Thursday, August 14, 2014
Adam B. Ashcraft, Kunal Gooriah, and Amir Kermani have posted Does Skin‐in‐the‐Game Affect Security Performance? Evidence from the Conduit CMBS Market on SSRN with the following abstract:
Does reducing the skin‐in‐the‐game of informed agents matter for the performance of securitized assets? In the conduit commercial mortgage backed securities (CMBS) market, an informed investor purchases the bottom five percent of the capital structure, known as the B‐piece, conducting independent screening of loans from which all other investors benefit. However, during the recent credit boom, a secondary market for B‐pieces developed, permitting these investors to significantly reduce their skin‐in‐the‐game. In this paper, we document, that after controlling for all information available at issue, the percentage of the B‐piece that is sold by these investors has a significant adverse impact on the probability that more senior tranches ultimately default. The result is robust to the use of an instrumental variables strategy which relies on the greater ability of larger B‐piece buyers to sell these positions given the need for large pools of collateral. Moreover we show the risk associated with this agency problem was not priced.
Andreas M. Fleckner has posted Regulating Trading Practices on SSRN with the following abstract:
High-frequency trading, dark pools, front-running, phantom orders, short selling — the way securities are traded ranks high among today’s regulatory challenges. Thanks to a steady stream of news reports, investor complaints and public investigations, calls for the government to intervene and impose order have become commonplace, both in financial and academic circles. The regulation of trading practices, one of the oldest roots of securities law and still a regulatory mystery to many people, is suddenly the talk of the town. From a historical and comparative perspective, however, many of the recent developments look less dramatic than some observers believe. This is the quintessence of the present chapter. It explains how today’s regulatory regime evolved, identifies the key rationale for governments to intervene, and analyzes the rules, regulators and techniques of the world’s leading jurisdictions. The chapter’s central argument is that governments should focus on the price formation process and ensure that it is purely market-driven. Local regulators and self-regulatory organizations will take care of the rest.
John C. Coates, IV has Securities Litigation in the Roberts Court: An Early Assessment posted on SSRN with the following abstract:
This article provides an early assessment – both quantitative and qualitative – of the Roberts Court’s securities law decisions. Such cases represent an increased share of Supreme Court’s docket, compared to prior Courts, but only because its overall docket has shrunk, while it has continued to take an average of one to two securities law cases per year. The Roberts Court has maintained the same overall split in “expansive” or “restrictive” outcomes as the post-Powell Rehnquist Court, with reduced polarization: more than half were unanimous and only three included five-vote majorities. An attitudinal model does no better than a coin flip in predicting outcomes. What are new is a heightened role for procedure and a resistance to bright-line rules, with procedural decisions more restrictive and rejections of bright-line rules more expansive. The turn to procedure matches the background and interests of the Chief Justice, a former appellate litigator leading a broader “procedural revolution” on the Court, beyond the limited reach of securities law. The analysis is applied to predict outcomes for cases to be argued in the October 2014 term, and is used to sketch the types of cases likely to attract the attention of the Court in the future.
Jesse Blocher and Robert E. Whaley have posted Passive Investing on SSRN with the following abstract:
Financial economists have long touted the benefits of passive investing, but see it as a lower cost subset of active investing. Instead, we show that passive fund managers have a fundamentally different business model than active fund managers, similar to a media/advertising model where the product (entertainment/news) is given away and the audience is monetized to generate revenue. Specifically, we show that Exchange Traded Funds (ETFs) derive most of their profits from securities lending, while charging a minimal expense ratio. Findings for passive index mutual funds are similar, but attenuated. ETF managers respond to these incentives by slanting their holdings toward more profitable to lend stocks. Investors see a small benefit, as securities lending revenue is associated with somewhat lower deviation from the underlying index.
Monday, August 11, 2014
The following law review articles relating to securities regulation are now available in paper format:
Elizabeth R. Gorman, Note, When the Poor Have Nothing Left to Eat: The United States' Obligation to Regulate American Investment in the African Land Grab, 75 Ohio St. L.J. 199 (2014).
David Groshoff, Kickstarter My Heart: Extraordinary Popular Delusions and the Madness of Crowdfunding Constraints and Bitcoin Bubbles, 5 Wm. & Mary Bus. L. Rev. 489 (2014).
Daniel E. Herz-Roiphe, Comment, Innocent Abroad? Morrison, Vilar, and the Extraterritorial Application of the Exchange Act, 123 Yale L.J. 1875 (2014).
The Foreign Corrupt Practices Act: A Panel at the 2012 National Lawyers Convention, Hon. William H. Pryor Jr., Moderator; Lanny A. Breuer, Mark F. Mendelsohn, Michael B. Mukasey and George T. Terwilliger III, Panelists, 51 Am. Crim. L. Rev. 433 (2014).
The SEC Actions Blog has compiled This Week In Securities Litigation (Week ending August 8, 2014).
Tuesday, August 5, 2014
Benjamin P. Edwards has posted Securities Fraud, Federalism & the Rise of the Disaggregated Class: The Case for Pruning the State Law Exit Option on SSRN with the following abstract:
In the securities litigation world, changes to federal law have repeatedly caused unintended consequences in state courts. This article explores two consequences of securities litigation reform and calls for further reform. First, the federal scheme for securities class action litigation has effectively excluded many individual state law claims from federal court. This reality, in connection with a well-documented trend toward institutional investors “opting out” of class actions to pursue higher-value individual claims in state court, has led to the second new and unexplored dynamic: a new procedural vehicle to aggregate lower-value individual claims outside of a securities fraud class, a vehicle I call the “disaggregated class.”
This article explores these dynamics and argues that the partial preclusion structure of the Securities Litigation Uniform Standards Act (“SLUSA”) should be extended to preempt many state law claims. At present, SLUSA only makes state law claims nonactionable in the class action form. To breathe life into precluded class claims, plaintiffs have begun to go to great lengths to aggregate individual claims in ways that do not trigger SLUSA’s application. As this trend continues, the distinction between class and individual actions begins to break apart and the rationales behind SLUSA’s ban on state law class action litigation begin to apply to individual actions. Expanding SLUSA to limit plaintiffs’ ability to exit federal class action litigation in favor of state law suits in state courts seems likely improve securities fraud deterrence by reducing over-deterrence costs, more appropriately aligning state and federal authority over the national securities markets, and by making private securities class counsel more responsive to exit threats from large investors.
William K. Sjostrom Jr. has posted Direct Private Placements on SSRN with the following abstract:
A direct private placement, or DPP, is a private securities offering to investors by a company without the aid of a placement agent. In other words, it is an offering marketed and sold directly to investors by company personnel. The paper examines two impediments to a DPP: (1) a company’s lack of relationships with accredited investors, and (2) company personnel lack of federal broker and state agent registrations.
Bryce C. Tingle, J. Ari Pandes, and Michael J. Robinson have posted The IPO Market in Canada: What a Comparison with the United States Tells Us About a Global Problem on SSRN with the following abstract:
Initial Public Offerings (IPOs) in the world’s most important financial markets have been falling for the past decade. This has not been a gentle decline, but a collapse that preceded the 2008 financial crisis and shows no sign of abating. Public companies have been an integral part of developed economies for the past century and their apparent decline has occasioned a great deal of concern in the United States, including recent law reform attempts to reverse the trend.
Surprisingly, there has been no analysis of the phenomenon in Canada, where the proliferation of Exchange-traded Funds (ETFs) and the rise and fall of income trust conversions have made trends in this country difficult to see without detailed analysis. Insofar as the Canadian IPO market has been referenced at all in U.S. discussions, it has been said to be in good health, with little change over the last decade, and used as a foil by those arguing something specific to American capital markets has gone wrong. This is not true, however. The Canadian IPO market has also undergone a severe contraction over the past decade, and the differing regulatory and legal regimes between the two culturally similar, economically-linked countries can tell us a lot about what is, and is not causing the decline of public markets in the United States and elsewhere.
William Christopher Gerken has posted Blockholder Ownership and Corporate Control: The Role of Liquidity on SSRN with the following abstract:
Employing an instrumental variable approach based on the regulatory change of tick sizes, I examine the link between the liquidity of a firm's equity and activism by large shareholders. I find that liquidity increases the likelihood of block formation. Blockholders of more liquid securities take smaller stakes that do not precommit them to monitor. I find evidence that the threat of exit from a block can discipline managers and that this threat is more effective when liquidity is higher. While liquidity increases exit from existing blocks, I find no evidence that share illiquidity forces blockholders to actively monitor.
Mercer Bullard has posted On Regulating Investors: The JOBS Act and the Accredited Investor Standard on SSRN with the following abstract:
This abstract sketches novel approaches that the Securities and Exchange Commission may consider when evaluating the accredited investor standard in 2014 and 2015. The current standard is internally inconsistent and contradicts modern portfolio theory, and alternative approaches in other contexts -- especially crowdfunding rules -- provide a model for fixing this longstanding problem.
Richard Bußmann has posted Evaluating Contingent Convertible Securities on SSRN with the following abstact:
This dissertation provides an in-depth analysis of the design, application and limitations of contingent convertible securities. This paper builds on and advances the existing literature, by showing that a contingent convertible’s value at its core is subject to the contingent convertible’s underlying asset volatility. In addition it addresses how contingent convertibles reduce moral hazard and how some designs may be ill suited to fit a contingent convertible’s (CoCo) purpose.
Monday, August 4, 2014
Philipp Paech has posted Intermediated Securities and Conflict of Laws on SSRN with the following abstract:
In developed financial markets securities are held through banks, brokers and other intermediaries. The question of which law governs the proprietary aspects in respect of securities in cross-jurisdictional holdings is subject of a fierce debate for about 10 years. There is agreement that the so called PRIMA approach is better than the older 'look-though approach'. However, PRIMA in itself is unclear as the concept is divided into a factual version of PRIMA and a consensual one. This dichotomy is perfectly reflected by the fact that the EU (using a fact based PRIMA in several instruments) is unlikely to implement the Hague Securities Convention which proposes a choice of law approach. This paper will look at the debate from a policy angle, analysing a number of issues which have probably fundamentally informed the earlier debate.
Zsuzsa R. Huszar, R.S.K. Tan, and Weina Zhang have posted Stock Lending from Lenders’ Perspective: Are Lenders Price Takers? on SSRN with the following abstract:
This study provides new insights about the source of short sale constraints, by showing that lending fees predict future returns beyond shorting demand in recent years. Focusing on lenders’ perspective, we reveal that lending fees are on average significantly higher for stocks with large active institutional ownership. For stocks with high active institutional ownership lending fees not only respond to shorting demand but are raised in anticipation of new future shorting demand. Specifically, fees are about 8% higher before earnings announcements and 15% higher before dividend declaration dates for stocks with 50% active institutional ownership than for stocks without active institutional ownership. Lastly, we find that the negative relationship between future returns and lending fees strengthens after the Lehman Brothers collapse as active institutions’ likely become more proactive in capitalizing lending fee revenues in the newly transparent and automated stock lending market.
Jeff Schwartz has posted The Corporatization of Personhood on SSRN with the following abstract:
This Article explores the burgeoning practice of investing in people as if they were corporations. Sometimes pitched as a way to pay-off student loans or fund a business idea, people now have the opportunity to sell shares of their future income to investors in exchange for cash today. Such transactions create a financial relationship closely analogous to that of a corporation and its shareholders. This Article considers how existing law applies to this new practice and whether today’s rules are responsive to the unique challenges these arrangements present. I argue that, despite raising both constitutional and public-policy concerns, these transactions should be permitted. Rather than outlaw such dealings, the nature of the financial relationships at issue means that they should be subject to securities regulation. Securities law alone, though, is insufficient. It is solely focused on protecting investors, leaving the broader social concerns raised by investing in people unaddressed and the more vulnerable parties to these transactions — those selling shares of themselves — without protection. To respond to these issues, I set forth a complementary regulatory template that would, among other things, require certain disclosures and set certain boundaries on these novel financial relationships.
Joan MacLeod Heminway has posted How Congress Killed Investment Crowdfunding: A Tale of Political Pressure, Hasty Decisions, and Inexpert Judgments That Begs for a Happy Ending on SSRN with the following abstract:
In April 2012, President Obama signed into law the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act (the “CROWDFUND Act”) as Title III of the Jumpstart Our Business Startups Act. The U.S. Securities and Exchange Commission (“SEC”) was compelled to promulgate enabling regulation to effectuate the CROWDFUND Act. That rulemaking has been slow in coming.
During this period of delay, commentators have routinely denounced the postponement and expressed fear that the SEC’s rulemaking would unduly limit investment crowdfunding. This Article demonstrates, however, that it is principally the U.S. Congress that has limited the capacity of the CROWDFUND Act to foster capital formation for small businesses through investment crowdfunding. The provisions of the CROWDFUND Act, as enacted by Congress, create a significant cost structure that is not likely to be outweighed by the benefits of a crowdfunded offering conducted under the Act. Building on earlier work by Professors C. Steven Bradford and Stuart Cohn, this article explains the history and current status of the regulation of investment crowdfunding under the Securities Act of 1933, as amended (the "1933 Act"), identifies and describes reasons for despair about the current regulatory environment, and suggests a way forward. The way forward assumes, without further analysis, that the CROWDFUND Act demonstrates the inevitability — even if not the desirability — of a viable 1933 Act registration exemption for investment crowdfunding.
Brent J. Horton has posted For the Protection of Investors and the Public: Why Fannie Mae’s Mortgage-Backed Securities Should Be Subject to the Disclosure Requirements of the Securities Act of 1933 on SSRN with the following abstract:
Despite the fact that Fannie Mae’s creation of mortgage-backed securities (MBS) played a major role in causing the 2008 financial crisis, the issue of reforming Fannie Mae’s securitization activities was ignored by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Congress’ legislative response to the crisis. Former Secretary of the Treasury Henry Paulson said in a February 5, 2014 interview with the Washington Times, “[i]t perplexes me that nothing has been done." Paulson worries that if nothing is done, any future failure of Fannie Mae — a very real possibility absent reform — will lead to what he calls a financial “horror show,” and that the “ensuing crisis [will be] much bigger than the financial collapse in the wake of the Lehman bankruptcy.”
Given the urgency of the matter, it is surprising that post-2008 financial crisis scholarship — much like Congress — has largely ignored the need to reform Fannie Mae. The scholarship that does exist on the topic tends to recommend abolishing Fannie Mae (allowing the private sector to fill the hole). This Article fills a major gap in the scholarly debate. This Article recognizes that Fannie Mae plays an important role in financing home ownership, and accordingly, proposes a solution that will maintain Fannie Mae, but constrain its risk taking in the future. Because as Louis Brandeis famously stated, “sunlight is said to be the best of disinfectants; electric light the most efficient policeman,” this Article proposes that the best way to reduce risk taking at Fannie Mae is to subject its MBS offerings to the disclosure requirements of the Securities Act of 1933. As this Article explains, right now — as was the case in 2008 — Fannie Mae only engages in ad-hoc voluntary disclosure, which is void of substance, and entirely inadequate given the number of investors that purchase its MBS daily.
In arguing that Fannie Mae’s MBS should be subject to the disclosure requirements of the Securities Act of 1933, this Article moves beyond the traditional justification — investor protection — and argues that disclosure can protect the taxpaying public. After all, in 2008, it was the taxpaying public that was called upon to bailout investors in Fannie Mae’s MBS. The bill was $116 billion. While subjecting Fannie Mae to the disclosure requirements of the Securities Act of 1933 to protect the taxpaying public is a novel application of the law, it is not without support. It is supported by the language of the Securities Act itself, which calls in several places for the “protection of the public.”
Abbey Stemler has posted The JOBS Act and Crowdfunding: Harnessing the Power – and Money – of the Masses on SSRN with the following abstract:
On April 5, 2012, President Barack Obama signed into law the Jumpstart Our Business Startups (JOBS) Act, dramatically changing the landscape for many companies raising capital. One of the most interesting sections of the Act is Title III, the CROWDFUND Act, which enables entrepreneurs and small business owners to sell limited amounts of equity in their companies to a large number of investors via social networks and various Internet platforms. Prior to the CROWDFUND Act, selling equity interests in companies via crowdfunding was for all practical purposes illegal under United States securities laws. The Act attempts to exempt crowdfunding from expensive registration requirements and allow crowdfunding websites to avoid the classification of broker, which would impose substantial registration costs on such sites. Through the CROWDFUND Act, equity-based crowdfunding has the potential to open funding opportunities to countless underfunded entrepreneurs and small businesses. In addition, it can provide investors with new ways to diversify their portfolios. However, the benefits of crowdfunding do not come without substantial risks. Given the combination of unsophisticated investors, inherently risky businesses, and the zeitgeist that changed regulations quickly, crowdfunding must be approached with caution.
Asaf Eckstein has posted Great Expectations: The Peril of an Expectations Gap in Proxy Advisory Firm Regulation on SSRN with the following abstract:
Large, institutional investors have come to wield great power over the shareholder votes in publicly held companies. These investors, with their enormous ownership shares, can dramatically influence issues put to a shareholder vote. And when deciding how to cast their ballots, institutional investors look to proxy advisory firms. These are entities that advise investors on which actions to take in shareholder votes. Because institutional investors prefer to focus on building portfolios, rather than on researching shareholder votes, they often outsource these duties to proxy advisory firms. As a result, financial industry and government leaders have voiced concern that proxy advisory firms exert too much power over corporate governance to operate unregulated. The Securities and Exchange Commission as well as the U.S. Congress have investigated and debated the merits of proxy advisory regulation. The U.S. House of Representatives held a hearing on the matter in June of 2013, and the SEC followed this hearing with a roundtable discussion in December of 2013. On June 30, 2014, the Investment Management and Corporate Finance Divisions of the SEC issued a bulletin outlining the responsibilities of proxy advisors and institutional investors when casting proxy votes. As of yet, no binding regulation has been promulgated, despite repeated calls for it. Rather than commenting on that debate, this Article urges policymakers to consider the potential for an Expectations Gap if proxy advisory regulation is adopted. An Expectations Gap arises when the parties interested in regulation, in this case particularly the mass media, academics, politicians and the general public, inaccurately estimate the efficacy of a regulatory regime. They typically overestimate a regulation’s effectiveness, which in the proxy advisory context could actually lead to a responsibility deficit. Both proxy advisory firms and institutional investors could shift blame away from themselves in the event of a corporate governance failure stemming from poorly-cast shareholder votes or a lack of oversight. This deficit would severely hamper the effect of any future regulation, and steps must be taken to reduce the possibility of that occurrence. This Article is the first to examine this potentially serious negative consequence of proxy advisory regulation. It is also the first comprehensive scholarly writing to propose solutions for minimizing an Expectations Gap arising from new regulation. This Article applies the Expectations Gap theory to the current proxy advisor debate taking place, and uses the theory to develop mechanisms for making potential regulation more effective. Additionally, these suggestions are applicable to any new regulation that is susceptible to an Expectations Gap. Taken together or individually, these suggestions could improve information symmetry in the financial market and help prevent serious corporate governance failures.