Securities Law Prof Blog

Birdthistle on Janus

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.

Perino on Institutional Fiduciaries as Lead Plaintiffs

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.

Bartlett on Institutional Investors' Trading Behavior After Morrison

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.

Fried et alia on Delaware Law as Lingua Franca

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.

Armour et alia on Migration from Delaware Courts

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

Birdthistle & Henderson on Financial Self-Regulation

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.

Davidoff & Hill on Limits of Disclosure

Limits of Disclosure, by Steven M. Davidoff, Ohio State University (OSU) - Michael E. Moritz College of Law; Ohio State University (OSU) - Department of Finance, and Claire A. Hill, University of Minnesota, Twin Cities - School of Law, was recently posted on SSRN.  Here is the abstract:

Disclosure has its limits. One big focus of attention, criticism, and proposals for reform in the aftermath of the 2008 financial crisis has been securities disclosure. But most of the criticisms of disclosure relate to retail investors. The securities at issue in the crisis were mostly sold to sophisticated institutions. Whatever retail investors’ shortcomings may be, we would expect sophisticated investors to make well-informed investment decisions. But many sophisticated investors appear to have made investment decisions without making much use of the disclosure. We discuss another example where disclosure did not work as intended: executive compensation. The theory behind more expansive executive compensation disclosures was that shareholders might react to the disclosures with outrage and action, and companies, anticipating shareholder reaction, would curtail their compensation pre-emptively. But it was apparently not the reality and instead compensation spiraled higher.

The two examples, taken together, serve to elucidate our broader point: underlying the rationale for disclosure are common sense views about how people make decisions — views that turn out to be importantly incomplete. This does not argue for making considerably less use of disclosure. But it does sound some cautionary notes. The strong allure of the disclosure solution is unfortunate, although perhaps unavoidable. The admittedly nebulous bottom line is this: disclosure is too often a convenient path for policymakers and many others looking to take action and hold onto comforting beliefs in the face of a bad outcome. Disclosure’s limits reveal yet again the need for a nuanced view of human nature that can better inform policy decisions.

Johnson on Regulatory Arbitrage & Global OTC Derivative Regulation

Regulatory Arbitrage, Extraterritorial Jurisdiction and Dodd-Frank: The Implications of US Global OTC Derivative Regulation, by Christian A. Johnson, University of Utah College of Law, was recently posted on SSRN.  Here is the abstract:

A review of the Dodd–Frank rulemaking projects suggests that the U.S. has entered into a “race to the top” of over-the-counter derivative regulation. Many of the Dodd-Frank statutes and proposed rules go well beyond the relatively modest objectives agreed to by the G20 countries in 2009. These efforts in the U.S. create a legal environment ripe for regulatory arbitrage and the isolation of U.S. OTC derivative markets. Isolation results from participants simply abandoning U.S. markets because of overly aggressive U.S. regulation. Regulatory arbitrage occurs as both U.S. and non-U.S. persons attempt to structure their trading activities to avoid the extraterritorial reach of Dodd-Frank. This paper will discuss the regulatory arbitrage implications triggered by the Dodd-Frank reforms and concerns surrounding the extraterritorial powers given to the CFTC to enforce these mandates.

Dent on Legalizing Insider Trading

Why Legalized Insider Trading Would Be a Disaster, by George W. Dent Jr., Case Western Reserve University School of Law, was recently posted on SSRN.  Here is the abstract:

Although insider trading is illegal and widely condemned, a stubborn minority still defends it as an efficient method of compensating executives and spurring innovation. However, their arguments depend on a crucial assumption that the scope of insider trading is constrained by the wealth of individual insiders. Accordingly, the abnormal profits realized by inside traders at the expense of outsiders are rarely or never so large as to cause outsiders to flee the affected stock. Similarly, the potential gains from insider trading are rarely if ever big enough to corrupt the managers’ conduct of the business. Thus insider trading generates benefits for stockholders that exceed their immediate losses from insider trading.

The theme of this note is that if insider trading were allowed, it would not be constrained by insiders’ wealth because insiders could obtain enough outside financing to fully exploit their informational advantage. In so doing they would inevitably muscle out public investors. Stock markets would drastically shrink if not disappear. The prospect of huge trading profits would tempt managers to alter many decisions and even to take steps damaging to the firm in ways that would be virtually impossible for corporate monitors to detect. The resulting damage to public shareholders would far exceed any benefits from insider trading. Individual companies cannot police insider trading. Accordingly, the case for legalizing insider trading is insupportable.

Couture on Criminal Securities Fraud

Criminal Securities Fraud and the Lower Materiality Standard, by Wendy Gerwick Couture, University of Idaho College of Law, was recently posted on SSRN.  Here is the abstract:

First, this essay argues that the materiality standard is lower under the relatively new criminal securities fraud provision, § 807 of the Sarbanes-Oxley Act, 18 U.S.C. § 1348, than under the traditional securities fraud provision, § 10(b) of the Securities and Exchange Act of 1934. In particular, in the context of alleged misrepresentations, § 1348 probably imposes a subjective materiality standard rather than an objective standard. In the context of insider trading, § 1348 probably imposes a source-oriented standard rather than an investor-oriented standard. Next, this essay considers the implications of this lower materiality standard in criminal securities fraud prosecutions under § 1348, including the chilling of legitimate market behavior, undue prosecutorial discretion, and disruption of the ordinary relationship between civil and criminal liability. Although these aforementioned concerns are also implicated by the mail and wire fraud statutes, this essay contends that § 1348 imposes a marginal impact. Finally, in light of these implications and this marginal impact, this essay offers guidance to market participants when engaging in behavior that might be within the broader scope of § 1348, to courts when interpreting § 1348, and to Congress when considering the appropriate incentives to encourage voluntary disclosure, securities analysis, and corporate transactions.

Cotter et alia on Say on Pay

The First Year of 'Say on Pay' Under Dodd-Frank: An Empirical Analysis and Look Forward, by James F. Cotter, Wake Forest University Calloway School; Alan R. Palmiter, Wake Forest University - School of Law; and Randall S. Thomas, Vanderbilt University - Law School; European Corporate Governance Institute (ECGI), was recently posted on SSRN.  Here is the abstract:

In this article, we ask whether Dodd-Frank has made a difference in how shareholders vote on executive pay practices and whether the Act has changed the dynamic in shareholder-management relations in U.S. companies. Using voting data from the first year of “say on pay” votes under Dodd-Frank, we look at the patterns of shareholder voting in advisory votes on executive pay. Consistent with our expectations based on the more limited experience with “say on pay” voting before Dodd-Frank, shareholders in the first year under Dodd-Frank gave generally broad support to management pay packages.

Yet, during the first year under Dodd-Frank, not all pay packages received strong shareholder support. At some companies, management suffered the embarrassment of failed “say on pay” votes – that is, less than 50% of their company’s shareholders voted in favor of the proposal. In particular, we find that poorly-performing companies with high levels of “excess” executive pay, low total shareholder return, and negative voting recommendations from the third-party voting advisor Institutional Shareholder Services (ISS) experienced greater shareholder “against” votes than at other firms. ISS and other third party voting advisors appeared to have played a significant role in mobilizing shareholder opposition at these firms – and often a management response.

Although these votes are non-binding and corporate directors need not take action even if the proposal fails, most companies receiving negative ISS recommendations or experiencing low levels of “say on pay” support undertook additional communication with shareholders or made changes to their pay practices – reflecting a change in their interactions with shareholders. During 2012, the second year of “say on pay” under Dodd-Frank, we find similar patterns, with companies responding proactively when the company comes onto shareholders’ radar screens because of an unfavorable ISS recommendation or an earlier poor, or failed, “say on pay” vote in 2011. We use four case studies to illustrate this new dynamic.

In all, our findings suggest that the Dodd-Frank “say on pay” mandate has not broadly unleashed shareholder opposition to executive pay at U.S. companies, as some proponents had hoped for. Nonetheless, it has affected pay practices at outlier companies experiencing weak performance, high executive pay levels, which are identified by proxy advisory firms like ISS. In addition, mandatory “say on pay” seems to have led management to be more responsive to shareholder concerns about executive pay and perhaps toward corporate governance generally. This shift in management-shareholder relations may be the most important consequence of the Act thus far.

Fisch on Business Roundtable

The Long Road Back: Business Roundtable and the Future of SEC Rulemaking, by Jill E. Fisch, University of Pennsylvania Law School - Institute for Law and Economics, was recently posted on SSRN.  Here is the abstract:

The Securities and Exchange Commission has suffered a number of recent setbacks in areas ranging from enforcement policy to rulemaking. The DC Circuit’s 2011 Business Roundtable decision is one of the most serious, particularly in light of the heavy rulemaking obligations imposed on the SEC by Dodd-Frank and the JOBS Act. The effectiveness of the SEC in future rulemaking and the ability of its rules to survive legal challenge are currently under scrutiny.

This article critically evaluates the Business Roundtable decision in the context of the applicable statutory and structural constraints on SEC rulemaking. Toward that end, the essay questions the extent to which deficiencies in the SEC’s rulemaking process can accurately be ascribed to inadequate economic analysis, arguing instead that existing constraints impede the SEC’s formulation of regulatory policy, and that this failure was at the heart of Rule 14a-11.

Bad rules make bad law, and Rule 14a-11 was a bad rule. This essay argues that the flaws in SEC rule-making are quite different, however, than those identified by the DC Circuit. Moreover, in the case of Rule 14a-11, Congress played a critical role by explicitly authorizing the SEC to adopt a proxy access rule. By substituting its own policy judgment for that of Congress, the DC Circuit threatens not just the ability of administrative agencies to formulate regulatory policy, but the ability of Congress to direct agency policymaking

Geffen on Mutual Fund Sales Notice Fees

Mutual Fund Sales Notice Fees: Are a Handful of States Unconstitutionally Exacting $200 Million Each Year?, by David M. Geffen, Dechert LLP, was recently posted on SSRN.  Here is the abstract:

As background, the article describes the political compromise struck in 1996 between Congress and state securities regulators. That year, Congress enacted the National Securities Markets Improvement Act of 1996 (NSMIA), which effected multiple changes to the federal securities laws to promote efficiency and capital formation by eliminating overlapping federal and state securities regulations.

With respect to mutual funds, NSMIA resolved the problem of overlapping regulation by preempting state substantive regulation and registration requirements of mutual funds, thereby providing for exclusive federal jurisdiction over the contents of a mutual fund’s prospectus and operation of each fund. NSMIA was welcomed by the mutual fund industry because it eliminated the “crazy quilt” of regulation that had made registration of mutual fund shares unnecessarily cumbersome — in some cases leading mutual funds to restrict their fund offerings to residents of certain states.

However, in order to secure the acquiescence of the states and secure NSMIA’s enactment, NSMIA preserved state authority to require mutual funds to file sales reports and to pay state filing fees based on those sales in connection with the sales reports. A handful of states have taken unfair advantage of this fee loophole.

Today, in six “Premium Fee States,” – Texas, Washington, Minnesota, Wisconsin, Nebraska and West Virginia – the notice filing fees paid by mutual funds are disproportionately greater than the notice filing fees paid by mutual funds to the remaining states. While the six states account for only 15% of the U.S. population, each year, these six states are paid approximately 50%, or approximately $200 million, of the total notice filing fees paid by mutual funds to all states.

The article examines the constitutional validity of the Premium Fee States’ disproportionate notice filing fees as state “regulatory fees” and as state taxes. It concludes that, regardless of whether these fees are deemed to be regulatory fees or taxes, the Premium Fee States’ notice filing fees are constitutionally invalid and, therefore, should be struck down.

The ramifications of striking down the Premium Fee States’ notice filing fees would be significant. Collectively, over the last three years, the Premium Fee States have unconstitutionally exacted approximately $600 million from mutual funds. These mutual funds and, therefore, the funds’ investors, may be able to recover roughly this amount from the Premium Fee States (or more, assuming a longer statute of limitations and the application of statutory interest). Prospectively, eliminating the annual $200 million unconstitutional exaction would be equivalent, in present value dollars, to a one-time savings by mutual funds and their investors of between $2 billion and $4 billion.

The article also examines a variety of issues that mutual funds’ advisers and boards of trustees/directors may want to consider in developing strategies to recover notice filing fees previously exacted unconstitutionally by the Premium Fee States, and to persuade the Premium Fee States to reduce their notice filing fees to adhere to constitutional requirements.

Heminway on SEC Disclosure Rules for ABS

The SEC’s New Line-Item Disclosure Rules for Asset-Backed Securities: MOTS or TMI?, by Joan MacLeod Heminway, University of Tennessee College of Law, was recently posted on SSRN.  Here is the abstract:

Despite the lack of a dominant explanation for the level of risk assumed by investors in asset-backed securities in the period preceding the financial crisis, the U.S. Congress proposed and passed new disclosure prescriptions addressing various aspects of the secondary mortgage market as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. This essay asks whether certain disclosure provisions embraced in Dodd-Frank and the related regulations of the U.S. Securities and Exchange Commission are merely new and necessary components of a disclosure infrastructure that the SEC has been building for years for the protection of investors and markets — more of the same (MOTS) — or whether they represent unnecessary window dressing (or worse yet, harmful overregulation) in calling for excessive additional information — too much information (TMI

Utset on Conduct as Securities Fraud

Fraudulent Corporate Signals: Conduct as Securities Fraud, by Manuel A. Utset, Florida State University College of Law, was recently posted on SSRN.  Here is the abstract:

Paying a dividend, repurchasing shares, underpricing an IPO, pledging collateral, and borrowing using short-term, instead of long-term debt, are all forms of corporate communications: they are “corporate signals” that tell investors certain things about a company’s operations and current financial position, and about the managers’ confidence of its future performance. This article provides the first comprehensive analysis of the relationship between corporate signals and securities fraud. The incentive to communicate using corporate signals has increased in recent years, a phenomenon that, I argue, is due to the growing complexity of public corporations, and, importantly, to a number of changes in Federal securities laws, aimed at better deterring fraud and making companies more transparent. The article makes three major contributions. First, it identifies this deep connection between the use of corporate signals (both truthful and deceptive) and recent changes in securities laws. Second, it identifies significant social costs associated with corporate signaling (which commentators and policymakers have overlooked); signals, I show, encourage stock bubbles, lead to costly “signaling races”, and to the loss of information about companies and industries. Third, the article provides a normative account of how a lawmaker would go about designing anti-fraud provisions under the securities laws, if its goal is to reduce total fraud, and not simply to re-channel deceptive practices, from the realm of written and oral statements to that of deceptive corporate signals.

Nagy & Painter on Selective Disclosure by Federal Officials

Selective Disclosure by Federal Officials and the Case for an FGD (Fairer Government Disclosure) Regime, by Donna M. Nagy, Indiana University Maurer School of Law, and Richard W. Painter, University of Minnesota Law School, was recently posted on SSRN.  Here is the abstract:

This Article addresses a problem at the intersection of securities regulation and government ethics: the selective disclosure of market-moving information, by federal officials in the executive and legislative branches, to securities investors outside the government who use that information for trading. These privileged investors, often aided by political intelligence consultants, can profit substantially from their access to knowledgeable sources inside the government. In most instances, however, neither the disclosure nor the trading violates the antifraud provisions of the federal securities laws (under which the insider trading prohibitions arise). This legally protected favoritism undermines investor confidence in the fairness and integrity of securities markets – and in government itself. Congress considered these consequences in the debates leading up to the Stop Trading on Congressional Knowledge (STOCK) Act of 2012. But it wisely opted to study the role of political intelligence in financial markets before legislating further.

To address securities trading on the basis of selectively disclosed government information, this Article examines an analogous situation in the private sector that plagued individual investors until relatively recently. Selective disclosure of issuer-information by corporate executives, to securities analysts and professional investors, had been regarded as blatantly unfair yet, in most instances, not illegal. Regulation FD, which the Securities and Exchange Commission (SEC) adopted in 2000, addressed this unfairness by looking beyond the construct of fraudulent tipping and trading under Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. The solution involved regulating the timing and manner of disclosures by corporate insiders, rather than the conduct of outsiders who gather and trade on the basis of those disclosures. Regulation FD embraced this approach for publicly-traded companies, and corporate executives have been adhering to it for more than a decade.

This Article proposes an analogous FGD regime – standing for Fairer Government Disclosure – that would prompt federal agencies, as well as Members of Congress and their staffs, to deploy a variety of strategies that could substantially reduce the amount of selective disclosure of nonpublic government information to persons who are likely to use it in securities trading. The Article first gathers together press reports, agency and congressional correspondence, and other materials that demonstrate the ubiquity of selective disclosure in the federal government. It then analyzes insider trading law to show that most of these instances of selective disclosure are not illegal. The Article concludes that the problem can be solved – or at least curtailed – with more effective internal controls on the federal officials who selectively disclose government information. It thus begins a discussion as to how such controls could be developed without compromising the quality and timeliness of disclosures to persons, including voters, who must have information in order to make informed decisions.

Griffith on Derivative Clearinghouses

Governing Systemic Risk: Towards a Governance Structure for Derivatives Clearinghouses, by Sean J. Griffith, Fordham Law School, was recently posted on SSRN.  Here is the abstract:

Derivatives transactions create systemic risk by threatening to spread the consequences of default throughout the financial system. Responding to the manifestations of systemic risk exhibited in the financial crisis, policy-makers have sought to solve the problem by requiring as many derivatives transactions as possible to be “cleared” (essentially guaranteed) by a clearinghouse. The clearinghouse will centralize and, through the creation of reserve accounts, seek to contain systemic risk by preventing the consequences of default from spreading. This centralization of risk makes the clearinghouse the new locus of systemic risk, and the question of systemic risk management thus becomes a question of clearinghouse governance. Unfortunately, each of the likely players in clearinghouse governance — dealers, customers, and investors — has significant incentive problems from the perspective of systemic risk management. I will argue that the policy-makers’ responses to these problems — focusing on voting caps and director independence — are inadequate to address the problem of systemic risk inherent in derivatives transactions. I argue, instead, in favor of the adoption of a new board structure more reflective of the public-private role of clearinghouses and suggest that models for this new governance structure can be found outside of traditional U.S. corporate governance norms in the dual-board structure of continental Europe.

Schwarcz on Financial Disintermediation

Regulating Shadows: Financial Disintermediation and the Need for a Common Language, by Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN.  Here is the abstract:

Financial disintermediation, or the removal of the need for bank intermediation between markets and the users of funds, has so transformed the financial system that scholars are finding it increasingly difficult to communicate about financial regulation. This article argues that legal scholars could better communicate by speaking in terms of the fundamental market failures underlying the disintermediated financial system (sometimes called the “shadow banking” system). The traditional perspectives and tools of legal scholars primarily address two market failures: information failure and agency failure. To a limited extent, they also address a third market failure: externalities. By amplifying systemic risk, however, disintermediation increases the potential magnitude of — and thus makes it even more important for scholars to address — externalities. But discussing externalities as a type of market failure can be confusing and counterintuitive because externalities are fundamentally consequences, not causes, of failures. Scholars could better communicate about the disintermediated financial system, the article contends, by denoting the cause of externalities as “responsibility failure” — a firm’s ability to externalize all or a portion of the costs of taking an action. The article also shows how a rudimentary common language using the terms information failure, agency failure, and responsibility failure could help legal scholars, and thus policymakers and regulators informed by their research, to communicate about financial regulation.

Henning on Managerial Accountability

Making Sure 'The Buck Stops Here': Barring Executives for Corporate Violations, by Peter J. Henning, Wayne State University Law School, was recently posted on SSRN.  Here is the abstract:

There have been persistent complaints about managerial accountability since the advent of the financial crisis in 2008, especially the lack of criminal prosecutions of senior executives. In contrast, there is widespread criticism of “overcriminalization” and the use of criminal punishments to accomplish what are viewed as regulatory goals, such as corporate compliance. So while there is frustration at the lack of prosecutions, there are complaints that there are too many prosecutions. The criminal law is a poor means to engage in oversight of corporate governance, especially of senior managers who are largely insulated from day-to-day decision-making that often triggers violations. In this article, I offer a modest means to police management of public companies and large investment firms by enhancing the authority of the Securities and Exchange Commission to seek the removal of executives when the company has engage in persistent or serious misconduct, even if the individuals were not directly implicated in a violation. This authority already exists in a limited form in certain industries, and a wider application of it could be a way to address concerns about managerial accountability for corporate criminal conduct.

Fisch on Price Distortion after Halliburton

The Trouble with Basic: Price Distortion after Halliburton, by Jill E. Fisch, University of Pennsylvania Law School - Institute for Law and Economics, was recently posted on SSRN.  Here is the abstract:

Many commentators credit the Supreme Court’s decision in Basic, Inc. v. Levinson, which allowed courts to presume reliance rather than requiring individualized proof, with spawning a vast industry of private securities fraud litigation. Today, the validity of Basic’s holding has come under attack as scholars have raised questions about the extent to which the capital markets are efficient. In truth, both these views are overstated. Basic’s adoption of the Fraud on the Market presumption reflected a retreat from prevailing lower court recognition that the application of a reliance requirement was inappropriate in the context of impersonal public market transactions. And, contrary to arguments currently being made to the Supreme Court in the Amgen case, FOTM does not require a strong degree of market efficiency – merely that market prices respond to information.

The Basic decision had another less widely recognized effect, however; it began shifting the nature of private securities fraud claims from transaction-based claims to market-based claims, a shift that was completed by the Court’s later decision in Dura. The consequence of this shift was to convert the nature of the plaintiff’s harm from a corruption of the investment decision to one of transacting at a distorted price.

The legal significance of price distortion was at the heart of the Halliburton decision. The lower court confused two temporally distinct concepts: ex ante price distortion, which is part of the reliance inquiry and ex post price distortion, which is a component of loss causation.

The Supreme Court limited its holding in Halliburton to identifying this confusion, leaving examination of the appropriate role of price distortion for future cases. In Amgen, the Court may be forced to tackle this question. This Article argues that Amgen highlights the incongruity of considering price distortion at the class certification stage and provides an opportunity for the Court to reconsider and reject Basic’s insistence on retaining a reliance requirement