September 19, 2010
Wagner on the SEC and Madoff
Too Close for Comfort: The Problem with Stationary SEC Officers, by Robert E. Wagner, Case Western Reserve University School of Law, was recently posted on SSRN. Here is the abstract:
The SEC was created in response to the market crash of 1929 to prevent fraud and corruption; in recent memory, however, the institution has greatly failed. One dramatic result of the flaws in the SEC's structure was its inability to detect the 50 billion-dollar fraud that Bernard Madoff perpetrated. Virtually all commentators agree that there was ample evidence as the fraud progressed, and that the SEC should have but was unable to recognize it in time. This Article posits that in Madoff's case, the problem was not a lack of harsh sentences to punish this type of offense as some have pondered (indeed, the court unsurprisingly gave him 150 years in prison). Rather, the SEC agents responsible for overseeing NYC did not act in a dispassionate manner when people brought red flags in Madoff's dealings to their attention. This Article suggests that the agents' objectivity was compromised by too great a degree of personal familiarity with Madoff as an individual and his history, which resulted from the fact that the same agents worked closely with the NYC industry for years on end. This Article proposes a mandatory system of office rotations through which most SEC officers - and certainly any with supervisory duties - would be regularly transferred to different geographic areas and internal departments. This simple but important step could provide a significant improvement into the investigative process and increase the scrutiny that officers lend to specific accounts.
Davidoff on Federal Corporate Ownership in the Financial Crisis
Uncomfortable Embrace: Federal Corporate Ownership in the Midst of the Financial Crisis, by Steven M. Davidoff, University of Connecticut School of Law, was recently posted on SSRN. Here is the abstract:
This essay traces the varying terms of all of the U.S. federal government’s corporate investments during the financial crisis and assesses the success of the government’s ownership experience. It concludes that government corporate ownership during the financial crisis achieved the government’s economic and social goals. It was a success. The government ultimately saved the financial system, stalled a financial panic, and averted a much more significant economic downturn.
The potential losses on the government’s corporate investments in the aggregate and individually pale in comparison to these avoided costs. Despite its success, the government often failed to negotiate financial and governance structures which were in the government's best interests, even allowing for legal, economic and time limitations. The government particularly and repeatedly refused to acquire equity stakes when it would have been commercially appropriate to do so, and otherwise failed to negotiate adequate control rights over its significant investments. The structure of government ownership consequently resulted in higher monetary losses than necessary, provided private benefits to undeserving actors, and may have encouraged public discontent and future moral hazard. These deleterious effects were exacerbated by the government’s “ownership by deal” approach under which different terms were negotiated for each significant investment.
U.S. government corporate ownership is likely to remain quite rare, but this essay concludes by drawing on the recent government ownership experience to set forth principles to guide the structure, monitoring and retention of private government investment to alleviate these issues in the future.
Bratton on Hedge Funds
Hedge Funds and Governance Targets: Long-Term Results, by William W. Bratton, University of Pennsyvlania Law School; European Corporate Governance Institute (ECGI), was recently posted on SSRN. Here is the abstract:
This article takes a second look at a database of 114 activist hedge fund engagements commenced between 2002 and 2006. The first look at the database, published as “Hedge Funds and Governance Targets,” 95 Georgetown Law Journal 1375 (2007), covered developments through December 31, 2006, and so caught most of the engagements at midstream. This second look tracks the engagements through mid 2009, providing an extended look at governance engagements by activist hedge funds. The number of engagements remaining open has fallen from 63 percent of the sample to 20 percent. Closure across most of the sample facilitates deeper inspection of the results. The financial yield, however, is disappointing. The hedge funds prove better at extracting target concessions and getting into boardrooms than at yielding long-term, market-beating financial gain. On the one hand, activist intervention led to something tangible in 88 percent of the cases, whether an asset sale, a stepped up cash payout, a board seat, or a legislative concession. On the other hand, only a minority of the targets’ stock prices beat market indices over the period of engagement, with financial underperformance being particularly notable in cases where the hedge fund entered the target boardroom. Overall, the hedge funds’ talents appear best suited to address matters that can be interrogated from outside the target. Any of a cash disgorgement, an asset sale, or a sale of the target as a whole can be planned based on publicly available information. Other value-creating initiatives, like reducing operating costs or otherwise enhancing business plans, call for hands on confrontation with the fuller set of information available only on the inside. The results here yield no overall evidence of constructive input at this level.
Armour et alia on Regulatory Sanctions and Reputational Damages
Regulatory Sanctions and Reputational Damage in Financial Markets, by John Armour, University of Oxford - Faculty of Law; Oxford-Man Institute of Quantitative Finance; European Corporate Governance Institute (ECGI); Colin Mayer, University of Oxford - Said Business School; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); and Andrea Polo, University of Oxford - Said Business School, was recently posted on SSRN. Here is the abstract:
We study the impact of the announcement of enforcement of financial and securities regulation by the UK’s Financial Services Authority and London Stock Exchange on the market price of penalized firms. Since these agencies do not announce enforcement until a penalty is levied, their actions provide a uniquely clean dataset on which to examine reputational effects. We find that reputational sanctions are very real: their stock price impact is on average ten times larger than the financial penalties imposed. Furthermore, reputational losses are confined to misconduct that directly affects parties who trade with the firm (such as customers and investors). The announcement of a fine for wrongdoing that harms third parties has, if anything, a weakly positive effect on stock prices. Our results have significant implications for understanding both corporate reputation and regulatory policy.
Hazen on Stock Broker Standards
Are Existing Stock Broker Standards Sufficient? Principles, Rules and Fiduciary Duties, by Thomas Lee Hazen, University of North Carolina (UNC) at Chapel Hill - School of Law, was recently posted on SSRN. Here is the abstract:
In recent years there has been concern as to the adequacy of broker-dealer regulation. SEC and self regulatory organization rulemaking addresses specific types of broker-dealer conduct but by and large the regulation has been based on principles and standards rather than voluminous detailed rules specifying prohibited conduct. In particular, a good deal of broker-dealer conduct is addressed under the umbrella of regulating according to fair and just principles of trade. Also, much of the SEC’s rulemaking authority is based on the ability to prohibit fraudulent, manipulative, and deceptive devices. It also has been suggested that broker-dealers should be subject to fiduciary duties but to a large extent, they already are. This article examines the extent to which principles-based regulation or the setting of general standards should be further supplemented by rulemaking addressing specific types of conduct.
Jordan on International Standards and the FSF
The Dangerous Illusion of International Standards and the Legacy of the Financial Stability Forum, by Cally Jordan, University of Melbourne - Law School; Duke University School of Law; European Corporate Governance Institute (ECGI), was recently posted on SSRN. Here is the abstract:
In the aftermath of the Asian Financial Crisis, and the criticism directed towards the International Monetary Fund, in particular, for not having seen it coming, the Financial Stability Forum (FSF) was created in 1999 under a mandate from the G7 ministers of finance and central bank governors. The Asian Financial Crisis arose suddenly, spread rapidly and spared neither developed nor developing economies in the region, although some fared much better than others. In retrospect, the causes of the crisis were obvious and the consequences predictable. “Contagion” entered the financial lexicon.
Thus the role of the FSF was to promote financial stability across national borders and provide an early warning system, identifying potential weaknesses or “vulnerabilities” in national financial systems, with a view to preventing a repetition of the localized financial chaos of 1997. The development of international standards for financial and other commercial regulation and the implementation of the Financial Sector Assessment Program or “FSAP” (designed to monitor and assess financial stability on a country by country basis) were two of the initiatives associated with the FSF.
The Asian Financial Crisis, however, was just a tremor compared to the earthquake of the current Global Financial Crisis (GFC) which has shaken financial markets around the world less than a decade after the establishment of the FSF.
That the FSF was a failure is patently obvious. It has been relegated to the dustbin of history with little ado. This paper will endeavour to identify some of the reasons for the failure of the FSF, with a particular focus on international standard setting and financial sector assessment initiatives, with a view to assessing the prospects of the reincarnation of the FSF, the new Financial Stability Board (FSB).
Armour et alia on Delaware Courts
Delaware’s Balancing Act, by John Armour, University of Oxford - Faculty of Law; Oxford-Man Institute of Quantitative Finance; European Corporate Governance Institute (ECGI); Bernard S. Black, Northwestern University - School of Law; Northwestern University - Kellogg School of Management; University of Texas at Austin - School of Law; McCombs School of Business, University of Texas at Austin; European Corporate Governance Institute (ECGI); and Brian R. Cheffins, University of Cambridge - Faculty of Law; European Corporate Governance Institute (ECGI), was recently posted on SSRN. Here is the abstract:
Delaware’s courts and well-developed case law are widely seen as integral elements of Delaware’s success in the competition among states for incorporations. Today, however, Delaware’s popularity as a venue for corporate litigation is under threat. Increasingly, as the empirical evidence summarized in this paper shows, corporate cases involving Delaware-incorporated companies are being brought and decided elsewhere. This paper examines the implications of this “out-of-Delaware” trend, emphasizing in so doing a difficult balancing act that the Delaware courts face. If Delaware accommodates litigation too readily, plaintiffs’ attorneys will file a plethora of “weak” cases and companies, fearful of lawsuits, may begin to incorporate elsewhere. On the other hand, if plaintiffs’ attorneys believe the Delaware judiciary is unwelcoming, they will tend to file cases in other courts. Delaware could then lose its status as the de facto national corporate law court and may no longer offer the rich body of up-to-date case law precedent upon which “users” of Delaware corporate law depend. Delaware’s overall corporate law “brand” could in turn become less valuable, thus jeopardizing its pre-eminence in the competition for incorporations.