Sunday, November 18, 2012
Downgrading Rating Agency Reform, by Jeffrey Manns, George Washington University Law School, was recently posted on SSRN. Here is the abstract:
The Dodd-Frank Act promised to usher in sweeping changes to overhaul the rating agency industry whose shortcomings helped to pave the way to the financial crisis. But two years after the Act’s passage, hopes have given way to disappointment. The most important challenges of how to enhance rating agency competition, accuracy, and accountability remain largely open questions. The Securities & Exchange Commission (SEC) has made progress in heightening rating agency oversight and addressing the most egregious abuses that fueled the financial crisis. But rating agency reforms have fallen far short of their potential due to the Act’s competing objectives to marginalize ratings, to expose rating agencies to greater sunlight and private liability exposure, and to treat rating agencies as a regulated industry. The most important part of the Act remains the most unresolved: the SEC’s mandate to design an alternative for the issuer-pays system that addresses the conflicts of interest created by debt issuers selecting their rating agency gatekeepers. Prospects for an independent commission to select rating agencies for structured finance products have foundered due to the challenges of crafting benchmarks for rating agency performance to use in selecting rating agencies and holding them accountable. The danger is that any standard chosen for rating agencies could fuel herding effects as rating agencies may shape their methodologies to game the system, rather than to enhance accurate and timely assessments of credit risk. Given the difficulties in resolving this issue, this Article suggests that policymakers should consider alternative ways to enhance competition such as by using regulatory incentives to break up the leading rating agencies, so that smaller rating agencies can more plausibly compete. Additionally, it suggests the potential for expanding the scope of private enforcement opportunities to leverage the self-interest of issuers to prosecute grossly negligent conduct by rating agencies. This approach would complement the SEC’s ongoing efforts to foster greater competition and accountability
The Supreme Court's Theory of the Fund, by William A. Birdthistle, Chicago-Kent College of Law, was recently posted on SSRN. Here is the abstract:
Just as the firm has long served as the foundational molecule of the U.S. capitalist economy, theories of the firm have for more than a century dominated legal and economic discourse. Ever since Ronald Coase published The Nature of the Firm in 1937 and asked why firms should exist in an efficient market, classicists and neoclassicists have competed to develop theories — predominantly managerialist and contractual — that best explain the structure and behavior of business organizations.
The investment fund, by contrast, has languished at the margins of corporate theory, relegated as simply a minor, if somewhat curious, example of the firm. But as the flow of assets into funds has swollen dramatically in recent years, so too has the relevance of the question whether funds are, in fact, best considered a subspecies of the firm or instead ought to be evaluated as independent phenomena.
Part II of this Article discusses the shortcomings of the recent ruling in Janus Capital Group v. First Derivative Traders, taking particular exception with the remarkable formalism of the majority’s reasoning, which appears to ignore or misapprehend the actual operations of mutual funds. If operating companies follow the lead of investment funds and use Janus as a model for immunity against securities litigation, deterrence of financial fraud is likely to drop substantially. Part III considers the potentially deleterious implications of the Court’s fund jurisprudence and predicts that substantial mischief will flow from the decision should its lessons be taken advantage of in other sectors of the economy. Part IV considers the theoretical lens — the theory of the fund — that justices of the Supreme Court appear to use to examine investment funds, and it identifies mistaken assumptions and problems with that lens and its use in the pair of recent rulings in Janus and Jones v. Harris. This Article considers whether alternative theories of the firm might inform a more useful theory of the fund for both the judicial and legislative branches in the future.
Have Institutional Fiduciaries Improved Securities Class Actions? A Review of the Empirical Literature on the Pslra's Lead Plaintiff Provision, by Michael A. Perino, St. John's University School of Law, was recently posted on SSRN. Here is the abstract:
In 1995, Congress substantially revamped the governance of securities class actions when it created the lead plaintiff provision as part of the Private Securities Litigation Reform Act. This paper reviews the empirical literature evaluating that provision. The story that emerges from these studies is of a largely successful statutory innovation that has markedly improved the conduct of these cases. There is little doubt that passage of the PSLRA spurred institutions to become more active in securities class actions. Overall, the results of that participation are positive. Existing studies demonstrate that cases with institutional lead plaintiffs settle for more and are subject to a lower rate of dismissal than cases with other kinds of lead plaintiffs, although some questions remain regarding whether these results are driven by institutional self-selection of higher quality cases. One study has shown that institutional participation is correlated with at least some improvements in corporate governance. Institutional lead plaintiffs have had their largest impact on attorneys’ fees. Not only is institutional participation correlated with lower fees and greater attorney effort, but there is evidence to suggest that institutions have created an economically significant positive externality — a reduction in fee awards even in cases without institutional plaintiffs. Institutional participation, however, has not been an unalloyed good. Other studies suggest that institutional investors are subject to their own agency costs, particularly in the form of pay-to-play arrangements with plaintiffs’ law firms. Those arrangements appear to eliminate some of the beneficial effects associated with institutional service as lead plaintiffs.
Friday, November 16, 2012
The SEC announced that, in coordination with the federal-state Residential Mortgage-Backed Securities Working Group, it charged J.P. Morgan Securities LLC and Credit Suisse Securities (USA) with misleading investors in offerings of residential mortgage-backed securities (RMBS). The firms agreed to settlements in which they will pay more than $400 million combined, and the SEC plans to distribute the money to harmed investors.
The SEC alleges that J.P. Morgan misstated information about the delinquency status of mortgage loans that provided collateral for an RMBS offering in which it was the underwriter. J.P. Morgan received fees of more than $2.7 million, and investors sustained losses of at least $37 million on undisclosed delinquent loans. J.P. Morgan also is charged for Bear Stearns' failure to disclose its practice of obtaining and keeping cash settlements from mortgage loan originators on problem loans that Bear Stearns had sold into RMBS trusts. The proceeds from this bulk settlement practice were at least $137.8 million. J.P. Morgan has agreed to pay $296.9 million to settle the SEC's charges.
According to the SEC's order against Credit Suisse, the firm similarly failed to accurately disclose its practice of retaining cash for itself from the settlement of claims against mortgage loan originators for problems with loans that Credit Suisse had sold into RMBS trusts and no longer owned. Credit Suisse also made misstatements in SEC filings about when it would repurchase mortgage loans from trusts if borrowers missed the first payment due. The firm made $55.7 million in profits and losses avoided from its bulk settlement practice, and its investors lost more than $10 million due to Credit Suisse's practices concerning first payment defaults. Credit Suisse has agreed to pay $120 million to settle the SEC's charges.
The RMBS Working Group brings together federal and state agencies to investigate those responsible for misconduct that contributed to the financial crisis through the pooling and sale of RMBS.
On Nov. 12, a federal district judge in California convicted David Tamman, a former partner at the law firm Nixon Peabody LLP for obstructing an SEC investigation into whether one of the law firm's former clients was running a Ponzi scheme. Tamman was convicted on all ten counts on which he was tried: one count of conspiring to obstruct justice, five counts of altering documents, one count of being an accessory after the fact to co-defendant John Farahi’s mail and securities fraud crimes (via NewPoint Financial Services), and three counts of aiding and abetting Farahi’s false testimony before the SEC.
According to the SIGTARP press release:
The evidence at trial showed that immediately after the SEC made a surprise inspection of Farahi’s business, Tamman met with Farahi and began altering and backdating documents to make it appear that Farahi had been disclosing to investors that Farahi was himself taking the majority of investors’ funds. Those altered documents were later produced to the SEC and falsely represented by Farahi to be the actual documents that had earlier been given to investors. The evidence at trial also showed that Tamman created and backdated promissory notes and supplemental disclosure documents and lied to his partners and co-counsel about the creation and alteration of documents that the SEC was seeking.
Thursday, November 15, 2012
The SEC alleges that BP made fraudulent public statements indicating a flow rate estimate of 5,000 barrels of oil per day. BP reported this figure despite its own internal data indicating that potential flow rates could be as high as 146,000 barrels of oil per day. BP executives also made numerous public statements after the filings were made in which they stood behind the flow rate estimate of 5,000 barrels of oil per day even though they had internal data indicating otherwise. In fact, they criticized other much higher estimates by third parties as scaremongering. Months later, a government task force determined the flow rate estimate was actually more than 10 times higher at 52,700 to 62,200 barrels of oil per day, yet BP never corrected or updated the misrepresentations and omissions it made in SEC filings for investors.
The proposed final judgment is subject to court approval.
The SEC issued its second annual staff report on the findings of examinations of credit rating agencies registered with the SEC as Nationally Recognized Statistical Rating Organizations (NRSROs).( Download Nrsro-summary-report-2012)The staff determined that with one exception, all NRSROs appropriately addressed the staff's recommendations in the first annual report in 2011. In addition, the staff announced a new initiative to highlight compliance issues at credit rating agencies between examinations.
The Dodd-Frank Act requires the Commission staff to examine each NRSRO at least annually and issue a report summarizing the essential findings of the examinations. In the reports, firms are referred to as "large NRSROs" or "small NRSROs" to promote the public's understanding without compromising due process requirements.
Findings identified at one or more NRSROs include the following:
The methodology applied to rating certain securities appears to have been changed, but the change was not publicly disclosed for several months
Certain securities were not timely downgraded in accordance with policies and procedures related to rating watch status
Methodologies were published and disclosed inconsistently and in a less-than-transparent manner
Directors were not actively exercising their required oversight duties
In addition to the recommendations to NRSROs based on the 2012 exams, the SEC's Office of Credit Ratings will promote compliance between exams by sending letters to the Designated Compliance Officers at all of the firms as issues arise. The first industry-wide "Dear DCO" letter, sent today, urges NRSROs to review SEC rules on preventing the misuse of material nonpublic information and avoiding unfair, coercive, or abusive practices with respect to credit ratings. The letter is available on the SEC's website.
The SEC released its 2012 Annual Report on the Dodd-Frank Whistleblower Program, which reports that over the past year, the agency received more than 3,000 whistleblower tips from all 50 states and from 49 countries. The report, which is required by the Dodd Frank Wall Street Reform and Consumer Protection Act, summarizes the activities of the SEC's Office of the Whistleblower. Download Annual-report-2012
Among other things, the report notes:
- The SEC made its first award under the new program to a whistleblower who helped the SEC stop an ongoing multi-million dollar fraud. The whistleblower received an award of 30 percent of the amount collected in the SEC's enforcement action, which is the maximum percentage payout allowed by law.
- The SEC received 3,001 tips, complaints, and referrals from whistleblowers from individuals in all 50 states, the District of Columbia, and the U.S. territory of Puerto Rico as well as 49 countries outside of the United States.
- The most common complaints related to corporate disclosures and financials (18.2 percent), offering fraud (15.5 percent), and manipulation (15.2 percent).
- There were 143 enforcement judgments and orders issued during fiscal year 2012 that potentially qualify as eligible for a whistleblower award. The Office of the Whistleblower provided the public with notice of these actions because they involved sanctions exceeding the statutory threshold of more than $1 million.
The SEC and Massachusetts Mutual Life Insurance Company settled charges that MassMutual failed to sufficiently disclose the potential negative impact of a "cap" it placed on a complex investment product that investors were planning to use for retirement. MassMutual, which removed the cap after the SEC's investigation to ensure that no investors will be harmed, agreed to pay a $1.625 million penalty.
The SEC's investigation found that MassMutual included a cap feature in certain optional riders offered to investors, and the cap potentially affected $2.5 billion worth of MassMutual variable annuities. Neither the prospectuses nor the sales literature sufficiently explained that if the cap was reached, the guaranteed minimum income benefit (GMIB) value would no longer earn interest. MassMutual's disclosures instead implied that interest would continue to accrue after the GMIB value reached the cap, and dollar-for-dollar withdrawals would remain available to investors. A number of MassMutual's own sales agents were confused by the language in the disclosures, and investors were not sufficiently informed of the potential negative effect of taking withdrawals if they reached the cap approximately a decade from now.
According to the SEC's order instituting settled administrative proceedings, MassMutual offered GMIB 5 and 6 riders from 2007 to 2009 as an optional feature on certain variable annuity products. The GMIB rider sets a minimum floor for a future amount that can be applied to an annuity option, known as the "GMIB value." Unlike the contract value of the annuity that fluctuates with the performance of the underlying investment, the GMIB value increases by a compound annual interest rate of either 5 or 6 percent and allows investors to make withdrawals any time during the annuity's accumulation phase.
According to the SEC's order, MassMutual advertised its GMIB riders as providing "Income Now" if investors elected to make withdrawals during the accumulation phase or "Income Later" if they elected to receive annuity payments. MassMutual's sales literature highlighted the guarantee provided by the riders by stating, "Even if your contract value drops to zero, you can apply your GMIB value to a fixed or variable annuity." The riders included a maximum GMIB value, and investors could not reach this cap until 2022. If the GMIB value reached the cap, every dollar withdrawn would reduce the GMIB value by a pro-rata amount tied to the percentage decrease on the contract value. After a number of such withdrawals, depending on market conditions, both the contract value and the GMIB value could decline and adversely affect the amount a customer could apply to an annuity and the future income stream.
According to the SEC's order, while MassMutual was offering GMIB riders, there were indications that sales agents and others did not understand the effect of post-cap withdrawals on the GMIB value, which should have alerted the company to the fact that its disclosures were inadequate. Beginning May 1, 2009, after it stopped offering the riders, MassMutual revised its prospectuses to better explain the consequences of taking withdrawals after the GMIB value reaches the cap. Following the SEC's investigation, MassMutual undertook the remedial step of removing the cap entirely from these riders in order to guarantee that no investor will ever reach the cap. This action contributed to the determination of the penalty amount. MassMutual consented to the SEC's order without admitting or denying the findings. In addition to the $1.625 million penalty, MassMutual agreed to cease and desist from committing or causing any violations and any future violations of Section 34(b) of the Investment Company Act.
The staff report prepared for the House Subcommittee on Oversight & Investigations, Committee on Financial Services, investigating the collapse of MF Global was released today. (Download MFGlobalStaffReport111512) The report finds that Jon Corzine caused MF Global's bankruptcy and put customer funds at risk through his excessively risky business model and lack of systems and controls. The report recommends that Congress consider enacting legislation that imposes civil liability on officers and directors who sign a FCM's financial statements or authorize specific transfers from customers' segregated accounts for regulatory shortfalls.
In addition, the report reopens the perennial debate over whether the SEC and CFTC should be merged. It finds that "The SEC and the CFTC Failed to Share Critical Information about MF Global
with One Another, Leaving Each Regulator with an Incomplete Understanding." It recommends:
The apparent inability of these agencies to coordinate their regulatory oversight efforts or to share vital information with one another, coupled with the reality that futures products, markets and market participants have converged, compel the Subcommittee to recommend that Congress explore whether customers and investors would be better served if the SEC and the CFTC streamline their operations or merge into a single financial regulatory agency that would have oversight of capital markets as a whole.
Wednesday, November 14, 2012
Former Board Member, Public Company Accounting Oversight Board
Baker Hostetler LLP; former Deputy Chief of Staff,
U.S. House of Representatives Financial Services Committee
Senior Counsel, U.S. Senate Committee on Banking, Housing and Urban Affairs
Linda Chatman Thomsen
Davis Polk & Wardwell LLP; former Director, SEC Division of Enforcement
Robert K.D. Colby
History Associates, Inc.
SEC Historical Society Live Video Broadcast
Thursday, November 15th
The SEC also announced that it obtained orders in fiscal year 2012 requiring the payment of more than $3 billion in penalties and disgorgement for the benefit of harmed investors. It represents an 11 percent increase over the amount ordered last year. In the past two years, the SEC has obtained orders for $5.9 billion in penalties and disgorgement.
The release contains additional information about specific enforcement actions.
The SEC and the DOJ released A Resource Guide to the U.S. Foreign Corrupt Practices Act. According to the press release:
The guide provides helpful information to enterprises of all sizes from small businesses doing their first transactions abroad to multi-national corporations with subsidiaries around the world. The guide addresses a wide variety of topics including who and what is covered by the FCPA's anti-bribery and accounting provisions; the definition of a "foreign official"; what constitute proper and improper gifts, travel, and entertainment expenses; facilitating payments; how successor liability applies in the mergers and acquisitions context; the hallmarks of an effective corporate compliance program; and the different types of civil and criminal resolutions available in the FCPA context. On these and other topics, the guide takes a multi-faceted approach toward setting forth the statute's requirements and providing insights into SEC and DOJ enforcement practices. It uses hypotheticals, examples of enforcement actions and matters that the SEC and DOJ have declined to pursue, and summaries of applicable case law and DOJ opinion releases.
Tuesday, November 13, 2012
A Bank of New York Mellon unit, Ivy Asset Management, will pay $210 million to settle claims that it concealed its doubts about Bernard Madoff's business operations. This resolves litigation brought by the New York AG, the U.S. Dept of Labor and investors. Ivy was a "feeder fund" that directed clients' funds to Madoff. According to the New York AG's press release:
Internal Ivy documents reveal the firm’s deep but undisclosed reservations about Madoff. One email from an Ivy principal to his subordinate stated: "Ah, Madoff, you omitted one possibility - he’s a fraud!"
Despite its reservations, Ivy did not disclose its suspicions to clients for fear of losing the fees Ivy received through the Madoff investments. Instead, it falsely told them that "we have no reason to believe there is anything improper in the Madoff operation," and that Ivy's only concern about Madoff was the difficulty of managing the enormous pool of assets he had under management.
The Financial Stability Oversight Council issued proposed recommendations calling for additional regulation of money market mutual funds for public comment. The Council issued three alternatives for consideration:
•Alternative One: Floating Net Asset Value. Require MMFs to have a floating net asset value (“NAV”) per share by removing the special exemption that currently allows MMFs to utilize amortized cost accounting and / or penny rounding to maintain a stable NAV. The value of MMFs’ shares would not be fixed at $1.00 and would reflect the actual market value of the underlying portfolio holdings, consistent with the requirements that apply to all other mutual funds.
•Alternative Two: Stable NAV with NAV Buffer and “Minimum Balance at Risk.” Require MMFs to have an NAV buffer with a tailored amount of assets of up to 1 percent to absorb day-to-day fluctuations in the value of the funds’ portfolio securities and allow the funds to maintain a stable NAV. The NAV buffer would have an appropriate transition period and could be raised through various methods. The NAV buffer would be paired with a requirement that 3 percent of a shareholder’s highest account value in excess of $100,000 during the previous 30 days — a minimum balance at risk (MBR) — be made available for redemption on a delayed basis. Most redemptions would be unaffected by this requirement, but redemptions of an investor’s MBR itself would be delayed for 30 days. In the event that an MMF suffers losses that exceed its NAV buffer, the losses would be borne first by the MBRs of shareholders who have recently redeemed, creating a disincentive to redeem and providing protection for shareholders who remain in the fund. These requirements would not apply to Treasury MMFs, and the MBR requirement would not apply to investors with account balances below $100,000.
•Alternative Three: Stable NAV with NAV Buffer and Other Measures. Require MMFs to have a risk-based NAV buffer of 3 percent to provide explicit loss-absorption capacity that could be combined with other measures to enhance the effectiveness of the buffer and potentially increase the resiliency of MMFs. Other measures could include more stringent investment diversification requirements, increased minimum liquidity levels, and more robust disclosure requirements. The NAV buffer would have an appropriate transition period and could be raised through various methods. To the extent that it can be adequately demonstrated that more stringent investment diversification requirements, alone or in combination with other measures, complement the NAV buffer and further reduce the vulnerabilities of MMFs, the Council could include these measures in its final recommendation and wouldreduce the size of the NAV buffer required under this alternative accordingly.
The Council’s proposed recommendations are not mutually exclusive and could be implemented in combination to address the structural vulnerabilities that result in the susceptibility of MMFs to runs. The Council also is seeking public comment on other potential reforms of MMFs that meet the objectives of addressing the structural vulnerabilities inherent in MMFs and mitigating the risk of runs.
The public comment period will run for 60 days.
FINRA announced that it "significantly increased transparency" in the "To-Be-Announced" (TBA) market for agency pass-through mortgage-backed securities. This market represents more than $270 billion traded on an average daily basis in 8,400 trades. Through the Trade Reporting and Compliance Engine (TRACE), FINRA has begun disseminating TBA transaction information, including the CUSIP, time of transaction, price, size and other related information.
In addition to the TBA market, the SEC approved a FINRA proposal to publicly disseminate transaction information in agency pass-through mortgage-backed securities traded "specified." This market represents approximately $19 billion traded on an average daily basis in 3,000 trades. FINRA will announce the effective date of this proposal in a forthcoming Regulatory Notice. Together, the market for agency pass-through mortgage-backed securities traded TBA and specified represent more than 93 percent of par value traded in all asset- and mortgage-backed securities.
TRACE was established in July 2002 to create a regulatory database and bring transparency to the corporate bond market.
Monday, November 12, 2012
The SEC lost an important enforcement action against Bruce Bent and his son Bruce Bent II, who were charged with misleading investors in attempts to stop a run on their Reserve Fund in September 2008. The fund "broke the buck." The jury found that two of the Bents' companies violated securities laws, but cleared both Bents of federal securities charges -- the son was found liable on one negligence count. This is yet another example of the regulators' inability to persuade juries to hold individuals responsible for their actions during the financial crisis.
On Nov. 9 the Supreme Court granted certiorari to a case many have been following for years. It raises the issue of whether class action waivers can be invalidated on federal grounds because plaintiffs have no effective individual remedy to vindicate a federal statutory right. Last term the Court rejected a challenge to a class action waiver on state law unconscionability grounds in AT&T Mobility LLC v. Concepcion.
• American Express Co. v. Italian Colors Restaurant, No. 12-133. Does the Federal Arbitration Act permit courts invoking the "federal substantive law of arbitrability" to invalidate arbitration agreements on the ground that they do not permit class arbitration of a federal law claim? The Second Circuit held that because the class action waiver in the contract between a group of plaintiff merchants and the defendant charge card service provider precluded the plaintiffs from enforcing their federal statutory right to bring antitrust claims, the arbitration provision was unenforceable.
By way of background, in its 2000 opinion, Green Tree Financial Corp. v. Randolph, 531 U.S. 79 (2000),the Supreme Court stated that “it may well be that the existence of large arbitration costs could preclude a litigant . . . from effectively vindicating her federal statutory rights in the arbitral forum.” The Second Circuit has been hostile toward class action waivers for this very reason. In its first opinion in In re American Express Merchants’ Litigation, 554 F.3d 300 (2d Cir. 2009), the Second Circuit held that a class action waiver was unenforceable because it would effectively preclude individual plaintiffs from vindicating their statutory rights under federal antitrust law, because of the high litigation costs and the small potential recovery. The court agreed with the plaintiffs that the class action waiver “flatly ensures that no small merchant may challenge American Express’s tying arrangements,” a troubling outcome because “private suits provide a significant supplement to the limited resources available to the Department of Justice for enforcing the antitrust laws and deterring violations.” Defendants sought certiorari before the Supreme Court, which granted the petition, vacated the decision, and remanded for reconsideration in light of Stolt-Nielsen S.A. v. AnimalFeeds International Corp., 130 S. Ct. 1758 (2010), in which the Court held that arbitrators exceeded their power under the FAA because they construed an arbitration clause in a shipping charter to permit class arbitration as a matter of public policy. In its opinion on remand, which was decided prior to Concepcion, the Second Circuit affirmed its earlier decision, essentially finding that Stolt- Nielsen was not relevant:
While Stolt-Nielsen plainly rejects using public policy as a means for divining the parties’ intent, nothing in Stolt-Nielsen bars a court from using public policy to find contractual language void. We agree with plaintiffs that “[t]o infer from Stolt-Nielsen's narrow ruling on contractual construction that the Supreme Court meant to imply that an arbitration is valid and enforceable where, as a demonstrated factual matter, it prevents the effective vindication of federal rights would be to presume that the Stolt-Nielsen court meant to overrule or drastically limit its prior precedent.”
634 F.3d 187 (2d Cir. 2011).
After the Court's decision in Concepcion, the Second Circuit again considered the issue and determined that Concepcion did not alter its analysis, 667 F.3d 204 (2d Cir. 2012), which rests squarely on "a vindication of statutory rights analysis, which is part of the federal substantive law of arbitrability." Nothing in either Concepcion nor Stolt-Nielsen, asserted the Second Circuit, requires that all class-action waivers be deemed per se enforceable. The Second Circuit declined to reconsider the case en banc, 681 F.3d 139, setting the stage for the showdown before the Supreme Court.
Sunday, November 11, 2012
Do Institutional Investors Value the 10b-5 Private Right of Action? Evidence from Investor Trading Behavior Following Morrison v. National Australia Bank Ltd., by Robert P. Bartlett III, University of California, Berkeley - School of Law; University of California, Berkeley - Berkeley Center for Law, Business and the Economy, was recently posted on SSRN. Here is the abstract:
Using an abrupt change in U.S. securities law, this paper examines the value institutional investors place on the private right of action under Rule 10b-5 of the Securities Exchange Act of 1934. In June 2010, a combination of the U.S. Supreme Court’s decision in Morrison v. National Australia Bank Ltd. and Congress’ prompt response to it ensured that U.S. institutional investors would henceforth no longer be permitted to pursue private 10b-5 actions against many of the non-U.S. issuers in their international equity portfolios. Rather, the U.S. antifraud regime that had increasingly been used by institutional investors to police foreign issuers would thereafter be limited to the domain of the SEC. With this new regime of 10b-5 enforcement, however, came one critical exception for U.S. investors seeking to maintain their power to bring private 10b-5 actions: Investors purchasing securities traded on a U.S. stock exchange could continue to pursue 10b-5 actions against the issuing company regardless of its domicile. In effect, the combination of this new bright-line rule and the fact that so many non-U.S. firms trade on both foreign and U.S. exchanges provided investors with something that had historically been difficult to achieve — the power to choose whether a security comes with the right to sue under Rule 10b-5.
By analyzing a proprietary data set of equity trades made by 360 institutional investors during the thirty month period surrounding Morrison, this paper examines whether investors reallocated their international buy-orders in cross-listed issuers from foreign markets to U.S. exchanges to exercise this newfound power. Notwithstanding the oft-voiced concerns among institutional investors that Morrison would encourage such a reallocation, the results of this study reveal a remarkable persistence in the allocation of investors’ purchase orders following the decision. Indeed, the overall trend in the fifteen months following Morrison was a modest decrease in U.S.-exchanged based purchases even after controlling for ADR trading costs. Overall, the absence of any significant change in trading behavior among this large sample of investors suggests that whatever concerns animate institutional investors’ public policy positions when it comes to Rule 10b-5 are not necessarily shared by their trading desks.