October 23, 2010
Zaring on the Post-Crisis
The Post-Crisis and its Critics, by David T. Zaring, University of Pennsylvania - Legal Studies Department, was recently posted on SSRN. Here is the abstract:
What should we make of the continuing government oversight over the recipients of bailout funds in the aftermath of the financial crisis? It certainly blurs the public-private distinction and involves the state in business practices in which, as recently as 2007, it would not have dreamed of overseeing. In this brief symposium essay, I evaluate the government's slow exit from its dramatic market intervention and reject the oft-made, but rather unrealistic claim that its conduct represents a permanent abandonment of free market principles. After all, the regulators did not ask for the roles they were given in the aftermath of the collapse of the financial markets. And as the government’s crisis response matures, its market interventions have begun to look more and more prosaic. In fact, the government has acted as any other investor might in some cases, while in others it is doing things to the financial system that it has done many times before – and that investors expect the government to do. The government’s post-crisis roles as private equity manager and insolvency cleanup specialist are the sorts of tasks that we want it to take on, at least in extraordinary times – and they are essentially the same sort of services that we would expect of vulture funds and cramdown specialists in the private sector to provide were the intervention not to have happened.
Choi et alia on Proxy Advisors
The Power of Proxy Advisors: Myth or Reality?, by Stephen J. Choi, New York University - School of Law; Jill E. Fisch, University of Pennsylvania Law School - Institute for Law and Economics; and Marcel Kahan
New York University - School of Law, was recently posted on SSRN. Here is the abstract:
Recent regulatory changes increasing shareholder voting authority have focused attention on the role of proxy advisors. In particular, greater shareholder empowerment raises the question of how much proxy advisors influence voting outcomes. This Article analyzes the significance of voting recommendations issued by four proxy advisory firms in connection with uncontested director elections. We find, consistent with press reports, that Institutional Shareholder Services (ISS) is the most powerful proxy advisor and that, of the others, only Glass, Lewis & Co. seems to have a meaningful impact on shareholder voting.
This Article also attempts to measure the impact of voting recommendations on voting outcomes. Unlike prior literature, it distinguishes correlation from causality by examining both the recommendation itself and the underlying factors that may influence a shareholder’s vote. Using several different tests, we conclude that popular accounts substantially overstate the influence of ISS. Our findings reveal that the impact of an ISS recommendation is reduced greatly once company- and firm-specific factors important to investors are taken into consideration. Overall, we estimate that an ISS recommendation shifts 6%–10% of shareholder votes. We also determine that a major component of ISS’s influence stems from its role as an information agent, aggregating factors that its subscribers consider important.
Chen et alia on Firms That Stop Giving Quarterly Earnings Guidance
Is Silence Golden? An Empirical Analysis of Firms that Stop Giving Quarterly Earnings Guidance, by Shuping Chen, University of Texas at Austin - Red McCombs School of Business; Dawn A. Matsumoto, University of Washington - Department of Accounting; and Shivaram Rajgopal, Emory University - Goizueta Business School, was recently posted on SSRN. Here is the abstract:
We investigate firms that stop providing earnings guidance ("stoppers") either by publicly announcing their decision ("announcers") or doing so quietly ("quiet stoppers"). Relative to firms that continue guiding, stoppers have poorer prior performance, more uncertain operating environments, and fewer informed investors. Announcers commit to nondisclosure because they (i) do not expect to report future good news; or (ii) have lower incentives to guide due to the presence of long-term investors. The three-day return around the announcement is negative. Stoppers subsequently experience increases in analyst forecast dispersion and decreases in forecast accuracy but no change in return volatility or analyst following
Fisch on Securities Intermediaries
Securities Intermediaries and the Separation of Ownership from Control, by Jill E. Fisch, University of Pennsylvania Law School - Institute for Law and Economics, was recently posted on SSRN. Here is the abstract:
The Modern Corporation and Private Property highlighted the evolving separation of ownership and control in the public corporation and the effects of that separation on the allocation of power within the corporation. This essay explores the implications of intermediation for those themes. The article observes that intermediation, by decoupling economic ownership and decision-making authority within the shareholder, creates a second layer of agency issues beyond those identified by Berle and Means. These agency issues are an important consideration in the current debate over shareholder empowerment.
The article concludes by considering the hypothetical shareholder construct implicit in the Berle and Means paradigm and in proposals to increase shareholder empowerment. Intermediation challenges the validity of this construct and raises questions about whether corporate law can rely on shareholders to constrain managerial power appropriately.
October 22, 2010
SEC Releases Strategic Plan for Agency
The SEC released its Strategic Plan for the next five years prepared in accordance with the Government Performance and Results Act of 1993. The plan sets out the Commission’s mission, vision, values, and strategic goals for fiscal years 2010 through 2015. After the plan surveys the forces shaping the SEC’s environment, it then details the outcomes the agency is seeking to achieve, the strategies and initiatives that will be undertaken to accomplish those outcomes, and the performance measures that will be used to gauge the agency’s progress.
SEC and Office Depot Settles Selective Disclosure Charges
The SEC, Office Depot and two Office Depot executives settled charges that they violated Regulation FD by selectively conveying to analysts and institutional investors that the company would not meet analysts' earnings estimates. The SEC also charged Office Depot with unrelated accounting violations.
Regulation FD requires that when issuers disclose material nonpublic information, they must make broad public disclosure of that information. The SEC's orders find that as they neared the end of Office Depot's second quarter for 2007, CEO Stephen A. Odland and then-CFO Patricia A. McKay discussed how to encourage analysts to revisit their analysis of the company. Office Depot then made a series of one-on-one calls to analysts. The company did not directly state that it would not meet analysts' expectations, but rather this message was signaled with references to recent public statements of comparable companies about the impact of the slowing economy on their earnings. The analysts also were reminded of Office Depot's prior cautionary public statements. Analysts promptly lowered their estimates for the period in response to the calls. Office Depot did not regularly initiate these types of calls to all analysts covering the company.
Office Depot agreed to settle the SEC's charges without admitting or denying the findings and allegations, and will pay a $1 million penalty. Odland and McKay also agreed to settle the Regulation FD charges against them without admitting or denying the findings, and will pay $50,000 each.
President's Working Group Releases Report on Money Market Fund Reform
The President’s Working Group on Financial Markets released a report this week on Money Market Fund Reform Options. Here is an excerpt from the Executive Summary:
The Treasury Department proposed in its Financial Regulatory Reform: A New Foundation (2009), that the President’s Working Group on Financial Markets (PWG) prepare a report on fundamental changes needed to address systemic risk and to reduce the susceptibility of MMFs to runs. Treasury stated that the Securities and Exchange Commission’s (SEC) rule amendments to strengthen the regulation of MMFs—which were in development at the time and which subsequently have been adopted—should enhance investor protection and mitigate the risk of runs. However, Treasury also noted that those rule changes could not, by themselves, be expected to prevent a run on MMFs of the scale experienced in September 2008. While suggesting a number of areas for review, Treasury added that the PWG should consider ways to mitigate possible adverse effects of further regulatory changes, such as the potential flight of assets from MMFs to less regulated or unregulated vehicles.
This report by the PWG responds to Treasury’s call.1 The PWG undertook a study of possible further reforms that, individually or in combination, might mitigate systemic risk by complementing the SEC’s changes to MMF regulation. The PWG supports the SEC’s recent actions and agrees with the SEC that more should be done to address MMFs’ susceptibility to runs. This report details a number of options for further reform that the PWG requests be examined by the newly established Financial Stability Oversight Council (FSOC). These options range from measures that could be implemented by the SEC under current statutory authorities to broader changes that would require new legislation, coordination by multiple government agencies, and the creation of new private entities. For example, a new requirement that MMFs adopt floating net asset values (NAVs) or that large funds meet redemption requests in kind could be accomplished by SEC rule amendments. In contrast, the introduction of a private emergency liquidity facility, insurance for MMFs, conversion of MMFs to special purpose banks, or a two-tier system of MMFs that might combine some of the other measures likely would involve a coordinated effort by the SEC, bank regulators, and financial firms.
Importantly, this report also emphasizes that the efficacy of the options presented herein would be enhanced considerably by the imposition of new constraints on less regulated or unregulated MMF substitutes, such as offshore MMFs, enhanced cash funds, and other stable value vehicles. Without new restrictions on such investment vehicles, which would require legislation, new rules that further constrain MMFs may motivate some investors to shift assets into MMF substitutes that may pose greater systemic risk than MMFs.
The PWG requests that the FSOC consider the options discussed in this report to identify those most likely to materially reduce MMFs’ susceptibility to runs and to pursue their implementation. To assist the FSOC in any analysis, the SEC, as the regulator of MMFs, will solicit public comments, including the production of empirical data and other information in support of such comments. A notice and request for comment will be published in the near future. Following a comment period, a series of meetings will be held in Washington, D.C. with various stakeholders, interested persons, experts, and regulators.
What's with the CFTC Judges?
Two interesting recent stories about the administrative law judges at the CFTC. According to yesterday's Wall St. Journal, court records in a guardianship case allege that George Painter, a 83-year old recently retired ALJ, decided matters when (according to his wife) he had mental and alcoholism-related problems. WSJ, Case Sheds Light on Judge. Meanwhile, the Washington Post, on Oct. 19, reported that when Painter retired from the CFTC, he specifically asked that his colleague, Bruce Levine, not be assigned his cases because, according to Painter, Levine never found in favor of commodities customers. WPost, Commodity Futures Trading Commission judge says colleague biased against complainants.
FINRA Fines Former Ferris Baker Watta for Unsuitable Sales of Reverse Convertible Notes
FINRA announced earlier this week that it fined the former Ferris, Baker Watts LLC, acquired by RBC Wealth Management, $500,000 for inadequate supervision of sales of reverse convertible notes to retail customers as well as unsuitable sales of reverse convertibles to 57 accounts held by elderly customers who were at least 85 years old and customers with a modest net worth. The firm was ordered to pay nearly $190,000 in restitution to the 57 account holders for net losses incurred as a result of purchasing reverse convertibles.
Reverse convertibles are notes with a coupon interest rate set for a fixed duration – three, six or twelve months – that are tied to the performance of a particular stock. If the price of the underlying stock drops below a certain level during the duration of the reverse convertible, the customer receives a predetermined number of shares of the stock at maturity of the note. Conversely, if the underlying security maintains its price level, at maturity, the customer receives return of the dollar amount invested and a final coupon payment. In most of the instances where customers received the underlying stock at maturity, the customer ended up with an investment loss. Reverse convertibles not only come with the risks associated with fixed income products, such as issuer default and inflation, but with the additional risk that the value of the underlying asset can significantly depreciate.
FINRA found that during the period January 2006 to July 2008, Ferris, Baker engaged in sales of reverse convertibles to approximately 2,000 retail accounts without providing sufficient guidance to its brokers and supervising managers on how to assess suitability in connection with their brokers' recommendations of reverse convertibles. Additionally, the firm did not have a system to effectively monitor customer accounts for potential over-concentrations in reverse convertibles.
In concluding this settlement, the firm neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
October 19, 2010
SEC Requests Comment on Reducing 404(b) Burden on Smaller Public Issuers
The SEC is requesting public comment related to a study of how the Commission could reduce the burden of complying with Section 404(b) of the Sarbanes-Oxley Act of 2002 for companies whose public float is between $75 million and $250 million, while maintaining investor protections for such companies, and whether any methods of reducing the compliance burden or a complete exemption for such companies from the auditor attestation requirement in Section 404(b) would encourage companies to list on exchanges in the United States in their initial public offerings. This study is required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Treasury Continues to Sell Off its Citigroup Shares
The U.S. Department of the Treasury today announced its continued sale of its holdings of Citigroup common stock. Treasury has entered into a fourth pre-arranged written trading plan under which Morgan Stanley, as Treasury's sales agent, will have discretionary authority to sell 1.5 billion shares of Citigroup common stock under certain parameters.
Treasury currently owns approximately 3.6 billion shares of Citigroup common stock and expects to continue selling its shares in the market in an orderly fashion. The sale of 1.5 billion additional shares of Citigroup common stock, as authorized pursuant to the fourth trading plan, would bring Treasury's holdings of Citigroup common stock to approximately 7 percent of total shares outstanding – down from a high of approximately 27 percent. It would also mean that Treasury had disposed of nearly three-quarters of its original 7.7 billion share common stock stake in Citigroup.
SEC Charges Hedge Fund Managers with Overvaluing Assets in "Side Pocket"
The SEC charged two Georgia hedge fund portfolio managers and their investment advisory businesses with defrauding investors in the Palisades Master Fund, L.P. by overvaluing illiquid fund assets they placed in a "side pocket." According to the SEC, Paul T. Mannion, Jr.and Andrews S. Reckles placed the Palisades hedge fund's investments in World Health Alternatives Inc. in a side pocket and valued those investments in a manner that was inconsistent with fund policy and contrary to an undisclosed internal assessment. A side pocket is a type of account that hedge funds use to separate particular investments that are typically illiquid from the remainder of the investments in the fund. The SEC's Asset Management Unit has been probing whether funds have overvalued assets in side pockets while charging investors higher fees based on those inflated values.
The SEC also alleges that the hedge fund managers stole approximately $1.6 million of investor money to pay for their own personal investments and made material misrepresentations in connection with a private securities transaction.
The SEC complaint,filed in federal district court in Georgia, charges defendants with violations of the antifraud provisions of the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940. The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest, and financial penalties.
October 18, 2010
Klein on Who Obama Should Hire for Economic Policy
The Washington Post's Ezra Klein is a pretty smart guy. Here's his thinking on The five people Obama should hire now to shape economic policy. See what you think.
SC Obtains Injunction Against Hedge Fund Manager
The SEC announced that on October 5, 2010, the federal district court in Minnesota entered by consent a Partial Final Judgment as to hedge fund manager Gregory Bell and his firm Lancelot Investment Management, LLC, permanently enjoining them from violating the antifraud provisions of the securities laws. Previously, in July 2009, the SEC filed an emergency action against Bell and Lancelot Investment Management, LLC that charged them with misleading investors into investing more than $2 billion in hedge fund assets with Petters while pocketing millions of dollars in fraudulent fees at the expense of investors in the funds. The SEC obtained an asset freeze and other emergency relief against Bell and his firm and repatriated $15 million of investors' money from Switzerland that Bell had misappropriated and placed in a Cook Islands Trust.
In addition, as a result of a separate action by the United States Attorney, District of Minnesota, on September 30, 2010 Gregory Bell, was sentenced to 72 months in prison, with credit for the 14 months he had served since his arrest in July 2009.
Aguilar on Regulatory Reform
SEC Commissioner Luis A. Aguilar spoke on An Insider’s View of the SEC: Principles to Guide Reform, at the Berkeley Center for Law, Business and the Economy, University of California at Berkeley, on Oct. 15.
SEC Proposes Rules on Say on Pay and Golden Parachutes
The SEC proposed rules that would enable shareholders to cast advisory votes on executive compensation and "golden parachute" arrangements. The rules are called for by Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Under the proposed rules, companies subject to the federal proxy rules would be required to:
- provide their shareholders with an advisory vote on executive compensation and an advisory vote on the desired frequency of these votes;
- provide shareholders with an advisory vote on compensation arrangements and understandings in connection with merger transactions, known as "golden parachute" arrangements; and
- provide additional disclosure of "golden parachute" arrangements in merger proxy statements.
The proposed rules would also require that institutional investment managers report their votes on executive compensation and "golden parachute" arrangements at least annually, unless the votes are otherwise required to be reported publicly by SEC rules.
Shareholder Approval of Executive Compensation
Section 14A(a) of the Exchange Act, which was added under the Dodd-Frank Act, specifies that say-on-pay votes are required at least once every three years beginning with the first annual shareholders' meeting taking place on or after Jan. 21, 2011. The SEC's proposal requires companies to provide disclosure about the say-on-pay vote in the annual meeting proxy statement, including whether the vote is non-binding. The proposal also would require the company to disclose in the Compensation Discussion and Analysis, or CD&A, whether, and if so, how companies have considered the results of previous say-on-pay votes.
Shareholder Approval of the Frequency of Shareholder Votes on Executive Compensation
Under the proposal, companies also would be required to allow shareholders to vote on how often they would like to cast a say-on-pay vote, namely: every year, every other year, or once every three years. Shareholders would be allowed to cast this non-binding "frequency" vote at least once every six years beginning with the first annual shareholders' meeting taking place on or after Jan. 21, 2011. The proposals would require companies to provide disclosure about the frequency vote in the annual meeting proxy statement, including whether the vote is non-binding.
Shareholder Approval and Disclosure of Golden Parachute Arrangements
Under the proposal, companies also would be required to provide additional information about the compensation arrangements with executive officers in connection with merger transactions. Disclosures of these "golden parachute" arrangements would be required of all agreements and understandings that the acquiring and target companies have with the named executive officers of both companies. This "golden parachute" disclosure also would be required in connection with going-private transactions and third-party tender offers, so that the information is available for shareholders no matter the structure of the transaction. Further, the proposed rules would require companies to provide a shareholder advisory vote to approve certain "golden parachute" compensation arrangements in merger proxy statements.
Institutional Investment Manager Reporting of Votes
The SEC also proposed rules that would require institutional investment managers to annually file with the SEC their votes on say-on-pay, frequency of say-on-pay votes, and "golden parachute" arrangements. The proposal would generally apply to every institutional investment manager that manages certain equity securities having an aggregate fair market value of at least $100 million. The manager would be required to identify securities voted, describe the executive compensation matters voted on, disclose the number of shares over which the manager held voting power and the number of shares voted, and indicate how the manager voted. The proposal would require institutional investment managers to report these votes annually not later than August 31 of each year, for the twelve months ended June 30.
The SEC will seek public comment on the proposals. The comment period will close on Nov. 18, 2010.
October 17, 2010
Skeel on Dodd-Frank
The New Financial Deal: Understanding the Dodd-Frank Act and its (Unintended) Consequences, by David A. Skeel Jr., University of Pennsylvania Law School; European Corporate Governance Institute (ECGI), was recently posted on SSRN. Here is the abstract:
Contrary to rumors that the Dodd-Frank Act is an incoherent mess, its 2,319 pages have two very clear objectives: limiting the risk of the shadow banking system by more carefully regulating derivatives and large financial institutions; and limiting the damage caused by a financial institution’s failure. The new legislation also has a theme: government partnership with the largest Wall Street banks.
The vision emerged almost by accident from the Bear Stearns and AIG bailouts of 2008 and the commandeering of the bankruptcy process to rescue Chrysler and GM in 2009. Its implications for derivatives regulation could prove beneficial: Dodd-Frank will impose order on this previously unregulated market by requiring that most derivatives be traded on an exchange and backstopped by a clearing house. The implications for regulating the largest financial institutions are more troubling. Rather than downsizing the dominant financial institutions, Dodd-Frank Act singles them out for higher capital requirements and more careful scrutiny. Although lawmakers did add several restrictions on banks’ size and scope - such as the Volcker Rule, which limits proprietary trading - these restrictions depend heavily on regulators’ discretion. Ironically, the negotiation with the financial industry over these rules could simply reinforce the partnership between the government and the largest banks.
The new resolution regime gives bank regulators the same sweeping authority to take over floundering financial giants that the FDIC has with ordinary banks. Dodd-Frank resolution will not end bailouts - all of the bank’s derivatives contracts are likely to be paid in full, for instance - and it is dangerously ad hoc, once again relying on regulatory discretion rather than clear rules that are known in advance.
After explaining these components of the new legislation and how they will work - as well as the new Consumer Financial Protection Bureau - The New Financial Deal concludes with several simple bankruptcy reforms that would curb the excesses of the new government-bank partnership, as well as ways to address international dimensions of the new financial order that are largely neglected by the Dodd-Frank Act.
Pritchard on Securities Law in Roberts Court
Securities Law in the Roberts Court: Agenda or Indifference?, by Adam C. Pritchard, University of Michigan Law School, was recently posted on SSRN. Here is the abstract:
Historically, securities law has not been a high priority for the Supreme Court. The first five years of the Roberts Court, however, suggest an upsurge of interest in the federal securities laws, with nine cases decided, a significant increase from the Rehnquist Court’s average. These numbers are deceptive. Analysis of the opinions deciding these cases – and more importantly, the issues debated by the justices – suggests that the Court is not interested in the substance of the securities laws or the policies that animate them. Instead, securities law serves as a backdrop for debates over statutory interpretation and the relationship of the judiciary to the administrative state. Only in the area of securities class actions is there any engagement with the specific subject matter. Notwithstanding charges that the Roberts Court is “pro business”, the Court has not charted a consistent course favoring corporate defendants. Instead, the Court has demonstrated a bias toward the status quo, resisting attempts to both expand – and restrict – the reach of Rule 10b-5 class actions. This article explores the implications of the Roberts Court’s indifference to securities regulation and securities markets for the making of securities law.
Agrawal & Cooper on Accounting Scandals in IPO Firms
Accounting Scandals in IPO Firms: Do Underwriters and VCs Help?, by Anup Agrawal, University of Alabama - Culverhouse College of Commerce & Business Administration, and Tommy Cooper, Kansas State University - Department of Finance, was recently posted on SSRN. Here is the abstract:
We examine whether underwriter reputation, venture capitalist (VC) backing, and VC reputation are related to the probability that a newly public firm has serious accounting problems. Using a novel dataset, we find that the probability of restatement by an IPO firm is positively related to underwriter reputation and negatively related to VC backing, VC reputation and VC maturity. Our results do not appear to be driven by the endogeneity of underwriter reputation or VC backing. Our findings suggest that while VCs positively influence the financial reporting quality of IPO firms, underwriters’ concerns about revenue generation outweigh their concerns about reputation.
Langevoort on Behavioral Economics of M&A
The Behavioral Economics of Mergers and Acquisitions, by Donald C. Langevoort, Georgetown University Law Center, was recently posted on SSRN. Here is the abstract:
The world of mergers and acquisitions seems like a setting in which rationality necessarily dominates. There are high stakes, focused and sustained attention, and expert advisers who are repeat players. In the economics and management literature, however, there has been a great deal of research on what might be called “behavioral M&A” - using insights from psychology to explain observed patterns of behavior in the acquisitions marketplace. To date, the law has largely been uninterested in the psychological dynamics of corporate acquisitions. This essay looks at recent research on such issues as the role of overconfidence, hubris, anchoring, etc. in explaining buy-side behavior, as well as comparable influences on the sell-side, and argues that there is a plausible case for behavioral explanations for the value destruction that often occurs because of acquirer overpayment and its spillover effects. It then turns to possible legal lessons, and suggests a normative (maybe ideological) account for why courts hold tightly to the assumption of rationality. In the end, the behavioral literature is likely to be more interesting and important to lawyers, directors and others engaged in the practice of M&A than a cause for judicial revisionism.