Wednesday, January 16, 2013
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).
Saturday, January 12, 2013
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.
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.
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.
Saturday, December 15, 2012
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.
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.
Sunday, December 9, 2012
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.
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.
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.
Sunday, December 2, 2012
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.
Monday, November 26, 2012
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.
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.
Sunday, November 18, 2012
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.
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.
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.
Delaware Law as Lingua Franca: Theory and Evidence, by Jesse M. Fried, Harvard Law School; Brian J. Broughman, Indiana University Maurer School of Law; and Darian M. Ibrahim, University of Wisconsin Law School, was recently posted on SSRN. Here is the abstract:
Why does Delaware dominate the market for corporate charters? Analyzing the incorporation and reincorporation decisions of 1,850 VC-backed startups, we show that firms often choose Delaware corporate law because it is the only law “spoken” by both in-state and out-of-state investors. Indeed, this “lingua-franca” effect is just as important as other factors that have been found to influence domicile decisions, such as corporate-law flexibility and the quality of a state’s judiciary. Our study provides further evidence that Delaware’s dominance is not necessarily due to the intrinsic quality of its corporate law.
Is Delaware Losing its Cases?, by John Armour, University of Oxford - Faculty of Law; University of Oxford - Said Business School; European Corporate Governance Institute (ECGI); Bernard S. Black, Northwestern University - School of Law; Northwestern University - Kellogg School of Management; European Corporate Governance Institute (ECGI); and Brian R. Cheffins, University of Cambridge - Faculty of Law; European Corporate Governance Institute (ECGI); was recently posted on SSRN. Here is the abstract:
Delaware's expert courts are seen as an integral part of the state's success in attracting incorporation by public companies. However, the benefit that Delaware companies derive from this expertise depends on whether corporate lawsuits against Delaware companies are brought before the Delaware courts. We report evidence that these suits are increasingly brought outside Delaware. We investigate changes in where suits are brought using four hand‐collected data sets capturing different types of suits: class action lawsuits filed in (1) large M&A and (2) leveraged buyout transactions over 1994–2010; (3) derivative suits alleging option backdating; and (4) cases against public company directors that generate one or more publicly available opinions between 1995 and 2009. We find a secular increase in litigation rates for all companies in large M&A transactions and for Delaware companies in LBO transactions. We also see trends toward (1) suits being filed outside Delaware in both large M&A and LBO transactions and in cases generating opinions; and (2) suits being filed both in Delaware and elsewhere in large M&A transactions. Overall, Delaware courts are losing market share in lawsuits, and Delaware companies are gaining lawsuits, often filed elsewhere. We find some evidence that the timing of specific Delaware court decisions that affect plaintiffs' firms coincides with the movement of cases out of Delaware. Our evidence suggests that serious as well as nuisance cases are leaving Delaware. The trends we report potentially present a challenge to Delaware's competitiveness in the market for incorporations
Becoming the Fifth Branch, by William A. Birdthistle, Chicago-Kent College of Law, and M. Todd Henderson, University of Chicago - Law School, was recently posted on SSRN. Here is the abstract:
Observers of our federal republic have long acknowledged that a fourth branch of government comprising administrative agencies has arisen to join the original three established by the Constitution. In this article, we focus our attention on the emergence of perhaps yet another, comprising financial self-regulatory organizations. In the late eighteenth century, long before the creation of state and federal securities authorities, the financial industry created its own self-regulatory organizations. These private institutions then coexisted with the public authorities for much of the past century in a complementary array of informal and formal policing mechanisms. That equilibrium, however, appears to be growing increasingly imbalanced, as financial SROs such as FINRA transform from “self-regulatory” into “quasigovernmental” organizations.
We describe this change through an account that describes how SROs are losing their independence, growing distant from their industry members, and accruing rulemaking, enforcement, and adjudicative powers that more closely resemble governmental agencies such as the Securities and Exchange Commission and the Commodity Futures Trading Commission. We then consider the confluence of forces that might be driving this increasingly governmental shift, including among others, demographic changes in the style and size of retail investments in the securities markets, the one-way ratchet effect of high-publicity failures and scandals, and the public choice incentives of regulators and the compliance industry.
The process by which such self-regulatory organizations shed their independence for an increasingly governmental role is an undesirable but largely inexorable development, and we offer some initial ideas for how to forestall it.