looking statement unlikely to be realized was knowingly omitted from the cautionary statements. Although there may be policy reasons why the safe harbor should have been different, this interpretation is compelled by the language of the statute and the legislative history, including the “bespeaks caution” line of cases on which the statutory safe harbor was based, and judicial and scholarly analyzes to the contrary are flawed.
Dispersed Ownership: The Theories, the Evidence, and the Enduring Tension Between 'Lumpers' and 'Splitters,' by John C. Coffee Jr, Columbia Law School; European Corporate Governance Institute (ECGI); American Academy of Arts & Sciences, was recently posted on SSRN. Here is the abstract:
From a global perspective, the single most noticeable fact about corporate governance is the radical dichotomy between dispersed ownership and concentrated ownerships systems, with the latter being much in the majority. Several prominent academics have offered grand theories to explain when dispersed share ownership arises, which have emphasized either legal or political preconditions. Nonetheless, mounting evidence suggests that these theories are overgeneralized and, in particular, do not account for the appearance (to varying degrees) of dispersed ownership in all securities markets. This article concludes that neither legal rules nor political conditions can adequately explain the spread of dispersed ownership across both the U.S. and the U.K., which developments occurred at different times, in different political and legal environments, and were precipitated by different exogenous factors. Instead, this article offers an alternative and simpler explanation: dispersed ownership arises principally from private ordering, with legal rules playing a minor role at best. Intermediaries - investment bankers, stock exchanges, and others - fill the void created by legal shortcomings and create bonding mechanisms that allow dispersed ownership to spread beyond the limited geographic area in which the founding entrepreneur is known and trusted. This process has two steps: (1) the appearance of numerous minority shareholders, gradually spreading across a broad geographic area, and (2) the break-up of controlling blocks. At the latter stage, historical contingencies have played a major role. In the United States, the merger boom of the 1890s played a critical role, and in the U.K. punitive tax changes compelled controlling shareholders to sell. The only common denominators across the two countries were: (1) political changes followed once share ownership dispersion was achieved, as law followed the market; and (2) private ordering and self-regulation encouraged minority owners to invest and protected their voting and control rights. This may suggest that in decentralized political economies (in which political and economic power tend to be separated and in which self-regulation is more common, such as the U.S. and the U.K.), dispersed ownership is more likely to arise, but it can arise for individual firms through private ordering in any market.