Securities Law Prof Blog

Bainbridge on Reforming LIBOR

Reforming LIBOR: Wheatley versus the Alternatives, by Stephen M. Bainbridge, University of California, Los Angeles (UCLA) - School of Law, was recently posted on SSRN.  Here is the abstract:

The London Interbank Offered Rate (LIBOR) is the trimmed average interest rate for interbank loans by a panel of leading London banks. LIBOR is the most widely used benchmark rate. An estimated $350 trillion in financial products are based on the LIBOR rate.

In late June 2012, a major scandal broke when Barclays PLC — one of the panel banks whose rates went into calculating LIBOR — agreed to pay $453 million in fines to UK and US regulators to settle allegations that Barclays had attempted to manipulate the LIBOR rate. The probe by multiple national regulators around the world quickly spread to include several other global banks.

In response, the United Kingdom’s Chancellor of the Exchequer charged a commission led by Martin Wheatley with conducting an independent review of the setting and usage of LIBOR. In September 2012, Wheatley released a report proposing a comprehensive 10-point reform plan. In October, the UK Government announced that it accepted “the recommendations of Martin Wheatley’s independent review of LIBOR in full.”

Even though Wheatley’s recommendations likely will have been implemented by the time this article appears in print, they are still deserving of analysis. First, changes and amendments may be necessary to further improve the process, perhaps including some of those suggested in this Article. Second, while LIBOR is one of the most important benchmark rates, it is not the only such rate. Some of these other benchmarks are already under scrutiny. Assessing the merits of various LIBOR reforms therefore may be helpful as regulators evaluate whether these other benchmark rates require similar reform.

In light of LIBOR’s systemic importance as a global interest rate benchmark and the compelling evidence of rate manipulation by panel banks, reforming LIBOR was both a political and economic incentive. This Article explores a number of alternatives that were available to the UK government.

The Article concludes that leaving the problem to market forces had failed and, moreover, was politically unfeasible. Switching to a government-supplied alternative benchmark was both impractical and unwise as a policy matter, as was installing a government agency as a replacement for BBA as the LIBOR administrator. Although vesting the LIBOR administrator with sufficiently strong intellectual property rights to ensure an adequate stream of licensing fees to provide adequate incentives for the administrator and panel banks is an important part of a reform package, but — contrary to what some commentators have suggested — is not viable as a stand-alone reform.

In contrast to the alternatives, the Wheatley Review provides a comprehensive reform package that has proven politically attractive and seems likely to significantly enhance LIBOR’s credibility and attractiveness as a interest rate benchmark. To be sure, the Wheatley regime is not perfect. To the contrary, this Article suggests a number of ways in which it can be expanded and improved. Over all, however, the analysis of the Wheatley Review herein strongly suggests that it will prove a viable starting point as a blueprint for reforming LIBOR and other interest rate benchmarks.

Gilson & Gordon On Activist Investors

The Agency Costs of Agency Capitalism: Activist Investors and the Revaluation of Governance Rights, by Ronald J. Gilson, Stanford Law School; Columbia Law School, and Jeffrey N. Gordon, Columbia Law School; European Corporate Governance Institute (ECGI), was recently posted on SSRN.  Here is the abstract:

Equity ownership in the United States no longer reflects the dispersed share ownership of the canonical Berle-Means firm. Instead, we observe the reconcentration of ownership in the hands of institutional investment intermediaries, which gives rise to what we call “the agency costs of agency capitalism.” This ownership change has occurred because of (i) political decisions to privatize the provision of retirement savings and to require funding of such provision and (ii) capital market developments that favor investment intermediaries offering low cost diversified investment vehicles. A new set of agency costs arise because in addition to divergence between the interests of record owners and the firm’s managers, there is divergence between the interests of record owners – the institutional investors – and the beneficial owners of those institutional stakes. The business model of key investment intermediaries like mutual funds, which focus on increasing assets under management through superior relative performance, undermines their incentive and competence to engage in active monitoring of portfolio company performance. Such investors will be “rationally reticent” – willing to respond to governance proposals but not to propose them. We posit that shareholder activists should be seen as playing a specialized capital market role of setting up intervention proposals for resolution by institutional investors. The effect is to potentiate institutional investor voice, to increase the value of the vote, and thereby to reduce the agency costs we have identified. We therefore argue against recent proposed regulatory changes that would undercut shareholder activists’ economic incentives by making it harder to assemble a meaningful toe-hold position in a potential target.

Wrona on Standards of Conduct for Investment Advisers and Broker-Dealers

The November 2012 issue of The Business Lawyer features an article entitled The Best of Both Worlds: A Fact-Based Analysis of the Legal Obligations of Investment Advisers and Broker-Dealers and a Framework for Enhanced Investor Protection by James S. Wrona, Vice President and Associate General Counsel at FINRA.   The author provides an indepth analysis of the development of the standards of conduct for investment advisers and broker-dealers and the current debate that is usually referred to the dichotomy between the fiduciary standard required of investment advisers and the suitability standard applicable to broker-dealers.  The article concludes with a framework for robust investor protection and recommends additional obligations on both financial advice providers "to achieve truly universal standards of conduct that are in investors' best interests."  The citation is 68 Bus. Law. 1 (2012), and it is available in hard copy or at the ABA website.

Sjostrom on Private Placement Regulation

Rebalancing Private Placement Regulation, by William K. Sjostrom Jr., University of Arizona - James E. Rogers College of Law, was recently posted on SSRN.  Here is the abstract: 

The Article examines the investor protection/capital formation balance with respect to private placements of securities. Specifically, it details various rule changes that were implemented over the years to enhance capital formation and other events that have occurred over the same timeframe that have weakened investor protection. The Article submits that the latest round of capital formation enhancements has tilted the balance too far in favor of capital formation and away from investor protection, especially given the size of the private placement market today. Hence, the Article puts forth a proposal for strengthening private placement investor protection. The proposal is meant to serve as a starting point for debate if policy makers conclude rebalancing is needed.

Colesanti on Rajaratnam Conviction

Wall Street as Yossarian: The Other Effects of the Rajaratnam Insider Trading Conviction, by Scott Colesanti, Hofstra University - Maurice A. Deane School of Law, was recently posted on SSRN.  Here is the abstract:

Without warning, the patient sat up in bed and shouted, ‘I see everything twice!’

And thus Yossarian, the war-weary bomber pilot of the masterful novel, Catch-22, was able to malinger in an Italian hospital even longer while nervous doctors attended to the strange malady of his neighbor.

The storied literary diversion may highlight the good fortune of those evading government prosecution of financial crimes in 2011, a year that fulfilled the promise that observers of hedge fund discipline would similarly see things twice. To wit, in May 2011, a Manhattan jury convicted billionaire hedge fund entrepreneur Raj Rajaratnam of fourteen counts of conspiracy and securities fraud. Chief among these convictions was the crime of insider trading. The case punctuated two years of criminal actions based upon insider trading allegations by the U.S. Attorney for the Southern District of New York, who had called Rajaratnam “the modern face of illegal insider trading.” Perhaps more significantly, five months later, Judge Richard J. Holwell sentenced Rajaratnam to eleven years in prison, in handing down the harshest sentence ever in such a case.

The Rajaratnam trial was the climax to a prolonged investigation that resulted in the conviction of over two dozen hedge fund workers and public company/financial firm employees for their roles in a $50 million scheme. The case also emphasized the unforgiving nature of securities fraud accusations where those who should know better (for example, attorneys) were concerned, as lawyers ensnared in the net cast at the fallen Galleon Management, LP (“Galleon”) received consistently glaring prison sentences. Further, the Rajaratnam conviction seemingly reverberated through the courts, leading to strict interpretations of procedural rules attending unrelated insider trading cases
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But the celebrated conviction failed to end the parallel U.S. Securities and Exchange Commission (the “SEC” or the “Commission”) investigation, litigation, or its pursuit of both fine and disgorgement. Thus, while commentators accurately noted that the use of Department of Justice (“DOJ”) wiretaps changed the nature of both the game and the results for Wall Street’s illegal players, receiving less attention is the delaying effect the trial had — both on clarifying insider trading law and questioning the unchecked use of government resources. While no one could quibble with the efficiency of the DOJ’s results, this Article seeks to reveal their equally significant effects on the government’s ongoing crusade against insider trading. Born via an administrative decision, decades after the adoption of the securities laws themselves, the uniquely American insider trading prohibition (and the attendant efforts of its chief enforcer) became perhaps a little more unique and problematic with the U.S. Attorney’s 2011 conviction of Rajaratnam.

Strine et alia on Putting Stockholders First

Putting Stockholders First, Not the First-Filed Complaint, by Leo E. Strine Jr., Government of the State of Delaware - Court of Chancery; Lawrence A. Hamermesh, Widener University School of Law; Matthew Jennejohn, Shearman & Sterling LLP, was recently posted on SSRN.  Here is the abstract:

The prevalence of settlements in class and derivative litigation challenging mergers and acquisitions in which the only payment is to plaintiffs’ attorneys suggests potential systemic dysfunction arising from the increased frequency of parallel litigation in multiple state courts. After examining possible explanations for that dysfunction, and the historical development of doctrines limiting parallel state court litigation — the doctrine of forum non conveniens and the “first-filed” doctrine — this article suggests that those doctrines should be revised to better address shareholder class and derivative litigation. Revisions to the doctrine of forum non conveniens should continue the historical trend, deemphasizing fortuitous and increasingly irrelevant geographic considerations, and should place greater emphasis on voluntary choice of law and the development of precedential guidance by the courts of the state responsible for supplying the chosen law. The “first-filed” rule should be replaced in shareholder representative litigation by meaningful consideration of affected parties’ interests and judicial efficiency.

Coffee-SEC Debate on SEC Enforcement Continues

In a post a few days ago, I reviewed the debate between Professor John Coffee and the SEC Enforcement Directors about the effectiveness of the agency's enforcement efforts.  Directors Khuzami and Canellos took issue with Professor Coffee's numbers.  Today Professor Coffee responds, with additional data about the median value of SEC settlements, and attaches the Power Point slides from his recent address on SEC Enforcement. (Coffee, SEC Enforcement:Rhetoric and Reality)  He also reiterates:

The most important claim I make is that the nature of corporate litigation has changed, partly as a result of “ediscovery” and the often millions of emails and related documents in the typical large case.  It is no longer feasible for a handful of SEC attorneys (even if all are diligent and able) to litigate effectively against the squadrons of associates that a large firm can throw at a complex case.  The result is a mismatch.  Hence, when facing a major financial institution, the SEC tends out of necessity to settle cheaply or not sue at all (as in Lehman).  My proposed answer to this problem is that the SEC should do what other financial regulators are already doing (including the FDIC):  namely, hiring independent counsel on a negotiated contingent fee basis.  Khuzami and Canellos object that I would cause the SEC to abandon prosecutorial discretion.  Nonsense!  The SEC would conduct the initial investigation and decide whether a suit was justified.  But, it would now hold increased leverage in negotiations because it could credibly threaten suit by independent counsel (who would only take the case only if they judged it to be promising).  SEC discretion would remain because the case would go forward only if the SEC’s staff decided that it had merit.  Such an approach would go far towards solving the SEC’s budgetary crisis, because attorneys’ fees would be earned only if a recovery was obtained and only out of the recovery (thus not depleting the SEC’s budget).

 

Black on Behavioral Economics and Investor Protection

Behavioral Economics and Investor Protection: Reasonable Investors, Efficient Markets, by Barbara Black, University of Cincinnati - College of Law, was recently posted on SSRN.  Here is the abstract:

The judicial view of a “reasonable investor” plays an important role in federal securities regulation, and courts express great confidence in the reasonable investor’s cognitive abilities. Behavioral economists, by contrast, do not observe real people investing in today’s markets behaving as the reasonable investors that federal securities law expects them to be. Similarly, the efficient market hypothesis (EMH) has exerted a powerful influence in securities regulation, although empirical evidence calls into question some of the basic assumptions underlying EMH. Unfortunately, to date, courts have only acknowledged the discrepancy between legal theory and behavioral economics in one situation, class certification of federal securities class actions. It is time for courts to address the gap between judicial expectations about the behavior of reasonable investors and behavioral economists’ views of investors’ cognitive shortcomings, consistent with the central purpose of federal securities regulation: protect investors from fraud.

Booth on Materiality

The Two Faces of Materiality, by Richard A. Booth, Villanova University School of Law, was recently posted on SSRN.  Here is the abstract:

To make out a claim for securities fraud under federal law, a plaintiff must plead and prove the misrepresentation of a material fact. The Supreme Court has repeatedly defined a material fact as one that would be important to a reasonable investor in deciding how to act in that it would change the total mix of information – although it need not necessarily change the ultimate decision of the investor as to how to vote or whether to trade. On the other hand, the courts have also defined a material fact as one that would affect market price – which clearly implies that it must have changed the decisions of some investors. Although these two definitions of materiality appear to conflict, they can be reconciled as alternative expressions of the same standard, the former referring to individual investors and the latter referring to investors in the aggregate. Indeed, the Supreme Court has held a fact cannot be material if it cannot matter to the ultimate outcome, suggesting that a fact cannot be material if it does not affect the behavior of a number of investors sufficient to move the market. Moreover, it is appropriate to consider price impact in connection with the decision to certify a securities fraud action as a class action since a class action involves the claims of investors in the aggregate and since price impact need not be dispositive as to the merits of the individual claim of the lead plaintiff who may be able to recover under the individual investor standard.

Rodrigues on Securities Law's Dirty Little Secret

Securities Law's Dirty Little Secret, by Usha Rodrigues, University of Georgia Law School, was recently posted on SSRN.  Here is the abstract:

Securities law's dirty little secret is that rich investors have access to special kinds of investments — hedge funds, private equity, private companies — that everyone else does not. This disparity stems from the fact that from its inception federal securities law has jealously guarded the manner in which firms can sell shares to the general public. Perhaps paternalistically, the law assumes that the average investor needs the protection of the full panoply of securities regulation, and thus should be limited to buying public securities. In contrast, accredited — i.e., wealthy — investors, who it is presumed can fend for themselves, have the luxury of choosing between the public and private markets.

This Article uses the emergence of new secondary markets in the shares of private companies to illustrate the above disparity, which has long characterized the world of investment access. First, focusing narrowly on these markets reveals their troubling potential effects on the venture capital world, a vital source of startup funding. More broadly, these new secondary markets bring to light the stark contrasts in investing power and access that have always been securities law’s dirty little secret: by making it easier for accredited investors to wield their special privilege, the new markets just make the disparity of investment access more obvious. For example, after Facebook’s initial public offering (IPO), it was widely reported that accredited investors had been buying shares of the high-profile company in the three years before it rather disastrously went public — at which point the big money had already been made.

Thus, the increased transparency the secondary markets bring to the world of private investment makes our overall securities law newly vulnerable to a fundamental critique: Government intervention has created an investing climate that lets the rich get richer, while the poor get left behind. The Article acknowledges elements keeping the current system in place, explaining the current inequality of investor access by way of public choice theory: regulators and companies alike favor the status quo. Viewed from the perspective of the little guy, however, inequality in investment access may prove less defensible and ultimately less tenable. I suggest a modest fix: letting the general public participate in the private market via mutual fund investment, something it currently cannot do.

Woody on Conflict Minerals Legislation

Conflict Minerals Legislation: The SEC's New Role as Diplomatic and Humanitarian Watchdog, by Karen E. Woody, Independent, was recently posted on SSRN.  Here is the abstract:

Buried in the voluminous Dodd-Frank Wall Street Reform and Consumer Protection Act is an oft-overlooked provision requiring corporate disclosure of the use of “conflict minerals” in products manufactured by issuing corporations. This article scrutinizes the legislative history and lobbying efforts behind the conflict minerals provision to establish that, unlike the majority of the bill, its goals are moral and political, rather than financial. Analyzing the history of disclosure requirements, the article suggests that the presence of conflict minerals in a company’s product is not inherently material information, and that the Dodd-Frank provision statutorily renders non-material information material. The provision, thus, forces the SEC to expand beyond its congressional mandate of protecting investors and ensuring capital formation by requiring issuers engage in additional non-financial disclosures in order to meet the provision’s humanitarian and diplomatic aims. Further, the article posits that the conflict minerals provision is a wholly ineffective means to accomplish its stated humanitarian goals, and likely will cause more harm than good in the Democratic Republic of Congo. In conclusion, this article proposes that a more efficient regulatory model for conflict minerals is the Clean Diamond Trade Act and the Kimberley Process Certification Scheme.

Pollman on Marketplaces for Trading Private Company Stock

Information Issues on Wall Street 2.0, by Elizabeth Pollman, Loyola Law School Los Angeles, was recently posted on SSRN.  Here is the abstract:

Billions of dollars have flooded new online marketplaces for trading private company stock. These marketplaces stand poised to become important, lasting features of the private company world as they provide a central meeting place for buyers and sellers and potentially increase the liquidity of private company stock. Increased liquidity is particularly important to investors in start-up companies, as these companies have faced longer periods of time before going public or being acquired. The new marketplaces also raise significant information issues, however, that threaten their legitimacy and efficiency. This Article is the first to examine these information issues — lack of information, asymmetric information, conflicts of interest, and insider trading — as well as possible solutions that would allow the markets to continue to evolve while promoting their integrity and investor protection goals. Specifically, the Article proposes establishing a minimum information requirement for secondary trading in private company stock and reexamining the thresholds for accredited investor status in order to ensure that market participants can fend for themselves without additional protections. The Article also examines potential responses to insider trading in these markets, arguing that a case exists for the SEC to take action in the private market context, since harm may be cognizable and the arguments for regulating insider trading are as strong in the private market arena as in the public.

Torres-Spelliscy on the SEC's Regulation of Money in Politics

Safeguarding Markets from Pernicious Pay to Play: The SEC's Money in Politics Model for Regulatory Intervention, by Ciara Torres-Spelliscy, Stetson University - College of Law; Stetson University College of Law, was recently posted on SSRN.  Here is the abstract:

At first blush, the SEC’s regulation of money in politics may seem to fall outside of its jurisdiction, but this is a mistake. This view ignores three previous times when the SEC stepped in to curb pay to play: (1) in the municipal bond market in 1994; (2) in the public pension fund market in 2010; and (3) in investigating questionable payments post-Watergate from 1974 to 1977. The result of the first two interventions led to new Commission rules and the third intervention resulted in the Foreign Corrupt Practices Act (a federal statute).

When these three previous SEC interventions into the role of money in politics are examined, a principled model emerges for when the Commission’s regulatory intervention is appropriate. The principled model, hereinafter known as the “Money in Politics Model,” has the following characteristics: there must be (1) a potential for market inefficiencies; (2) a problem that is not likely self-correct through normal market forces; (3) a lack of transparency; (4) a material amount of aggregated money at stake; and (5) a high probability for corruption of the government.

The Money in Politics Model’s characteristics were present in the all three past SEC interventions. As will be explained in more detail below, in the municipal bond market and public pension funds, there was an endemic problem of pay to play between state elected officials and businesses eager to contract with them for lucrative fees. The post-Watergate investigation revealed even more profound problem of secret corporate funds used for political contributions domestically and bribes of foreign officials abroad.

So does the post-Citizens United world of corporate political spending rise to the same level as these three previous examples? Does post-Citizens United political spending fit the SEC’s Money in Politics Model and merit the SEC’s intervention? This article will argue that the Model fits and the SEC should act.

The SEC is not new to the inherent conflicts of interest between business and government, especially when elected officials have the ability to make private contractors in the financial services industry rich through commissions and fees. The risk of corruption is intrinsic in such a situation. Here corruption is best captured by the definition as “the misuse of public … office for direct or indirect personal gain.” What is new as of January 2010, thanks to Citizens United, is the potential for every publicly traded company to try to influence the government not just through traditional lobbying, but also through campaign expenditures. This new problem merits a new SEC intervention to reveal the campaign activities of public companies.

Squire on the Benefits of a Clearinghouse in a Financial Crisis

The Speed and Certainty Benefits of a Clearinghouse in a Financial Crisis, by Richard Squire, Fordham University School of Law, was recently posted on SSRN.  Here is the abstract:

The Article argues that the primary benefit of a clearinghouse in a financial crisis is to accelerate payouts to creditors when a trading firm fails. Through netting, clearinghouses provide immediate payouts to creditors who otherwise would have to wait for slower bankruptcy payouts. Quicker payouts reduce illiquidity and uncertainty, two sources of systemic risk. Clearinghouse netting can reduce illiquidity and uncertainty even if the clearinghouse is itself insolvent. Unlike benefits of clearinghouses purported by other scholars, faster payouts are not zero-sum: besides accelerating payouts to members, clearinghouses ease the administrative burden on the failed member’s bankruptcy trustee or receiver, permitting quicker payouts to non-clearinghouse creditors as well. By identifying faster payouts as the main systemic benefit of clearinghouses, this Article shows that there is a high degree of complementarity between the Dodd-Frank Act’s clearing mandate, which requires central clearing of swap contracts, and the statute’s “orderly liquidation authority” for large financial firms. The clearing mandate will reduce the need for the liquidation authority to be invoked, and when the authority is invoked the mandate will simplify the FDIC’s duties as receiver.

Green & Podgor on Corporate Internal Investigations

Unregulated Corporate Internal Investigations: Achieving Fairness for Corporate Constituents, by Bruce A. Green , Fordham University School of Law, and Ellen S. Podgor, Stetson University College of Law, was recently posted on SSRN.  Here is the abstract:

This Article focuses on the relationship between corporations and their employee constituents in the context of corporate internal investigations, an unregulated multi-million dollar business. The classic approach provided in the 1981 Supreme Court opinion, Upjohn v. United States, is contrasted with the reality of modern-day internal investigations that may exploit individuals to achieve a corporate benefit with the government. Attorney-client privilege becomes an issue as corporate constituents perceive that corporate counsel is representing their interests, when in fact these internal investigators are obtaining information for the corporation to barter with the government. Legal precedent and ethics rules provide little relief to these corporate employees. This Article suggests that courts need to move beyond the Upjohn decision and recognize this new landscape. It advocates for corporate fair dealing and provides a multi-faceted approach to achieve this aim. Ultimately this Article considers how best to level the playing field between corporations and their employees in matters related to the corporate internal investigation.

Donelson & Yust on Litigation Risk and Nevada Corporate Law

Litigation Risk and Agency Costs: Evidence from Nevada Corporate Law, by Dain C. Donelson, University of Texas at Austin - McCombs School of Business, and Christopher G. Yust, University of Texas at Austin - McCombs School of Business, was recently posted on SSRN.  Here is the abstract:

In 2001, Nevada significantly limited the personal legal liability of corporate officers and directors. We use this exogenous shock to examine the impact of officer and director litigation risk on agency costs. Specifically, we examine changes in firm value, operating performance and CEO compensation. We find that this change adversely affected firm value, especially for firms with the highest expected agency costs. In addition, we find an adverse impact on operating performance and lower CEO pay-for-performance sensitivity for Nevada firms subsequent to the change. Our findings emphasize that officer and director litigation risk is a powerful and effective governance mechanism.

Brummer on Transatlantic Credit Rating Agency Regulation

The New Politics of Transatlantic Credit Rating Agency Regulation, by Chris Brummer, Georgetown University Law Center, was recently posted on SSRN.  Here is the abstract:

In the years immediately leading up to the global financial crisis, and shortly thereafter, scholars envisaged a possible “convergence” of rules relating to the cross-border regulation of credit rating agencies (CRAs). This paper argues, however, that any full harmonization of approaches will, be difficult due to varying political and economic realities motivating CRA regulation on both sides of the Atlantic. To demonstrate, this article traces the regulation of CRAs from the early 1900s in the United States through today’s European debt crisis. It shows that Europe’s incentives to regulate CRAs have started to diverge from the United States as its economy has shifted from bank to capital market finance, as globalization internationalized the consequences of what was weak CRA governance in the United States, and as CRA ratings of sovereign debt have come to more directly impact EU officials’ ability to manage responses to the crisis. In the wake of these developments, European regulators are poised to adopt measures that may move beyond not only U.S. approaches, but also the consensus expressed in G-20 declarations and the IOSCO Code of Conduct.

Omarova on Financial Conglomerates

The Merchants of Wall Street: Banking, Commerce, and Commodities, by Saule T. Omarova, University of North Carolina at Chapel Hill School of Law, was recently posted on SSRN.  Here is the abstract:

This article examines the principal legal, policy, and theoretical implications of a transformative – but so far unrecognized – change in the banking industry: the emergence, over the last decade, of U.S. financial conglomerates as leading global merchants in physical commodities, including crude and refined oil products, natural gas, coal, base metals, and wholesale electricity. Historically, one of the core principles of U.S. bank regulation has been the separation of banking from commerce. Several statutes – including the National Bank Act of 1863, the Bank Holding Company Act of 1956, the Gramm-Leach-Bliley Act of 1999, and even the Dodd-Frank Act of 2010 – affirm this foundational principle, which generally prohibits banks and bank holding companies from conducting commercial (i.e., non-financial) activities. Notwithstanding these statutory restrictions, however, large U.S. bank holding companies – notably, Morgan Stanley, Goldman Sachs, and JPMorgan – have since the early 2000s been moving aggressively into the purely commercial businesses of mining, processing, transporting, storing, and trading a wide range of vitally important physical commodities. And, equally surprisingly, it is virtually impossible under the current system of public disclosure and regulatory reporting to understand the true nature and scope of these institutions’ commodity activities.

This article puts together the first comprehensive account to date of what appears to be publicly knowable about the nature and scope of U.S. banking organizations’ physical commodities activities and analyzes the existing legal and regulatory framework for conducting such activities. Based on this analysis, the article advances several claims.

As a matter of legal doctrine, the article argues that the quiet transformation of U.S. bank holding companies into global commodity merchants effectively nullifies the foundational principle of separation of banking from commerce. It further argues that the currently existing statutory framework does not provide a sufficiently robust structure for the regulation and supervision of banking organizations’ extensive commercial operations in global commodity and energy markets.

As a normative matter, the article argues that banking organizations’ physical commodities activities raise potentially serious public policy concerns. These activities threaten to undermine the fundamental policy objectives that underlie the principle of separating banking from commerce: ensuring the safety and soundness of the U.S. banking system, maintaining a fair and efficient flow of credit in the economy, protecting market integrity, and preventing excessive concentration of economic power. In addition, banking organizations’ expansion into physical commodities implicates a distinct set of policy concerns relating to potential new sources and transmission channels of systemic risk, the integrity and efficacy of the regulatory process, and the governability of financial markets and institutions.

Finally, the article argues that these developments in banks’ activities raise fundamental theoretical and conceptual questions about the very nature and social functions of financial intermediation. A factually-grounded examination of large financial institutions’ physical commodity activities lays a necessary conceptual foundation for potentially reconfiguring the entire system of financial services regulation.

Jeffries on Janus and Collective Scienter

The Implications of Janus on the Liability of Issuers in Jurisdictions Rejecting Collective Scienter, by N. Browning Jeffries, Atlanta's John Marshall Law School, was recently posted on SSRN.  Here is the abstract:

This article addresses the increasing limitations placed on both the Securities and Exchange Commission (“SEC”) and private litigants to pursue claims of fraud against wrongdoers under the federal securities laws, specifically for claims of misrepresentation under Section 10(b) of the Securities Exchange Act of 1934 and the SEC’s Rule 10b-5. The most recent and glaring example of this curtailment occurred in 2011 with the United States Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders. For a defendant to be liable for a misrepresentation, Rule 10b-5(b) requires that the defendant be the “maker” of the false statement. The Janus decision significantly limits the universe of individuals who can be considered a “maker” of a misstatement for purposes of 10b-5 liability. After Janus, merely participating in the preparation or publication of a statement, even if that involvement is significant, is not sufficient to subject one to 10b-5 liability as a “maker.”

As lower courts have interpreted Janus, they have extended its holding to corporate insiders such as officers, directors, and employees of an issuer. Though lower courts have not found that Janus serves as an outright bar to bringing claims against corporate insiders, in order to satisfy the definition of “maker” set forth in Janus, it appears that the misrepresentation must have been publicly attributed to the insider for liability to attach. But the person to whom public statements are publicly attributed is not necessarily the same person who has scienter, a required element for establishing 10b-5 liability. As such, scenarios will frequently arise where a plaintiff is unable to establish liability of any insider because the individual with scienter is not considered the “maker” after Janus, and the only insider who may be viewed as the “maker” had no reason to know that the public statements attributed to him or her contained misrepresentations.

Even more troubling than the impact of Janus on the potential liability of culpable insiders, however, is the fact that, in many jurisdictions, Janus may thwart claims against even the issuer to which the misstatement is attributed. Although a plaintiff typically can establish the scienter of a corporation by imputing to the corporation the scienter of one or more culpable officers, directors, or employees, some jurisdictions require, for imputation purposes, that the individual with the requisite scienter also be the “maker” of the statement. Such jurisdictions have rejected the theory commonly referred to as “collective scienter,” which allows a court to impute to the corporation the scienter of some or all of the employees, even where none of the wrongdoers are necessarily the “maker” or where the wrongdoer has not yet been identified. As such, in jurisdictions rejecting collective scienter, courts may refuse to impute the sceinter of the individual to the corporation where the individual with scienter is not the person who made the misrepresentation. In the wake of Janus, which curtails the universe of potential “makers” of a statement, plaintiffs in such jurisdictions may not be able to identify any defendant with the requisite scienter – not even the issuer itself. Consequently, plaintiffs may have no defendant against whom they can pursue a 10b-5 claim, even in the face of blatant fraud. And since Janus has been extended beyond private suits to SEC enforcement actions as well, this significant limitation has an even greater impact.

This article explores the implications of Janus on the liability of primary actors – the issuer itself and its corporate insiders. The article analyzes the lower courts’ interpretations of Janus in the year since it was decided, and addresses the liability gaps the decision has created, particularly when viewed in connection with previously-existing precedent in jurisdictions rejecting collective scienter. The article argues that the limitations imposed by Janus do not accurately reflect the realities of the marketplace, where statements made available to the public are a product of diffuse responsibility of a team of individuals, rather than attributable to one and only one “maker.” After discussing policy considerations that weigh in favor of warranting a more expansive view of liability for fraudulent misrepresentations than that permitted by Janus, the article proposes some potential solutions to the liability gaps established by Janus, including a call for legislative action.

Manns on Rating Agency Reform

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