Tuesday, November 12, 2019
As a professor, I love it when academic research is front-page news! So, I was delighted yesterday to see a piece there in the Financial Times, Academics accuse Morningstar of misclassifying bond funds (here – subscription required), on Huaizhi Chen, Lauren Cohen, and Umit G. Gurun’s recently posted SSRN article: Don’t Take Their Word For It: The Misclassification of Bond Mutual Funds (here).
The gist of the article is that in deriving its risk classifications/ratings for bond funds, Morningstar’s rating system relies upon self-reported, summary data – often misreported – from bond mutual fund managers about the percentages of funds’ assets in different risk categories (AAA, AAA, B, etc.) rather than using it to supplement the data that those same funds file quarterly with the SEC. The authors explain that assets in equity funds are generally of the same security type (for example, common stock), but that this isn’t true in the case of bond funds, which are “more bespoke and unique” with differences “in yield, duration, covenants, etc. – even across issues of the same underlying firm.” (p.2) And while equity might have about 100 positions, bond funds generally have more than 600 issues. (p.2) So, in the case of fixed income funds, the role of information intermediaries such as Morningstar is incredibly important.
The article suggests that “[t]his misreporting has been persistent, widespread, and appears strategic – casting misreporting funds in a significantly more positive position than is in actuality.” (p.1) This matters because such misclassified funds then appear to perform better than others with the same risk classification and, not surprisingly, both retail and institutional investors increase their investment in these funds. (p.3) It also increases expense ratios. (p.5)
Interestingly, the authors comment “[s]tepping back, what makes this even somewhat more surprising is that the funds actually do report holdings directly to Morningstar, and these holdings line up almost perfectly with the SEC-downloaded holdings. Thus, it is literally that Morningstar uses the Summary Reports itself (and not the other data also delivered directly to it by funds) instead of taking the extra step of calculating riskiness itself that contributes to classification.” (p. 5-6). So, did Morningstar allegedly not “tak[e] the extra step” for reasons of cost, an unfortunate oversight, or another possible explanation? Note that the FT article quotes Morningstar as saying “We stand by the accuracy of our data and analytics, and we are reaching out to the authors with an offer to help understanding the data they used and to clarify the…methodologies we employ.” Commentary on this article by Morningstar, Morningstar Stands Behind Its Fixed-Income Data and Fund Ratings, is here.
If the article’s analysis is accurate, at least some funds must have been aware of the misclassifications. If so, what (if any) related responsibility (legal or ethical) might they have in this systemic issue? If the article’s analysis is correct, I would imagine that lawsuits won’t be far behind. Stay tuned! For now, here’s the abstract:
We provide evidence that mutual fund managers misclassify their holdings, and that these misclassifications have a real and significant impact on investor capital flows. In particular, we provide the first systematic study of bond funds’ reported asset profiles to Morningstar against their actual portfolios. Many funds report more investment grade assets than are actually held in their portfolios, making these funds appear significantly less risky. This results in pervasive misclassifications across the universe of US fixed income mutual funds by Morningstar, who relies on these reported holdings. The problem is widespread- resulting in about 30% of funds being misclassified with safer profiles, when compared against their actual, publicly reported holdings. “Misclassified funds” – i.e., those that hold risky bonds, but claim to hold safer bonds– outperform the actual low-risk funds in their peer groups. “Misclassified funds” therefore receive higher Morningstar Ratings (significantly more Morningstar Stars) and higher investor flows due to this perceived outperformance. However, when we correctly classify them based on their actual risk, these funds are mediocre performers. Misreporting is stronger following several quarters of large negative returns, and it is strong at the fund family level.
Tuesday, October 29, 2019
“Big banks do not usually gang up to demand more financial regulation, least of all with asset managers in tow.” That’s the first sentence of Gillian Tett’s recent piece, Banks are right to say that clearing houses are ripe for reform, in the Financial Times (here – subscription required). Her title and lead sentence are spot on. That should be worrisome to all. Tett’s piece centers on a white paper, A Path Forward for CCP Resilience, Recovery, and Resolution (here), released on October 24, 2019, by nine financial institutions (Allianz Global Investors, BlackRock, Citi, Goldman Sachs, Societe Generale, JPMorgan Chase & Co., State Street, T.RowePrice, and Vanguard). Tett states: “the current status quo around clearing houses is worrying.” As BLPB readers know, I agree.
The white paper calls for “enhanced risk management standards and aligning incentives through requirements for meaningful CCP [clearinghouse] own capital for covering both default and non-default losses and recapitalization resources.” (p.1) It highlights the incentive misalignment present in many clearinghouses given their publicly-traded, shareholder ownership status: “Although CCP shareholders take 100% of the returns a CCP earns from clearing revenues, they bear only a small portion of the losses the CCP incurs as a result of a default.” (p.10) Many of its recommendations are not new, but some are. These include: a clearing member voting mechanism in recovery; ex-ante provision of financial resources for resolution; and, the possibility of “long-term debt that could be bailed in for recapitalization.” (p.1)
While I generally agree with the white paper’s recommendations, I don’t think they go far enough. As I’ve posted before on clearinghouses (here, here, here, here) and will do so in the future, I’ll just highlight a few things. First, while increasing clearinghouse capital is a step in the right direction towards better incentive alignment, it’s only a start. The ownership structure itself of these institutions needs to be addressed. If clearinghouses were owned by their members – as they were historically – the incentive misalignment between members and owners would largely diminish. However, as I’ve noted in Incomplete Clearinghouse Mandates (here), even if clearinghouses are all member-owned, this doesn’t solve the problem of who ultimately holds the extreme tail risk of these institutions. In a previous post (here), I pointed out parallels between clearinghouses and the residential mortgage giants, Fannie Mae and Freddie Mac, whose exit from government ownership is still pending more than a decade after the financial crisis. Let’s not go down the same route in the clearinghouse space.
Second, the white paper argues that clearinghouses should generally be responsible for non-default losses. I agree. However, as I’ve noted before, both types of losses could occur in close proximity. Hence, it could be very difficult in practice to separate them out to allocate any losses in the case of investor-owned clearinghouses. Finally, as I write about in forthcoming research, clearinghouses are self-regulatory organizations (SROs). Presumably, they would be acting in a regulatory capacity in a recovery scenario as it is arguably the analog to government action in a resolution scenario. Exchanges, as SROs, are generally entitled to regulatory immunity for actions taken in a regulatory capacity (for more on exchange immunity, see here). At the same time, the recovery of an investor-owned, distressed clearinghouse is also inherently a commercial endeavor. It is fundamentally about the survival of the clearinghouse, and potentially the exchange group structure itself. So, it could be very difficult in practice to separate regulatory from commercial action for purposes of regulatory immunity. Given this consideration, investor-owned clearinghouses could have less incentive to be circumspect about recovery decisions that might adversely impact members.
Tett refers to a “trenchant letter” from the Systemic Risk Council to the Financial Stability Board “demanding action” on clearinghouses. Paul Tucker, who chairs the Council, is the former Deputy Governor of the Bank of England. In closing, I recommend that readers interested in understanding more about the centrality of clearinghouses in financial markets read a 2014 speech by Tucker: Are Clearing Houses the New Central Banks? If the answer to Tucker's question is yes, that says it all!
Sunday, October 13, 2019
Yesterday, two highly important events occurred in the sports world. First, OU prevailed in the Red River Showdown. Boomer Sooner! But, that’s not what this post is about (so, stay w/me Texas Longhorns fans!). Second, famed Kenyan marathoner Eliud Kipchoge broke the 2-hour marathon barrier. Today’s post is my heartfelt way of paying tribute to Kipchoge’s historic moment.
In June, co-blogger and fellow runner Haskell Murray wrote about inspirational runners exemplifying toughness, self-discipline, humility, and perseverance (here). In July, I followed suit (here). In reflecting upon the little I know of Kipchoge’s journey that led to smashing a barrier many thought impossible, it’s clear to me that he has these character traits in abundance.
In November 2016, Nike announced its Breaking2 project. In a nutshell, it involved years of planning, the assembly of world-class scientists, trainers, runners, and even a new shoe, in the quest for a sub-two hour marathon. In May 2017, after months of intense preparation, Kipchoge almost achieved this objective. His time: 2:00:25 (a Nike/National Geographic documentary of the Breaking2 project is: here). He’d given 100%, but ultimately failed to reach the goal. Nevertheless, Kipchoge did not quit. Indeed, in the 2018 Berlin Marathon, he set the current official world marathon record of 2:01:39.
Yesterday, Kipchoge made history. This required tremendous perseverance, extreme self-discipline, mental toughness, and the humility to risk once again falling short of the goal in the international spotlight. As I’ve learned more about Kipchoge’s running career through reading and short films like the one released ahead of the 2019 London Marathon of his training camp and philosophies (here), several takeaways and life-lessons for all seem to be:
Never give up.
“If you want to be successful, you need to choose. But to choose well, you must know who you are and what you stand for. Where you want to go and why you want to get there.”
The importance of sacrifice in achieving success.
Keep it simple and focused.
The importance of taking risks
“In training, it’s teamwork” – “1 percent of the whole team is really more important than 100 percent of yourself.”
Believe in the impossible!
[10/15/19 Postscript: Kipchoge won two Olympic medals: bronze (2004) and silver (2008) in the 5000m. He pivoted to distance running after failing to make the 2012 Kenyan Olympic team (here). In 2016, he won the Olympic marathon. Yet one more example of his not letting failure stop him, but instead persevering and turning it into triumph!]
Monday, September 16, 2019
I am pleased to announce that The University of Tennessee College of Law is again hosting editors of this blog for a symposium focusing on current topics in business law. The website for the symposium, which is sponsored by UT Law's Clayton Center for Entrepreneurial Law, is here. Faculty and students from UT Law will comment on presentations given by my fellow BLPB bloggers. Participating editors of the BLPB in this year's program include Colleen Baker, Ben Edwards, Josh Fershee, me, Doug Moll, Haskell Murray, and Stefan Padfield. The lunchtime panel features me and two of my UT Law colleagues exploring the legal meaning and understanding of mergers and other business combinations from various perspectives, including business associations law, bankruptcy and UCC law, and federal income tax law. That, alone, is surely worth the price of entry!
If you live in or near Knoxville, please come and join us. Continuing legal education credit is available to members of the Tennessee bar. If you cannot make it to the symposium, however, a video recording of the proceedings will later be available on UT Law's website, with an expected option for online continuing legal education credits. (Last year's program is available here with a continuing legal education credit option.) In addition, the written proceedings of the symposium are scheduled to be published in the spring volume of Transactions: The Tennessee Journal of Business Law.
I am looking forward to having many of my BLPB co-editors in town for this program. It's always a special time when we are together.
Sunday, August 18, 2019
Last week, I posted about the Annual Conference of the Academy of Legal Studies in Business. Since then, I reflected on Robert Prentice’s fantastic presentation at this event on Ethical Decision Making and the Conformity Bias. So, I decided to mention the conference again both to highlight Prentice’s extensive and important work in business ethics, and to remind – and perhaps in some cases, introduce – BLPB readers of a phenomenal teaching resource: Ethics Unwrapped, a program within the Center for Leadership and Ethics (CLE) at the McCombs School of Business at the University of Texas.
Prentice’s conference talk was entertaining, engaging, and thought-provoking. Here’s the description: Even the best people are only boundedly ethical. A wide range of social and organizational pressures, cognitive heuristics and biases, and situational factors affect (often adversely) people’s ethical decision making. This paper explores one of these influences that is often underestimated—the conformity bias, which is the tendency that people have to take their cues as to what to think and how to act from those around them, particularly members of their in-group. Click here to download the paper: Download Conformity Bias Paper Montreal
One of the many videos offered by Ethics Unwrapped is on the conformity bias. As with other videos on this site, it is also accompanied by related discussion questions, case studies, teaching notes, and additional resources. If you’ve never browsed the website, I highly encourage you to spend a few minutes familiarizing yourself with [t]his free educational program…used around the world by more than 1,200 colleges and universities, in hundreds of businesses and organizations, and by tens of thousands of ethics learners. It will definitely be time well spent!
Sunday, August 11, 2019
I just returned from the Annual Conference of the Academy of Legal Studies in Business (ALSB) in Montreal, Canada. It was a great conference, packed with a variety of panels, paper presentations, workshops, social opportunities, and events showcasing this beautiful city to the north. Hence, there’s much that could be shared! In today’s post, I’ve decided to highlight two conference panels whose format I found to be creative and intellectually exciting. Both identified an overarching theme, and then scholars with divergent interests discussed the theme in the context of their own research. Then, after panelists’ initial remarks, the moderator posed questions to panel participants before welcoming audience queries.
Stephen Park assembled and moderated a group of scholars (including me!) to discuss interconnections among global financial markets and sovereign actors, as both regulators and market participants. Tim Samples examined sovereign debt restructuring; Matthew Turk focused on the sovereign/banking nexus and interactions between governments and intergovernmental actors; Jeremy Kress discussed bank capital requirements for sovereign debt; and, I considered the use of sovereign debt to meet clearinghouse margin requirements. The panel was a lot of fun and we were all really grateful to Stephen for taking the lead in organizing it! Here’s the panel’s official description:
Financial Crisis and Reform: Sovereign Debt, Systemic Risk, and Government Insolvency. Like companies, governments participate in the financial markets in various ways, including issuing bonds. However, this shared modus operandi obscures fundamental legal differences between corporate and government financing and the deep linkages between government debt and the broader financial markets. The significance of these differences is particularly evident when governments become insolvent or when their activities pose a risk to the financial system. This panel explores the implications of these dynamics under bankruptcy, banking, securities, and international law and in the context of sovereign and municipal debt restructurings, the use of sovereign debt as collateral, and macroprudential regulation.
Sarah Light and Stephen Park organized the second panel. It centered on standard setting, collective action problems, and governance by private actors in different subject matter areas. David Zaring discussed the Equator Principles and the Santiago Principles; Kevin Kolben examined the protection of labor rights in global supply chains; Scott Shackelford considered the issue of cyber peace; Stephen Park focused the intersection of international economic law, corporate social responsibility, and financial law, particularly in regard to ESG reporting; and, Sarah Light explored efforts to insure nature by private actors. Here’s the panel’s official description:
Private Governance and the Collective Action Problems Facing Business Today. Private standards—created, monitored, and enforced by groups of non-state actors—are proliferating to address emerging risks and opportunities in business. Their appeal lies in their capacity to address collective action problems that governments are not addressing effectively on their own. Their growing influence calls for new ways of analyzing the process of lawmaking, the accountability of lawmakers, and the enforceability of standards that do not rely on coercive governmental authority. This panel will address these questions and others across several emerging areas, including labor and employment law, cybersecurity, financial regulation, international trade, environmental protection, and socially responsible investing.
In sum, both panels were thought-provoking, and followed a great format. I’m already looking forward to the 2020 ALSB Annual Conference in Providence, Rhode Island! And, lastly, on the flight home today, I read through half of Cal Newport’s Deep Work: Rules for Focused Success in a Distracted World (noted by co-blogger Haskell Murray). Thus far, I strongly second his recommendation!
Monday, August 5, 2019
I did not manage to do much outside reading over the summer, given a move to the Nashville suburb of Franklin.
Always open to recommendations. I am also interested in podcast recommendations for my new commute.
On Paradise Drive - David Brooks (Social Commentary) (2004). Rough satire (or is it satire?) to read right before we moved to the suburbs.
Running for My Life - Lopez Lomong and Mark Tabb (Biography) (2012). Recommendation from Colleen Baker. Inspiring story of how one of the lost boys of Sudan became a US Olympic athlete. Just a few weeks ago, Lopez Lomong won both the 5000m and 10,000m at the U.S. Championships.
Deep Work - Cal Newport (Self-Help) (2016). Georgetown computer science professor argues that there are increasing rewards for “deep work” (challenging work, requiring full concentration), but that society is pushing us toward “shallow work” with social media, constant e-mailing, open office, and the like. He suggests setting routines, fully resting (embracing boredom), and scheduling internet use (and avoiding the internet outside of those times).
Advanced Marathoning - Pete Pfitzinger and Scott Douglas (Fitness) (2d. 2009). Recommended by two of the best runners I know. Will use this book (along with the advice of my friend and supper runner Joey Elsakr) to train for the Rocket City Marathon in December 2019. The third edition is now available.
Gilead - Marilynne Robinson (Novel) (2004). Narrator shares his experiences and the experiences of his father and grandfather as ministers in Gilead, Iowa. Winner of the Pulitzer Prize for Fiction in 2005. On the short-list of President Obama’s favorite books.
Sunday, July 28, 2019
When I first met co-blogger Haskell Murray at SEALSB, we talked about running. Last month, he shared stories of inspirational runners embodying toughness, self-discipline, humility, and perseverance. I loved his post. Yesterday at a family gathering, my sister ribbed me for telling everyone and anyone who would listen about one of the most inspirational books I’ve ever read: Running for My Life: One Lost Boy's Journey from the Killing Fields of Sudan to the Olympic Games. While running this morning with a friend, I found myself proving her point. And when I saw that three days ago, Another chapter in the amazing life story of the Bowerman Track Club’s Lopez Lomong had been written, I decided it was my turn to share with BLPB readers about one of the runners who most inspires me.
As a six-year-old, now two-time U.S. Olympian Lopez Lomong was taken from his mother’s arms by soldiers during a church service in Sudan. After several weeks, he and three older boys he calls his “angels” escaped from a rebel prison camp and ran towards what they thought was their village, Kimotong. Instead, they were running towards Kenya, where they encountered border guards who took the boys to the UN refugee camp, Kakuma. This would be the six-year-old’s home for the next ten years.
During the hardships of those years, soccer became a favorite activity and distraction. Though having an actual soccer ball was a rarity, having too many soccer players on the field was not. Consequently, the older boys solved this problem by making up a rule that one had to run Kakuma’s perimeter – a mere 30 kilometers or 18 miles – each day before being allowed on the field to play. The toughness, self-discipline, and perseverance Lomong practiced in these daily runs and during those difficult years helped develop the toughness, self-discipline, and perseverance needed by world-class athletes.
At sixteen, Lomong learned of a program that would give 3500 boys living in Kakuma the opportunity to move to the U.S. However, applicants had to write their story in English, a language Lomong hardly knew. His response: “I won’t let a little thing like that get in my way.” (p.61) This inspirational attitude - whether about running 18 miles, writing a letter in a barely known language, or a plethora of equally challenging circumstances – has been a constant in Lomong’s amazing life story.
As my sister would tell you, I could go on much more about Running for My Life and the inspiration it has provided to me. However, I’d love for BLPB readers to read the book themselves (or at least watch a YouTube clip). I’ll additionally share that Lomong was: among the 3500 boys selected; taken in by host-parents, Rob and Barbara Rogers, who lived in upstate New York, and would eventually host several additional youths from Sudan; the flag bearer for the U.S. delegation during his first Olympic games in 2008; and, a fall 2011 graduate of the W.A. Franke School of Business at Northern Arizona University.
Last summer after battling several years of injuries, Lomong’s characteristic perseverance, self-discipline, and grit once again paid off when he made History by Becoming First American to Win 1,500 and 10,000m Titles. And as I shared in the first paragraph of this post, he’s been on a roll ever since!
Lomong’s website mentions the words “excellence, sacrifice, dedication.” It’s perhaps another way of stating the qualities of Haskell’s inspirational runners. As impressive as his running, is Lomong's humility in seemingly seeing one of his most important responsibilities as also using his opportunities, talents, and success to promote the development of others through the 4 South Sudan project, whose mission is to Provide Clean Water, Education, Health Care, and Nutrition to the world's most vulnerable people in South Sudan. Lomong aspires to run in his third Olympics next summer. I’ll be rooting for him every step of the way!
Sunday, July 21, 2019
Last Thursday and Friday, I had the honor and pleasure of joining a large group of women interested in law school leadership at the second annual Women's Leadership in Legal Academia conference. The two days provided many opportunities for education and inspiration. Four of my UT Law colleagues started off the conference with a workshop focused on microaggressions. My mini-workshop entitled "Leading from Where We Are" (picture above taken by fellow BLPB blogger Colleen Baker, who attended the session) followed.
The workshop extended my thoughts on leadership as a concept distinct from titles--thoughts I had touched on in an earlier blog post for the Leading as Lawyers blog. It also offered me the chance to describe an optimal organizational structure, with leaders at every key juncture. In introducing my panelists, I noted leadership attributes that I had observed in each and told a related/relevant story about our relationship. Then, we offered for discussion two hypothetical situations in which a faculty member is challenged to lead. In each case, we started with small group work and followed through with a report-out to the "committee of the whole." One of the hypotheticals involved a (potential) misunderstanding between the dean and the faculty, and the other related to a traumatic incident involving one or more students from one of your classes. The small group discussions yielded excellent thoughts for consideration in the larger group forum.
Among the observations? I will highlight just two here. First, that the way a faculty member handles a potentially divisive situation involving the dean and the faculty may depend on the dean's leadership style (dictatorial or collaborative, e.g.) and the level of mutual trust between the dean and the faculty. Also, in exploring the various ways in which a faculty member might address traumatic events known to the public (e.g., fires and floods) and those that are more private (e.g., a student death under unusual circumstances), we identified different levels of faculty comfort in addressing trauma in the classroom. There was especial discomfort in addressing individual, personal trauma.
Colleen or I may have more to say about the conference in future posts. I was thrilled with the creative energy generated by this panel. I am grateful to have had the opportunity to share and learn. What's more, organizing the session enabled me to reconnect with four fabulous leaders in legal academia and to meet many more. A total "win" for me.
Sunday, July 7, 2019
In reading Izabella Kaminska’s Why dealing with fintechs is a bit like dealing with pirates [FT Alphaville is free, but registration is required], I thought of two points from past blogs. First, the critical, controversial issue of who should have access to an account at a central bank. The article notes China’s decision to require “domestic fintechs like Alipay and WeChat…[to] hold their customer deposits on a full reserve basis at the central bank directly,” and also points to Governor Mark Carney’s recent discussion of permitting fintech companies to deposit funds at the Bank of England. Second, the strategic point of recognizing when change is inevitable, and proactively helping to shape it. Kaminska seems to suggest that a potential reason for this expansion in central bank account access is recent power shifts in the area, and central bankers’ desire to proactively shape the inevitable changes on the horizon in financial markets. As is generally the case, Kaminska's piece is a worthwhile read.
Sunday, June 30, 2019
I don’t have enough material for another focused post on advice for new business law professors (see posts I, II, III, and IV). However, I do have a smattering of additional thoughts that I wanted to share in hopes that new professors, and potentially others, might find them helpful. So, in no particular order:
- As in much of life, less is generally more. Specifically, in prepping a new class, in your excitement, you might initially want to try to cover almost all of the casebook. Just say no! For example, given my research interests, I always wanted to cover derivatives etc. in my Banking and Financial Institutions Law course. However, I finally learned that in a three-hour course without prerequisites, I only had time to cover how banks (and some bank-like financial institutions) were structured, regulated, and handled when in trouble.
- I think it’s helpful to add syllabus language (and note it to students) along the lines of the following: “In practice, the learning experience of each course is unique. I reserve the right to modify the scheduled readings or material to be covered to promote the best educational experience for students.” I certainly don’t recommend wholesale changes mid-course to the syllabus. However, I do think, as fellow co-bloggers have aptly pointed out, that clearly setting expectations early on is critical. Hence, it is helpful to set the expectation that there might be some variation in the assignments over the course of the semester to match the pace of the class.
- The professor sets the energy level of each class. This is particularly important to remember if one is teaching at 8am, right after lunch, or in the evening!
- When possible, be encouraging! We all love to receive encouragement! Let’s do our best to distribute it too! For example, if a student’s answer to a question is wrong, is there something positive you can say about their response, and then steer the class to the right answer?
- Our words, even if only casual remarks, often carry great weight with our students.
- Where possible, I find it helpful to use in-class examples students can relate to, and occasionally to share recent news stories relevant to the material we’re studying.
- In some courses, I’ve found it helpful to begin each class by summarizing at a very high level what we’ve already covered, what we’ll be covering that day, and what we are going to cover in the near future. Many students appreciate a reminder of the big picture.
Ok experienced professor-readers, is there something we’ve yet to mention that you think important to share with new business law professors? If so, please help us out with a comment!