November 26, 2011
Rose on FOTM
Fraud on the Market: An Action Without a Cause, by Amanda M. Rose, Vanderbilt Law School, was recently posted on SSRN. Here is the abstract:
This is a response to William W. Bratton & Michael L. Wachter, The Political Economy of Fraud on the Market, 160 U. PA. L. REV. 69 (2011). Bratton and Wachter argue that fraud-on-the-market class actions (FOTM) should be eliminated and replaced with stepped-up public enforcement efforts targeted at individual wrongdoers (rather than the corporate enterprise, the FOTM target of choice). In this Response, I do not disagree: My own scholarship has similarly emphasized the benefits of shifting away from FOTM to greater reliance on public enforcement mechanisms. Instead, I take the opportunity to elaborate on the deterrence and corporate governance shortcomings of FOTM, strengthening further the case Bratton and Wachter make for an enhanced public enforcement role
Choi et alia on Sovereign Debt Contracts
Political Risk and Sovereign Debt Contracts, by Stephen J. Choi, New York University (NYU) - School of Law; G. Mitu Gulati, Duke University - School of Law; and Eric A. Posner, University of Chicago - Law School, was recently posted on SSRN. Here is the abstract:
Default on sovereign debt is a form of political risk. Issuers and creditors have responded to this risk both by strengthening the terms in sovereign debt contracts that enable creditors to enforce their debts judicially and by creating terms that enable sovereigns to restructure their debts. These apparently contradictory approaches reflect attempts to solve an incomplete contracting problem in which debtors need to be forced to repay debts in good states of the world; debtors need to be granted partial relief from debt payments in bad states; debtors may attempt to exploit divisions among creditors in order to opportunistically reduce their debt burden; and debtors and creditors may attempt to externalize costs on the taxpayers of other countries. We support this argument with an empirical overview of the development of sovereign bond terms from 1960 to the present.
Langevoort on In-House Lawyers
Getting (Too) Comfortable: In-House Lawyers, Enterprise Risk and the Financial Crisis, by Donald C. Langevoort, Georgetown University Law Center, was recently posted on SSRN. Here is the abstract:
In-house lawyers are under considerable pressure to "get comfortable" with the legality and legitimacy of client goals. This paper explores the psychological forces at work when inside lawyers confront such pressure by reference to the recent financial crisis, looking at problems arising from informational ambiguity, imperceptible change, and motivated inference. It also considers the pathways to power in-house, i.e., what kinds of cognitive styles are best suited to rise in highly competitive organizations such as financial services firms. The paper concludes with a research agenda for better understanding in-house lawyers, including exploration of the extent to which the diffusion of language and norms has reversed direction in recent years: that outside lawyers are taking cognitive and behavioral cues from the insiders, rather than establishing the standards and vocabulary for in-house lawyers
November 23, 2011
Should the Fed Be Talking to Investors Behind Closed Doors?
There has been much discussion the last few weeks about whether Congress-people and their staff have profited by trading on confidential information acquired through their positions. Today the Wall St. Journal reports on other privileged investors that may have access to confidential information. According to the WSJ, certain investors and analysts meet frequently with top Fed Reserve officials, who may provide them with clues about its policy changes. It gives an an example an August 15 meeting between Ben Bernanke and Nancy Lazar, an economist with International Strategy & Investment Group, after which Lazar, according to the Journal, called clients and told them the Fed was about to implement a strategy that would boost long-term bonds.
Of course, meetings between regulators and industry representatives are not by themselves nefarious. It makes sense that the Fed wants to hear from those affected about the impact of its policies. Nonetheless, close contacts between regulators and industry it regulates are troublesome, particularly if the industry may derive more value from these meetings than the regulators do.
November 22, 2011
FINRA Fines REIT Wholesaler for Misleading Sales Literature
FINRA announced that it fined Wells Investment Securities, Inc. $300,000 for using misleading marketing materials in the sale of Wells Timberland REIT, Inc., a non-traded Real Estate Investment Trust (REIT). Wells was the dealer-manager and wholesaler for the public offering of Wells Timberland REIT, which invested in timber-producing land.
As the wholesaler, Wells reviewed, approved and distributed the marketing materials for Wells Timberland. FINRA found that from May 2007 through September 2009, Wells reviewed, approved and distributed 116 advertising and sales materials containing misleading, unwarranted or exaggerated statements. The majority of the sales literature failed to disclose the significance of Wells Timberland's non-REIT status or suggested that Wells Timberland was a REIT at a time when in fact it had not qualified as a REIT. The communications also contained misleading statements regarding Wells Timberland's portfolio diversification and ability to make distributions and redemptions.
Although non-traded REITs are generally illiquid, often for periods of eight years or more, they can avoid particular tax consequences if they qualify under certain Internal Revenue Service requirements. The Wells advertisements at issue did not make it clear to potential investors who might be seeking such favorable tax treatment, that the investment at issue was not yet a REIT and therefore would not be able to offer the desired tax benefits at the time the ads were being used.
In concluding this settlement, the firm neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
A New Survey Reports the Costs of Going Public
It is commonplace to state that there is a high cost to going public, and the costs of compliance with SEC regulation, in particularl Sarbanes-Oxley 404, are usually blamed for those high costs. A recent Ernst & Young survey points to another source: increased compensation paid to officers, directors and advisors. The survey (which is described in a recent CFO.com post) looked at data from 26 companies that went public in the last two years and reports that being public adds about $2.5 million, on average, to costs, with $1.5 million attributable to higher compensation for CEOs, CFOs and others in the finance function, as well as increased board costs. CFO.com, The True Costs of Being Public: More Than You Think
November 21, 2011
Former E&Y Accountant Settles Insider Trading Charges Involving Vivendi Acquisition
The SEC settled charges against Mark A. Konyndyk, CPA, for insider trading in advance of a tender offer. The SEC alleged that Konyndyk, a former manager in the Transaction Advisory Services Group of Ernst & Young (“E&Y”), learned through his work at E&Y that Activision, Inc. was the target of highly confidential acquisition talks, code-named “Project Sego,” in which Vivendi S.A. was the potential acquirer. In particular, Konyndyk performed due-diligence work on Project Sego for E&Y’s client, Vivendi, billing 36 hours to the engagement. Both before and shortly after his departure from E&Y’s employ on November 2, 2007, including just days before the December 2, 2007, public announcement of the Vivendi-Activision merger, Konyndyk bought Activision out-of-the-money call options with near-term expirations. He sold the options shortly after the public announcement, earning gross profits of $9,725.
Without admitting or denying the allegations, Konyndyk has agreed to settle the Commission’s allegations against him. The final judgment to which Konyndyk consented would order that he is liable for disgorgement of $9,725 (comprising all the profits flowing from his own illegal trading) plus $1,789.28 in prejudgment interest thereon as well as a $9,725 civil penalty, but allow him one year to pay the foregoing sums. Additionally, Konyndyk consented, in related administrative proceedings, to the entry of a Commission order that would suspend him, pursuant to Commission Rule of Practice 102(e), from appearing or practicing before the Commission as an accountant, with a right to seek reinstatement after two years. If approved by the Court, this settlement would fully resolve this case.
Former Schwab Executive Settles Fraud Charges Involving YieldPlus Fund
The SEC announced that Randall Merk settled SEC charges related to the Schwab YieldPlus Fund. Merk was an Executive Vice President at Charles Schwab & Co., Inc., President of Charles Schwab Investment Management, and a Trustee of the Schwab YieldPlus Fund and other Schwab funds.
In January 2011, the Commission filed a complaint alleging that Merk and another official committed securities law violations in connection with the offer, sale, and management of the YieldPlus Fund. YieldPlus is an ultra-short bond fund that, at its peak in 2007, had $13.5 billion in assets and over 200,000 accounts, making it the largest ultra-short bond fund at the time. The fund suffered a significant decline during the credit crisis of 2007-2008 and saw its assets fall from $13.5 billion to $1.8 billion during an eight-month period.
According to the complaint, Merk misled or failed to inform investors adequately about the risks of investing in YieldPlus. The complaint also alleged that Merk approved other Schwab funds’ redemptions of their investments in YieldPlus at a time when he knew or was reckless in not knowing that a portfolio manager for those funds had received material, nonpublic information about YieldPlus without the authorization of the YieldPlus Fund’s board of trustees.
Without admitting or denying the Commission’s allegations, Merk consented to the entry of a final judgment permanently enjoining him from aiding and abetting violations of, or otherwise violating, Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. The proposed final judgment also would enjoin Merk from future violations of Section 34(b) of the Investment Company Act of 1940, which prohibits the making of untrue statements of material fact, or material omissions, in documents filed with the Commission. Merk also agreed to pay a $150,000 civil penalty, which the Commission is seeking to have included in an existing Fair Fund for distribution to injured YieldPlus investors. The proposed judgment is subject to the Court’s approval.
If the Court enters the injunction, Merk also has agreed to settlement of a yet-to-be instituted administrative proceeding in which the Commission would suspend Merk for 12 months from associating with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in any penny stock offering.
The Commission previously entered into a $118 million settlement with three Schwab entities regarding the YieldPlus Fund and another bond fund.
Longtime Madoff Trader Pleads Guilty and Settles SEC Fraud Charges
The SEC charged David Kugel, a longtime Bernie Madoff employee, with fraud for his role in creating fake trades to facilitate the massive Ponzi scheme. According to the SEC, Kugel, who worked at Bernard L. Madoff Investment Securities LLC (BMIS) for nearly four decades, was asked by Madoff to provide the firm’s investment advisory operations with backdated arbitrage trade information to be formulated into fictitious trading on investors’ account statements. Kugel’s own account at BMIS was among those in which backdated trades were entered, and he withdrew nearly $10 million in “profits” from the fictitious trading over several years. Kugel's illegal activities began sometime in the early 1970s.
The U.S. Attorney’s Office for the Southern District of New York has filed parallel criminal charges against Kugel, who has pled guilty and also agreed to settle the SEC’s civil charges. Subject to court approval, the civil case will result in a permanent injunction against Kugel, who must forfeit his ill-gotten monetary gains upon entry of a criminal forfeiture order in the criminal case.
Former AIG CEO Challenges Bailout as Unconstitutional Taking
Did the U.S. Government's bailout of AIG constitute an illegal taking under the 5th Amendment? That is the argument that former AIG CEO "Hank" Greenberg (through Starr International Co., which he controls) is making in two lawsuits filed today.
The complaint in Starr International Co. v. U.S. (Download StarrvsUS11212011), filed in the U.S. Court of Federal Claims, alleges that, rather than provide AIG with liquidity support offered to comparable firms, the Government took steps in September 2008 that resulted in its taking control away from AIG shareholders and taking 80% of shareholder equity, without shareholder approval and without just compensation.
Starr International also filed a complaint (Download StarrvsNYFed11212011) in federal district court in Manhattan against the New York Federal Reserve, alleging that as AIG's controlling shareholder and controlling lender, it breached duties owed to AIG and Starr International.
Fordham's Securities Law Moot Court Seeks Judges
Fordham Law's Kaufman Securities Law Moot Court Competition is looking for a few good judges! I am happy to post the following notice on its behalf:
Each spring, Fordham University School of Law hosts the Irving R. Kaufman Memorial Securities Law Moot Court Competition. Held in honor of Chief Judge Kaufman, a Fordham Alumnus who served on the United States Court of Appeals for the Second Circuit, the Kaufman Competition has a rich tradition of bringing together complex securities law issues, talented student advocates, and top legal minds.
The year’s Kaufman Competition will take place on March 23, 2012 to March 25, 2012.
Our esteemed final round panel includes Judge Paul J. Kelly, Jr., of the Tenth Circuit; Chief Judge Alex Kozinski, of the Ninth Circuit; Judge Boyce F. Martin, Jr., of the Sixth Circuit; Judge Richard A. Posner, of the Seventh Circuit; Judge Jane Richards Roth, of the Third Circuit; and Commissioner Troy A. Paredes, of the United States Securities and Exchange Commission.
We are currently soliciting practitioners and academics to judge oral argument rounds and grade competition briefs. No securities law experience is required to participate and CLE credit is available.
Information about the Kaufman Competition and an online Judge Registration Form is available on our website. Please contact Michael A. Kitson, Kaufman Editor, at KaufmanMC@law.fordham.edu or (212) 636-6882 with any questions.
November 20, 2011
Chaffee & Rapp on Peer-to-Peer Lending
Regulating On-Line Peer-to-Peer Lending in the Aftermath of Dodd-Frank: In Search of an Evolving Regulatory Regime for an Evolving Industry, by Eric Chaffee, University of Dayton School of Law, and Geoffrey Christopher Rapp, University of Toledo - College of Law, was recently posted on SSRN. Here is the abstract:
The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act called for a government study of the regulatory options for on-line Peer-to-Peer lending. On-line P2P sites, most notably for-profit sites Prosper.com and LendingClub.com, offer individual “investors” the chance to lend funds to individual “borrowers.” The sites promise lower interest rates for borrowers and high rates of return for investors. In addition to the media attention such sites have generated, they also raise significant regulatory concerns on both the state and federal level. The Government Accountability Office report produced in response to the Dodd-Frank Act failed to make a strong recommendation between two primary regulatory options – a multi-faceted regulatory approach in which different federal and state agencies would exercise authority over different aspects of on-line P2P lending, or a single-regulator approach, in which a single agency (most likely the new Consumer Financial Protection Bureau) would be given total regulatory control over on-line P2P lending. After discussing the origins of on-line P2P lending, its particular risks, and its place in the broader context of non-commercial lending, this paper argues in favor of a multi-agency regulatory approach for on-line P2P that mirrors the approach used to regulate traditional lending.
Stratmann & Verret on Small Public Companies and Proxy Access
Does Shareholder Proxy Access Damage Share Value in Small Publicly Traded Companies?, by Thomas Stratmann, George Mason University - Buchanan Center Political Economy; CESifo (Center for Economic Studies and Ifo Institute for Economic Research), and J. W. Verret, George Mason University School of Law, was recently posted on SSRN. Here is the abstract:
The field of corporate governance has long considered the costs of the separation of ownership from control in publicly traded corporations and the regulatory and market structures designed to limit those costs. The debate over the efficiency of regulations designed to limit agency costs has recently focused on the SEC’s new rule requiring companies to include shareholder nominees on the company financed proxy statement to facilitate insurgent challengers to incumbent board members in board elections. A recent vein of empirical literature has examined the stock price effects of events surrounding the new proxy access rule. We present a study that focuses on small companies who expected an exemption from the rule under the Dodd-Frank legislation that preceded the adoption of the SEC rule. We consider the effect of the August 25, 2010 announcement of the proxy access rule, comparing its effect on the value of firms that expected to be subject to the full rule against its effect on the value of small firms unexpectedly given only a temporary exemption from part of the rule (Rule 14a-11) and no exemption from part of the rule (Rule 14a-8). Supporters of proxy access have long argued that it will enhance shareholder value. Critics of proxy access have argued that it will empower investors with conflicted agendas that will destroy shareholder wealth. The unexpected application of the rule to small-cap companies on August 25 provides a natural experiment for this question and allows us to examine the differential effect of the rule on firms above and below the arbitrary SEC cutoff of $75 million dollars in market capitalization. We find that the unanticipated application of the proxy access rule to small firms, particularly when combined with the presence of investors with a 3% interest able to use the rule, resulted in negative abnormal returns. We present multiple methods to measure that effect and demonstrate losses for our sample of roughly 1,000 small companies of as much as $335 million.
Packin on Living Wills
The Case Against the Dodd-Frank Act’s Living Wills: Contingency Planning Following the Financial Crisis, by Nizan Geslevich Packin, University of Pennsylvania, was recently posted on SSRN. Here is the abstract:
The Dodd-Frank Act’s “living will” requirement mandates that systemically important financial institutions develop wide-ranging strategic analyses of their business affairs, and submit comprehensive contingency plans for reorganization or resolution of their operations to regulators. The goal is to mitigate risks to the financial stability of the US and encourage last-resort planning, which will allow for a rapid and efficient response in the event of an emergency. Beyond the general framework set forth in the Dodd-Frank Act, very little is known about living wills; no legal literature currently exists on what the concept entails, and regulators have not yet created any rules that detail how living wills will operate. Nevertheless, living wills are perceived to be a successful regulatory solution to the problems highlighted by the recent financial crisis. This article focuses on two issues: (i) the implementation and operation of living wills for systemically important financial institutions; and (ii) the problematic aspects of living wills, and how they can lead to the failure of even the most ideally planned living wills. The article concludes that living wills are merely a disclosure requirement with high expectations, but only limited power; accordingly, they should not be perceived as a comprehensive, satisfactory regulatory solution to the too-big-to-fail problem.