Tuesday, April 8, 2014
Larissa Lee has posted The Ban Has Lifted: Now is the Time to Change the Accredited-Investor Standard on SSRN with the following abstract:
On July 10, 2013, the United States Securities and Exchange Commission lifted an eighty-year ban on general solicitation and general advertising for certain private securities offerings. This was part of a mandate from the Jumpstart Our Business Startups Act ("JOBS Act") in an effort to help small and emerging companies get on their feet. Before, private companies had to rely on private connections or hire an investment bank with those connections in order to raise capital. Now, these companies may solicit or advertise securities through the mail, phone, and online, but only when they are selling to accredited investors. This new rule does not replace the old rule, which allowed a portion of the investors to be unaccredited; it is in addition to the old rule.
The problem with the current accredited-investor standard is that it considers only wealth in determining whether a person may invest. These exempted securities are typically highly risky and because the standard does not take into account investor sophistication or cap the investment amount, it is possible for investors to lose everything on one bad investment. Lifting the general advertising ban creates even more risk that investors may be harmed as issuers can target the elderly and those who are most likely to need protection.
To ameliorate these harms, I therefore propose a new accredited-investor standard involving a mixture of wealth, financial sophistication, and diversification considerations. Additionally, I argue that companies should be required to disclose certain information including the amount of risk and the fact that the securities are unregistered before they may solicit or sell their securities. Finally, I argue that investors should not be allowed to invest all of their income or net worth into one investment; rather investors should only be allowed to invest a certain percentage, to ensure that if the securities fail or are fraudulent, investors won’t lose all of their savings at once.
Larissa Lee has posted Admission of Guilt: Sinking Teeth into the SEC's Sweetheart Deals on SSRN with the following abstract:
Throughout its existence, the Securities and Exchange Commission (SEC) has allowed defendants to settle cases without admitting to the allegations of wrongdoing. This "neither admit nor deny" policy has received heavy criticism by judges, Congress, and the public, especially in the wake of the 2008 financial crisis. On June 18, 2013, SEC Chairman Mary Jo White announced the agency’s intention to require admissions of guilt in certain cases. While Chairman White did not articulate a clear standard of when admissions would be required, she did say that the agency would focus on the egregiousness of the defendant’s conduct and the harm to investors. This Article develops a model to help determine which settlements should require an admission of wrongdoing. This model balances the costs of requiring admissions — in resources and litigation expenses, with the social benefits of requiring admissions — both in ensuring that the defendants are responsible for their actions and allowing the public to distinguish between technical violators and the more culpable offenders.
Yoon-Ho Alex Lee has posted The Efficiency Criterion for Securities Regulation: Investor Welfare or Total Surplus? on SSRN with the following abstract:
Recent regulatory debates have centered on whether independent agencies should be subjected to a more rigorous cost-benefit analysis requirement than their current mandates or should otherwise be required conduct cost-benefit analysis that conforms to the Office of Management and Budget’s guidance under Circular A-4. The Article closely examines the way in which one particular agency--the Securities and Exchange Commission (the “SEC”)--conducts its economic analysis in rulemaking. The SEC’s economic analysis, conducted pursuant only to its statutory mandate to consider the effects on “efficiency, competition, and capital formation,” mainly compares benefits that would accrue to investors against out-of-pocket compliance costs to be incurred by regulated entities. Circular A-4, by contrast, recommends a total surplus approach, whereby benefits and costs are considered from the perspective of all market participants, without making any value judgment as to which parties are inherently more deserving of surpluses. The current debates therefore raise an urgent policy question for the SEC: whether it makes sense to have the agency consider costs and benefits of its rules from the perspective of total surplus, or instead have it consider them from the perspective of investors only. This Article raises three points pertaining to this debate. First, because the two approaches provide conflicting standards for considering whether a rule’s benefits outweigh costs, unless there is first a general consensus regarding the efficiency criterion for SEC rules, no meaningful discussions can take place as to requiring the SEC to conduct more extensive cost-benefit analyses. Second, because Circular A-4 provides a broader perspective of considering costs and benefits, those concerned exclusively with investors’ economic welfare should have reasons to oppose, rather than support, applying Circular A-4’s approach to SEC rules. Third, despite such reasons, there is nevertheless a case for preferring Circular A-4’s approach because a total surplus approach, if used properly, offers several important benefits from policy perspectives.
Vytautas Plečkaitis has posted Rent-Seeking Activities in Hot IPO Allocations: An Analysis from a Law and Economics Perspective on SSRN with the following abstract:
Laddering, spinning and the demanding of premium commissions in exchange for a favourable allocation in hot IPOs were prevalent phenomena during the internet bubble period (1999-2000). An analysis of these practices shows that functioning as trade-based price manipulation laddering boosts the value of the issue. To maximise its profits, a lead-underwriter uses this outcome to increase the offer price and the underpricing level. This, in turn, creates the conditions needed for the other two rent seeking activities, which are considered as separate forms of profit-sharing, to arise. The decreased transparency of the share allocation process and the artificially boosted offer and after-market prices impair stock market development and thus have a negative effect on economic growth in the long-run. Current regulatory regimes in the US and the EU contain different securities law provisions addressing laddering, spinning and the demanding of premium commissions in exchange for a favourable allocation. Despite these numerous regulations, the present legal model contains significant imperfections and, therefore, cannot ensure an efficient outcome. As regards the private enforcement (tort liability) approach, the shortcomings include too complicated pleading requirements, strict issuers’ liability, limits on damage compensation and too short limitation periods for laddering actions. As regards the public enforcement approach they refer to behaviour prohibitions and information disclosure requirements as well as the magnitude and the probability of the imposition of sanctions.
Umakanth Varottil has posted The Protection of Minority Investors and the Compensation of Their Losses: A Case Study of India on SSRN with the following abstract:
Any legal system may potentially deploy two separate but related models to ensure the accuracy of disclosure in the capital markets. First, it may possess legal institutions in the form of regulatory bodies with power to make regulations regarding disclosures and to enforce those regulations through powers of sanction conferred upon them. Second, it may adopt the model that relies upon the courts to grant remedies to investors who are victims of inaccurate or misleading disclosures thereby suffering losses.
This paper tests the efficacy of the two models in their application to India. The exploration of India is interesting and helpful because India’s capital markets have witnessed exponential growth in the last two decades. At first blush, it might be simple to attribute this to India’s legal system through civil liability and its enforcement through the judiciary. Counterintuitively, though, India’s common law legal system operating through the judiciary has not played a vital role in the development of the capital markets through a rigorous civil liability regime. Delays in proceedings due to alarming pendency levels in litigation before Indian courts and skyrocketing costs in initiating litigation are some of the factors that have disincentivized investors from relying upon the civil liability regime for enforcing their compensation claims.
At the same time, other factors have been at play. India’s capital markets regulator, the Securities and Exchange Board of India (SEBI) has been instrumental in formulating policies and regulations governing capital markets, and its actions have been rapid and dynamic to suit the needs of the changing markets, by operating through the power of sanctioning various market players.
The paper concludes with the finding that while the general approach in most common law markets is for courts to play a significant role in the development of the capital markets through the process of compensating investors for losses, the success of India’s capital markets growth has hinged upon the regulatory process rather than the courts.
Alexis Direr and Eric Yayi have posted Portfolio Choice over the Business Cycle and the Life Cycle on SSRN with the following abstract:
Do households holding risky financial securities tend to invest in the stock market, buying at the top and selling at the bottom? Do they reduce their risk exposure with age and especially when approaching retirement? We answer these questions using data on retirement savings contracts from a large French insurer over the period 2002 to 2009. Subscribers can invest their savings in two types of investment vehicles: a euro fund composed primarily of money market securities with almost no risk, and unit-linked funds representing UCITS shares invested in risky securities.
We show that the share of capital invested in unit-linked funds is sensitive to market conditions, but mainly at the date of subscription. Once the initial share has been selected, inertia of portfolio choice is observed as investors rarely revise their position subsequently. We observe a steep procyclicality of investment choices which can be explained by extrapolation of recent market performance. New subscribers buy risky assets when the stock market rises and stop buying them when it drops. This leads them to hold a minimum share of risky assets in 2004, a beginning of a 4-year rising phase and a maximum share in 2008 at the beginning of a fall market.
We also find that the risky share declines with age once time effects are controlled for and cohort effects are excluded. The age profile also declines in the reverse configuration (taking into account cohort effects and excluding time effects) but the decline is less pronounced. After a discussion of the plausibility of the different effects, we estimate a probability of unit-linked detention which decreases by about 12 percentage points with age between ages 40 and 60, and a conditional equity share which decreases by about 6 percentage points with age between 40 and 60 years. This decrease is too small to bring the invested share to zero when approaching retirement.
On April 8, 2014 at the North American Securities Administrators Association Annual NASAA/SEC 19(d) Conference in Washington, D.C., Commissioner Luis A. Aguilar offered remarks on NASAA and the SEC: Presenting a United Front to Protect Investors.
Monday, April 7, 2014
Ryan Kantor has posted Why Venture Capital Will Not Be Crowded Out by Crowdfunding on SSRN with the following abstract:
As the recovery period from one of the worst recessions in our history continues on, life for the fledgling and even, often times, experienced entrepreneur has been tough. Indeed, President Obama remarked “[c]redit’s been tight, and no matter how good their ideas are, if an entrepreneur can’t get a loan from a bank or backing from investors, it’s always impossible to get their businesses off the ground.” In response to this ever-present need for business funding, and in an attempt to stimulate the economy and job growth, Obama signed the Jumpstart Our Business Startups Act (“JOBS Act”) into law on April 5, 2012. The Act, among other things, increases a business’s access to capital by enabling them to sell securities to both accredited and non-accredited investors without registering or completing the full disclosure requirements typically required for public offerings.
The overarching purposes of this paper will be to: 1) explain and analyze the relationship and overall dynamic that will exist between crowdfunding and VCs; 2) elucidate why investors should avoid or, at the very least, be wary of investing money through the crowdfunding medium; and 3) expound reasons as to why crowdfunding as a means of financing should be used as a last resort for a budding entrepreneur.
Taylor J. Phillips has posted The Federal Common Law of Successor Liability and the Foreign Corrupt Practices Act on SSRN with the following abstract:
Although successor liability is a key aspect of the government’s FCPA enforcement policy, the Department of Justice and the Securities and Exchange Commission have not distinguished clearly between the contexts of mergers, stock purchases, and asset acquisitions. As demonstrated by this article, asset purchases should be recognized as an acquisition structure that minimizes the risk of FCPA liability. That is because the law that should be applicable to such transactions is not a relatively broad federal common law of successor liability. Instead, it is state common law, which traditionally concedes only very narrow exceptions to the general rule of successor nonliability. Furthermore, given the remedial foundations of most successor liability doctrines, it is not obvious that traditional state common law encompasses punitive — much less criminal — successor liability theories.
Kevin S. Haeberle has posted on SSRN with the following abstract:
It is well understood that society is better off when public companies’ stock prices are more accurate. But those who make stock prices more accurate are unable to capture the full social benefits of their efforts, so market forces alone will produce only a sub-optimal level of stock-price accuracy. Scholars and policymakers have therefore examined the extent to which securities law can be used to spur the production of accurate stock prices. However, their work has overwhelmingly focused on the traditional core of securities law — that is, the disclosure, fraud, and insider-trading rules that mainly regulate the firms that issue stock — and has overlooked what I refer to as “stock-market law” — that is, the law that governs the market in which stocks are traded.
This Article theorizes that central aspects of stock-market law are resulting in society generating a lower level of stock-price accuracy than it otherwise might. Accordingly, the Article identifies new ways in which securities law may be modified to increase the accuracy of public firms’ stock prices and the social benefits to which that enhanced accuracy leads — and offers a framework for lawmakers to determine whether those alterations are socially desirable.
Lars Hornuf and Armin Schwienbacher have posted Which Securities Regulation Promotes Crowdinvesting? on SSRN with the following abstract:
In this paper, we show that too strong investor protection may harm small firms and, thus, entrepreneurial initiatives. This situation is particularly relevant in crowdinvesting, which refers to a recent financial innovation originating on the Internet. In general, securities regulation offers exemptions to prospectus and registration requirements. From an analysis of selected countries, we offer first evidence that portals shape the securities contracts they provide to startups based on these exemptions. This, in turn, can limit the amount of capital raised by the firms as well as the type of investors participating in the campaigns. Finally, we offer a ‘law and finance’ analysis of recent reforms of securities regulation in different countries that have been initiated as a means to encourage crowdinvesting.
Rutheford B. Campbell Jr. has posted Proposed Crowdfunding Regulations Under the Jobs Act: Please, SEC, Revise Your Proposed Regulations in Order to Promote Small Business Capital Formation on SSRN with the following abstract:
The Jobs Act was enacted to promote efficient access to external capital by small businesses. Title III of the Jobs Act offers small businesses the chance of efficient financial intermediation through crowdfunding. The crowdfunding exemption is not self-executing but, instead, requires regulatory implementation by the SEC.
The Commission’s first iteration of its crowdfunding rules fails to offer small businesses efficient access to external capital. Principally, this is because the proposed crowdfunding rules: (1) require excessive disclosures, especially regarding smaller crowdfunding offerings; (2) fail to offer small businesses relying on the crowdfunding exemption two-way safe harbor integration protection; and (3) fail to protect small businesses from the loss of the crowdfunding exemption as the result of the financial intermediary’s failure to meet its statutory and regulatory obligations.
The problems can be fixed by the Commission by revising its proposed crowdfunding regulations, thereby fulfilling its broad and ubiquitous obligation to balance capital formation and investor protection.
Usha Rodrigues has posted The Effect of the JOBS Act on Underwriting Spreads on SSRN with the following abstract:
U.S. underwriting fees, or spreads, have somewhat inexplicably clustered around 7% for years, a phenomenon that some have suggested evidences implicit collusion. The goal of Title I the JOBS Act of 2012 was to make going public easier for smaller firms; certain provisions specifically should make the underwriters’ task less risky, and thus less expensive. Presuming these provisions are effective, then one would predict that underwriting spreads would decrease as the costs to the underwriter for a public offering declined. Admittedly the prior presumption is a big one: it may be that the JOBS Act reforms were largely ineffective, and thus could be expected to have little effect on underwriter cost. This article is the first to examine post-JOBS Act underwriting spreads to determine whether spreads have in fact declined. A finding that underwriting costs stayed constant might be evidence of either collusion or that the JOBS Act was ineffective at reducing the cost of going public. I find that one provision has lowering the spread, thus suggesting elasticity in the spread and offering at least some evidence of the Act’s effectiveness.
Christine Hurt has posted Pricing Disintermediation: Crowdfunding and Online Auction IPOs on SSRN with the following abstract:
Recently, the concept of crowdfunding has reignited a desire among both entrepreneurs and investors to harness technology to assist smaller issuers in the funding of their business ventures. Like the online auction IPO of the previous decade, equity crowdfunding promises both to disintermediate capital raising and democratize retail investing. In addition, crowdfunding could make capital raising more accessible to small issuers than any type of IPO or private offering. Until the passage of the Jumpstart Our Business Startups Act (“JOBS” Act) in 2012, however, crowdfunding sites operated in a netherworld of uncertain regulation. In this crowdfunding Wild West, various types of entrepreneurs raised monies in various ways, some in obvious violation of the Securities Act. For entrepreneurs looking to raise start-up capital, crowdfunding was attractive but dangerous. Some investor crowdfunding portals, such as ProFounder, Prosper and Lending Club, purported to give entrepreneurs an easy and legal way to crowdfund equity capital or interest-bearing loans; however, regulatory scrutiny caught up with those skirting securities laws.
The passage of Title III of the JOBS Act, the Capital Raising Online While Deterring Fraud and Unethical Non-disclosure Act (“CROWDFUND” Act) seemed to bless the attempts of crowdfunding pioneers in the area of capital raising, at least in theory. However, the statutory language does not exempt early entrants’ efforts; instead, it provides a mechanism for future attempts to qualify for an exemption. The proposed Regulation Crowdfunding leaves little doubt that crowdfunding will not be easy: disclosure requirements, portal registration, and capital limitations are just a few of costly burdens added to this would-be alternative. The most optimistic commentators hope that crowdfunding eases access to capital markets for promising for-profit ventures, creating a new step in the life cycle of a startup: friends and family funding, crowdfunding, angel investing, venture capital, IPO. On the other hand, critics predict that crowdfunding goes the way of the online auction, an unnecessarily complicated mechanism that stigmatizes those issuers who try to sidestep traditional Wall Street intermediaries.
However, even if crowdfunding may not be the optimal path for start-ups with an ultimate goal of a successful IPO, crowdfunding may be useful for other types of for-profit ventures. Regardless of the future of the SEC regulations, the legal charitable crowdfunding of donations will be unaffected and will continue to increase in popularity and acceptance. With the growth of charitable crowdfunding, for-profit social entrepreneurship may find equity crowdfunding both appealing and available. For-profit social entrepreneurs may be able to use the crowdfunding vehicle to brand themselves as pro-social, attracting individual and institutional cause investors who may operate outside of traditional capital markets and may look for intangible returns. Just as charitable crowdfunders rebut the conventional wisdom that donors expect tax-deductibility, prosocial equity crowdfunders may rebut the conventional wisdom that early equity investors expect high returns or an exit mechanism. This avenue may be an attractive alternative to private equity financing, which may be tempting but may also lead to mission drift and loss of founder control.
Saturday, April 5, 2014
The following law review articles relating to securities regulation are now available in paper format:
Danielle A. Austin, Note, We the People or We the Legislature?: The STOCK Act's Compromise Between Politically-Motivated Accountability and Keeping Congress Above the Law, 42 Hofstra L. Rev. 267 (2013).
Judge Stanley Sporkin, The SEC Can No Longer Regulate from Behind, 18 N.C. Bank. Inst. 65 (2013).
The SEC Actions Blog has compiled This Week In Securities Litigation (Week ending April 4, 2014).
Thursday, April 3, 2014
Tom C. W. Lin has posted The New Financial Industry on SSRN with the following abstract:
Modern finance is undergoing a fundamental transformation. Artificial intelligence, mathematical models, and supercomputers have replaced human intelligence, human deliberation, and human execution. A financial industry once dominated by humans has evolved into one where humans and machines share power. Modern finance is becoming cyborg finance — an industry that is faster, larger, more complex, more global, more interconnected, and less human.
This Article offers an early systemic examination of this ongoing financial transformation, and presents an original set of regulatory principles for governing the emerging, new financial industry. This Article provides a normative and descriptive cartography of this changing financial landscape. It identifies particular perils, systemic risks, and regulatory shortcomings emanating from this financial transformation. It then proposes new guiding principles for the future of financial regulation in response to this sea-change. Drawing from a rich literature of past financial crises and transformations, this Article explores the next big movement in finance and financial regulation. And it offers fresh insights for better addressing the perils and promises emerging from the new financial industry.
Wednesday, April 2, 2014
On April 2, 2014, Commissioner Luis A. Aguilar delivered a speak on Taking an Informed Approach to Issues Facing the Mutual Fund Industry.