Saturday, June 25, 2022

House Majority Staff Report on the GameStop Market Event

Last year, several BLPB posts focused on the GameStop market event (for example, here, here, here, here, and here). For BLPB readers with continuing interest in this topic, I wanted to flag that yesterday, a report prepared by the Majority Staff of the Committee on Financial Services of the U.S. House of Representatives was released: Game Stopped: How the Meme Stock Market Event Exposed Troubling Business Practices, Inadequate Risk Management, and the Need for Legislative and Regulatory Reform.  I look forward to reviewing the report in more detail!

[revised]

 

June 25, 2022 in Colleen Baker, Financial Markets | Permalink | Comments (0)

Friday, June 24, 2022

Rethinking Insider Trading Compliance Policies in Light of the SEC's New "Shadow Trading" Theory of Insider Trading Liability

In August 2021, the SEC announced that it had charged Matthew Panuwat with insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934. Panuwat was the head of business development at Medivation, a mid-sized biopharmaceutical company when he learned that his company was set to be acquired by Pfizer at a significant premium.

If Panuwat had purchased Medivation stock in advance of the announcement of the acquisition, it is likely he would have been liable for insider trading under the classical theory. Liability for insider trading under the classical theory arises when a firm issuing stock, its employees, or its other agents strive to benefit from trading (or tipping others who then trade) that firm’s stock based on material nonpublic information. Here the insider (or constructive insider) violates a fiduciary duty to the counterparty to the transaction (the firm’s current or prospective shareholders) by not disclosing the information advantage drawn from the firm’s material nonpublic information in advance of the trade.

If Panuwat had purchased shares of Pfizer in advance of the announcement, then it is likely he would have been liable under the misappropriation theory. Liability for insider trading under the misappropriation theory arises when one misappropriates material nonpublic information and trades (or tips another who trades) on it without first disclosing the intent to trade to the information’s source. As the Supreme Court held in United States v. O’Hagan, 521 U.S. 642, 652 (1997), the “misappropriation theory premises liability on a fiduciary-turned-trader’s deception of those who entrusted him with access to confidential information” by duping them out of “the exclusive use of that information.”

But Panuwat did not trade in either Medivation or Pfizer. Instead, he purchased stock options in Incyte, another pharmaceutical company that was similar in size and market focus to Medivation. According to the SEC’s litigation release, “Panuwat knew that investment bankers had cited Incyte as a comparable company in discussions with Medivation and he anticipated that the acquisition of Medivation would likely lead to an increase in Incyte’s stock price.” Panuwat’s gamble paid off. Incyte’s stock price increased 8% when Pfizer’s acquisition of Medivation was announced. Panuwat earned $107,066 from his trade.

Panuwat moved to dismiss the SEC’s insider trading charges, arguing that his trading in the shares of an unrelated third-party issuer did not violate any recognized theory of insider trading liability.  While the district court acknowledged this was a case of first impression, it denied Panuwat’s motion and permitted the SEC to proceed with its first enforcement action under the "shadow trading" theory of insider trading liability.

The principal basis for the court’s decision seems to be that Panuwat’s trading arguably violated the misappropriation theory by breaching the broad terms of Medivation’s insider trading policy, which includes the following language:

During the course of your employment…with the Company, you may receive important information that is not yet publicly disseminated…about the Company. … Because of your access to this information, you may be in a position to profit financially by buying or selling or in some other way dealing in the Company’s securities…or the securities of another publicly traded company, including all significant collaborators, customers, partners, suppliers, or competitors of the Company. … For anyone to use such information to gain personal benefit is illegal.

To me, the most interesting question raised by the Panuwat case, and the problem of shadow trading more generally, is why would Medivation (or any company) adopt such a broadly worded insider trading policy? How did this broad proscription on employee trading benefit Medivation’s shareholders?

Medivation’s shareholders could not have been harmed by Panuawat’s trading. Such trading could not affect Medivation’s stock price, nor could it put the acquisition in jeopardy. So why is the blanket proscription against trading in “another publicly traded company” in the policy at all? The final sentence of the policy as quoted above suggests that the drafters were under the impression that such trading would be illegal under the securities laws. This may be true under the misappropriation theory, but only because Medivation chose to make it so by including the language in the policy. What if Medivation’s policy had instead provided something like the following language:

Because of your access to this information, you may be in a position to profit financially by trading in the Company’s securities, or the securities of its customers and suppliers. Such trading is strictly prohibited. Nothing in this policy should, however, be read as prohibiting your trading or dealing in any other issuers’ securities unless expressly restricted by the Company.

Under this policy, the SEC would have had no basis for the charge that Panuwat’s trading violated the misappropriation theory. In other words, it is entirely up to issuers whether they want to expose themselves and their employees to “shadow trading” liability. But if such exposure to liability does not benefit an issuer’s own shareholders, it can only hurt them (by needlessly exposing the company’s employees and the company itself to direct or derivative insider trading liability). So what business justification is there for issuers to include the broader language in their insider trading compliance policies? I hope readers will offer their thoughts in the comments below.

June 24, 2022 in Compliance, Financial Markets, John Anderson, Securities Regulation, White Collar Crime | Permalink | Comments (9)

Wednesday, June 15, 2022

Custodia Bank Sues the Fed

In December 2018, in one of my earliest posts on the BLPB, I shared “although esoteric, such issues as who has access to an account at the Fed are critical social policy choices with real world implications that merit broad-based public debate.”  And I’ve continued to highlight this issue with posts such as “Master Accounts at the Fed: An Arcane But Highly Important Issue” and “Professor Hill on Bank Access to Federal Reserve Accounts and Payment Systems.”  And I’m going to continue to do so today and in the future.  It's just that important. 

So today, I want to highlight that Custodia Bank, Inc. recently filed a lawsuit against the Federal Reserve Board of Governors and the Federal Reserve Bank of Kansas City.  Custodia alleges that the defendants have unlawfully delayed – for more than 19 months now – processing its application for a Fed master account.  A few related news stories are: here, here, and here.  Recall that TNB USA Inc. sued the Federal Reserve Bank of New York for related reasons (here), but this lawsuit was dismissed.  I’ll be sure to keep BLPB readers posted regarding what happens in Custodia’s case.            

June 15, 2022 in Colleen Baker, Financial Markets | Permalink | Comments (0)

Friday, June 10, 2022

Why Transactional Lawyers Need to Educate Themselves on Compliance

Prior to joining academia, I served as a compliance officer for a Fortune 500 company and I continue to consult on compliance matters today. It's an ever changing field, which is why I'm glad so many students take my Compliance, Corporate Governance, and Sustainability course in the Fall. I tell them that if they do transactional or commercial litigation work, compliance issues will inevitably arise. Here are some examples: 

  • In M&A deals, someone must look at the target's  bribery, money laundering, privacy, employment law, environmental, and other risks
  • Companies have to complete several disclosures. How do you navigate the rules that conflict or overlap?
  • What do institutional investors really care about? What's material when it relates to ESG issues?
  • What training does the board need to ensure that they meet their fiduciary duties?
  • How do you deal with cyberattacks and what are the legal and ethical issues related to paying ransomware?
  • How do geopolitical factors affect the compliance program?
  • Who can be liable for a compliance failure?
  • What happens when people cut corners in a supply chain and how can that affect the company's legal risk?
  • What does a Biden DOJ/SEC mean compared to the same offices under Trump?
  • Who is your client when representing an organization with compliance failures?
  • and so much more

I'm thrilled to be closing out the PLI Compliance and Ethics Essentials conference in New York with my co-panelist Ben Gruenstein of Cravath, Swaine, & Moore. It's no fun being the last set of presenters, but we do have the ethics credits, so please join us either in person or online on June 28th. Our areas of focus include:

  • Risk assessment, program assessment, and attorney-client privilege
  • Ethical obligations for lawyers and compliance officers
  • Which compliance program communications can (and should) be privileged?

In addition to discussing the assigned issues, I also plan to arm the compliance officers with more information about the recent trend(?) of Caremark cases getting past the motion to dismiss stage and compliance lessons learned from the Elon Musk/Twitter/Tesla saga. 

Here's the description of the conference, but again, even if you're not in compliance, you'll be a better transactional lawyer from learning this area of the law. 

Compliance and ethics programs are critically important to the success of any organization. Effective programs allow organizations to identify and mitigate legal risks. With an increasingly tough enforcement environment, and greater demands for transparency and accountability, an effective compliance program is no longer just “nice-to-have.” It’s essential. 

Whether you are new to the area or a seasoned compliance professional, PLI’s program will give you the tools you need to improve your organization’s compliance program.  We will review the principal elements of compliance programs and discuss best practices and recent developments for each.  Our distinguished faculty, drawn from major corporations, academia, law firms and the government, can help you improve your program, increase employee awareness and decrease legal risk.  Compliance and Ethics Essentials 2022 is highly interactive and includes case studies, practical tools and real-time benchmarking.

What You Will Learn 

  • Designing and conducting effective compliance risk assessments that enhance your program
  • Structuring your program for appropriate independence and authority
  • The evolving role of the board
  • ESG and your compliance program
  • Using data analytics to improve your program
  • Encouraging reporting and investigating allegations of wrongdoing
  • Best practices in compliance codes, communications, training and tools
  • Ethics for compliance professionals

Who Should Attend

If you are involved in any aspect of corporate compliance and ethics as in-house counsel, a compliance and ethics officer, human resources executive, outside counsel, or risk management consultant, this event should be on your annual calendar.

Special Feature: Special luncheon presentation with guest speaker

If you do come to the conference, I would love to grab a cup of coffee with you, so reach out.

June 10, 2022 in Compliance, Conferences, Consulting, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Lawyering, Legislation, M&A, Marcia Narine Weldon | Permalink | Comments (0)

Monday, June 6, 2022

Colin Marks: Total Return Swaps ≡ Secured Transactions?!

I am excited to be promoting here an inventive and interesting paper, Total Return Meltdown: The Case for Treating Total Return Swaps as Disguised Secured Transactions, written by friend-of-the-BLPB Colin Marks (St. Mary's School of Law).   The SSRN abstract follows.

Archegos Capital Management, at its height, had $20 billion in assets. But in the spring of 2021, in part through its use of total return swaps, Archegos sparked a $30 billion dollar sell-off that left many of the world’s largest banks footing the bill. Mitsubishi UFJ Group estimated a loss of $300 million; UBS, Switzerland’s biggest bank, lost $861 million; Morgan Stanley lost $911 million; Japan’s Nomura, lost $2.85 billion; but the biggest hit came to Credit Suisse Group AG which lost $5.5 billion. Archegos, itself lost $20 billion over two days. These losses were made possible due to the unique characteristics of total return swaps and Archegos’ formation as a family office, both of which permitted Archegos to skirt trading regulations and reporting requirements. Archegos essentially purchased beneficial ownership in large amounts of stocks, particularly ViacomCBS Inc. and Discovery Inc., on credit. Under Regulation T of the Federal Reserve Board, up to 50 percent of the purchase price of securities can be borrowed on margin. However, to avoid these rules, Archegos instead entered into total return swaps with the banks whereby the bank is the actual owner of the stock, but Archegos would bear the risk of loss should the price of the stock fall and reap the benefits if the stock were to go up or were to make a distribution. Archegos would still pay the transaction fees, but the device permitted Archegos to buy massive amounts of stock without having the initial margin requirements, thus making Archegos heavily leveraged. This article argues that the total return swap contracts are analogous to and should be re-characterized as what they really are – disguised secured transactions. Essentially the banks are lending money to enable the Archegoses of the world to buy stocks, and are simply retaining a security interest in the stocks. Such a re-characterization should place such transactions back into Regulation T and the margin limits. But re-characterization also offers another contract law approach that is more draconian. If the structure of the contract violates a regulation, then total return swaps could be declared void as against public policy. This raises the specter that a court could apply the doctrine of in pari delicto and leave the parties where they found them in any subsequent suits to recover outstanding debts.

I do not teach, research, or write in the secured transactions space, but this work engages corporate finance and contract law as well.  (I am grateful that Colin, among others, has encouraged my forays into contract law research over the years.)  I was privileged to have the opportunity to preview Colin's arguments and offer some feedback during his research and writing of this paper, which is forthcoming in the Pepperdine Law Review.  I find his argument creative and intriguing.  I think you may, too.

June 6, 2022 in Contracts, Corporate Finance, Financial Markets, Joan Heminway, Securities Regulation | Permalink | Comments (1)

Wednesday, June 1, 2022

Two Quick Clearing Follow-ups on Last Week's Post

I wanted to make two quick follow-ups to last week’s post on FTX’s proposed new clearing model for retail customers.  First, I highly recommend reading the recent FT Alphaville piece Did a major financial institution kinda maybe slightly default in March 2020? (FT subscription required) Among other things, it highlights remarks made by some participants during last week's CFTC Staff Roundtable on Disintermediation relating to the potential cost of largely removing human discretion from the clearing risk management process (thanks to today’s Money Stuff by Matt Levine for bringing this piece to my attention!).  Second, a recent article by Rebecca Lewis and David Murphy, What Kind of Thing Is a Central Counterparty? The Role of Clearinghouses As a Source of Policy Controversy, does an excellent job of discussing clearing for BLPB readers who want to learn more about this area.  Murphy was among the participants in the CFTC Staff Roundtable!  I highly recommend this piece!  Here’s the abstract:

"Public policy surrounding central counterparties (‘CCPs’) is beset by conflicts between stakeholders. These turn on who bears which risks, who profits from clearing, and who has what say in CCP governance. They involve CCP equity holders, clearing members, clients, regulators, and taxpayers, among others. In order to probe them, three stylized edge case models of the role of the CCP are introduced: utilities, for-profit corporations under shareholder primacy, and clubs. The governance of each edge case is discussed and compared to the current situation in clearing and its framing in regulatory requirements. The risks in central clearing, who bears them, and the policies surrounding them, are surveyed. The paper argues that stakeholder risk-bearing affects CCP governance because risk bearing should, in equity, be accompanied by governance rights. Each edge case model suggests a different resolution to the key conflicts but none of the models are sufficient to explain existing CCP practice, and the resolutions suggested are unsatisfactory. This insufficiency suggests that the current policy conflicts are rooted in fundamental disagreements about the role of the CCP and thus in whose interests the CCP should act. Stakeholder theory is presented as a model which explains the nature of these conflicts and their persistent character, and which can provide an equitable setting for their continuing re-negotiation."

 

June 1, 2022 in Colleen Baker, Financial Markets | Permalink | Comments (0)

Friday, May 27, 2022

Kevin Douglas on "Has the Strong-Form of the Efficient Capital Market Hypothesis Crept into U.S. Securities Regulation?"

In the fall, I posted on Professor Kevin R. Douglas's article, "How Creepy Concepts Undermine Effective Insider Trading Reform" (linked below), which is now forthcoming in the Journal of Corporation Law. The following post comes from Professor Douglas. In it, he develops one theme from that article:

Would U.S. officials imprison real people for failing to adhere to the most unrealistic assumptions in prominent economic models? Yes, if the assumption is that no one can generate risk-free profits when trading in efficient capital markets. What are risk-free profits, and why should you go to jail for trying to generate them? Relying on the ordinary dictionary definition of “risk” makes the justification for criminal penalties described above seem absurd. One dictionary defines risk as “the possibility of loss, injury, or other adverse or unwelcome circumstance,” and another simply defines risk as “the possibility of something bad happening.” Why should someone face criminal liability for attempting to generate trading profits without something bad happening—without losing money? The absurdity is especially jarring when thinking about securities markets, where hedge fund managers rely heavily on risk reduction strategies.

However, if we turn to the definition of “risk” used in prominent models of the efficient capital market hypothesis (ECMH), punishing investors who attempt to generate risk-free profits seems logical, if not sensible. The ECMH is the hypothesis that securities prices reflect all available information. Additional assumptions transform this hypothesis into the implication “that it is impossible to beat the market consistently on a risk-adjusted basis since market prices should only react to new information.” Here “beat the market” means generating profits that are greater than the returns of some index of the market. With these assumptions in mind, criminalizing the attempt to generate no-risk profits can seem logical if the existence of no-risk profits indicates market inefficiencies…and we accept that a proper role of government is increasing the efficiency of securities markets. Whether or not this approach is sensible depends on whether this model of risk bears any resemblance to anything operating in the real world. And even Eugene Fama who is thought of as the father of the ECMH, acknowledges that the model “is obviously an extreme null hypothesis. And, like any other extreme null hypothesis, we do not expect it to be literally true.

Sensible or not, I argue that U.S. courts have relied on the ECMH’s model of risk for almost 60 years. Consider just one of several examples cataloged in my forthcoming article, How Creepy Concepts Undermine Effective Insider Trading Reform. The Court in SEC v. Texas Gulf Sulphur Co. provides the following justification for imposing insider trading liability under Rule 10b-5:

It was the intent of Congress that all members of the investing public should be subject to identical market risks,—which market risks include, of course the risk that one’s evaluative capacity or one’s capital available to put at risk may exceed another’s capacity or capital. … [However] inequities based upon unequal access to knowledge should not be shrugged off as inevitable in our way of life, or, in view of the congressional concern in the area, remain uncorrected.

It may seem arbitrary to expect equal “risk” for market participants to mean equality of information, but not equality of capital or skill. However, this disconnect is in harmony with models of market efficiency that focus on whether securities prices always “fully reflect” available information. Other cases identifying the attempt to generate risk-free profits to justify imposing liability for insider trading include two cases related to Ivan Boesky and Michael Milken, and Justice Ruth Bader Ginsburg’s majority opinion in United States v. O’Hagan. To differentiate acceptable and unacceptable information advantages, Justice Ginsburg states that the “misappropriation theory targets information of a sort that misappropriators ordinarily capitalize upon to gain no-risk profits through the purchase or sale of securities.”

Can explaining liability for securities fraud by reference to “risk-free profits” mean anything other than the implicit adoption of the strong form of the ECMH? If prominent economic models inspire the reference to risk-free profits in these cases, then it is astounding how little has been said about this fact. It was a big deal when the United States Supreme Court relied on some assumptions of the semi-strong form of the ECMH to justify adopting the fraud on the market theory. It is puzzling how quietly this feature of the ECMH crept into the insider trading case law.

May 27, 2022 in Financial Markets, John Anderson, Securities Regulation | Permalink | Comments (2)

Wednesday, May 25, 2022

A Few Comments on Today's CFTC Staff Roundtable on Disintermediation

I spent much of today watching the CFTC Staff Roundtable on Disintermediation.  The focus of this event was the “disintermediation” or direct clearing that FTX – “an international cryptocurrency exchange valued at $32bn” – proposes to offer to U.S. retail customers (though the option for customers to use an intermediary should still exist).  The House Committee on Agriculture also recently held a hearing on this topic.  Sam Bankman-Fried, the 30-year-old FTX CEO, cofounder and billionaire, is the son of two Stanford University law professors

In a nutshell, FTX proposes to offer U.S. retail customers direct clearing, meaning they would no longer need intermediation by a futures commission merchant (FCM) as under the existing market structure, for cryptocurrencies (at least as the initial asset class).  FTX would calculate margin requirements every 30 seconds and computer algorithms would automatically start liquidating a customer’s positions in specified increments were a customer’s account to be under-margined.  Customers could post a wide variety of collateral, including cryptocurrencies, to meet margin requirements.  FTX plans to also contract with backup liquidity providers who would put up their own collateral as a backup and, potentially, be allocated a portion of a defaulter’s portfolio at a discount to the market price.  Hence, FTX’s proposal would largely automate clearinghouse risk management.  Roundtable participants commented at length upon whether largely removing human discretion from this process was a net positive or negative.    

When I first read about FTX’s clearing proposal (here) for U.S. retail investors, I thought it interesting, but I also worried about several things, including potential market stability issues from the rapid sale of a defaulter’s portfolio and conflicts of interest, particularly with the potential allocation of a defaulter’s portfolio.  Others mentioned similar concerns during today’s Roundtable.  On the other hand, I’ve noted in the past (here) the small number of FCMs and the tremendous concentration of margin being held by these handful of clearing members.  It’s a problem.   Direct clearing could be a potential solution to this issue.  However, direct clearing arrangements can also be problematic as illustrated in the case of an individual power trader directly clearing trades at a Nasdaq clearinghouse in 2018.   

I’ve now started wondering if the general investment risk clearinghouses’ face when they invest customers’ collateral could be exacerbated by FTX’s approach.  I don't recall mention of this concern.  However, what I know for sure is that I’ve much more to learn about this topic and look forward to keeping BLPB readers posted about this issue!

May 25, 2022 in Colleen Baker, Financial Markets | Permalink | Comments (0)

Friday, May 20, 2022

What Do FIFA, Nike, and PornHub Have In Common?

It's a lovely Friday night for grading papers for my Business and Human Rights course where we focused on ESG, the Sustainable Development Goals (SDGs), and the UN Guiding Principles on Business and Human Rights. My students met with in-house counsel, academics, and a consultant to institutional investors; held mock board meetings; heard directly from people who influenced the official drafts of EU's mandatory human rights and environmental due diligence directive  and the ABA's Model Contract Clauses for Human Rights; and conducted simulations (including acting as former Congolese rebels and staffers for Mitch McConnell during a conflict minerals exercise). Although I don't expect them all to specialize in this area of the law, I'm thrilled that they took the course so seriously, especially now with the Biden Administration rewriting its National Action Plan on Responsible Business Conduct with public comments due at the end of this month.

The papers at the top of my stack right now:

  1. Apple: The Latest Iphone's Camera Fails to Zoom Into the Company's Labor Exploitation
  2. TikTok Knows More About Your Child Than You Do: TikTok’s Violations of Children’s Human Right to Privacy in their Data and Personal Information
  3. Redraft of the Nestle v. Doe Supreme Court opinion
  4. Pornhub or Torthub? When “Commitment to Trust and Safety” Equals Safeguarding of Human Rights: A Case Study of Pornhub Through The Lens of Felites v. MindGeek 
  5. Principle Violations and Normative Breaches: the Dakota Access Pipeline - Human rights implications beyond the land and beyond the State
  6. FIFA’s Human Rights Commitments and Controversies: The Ugly Side of the Beautiful Game
  7. The Duty to Respect: An Analysis of Business, Climate Change, and Human Rights
  8. Just Wash It: How Nike uses woke-washing to cover up its workplace abuses
  9. Colombia’s armed conflict, business, and human rights
  10. Artificial Intelligence & Human Rights Implications: The Project Maven in the ‘Business of war.’
  11. A Human Rights Approach to “With Great Power Comes Great Responsibility”: Corporate Accountability and Regulation
  12. Don’t Talk to Strangers” and Other Antiquated Childhood Rules Because The Proverbial Stranger Now Lives in Your Phone
  13. Case studies on SnapChat, Nestle Bottling Company, Lush Cosmetics, YouTube Kidfluencers, and others 

Business and human rights touches more areas than most people expect including fast fashion, megasporting events, due diligence disclosures,  climate change and just transitions, AI and surveillance, infrastructure and project finance, the use of slave labor in supply chains, and socially responsible investing. If you're interested in learning more, check out the Business and Human Rights Resources Center, which tracks 10,000 companies around the world. 

May 20, 2022 in Compliance, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Human Rights, International Business, International Law, Marcia Narine Weldon, Securities Regulation, Teaching | Permalink | Comments (0)

Friday, April 29, 2022

"We Know Wrongful Trading When We See It" - Some Observations Concerning the Recent Senate Hearing on the Insider Trading Prohibition Act

Earlier this month, the U.S. Senate Committee on Banking, Housing, and Urban Affairs held a hearing on the Insider Trading Prohibition Act (ITPA), which passed the house with bipartisan support in May of last year. Some prominent scholars, like Professor Stephen Bainbridge, have criticized the ITPA as ambiguous in its text and overbroad in its application, while others, like Professor John Coffee, have expressed concern that it does not go far enough (mostly because the bill retains the “personal benefit” requirement for tipper-tippee liability).

My own view is that there are some good, bad, and ugly aspects of the bill. Starting with what’s good about the bill:

  • If made law, the ITPA would end what Professor Jeanne L. Schroeder calls the “jurisprudential scandal that insider trading is largely a common law federal offense” by codifying its elements.
  • The ITPA would bring trading on stolen information that is not acquired by deception (e.g., information acquired by breaking into a file cabinet or hacking a computer) within its scope. Such conduct would not incur Section 10b insider trading liability under the current enforcement regime.
  • The ITPA at least purports (more on this below) to only proscribe “wrongful” trading, or trading on information that is “obtained wrongfully.” Since violations of our insider trading laws incur criminal liability and stiff penalties, I have argued for some time that liability should be limited to conduct that is morally wrongful.
  • The ITPA preserves the “personal benefit” test as a limiting principal on what otherwise would be an ambiguous and potentially overbroad test for when tipping would breach a fiduciary or similar duty of trust and confidence. Traders need (and justice demands) bright lines that will allow them to determine ex ante whether their trading is legal or will incur 20 years of prison time (but more on this below).

Now, turning to what is bad about the bill, I share some concerns raised by Professor Todd Henderson in his testimony before the Senate Committee:

  • Though the ITPA codifies the personal benefit test as a limit on liability, it includes “indirect personal benefit[s]” within its scope. As Henderson points out, “[i]t is possible to describe virtually any human interaction as providing an ‘indirect benefit’ to the participants. Instead, the law should reflect the common sense notion that the source of information either received something tangible and valuable in return or what amounts to a monetary gift to a relative or friend.” The personal benefit test only fulfills its intended function as a limiting principle if it imposes real limits on liability. The test should therefore only be satisfied by objective evidence of self-dealing. If indirect psychological or other benefits that can be found in any voluntary human action can satisfy the test, then it cannot function as a limit on liability.
  • At least some versions of the ITPA include a catchall provision to the definition of wrongfully obtained or used information that would include “a breach of a confidentiality agreement, [or] a breach of contract.” Not only does this challenge the time-honored concept of efficient breach in the law of contracts, but as Professor Andrew Verstein has argued, this provision can open the door to the weaponization of insider trading law through the practice of “strategic tipping.” Professor Henderson raised this concern before the Senate committee, noting that so broad an understanding of wrongful trading is “ripe for abuse, with companies potentially able to prevent individual investors from trading merely by providing them with information whether they want it or not.” The recent examples of Mark Cuban and David Einhorn come to mind.
  • The ITPA would impose criminal liability for “reckless” conduct. As Henderson explained to the Committee, under the ITPA, “anyone who ‘was aware, consciously avoided being aware, or recklessly disregarded’ that the information was wrongfully obtained or communicated can have a case brought against them. The ITPA is silent on the meaning of ‘recklessly disregarded,’ which would appear to rope in innocent traders along with actual wrongdoers.” Moreover, permitting mere recklessness to satisfy the mens rea element of insider trading liability will no doubt have a chilling effect on good-faith transactions based on market rumors that would otherwise be value enhancing for traders, their clients, and the markets. The loss of such trades will diminish market liquidity and reduce price accuracy.
  • Finally, Henderson raised the concern that the ITPA lacks an “exclusivity clause stating that it will be the sole basis for bringing federal insider trading claims.” Henderson explained that “allowing prosecutors to cherry pick their preferred law is no way to provide clear rules for the market.” Professor Karen Woody has written about how prosecutors may be starting to bring insider trading cases under 18 U.S.C. § 1348 to avoid the court-imposed personal benefit test under Exchange Act §10b. Without an exclusivity clause, prosecutors will be free to make the same end run around the personal benefit test imposed by the ITPA.

Finally, the ITPA is straight-up ugly because, while it promises that it will limit insider trading liability (which can be punished by up to 20 years imprisonment) to only “wrongful” conduct, the bill defines the term “wrongful” in a way that suggests the drafters have no intention of delivering on that promise. For example, as noted above, some versions of the bill define any breach of contract as “wrongful,” but this is in clear tension with common sense, common law, and the doctrine of efficient breach.

In addition, though there is ambiguity in the text, current versions of the ITPA appear to embrace SEC Rule 10b5-1’s “awareness” test for when trading on material nonpublic information incurs insider trading liability. Under the awareness test, a corporate insider incurs insider trading liability if she is aware of material nonpublic information while trading for totally unrelated reasons. In other words, liability may be imposed even if the material nonpublic information played no motivational role in the decision to trade. But if the material nonpublic information played no motivational role, then the trading cannot be judged “wrongful” under any common-sense understanding of that term.

For these (and other reasons there is no space to address here), the ITPA leaves too much room for play in its definition of what constitutes “wrongful” trading and tipping to cohere with our common-sense understanding of that term. Former SEC Commission Robert J. Jackson assured the Committee that “we know wrongful trading when we see it.” Presumably Professor Jackson’s implication was that the SEC and DOJ can be trusted to exercise sound discretion in interpreting the play in the statutory language. In response, I offer the following question for Professor Jackson or any reader of the ITPA to consider: Would issuer-licensed insider trading violate the statute? I have defined “issuer licensed insider trading” as occurring where:

(1) the insider submits a written plan to the firm that details the proposed trade(s);

(2) the firm authorizes that plan;

(3) the firm has previously disclosed to the investing public that it will permit its employees to trade on the firm’s material nonpublic information when it is in the interest of the firm to grant such permission; and

(4) the firm discloses ex post all trading profits resulting from the execution of these plans.

I have argued that trading under these conditions is neither morally wrongful nor harmful to markets. If it violates ITPA, what provisions? I hope some readers will share their thoughts on this in the comments below!

April 29, 2022 in Current Affairs, Ethics, Financial Markets, John Anderson, Securities Regulation, White Collar Crime | Permalink | Comments (1)

Wednesday, April 27, 2022

Recently Released - the IMF's Global Financial Stability Report April 2022

The IMF recently released its Global Financial Stability Report April 2022.  The Executive Summary provides an informative overview of the financial risks facing markets in these turbulent times.  I was particularly interested in Box 1.1 of the Report: Extreme Volatility in Commodities: The Nickel Trading Suspension.  For those readers who might be unaware, the London Metal Exchange (LME) halted nickel trading "on March 8 after prices doubled over the course of a day to a record $100,000 (£76,200) a tonne"  and cancelled all nickel transactions that day.  Nickel is a key metal for electric car batteries.  Not surprisingly, the LME’s actions proved controversial and are now the subject of several regulatory investigations.  As the end of the Executive Summary highlights: “Recent measures taken in markets and exchanges in response to elevated volatility in commodity prices highlight the need for regulators to examine the broader implications, including exchange governance mechanisms, resiliency of trading systems, concentration of risk, margin setting, and trading transparency in exchange and over-the-counter markets” (p. xiv).    

April 27, 2022 in Colleen Baker, Financial Markets | Permalink | Comments (1)

Saturday, April 23, 2022

Elon Musk is a Blessing and a Curse

I'm doing what may seem crazy to some- teaching Business Associations to 1Ls. I have a group of 65 motivated students who have an interest in business and voluntarily chose to take the hardest possible elective with one of the hardest possible professors. But wait, there's more. I'm cramming a 4-credit class into 3 credits. These students, some of whom are  learning the rule against perpetuities in Property and the battle of the forms in Contracts while learning the business judgment rule, are clearly masochists. 

If you're a professor or a student, you're coming close to the end of the semester and you're trying to cram everything in. Enter Elon Musk. 

I told them to just skim Basic v. Levenson and instead we used Rasella v. Musk, the case brought by investors claiming fraud on the market. Coincidentally, my students were already reading In Re Tesla Motors, Inc. Stockholder Litigation because it was in their textbook to illustrate the concept of a controlling shareholder. Elon's pursuit of Twitter allowed me to use that company's 2022 proxy statement and ask them why Twitter would choose to be "for" a proposal to declassify its board, given all that's going on. Perhaps that vote will be moot by the time the shareholder's meeting happens at the end of May. The Twitter 8-K provides a great illustration of the real-time filings that need to take place under the securities laws, in this case due to the implementation of a poison pill. Elon's Love Me Tender tweet provides a fun way to take about tender offers. How will the Twitter board fulfill it's Revlon duties? So much to discuss and so little time. But the shenanigans have made teaching and learning about these issues more fun. And who knew so many of my students held Twitter and Tesla stock?

I've used the Musk saga for my business and human rights class too. I had attended the Emerge Americas conference earlier in the week and Alex Ohanian, billionaire founder of Reddit, venture capitalist, and Serena Williams' husband, had to walk a fine line when answering questions about Musk from the CNBC reporter. The line that stuck out to me was his admonition that running a social media company is like being a head of state with the level of responsibility. I decided to bring this up on the last day of my business and human rights class because I was doing an overview of what we had learned during the semester. As I turned to my slide about the role of tech companies in society, we ended up in a 30 minute debate in class about what Musk's potential ownership of Twitter could mean for democracy and human rights around the world. Interestingly, the class seemed almost evenly split in their views. While my business associations students are looking at the issue in a more straightforward manner as a vehicle to learn about key concepts (with some asking for investment advice as well, which I refused), my business and human rights students had a much more visceral reaction. 

Elon is a gift that keeps on giving for professors. He's a blessing because he's bringing concepts to life at a time in the semester where we are all mentally and physically exhausted. Depending on who you talk to in my BHR class and in some quarters of the media, he's also a curse.

All I know is that I don't know how I'll top this semester for real-world, just-in-time application.

Thanks, Elon.

Signed,

A tired but newly energized professor who plans to assign Ann Lipton's excellent Musk tweets as homework. 

 

 

 

 

 

April 23, 2022 in Corporate Governance, Corporate Personality, Corporations, Current Affairs, Financial Markets, Law School, Management, Marcia Narine Weldon, Securities Regulation, Shareholders | Permalink | Comments (0)

Friday, April 15, 2022

Is the SEC Proposing a "Loaded Question" Climate Disclosure Regime?

Shortly after President Barack Obama’s first press conference in 2009, the Huffington Post published an article, "When Did You Stop Beating Your Wife?", that challenged the false premises of many of the questions being asked of the new president. The article opens by noting:

Sooner or later every human being on the face of this planet is confronted with tough questions. One of the toughest and most common is the infamous loaded question, “when did you stop beating your wife?” which implies that you have indeed been beating your wife. How do you answer without agreeing with the implication? How do you not answer without appearing evasive?

The author’s solution is that you should refuse to answer the question by simply responding, “no,” or by challenging the false assumption imbedded in the question. But what if the question is not asked at a press conference, by opposing counsel in the courtroom, or at a cocktail party, but as part of a federally mandated disclosure regime? This is a dilemma issuers may face if the Securities and Exchange Commission’s (SEC’s) proposed rule to "Enhance and Standardize Climate-Related Disclosures for Investors" is adopted.

Existing SEC disclosure rules and guidance already require that issuers disclose man-made-climate-change-related risks that would materially impact market participants’ investment decisions concerning the company. Nevertheless, the SEC has determined that the existing regime grants boards too much discretion in deciding whether and how to disclose climate risk—which has resulted in climate-related disclosures that are insufficiently "consistent," "comparable," and "clear."

The SEC’s proposed changes to the disclosure regime would compel all publicly-traded companies to answer specific, standardized climate-related questions concerning, for example, the physical risks of human-caused-climate-related events (e.g., “severe weather events and other natural conditions”) on their business models and earnings in a manner that will be consistent and comparable with the answers of the thousands of other regulated issuers. But what if the boards’ honest answers to these difficult questions cannot be made to fit the SEC’s proposed one-size-fits-all mold? What if some issuers question the premises of the questions?

What if, for example, a board is not convinced that extreme weather events such as hurricanes, tornadoes, wildfires, droughts, etc., can be traced directly to human versus non-human causes? In such circumstances, mandatory reporting on either transitional or physical risks due to human-caused climate change might look a lot like mandatory disclosures on questions like “When did you stop beating your spouse?” Can issuers satisfy the SEC’s reporting requirements by simply answering “no,” as the Huffington Post author suggested President Obama should have answered such questions, or by challenging the premise of the question?

There is no doubt that the extent, effects, and appropriate response to human-caused-climate change is a partisan issue in the United States. One Vanderbilt survey found that 77.3% of respondents who identify as “liberal” believe that climate change is a serious problem, but only 17.2% of those who identify as “conservative” regard climate change as a serious problem. Moreover, the division over the impacts and appropriate responses to climate change are not just political—they exist in the scientific community as well. For example, Steven E. Koonin, a former Undersecretary for Science in the U.S. Department of Energy under President Obama, and member of the Academy of Sciences, recently published a book, Unsettled: What Climate Science Tells Us, What It Doesn’t, and Why It Matters, which questions a number of the premises informing the SEC’s proposed disclosure regime.

Take, as just one example, the proposed rule’s mandatory disclosure of “physical” risks to issuers due to extreme weather events resulting from human-caused-climate change. The home page of the Task Force on Climate-Related Financial Disclosures, which the SEC credits as a principal source for its proposed rule, includes a video presentation by former Democratic Presidential Candidate, Michael Bloomberg, stating that climate change is a “crisis that shocked the [financial] system” in 2021: “wildfires, heat, flooding, and other extreme weather events have devastated communities and cost trillions of dollars this year alone.”

The premise of Bloomberg’s statement, which the SEC has effectively adopted, is that our models can reliably trace these extreme weather events to human causes. But is this true? Koonin points out that while a recent U.S. government climate report claims that heat waves across the U.S. have become more frequent since 1960, it “neglected to mention that the body of the report shows they are no more common today than they were in 1900.” Koonin also points out similar holes in common claims that human-caused climate change is responsible for extreme weather events like flooding, wildfires, and hurricanes. More fundamentally, Koonin argues that the new field of “event attribution science,” which provides the principal basis for claimed causal links between human influences and extreme weather events is “rife with issues,” and he is “appalled such studies are given credence, much less media coverage.”

None of the above should be interpreted as an attempt on my part to take sides in the climate debate. (I am no authority; my PhD is in philosophy, not in anything useful.) It is just to illustrate how these issues continue to be highly contested subjects of debate in both political and scientific circles.

The worry I raise here is that this sphere of discourse is far too contested and politically charged to be the subject of a mandatory disclosure regime. In response to challenges by Commissioner Hester Peirce and others that the SEC’s proposed rule on climate disclosure compels speech in a manner inconsistent with the First Amendment, Commissioner Gensler has responded that the reporting requirements do not mandate content. But, again, is this correct? If the disclosure questions are loaded, don’t they (at least implicitly) dictate the content of the response—particularly if the questions are carefully designed to elicit “standardized,” “consistent,” “comparable,” and “clear” answers?

April 15, 2022 in Corporate Governance, Financial Markets, John Anderson, Securities Regulation | Permalink | Comments (1)

Friday, March 25, 2022

Post-pandemic evolution, change management, and the role of in-house counsel

Join me in sunny Miami on April 26 for this in-person conference featuring outside counsel, inhouse practitioners, and academics. 

Panel topics include:

Change Management: The Legal Department of the Future -  More and more, in-house legal departments are employing new hybrid and remote work models, incorporating artificial intelligence and technology in their workflows, and restructuring and absorbing new teams after mergers, acquisitions, and divestitures. This panel discussion will focus on how the in-house legal department can be a champion in leading successful developmental and transformational change by implementing change management best practices to be effective and efficient, remaining client-focused, and being a trusted business advisor.

Remote Work:  Accelerated Adoption and Related Challenges - Which option would you choose: on-site, hybrid, or virtual? We will discuss the pros and cons of remote work arrangements, including the challenges of implementing a remote work policy in Latin America where the legal framework is a complex patchwork of requirements, as well as the strategies for creating culture and building a team in a remote work environment.

Counseling the Board of Directors (the panel I'm on)-  This panel will focus on issues that arise when counseling the board of directors and address important topics, including governance, ethics, fiduciary duties, director liability, best practices (diversity and environmental, social, and governance (ESG)), privileged insurance, and D&O insurance all in the context of private and public companies operating in the United States and Latin America.

Supply Chain: Challenges and Opportunities- Lessons learned from recent disruptions in global supply chains will shape crossborder business in the coming years. Our panel will discuss short- and long-term challenges and opportunities in supply chain management and logistics, as well as practical strategies for using technology, contractual protections, and risk-transfer solutions to overcome future supply-chain challenges.

What Is Your Company’s ESG Score? This panel will discuss the origins of climate change management, sustainability and how to operationalize it at your company, as well as how to transition to a low-carbon economy— including standards and disclosures. Panelists will also discuss the importance of implementing mechanisms to adopt a company’s ESG score as an ethical obligation to company commitments and as a governance imperative.

Click here to register.

If you make it down to Miami, I promise to buy you a mojito or cafecito. And don't worry, hurricane season doesn't start until June. 

 

March 25, 2022 in Compliance, Conferences, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, Financial Markets, International Business, Law Firms, Lawyering, Marcia Narine Weldon | Permalink | Comments (0)

Tuesday, March 22, 2022

Guttentag's Response to My Post Concerning His Article on Insider Trading as Wasteful Competition

The following comes to us from Professor Mike Guttentag in response to my recent post on his excellent and thought-provoking new article, Avoiding Wasteful Competition: Why Trading on Inside Information Should be Illegal. This is a worhy discussion I look forward to continuing--and I hope others will engage in the comments below. Now, here is Professor Guttentag's response:

As always, I am honored and impressed by the seriousness and respect with which Professor Anderson approaches my work.  I would, however, take exception to the reasons he offers for rejecting my conclusions.

The debate about insider trading over the past five decades has suffered from limited evidence of either benefits or harms. Those who have objected to a strict insider trading prohibition have reasonably asked: what evidence is there that the harms of insider trading justify a broad prohibition?

In my article I believe I have answered that challenge.  First, I explain why there is a significant mismatch between private gains and social gains when trading on inside information. This mismatch arises both because of how inside information is produced (largely as a byproduct of other activities) and how trading on this information generates profits (at the expense of others). I next show how this mismatch between private gains and social gains (perhaps the defining economic feature of insider trading) leads to an unusual problem: the problem of too much or wasteful competition. This is not just a theoretical concern. I offer concrete estimates of the magnitude of the costs of this wasteful competition problem. One very conservative estimate puts the costs of wasteful competition in United States equity markets in the range of tens of billions of dollars a year. The logic is compelling, and the amounts involved substantial: insider trading is a socially wasteful activity that should be outlawed. 

The time has now come for those who would do less than outlaw all trading when in possession of inside information to provide either equally compelling evidence of the benefits of an alternative regime or an explanation as to why my calculations are flawed. I do not believe that Anderson’s critiques meet either of these challenges.  

I will go through Anderson’s critiques one by one. The first concern Anderson raises is that he believes my argument hinges on the claim that all inside information is produced as a byproduct of other activities. Anderson has read my argument as relying on a stronger claim than I think it needs to rely on. I do not aim to refute the vast body of work by the likes of Henry Manne and many, many others on the various costs and benefits of insider trading. These lists of the potential costs and benefits established over the past decades are largely correct. However, there are two problems with these lists. First, these lists have consistently failed to realize the magnitude and importance of the wasteful competition problem created by insider trading (I have addressed the reasons for this oversight elsewhere, Law and Surplus: Opportunities Missed). Second, once the costs of wasteful competition are included in the calculus the appropriate starting point shifts. Given how significant the wasteful competition problem is, we need more than just a list of plausible but hard-to-quantify costs and benefits to rebut the presumption that all trading when in possession of inside information should be outlawed. That is the extent of my claim.

The second point that Anderson raises in his comments is that he does not think I have carried out an adequate “comparative institutional approach to market failure.” In fact, I think I do a fair job in the article of addressing this question, and show, for example, why private ordering is not an effective alternative to legal intervention as a way to address the wasteful competition problem created by insider trading. Moreover, the correct comparison should be between the cost of our muddled and confused current regime and the simple proposal I offer, a proposal, by the way, that is similar to the insider trading prohibition already in place in Europe (albeit with less enforcement capability in Europe). I do not see what institution Anderson thinks could do a better job addressing the problem I have identified than the federal government. As a side note, if we want to minimize the kind of rent-seeking by government officials that Anderson also mentions, then a bright-line such as the one I propose might well be preferable to the murky waters that now surround the insider trading prohibition.

The third point Anderson raises is that he finds my consideration of internal compliance costs lacking.  My response to this observation is: internal compliance costs as compared to what baseline? The current system is a quagmire, whereas the one I propose would be more straightforward to implement. It seems to me that when it comes to minimizing internal compliance costs my proposal is preferable to the status quo.  But even if I am incorrect about the relative costs of internal compliance under different regulatory regimes the larger point remains: discussions of these kinds of second order, difficult-to-quantify cost simply do not offer enough evidence to justify accepting the costs of wasteful competition that a very conservative estimate puts in the range of tens of billions of dollars a year in only one marketplace.

The fourth point Anderson raises is yet another potential cost of my proposal as compared to the status quo. Anderson correctly points out that my rule may be over-inclusive and prevent some individuals from gathering and trading on information for which social gains are equal to or greater than private gains. This is true. However, again, where is the concrete evidence that these costs of over-inclusivity are anything near the magnitude of the quantifiable costs that result from wasteful competition. The evidence in support of a sweeping prohibition remains.

Finally, Anderson raises the specter of criminal punishment. I did not hope, as Anderson suggests, to fully “detach my model from the debate over the morality of insider trading.” I only rejected current efforts to base an insider trading prohibition on fairness concerns. In terms of advancing my own arguments, I felt that as a practical matter the topic of links between solutions to a wasteful competition problem and criminality was too vast to fit in an already long article. For those who are interested, I have begun to further explore these connections elsewhere in work on the relationships between evolutionary psychology and the use of law as a tool to share resources.

The one point I did make in the article relevant to the question of criminal liability for insider trading was to observe that engaging wasteful competition can trigger moral outrage in some circumstances. Such feelings can be observed, for example, when others react to people cutting in line. We have normative reactions to people who pursue their naked self-interest in situations where payoffs through cooperation are greater than those that can be realized through competition by, for example, refusing to honor a queue.  Anderson investigates this analogy by asking about someone who has permission to cut in line.  Presumably, he means to draw a parallel to issuer-sanctioned insider trading wherein firms allow employees to trade on material nonpublic information. The question of whether or how permission to cut in line might be granted is quite complex and is a topic for another day. I only hoped in this article to suggest why there might be a link between my conclusion that avoiding wasteful competition justifies an insider trading prohibition and the choice to criminalize insider trading.

Again, I truly appreciate Anderson’s honest engagement with my work. However, I think he fails to provide a compelling rebuttal. What we need now in the United States is a prohibition on all trading when in possession of inside information.

March 22, 2022 in Corporations, Ethics, Financial Markets, John Anderson, Law and Economics, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Friday, March 18, 2022

Guttentag on Wasteful Competition and Insider Trading Reform

For some time now, the insider trading enforcement regime in the United States has been criticized by market participants, scholars, and jurists alike as lacking clarity, theoretical integrity, and a coherent rationale. One problem is that Congress has never enacted a statute that specifically defines “insider trading.” Instead, the current regime has been cobbled together on an ad hoc basis through the common law and administrative proceedings. As the recent Report of the Bharara Task Force on Insider Trading puts it, the absence of an insider trading statute “has left market participants without sufficient guidance on how to comport themselves, prosecutors and regulators with undue challenges in holding wrongful actors accountable, those accused of misconduct with burdens in defending themselves, and the public with reason to question the fairness and integrity of our securities markets.”

Congress appears to be responding, and a number of bills that would define insider trading and otherwise reform the enforcement regime are receiving bipartisan support. But it would be a mistake to pass new legislation without first taking the time to get clear on the economic and ethical reasons for regulating insider trading. This is particularly true in light of the fact that the general public is clearly ambivalent about whether and why insider trading should be regulated.

Mike Guttentag's new article, Avoiding Wasteful Competition: Why Trading on Inside Information Should Be Illegal, offers an important new (or at least heretofore underappreciated) lens through which the potential costs of insider trading may be identified. For Guttentag, inside information is generally created as a mere byproduct of otherwise productive economic activity. But though it takes no additional effort to create, it has significant economic value for those who can trade on it. The rush to capture this surplus results in “wasteful competition because competition for surplus (or rent-seeking in the terminology economists prefer) is both hard to prevent and inherently wasteful.” Absent comprehensive regulation of insider trading, vast resources would be wasted in efforts by market participants to capture what Guttentag estimates may amount to tens of billions of dollars in potential insider trading profits each year.

Since the problem of wasteful competition arises whenever trading with material nonpublic information is permitted, Guttentag recommends “(1) that federal insider trading legislation should be enacted that prohibits all trading on inside information regardless of whether the information is wrongfully acquired, (2) courts should not require proof that a tipper received a personal benefit to find tippers and tippees culpable, and (3) the mere possession of inside information should be sufficient to trigger a trading prohibition.”

Guttentag’s arguments are original and compelling, but I am not convinced they justify the reforms he proposes. Here are some of my reasons:

  • First, Guttentag’s wasteful competition argument turns on the claim that all inside information is a mere byproduct of otherwise productive activity. But this seems to beg the question against Henry Manne and others who have argued that insider trading as compensation can be an effective incentive for entrepreneurship and innovation at firms. And this incentive can come at a savings to shareholders by reducing the need for other forms of compensation. If the production of inside information is part of the motivation behind innovation, it is not a surplus. Guttentag does address some (though not all) of Manne’s arguments concerning insider trading as compensation, but I would like to see a more complete treatment.
  • Second, even if we are convinced that insider trading drives wasteful rent-seeking, I’m not sure Guttentag has shown that the broad enforcement regime he recommends is the appropriate response. Under the comparative institutional approach to market failure, the proponent of regulation needs to show the regulation would improve matters. Rent-seekers come in all shapes and sizes, and government agencies such as the SEC are by no means immune to the temptation to engage in rent-seeking and rent-selling. Expanded authority would no doubt increase the opportunities and incentives for such wasteful action on the part of the regulators. Guttentag fails to address this concern.
  • Third, Guttentag fails to acknowledge the internal compliance costs his proposed expansion of liability will impose on issuers. I address the significant costs of insider trading compliance in my article, Solving the Paradox of Insider Trading Compliance. I suspect these already significant costs (and incentives to rent-seek from regulators) would only increase under Guttentag’s proposed regime. This concern should be considered as part of a comparative institutional analysis.
  • Fourth, Guttentag’s proposed reform would impose liability for trading while in possession of inside information even if that information played no part in the trading. But trading for reasons unrelated to inside information does not evidence wasteful competition for that information. Guttentag’s rationale cannot therefore justify this rule. He suggests that this mere possession rule can be justified as a prophylactic measure—simplifying enforcement of insider trading that does derive from wasteful competition. Guttentag fails, however, to consider the significant costs (e.g., in terms of [a] liquidity for those who are compensated with equity and [b] the preclusion of otherwise innocent, value-enhancing trades) the broad restriction would impose on the insiders, the issuers, and the market more broadly.
  • Finally, Guttentag considers it a virtue of his wasteful competition model that it does not rely on any controversial claims regarding the ethics of insider trading to justify its regulation. His model imposes liability on those who trade while possessing inside information because it is wasteful—not because it is wrongful. But insider trading liability in the United States has historically carried stiff criminal penalties. Guttentag is comfortable with the idea that these penalties be imposed under his proposed regime as well. This makes me wonder what other criminal sanctions for morally innocent but wasteful behavior this logic might justify. Guttentag seems to anticipate this concern and hedges a bit by suggesting that wasteful behavior may not be morally innocent after all. He notes that, for example, those who engage in wasteful behavior like cutting in line typically elicit “strong feelings of moral disapproval.” First, this may be true, but what about those who ask permission to cut (for some good reason)—and receive that permission? Such persons’ behavior would be just as wasteful, but would probably not receive the same moral disapproval. Second, to the extent Guttentag considers detaching his model from the debate over the morality of insider trading, this line-cutting example pulls him right back in.

Despite these concerns, I am convinced that Guttentag’s new article advances the discussion about why insider trading is (or can be) harmful to markets and society. I recommend it to anyone who wishes to be educated on the subject. Here’s the abstract to Mike’s article:

This article offers a new and compelling reason to make all trading based on inside information illegal.

The value realized by trading on inside information is unusual in two respects. First, inside information is produced at little or no incremental cost and is nevertheless quite valuable. Second, profits made from trading on inside information come largely at the expense of others. When the value of something exceeds the cost to produce it, a wasteful race to be the first to capture the resulting surplus is likely to ensue. Similarly, resources expended solely to take something of value from others are wasted from an overall social welfare perspective. Thus, both at its source and in its use inside information invites wasteful competition. A law prohibiting insider trading is the best way to avoid this wasteful competition.

Previous scholarship misses this obvious conclusion because of its reliance on one of three assumptions. First, wasteful competition is assumed to be a problem that markets can rectify. Second, private ordering solutions are assumed to be available even when market mechanisms fail to address this problem. Third, a wasteful race to acquire and use inside information is viewed as otherwise unavoidable. None of these assumptions is correct.

The findings here have immediate policy implications. First, insider trading legislation should be enacted that bans all insider trading and not just trading based on wrongfully acquired information. Second, there is no reason to require proof that a tipper received a personal benefit to prosecute someone for tipping inside information. Third, the possession and not the use of inside information should be enough to trigger a trading prohibition.

March 18, 2022 in Corporations, Ethics, Financial Markets, John Anderson, Law and Economics, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Wednesday, March 2, 2022

Menand on The Logic and Limits of the Federal Reserve Act

Professor Lev Menand has written another must read article on the Fed, The Logic and Limits of the Federal Reserve Act.  It's a timely and incredibly important piece that I recommend to all BLPB readers.  Here's the abstract:

"Over the past fourteen years, the U.S. Federal Reserve has rescued overleveraged financial companies, purchased trillions of dollars of mortgage-backed securities, and created novel facilities to support ordinary businesses, nonprofits, and local governments. While some argue that the Fed has gone too far, others believe that it should expand its ambit further still to address issues such as climate change, racial injustice, and crumbling infrastructure. This Article seeks to clarify the nature and stakes of this debate by recovering the logic and limits of the Federal Reserve Act. It argues that to understand the Fed it is necessary first to understand the U.S. system of money and banking. That system uses publicly chartered, investor-owned banks to issue most of the money supply. Congress designed the Fed for a limited purpose: to administer the banking system. And Congress equipped the Fed with an integrated set of tools to achieve a specific objective: ensure that the banking system creates enough money to keep economic resources productively employed nationwide. The rise of shadow banks—firms that issue money instruments without a bank charter—has impaired the Fed’s tools. As the Fed has scrambled to adapt, it has taken on tasks it was never designed to handle. This has prompted calls for it to do more and pleas for it to do less. These conflicting demands reflect rival visions about how to divide responsibility for creating money between politicians, technocrats, and private interests. These visions are often untethered from the considerations that animate existing law, sidelining politicians and elevating technocrats and investors. Only by reexamining the Fed’s statutory framework can we appreciate the fault lines in the present debate and evaluate the Fed’s capacity in the future."

 

March 2, 2022 in Colleen Baker, Financial Markets | Permalink | Comments (0)

Monday, February 28, 2022

2022 Online Symposium – Mainstreet vs. Wallstreet: The Democratization of Investing Friday, March 4 12:30-3:30

2022 Online Symposium – Mainstreet vs. Wallstreet: The Democratization of Investing

I'm thrilled to moderate two panels this Friday and one features our rock star BLPB editor, Ben Edwards. 

                                                                     REGISTER HERE

The University of Miami Business Law Review is hosting its 2022 online symposium on Friday, March 4, 2022. The symposium will run from 12:30 PM to 3:30 PM. The symposium will be conducted via Zoom. Attendees can apply to receive CLE credits for attending this event—3.5 CLE credits have been approved by the Florida Bar. 

The symposium will host two sessions with expert panelists discussing the gamification of trading platforms and the growing popularity of aligning investments with personal values.

The panels will be moderated by Professor Marcia Narine Weldon, who is the director of the Transactional Skills Program, Faculty Coordinator of the Business Compliance & Sustainability Concentration, and a Lecturer in Law at the University of Miami School of Law.

Panel 1: Gamification of Trading 

This panel will focus on the role of social media and “gamification” of trading apps/platforms in democratizing investing, and the risks that such technology may influence investor behavior (i.e., increase in trading, higher risk trading strategies like options and margin use, etc.).

Gerri Walsh:

Gerri Walsh is Senior Vice President of Investor Education at the Financial Industry Regulatory Authority (FINRA). In this capacity, she is responsible for the development and operations of FINRA’s investor education program. She is also President of the FINRA Investor Education Foundation, where she manages the Foundation’s strategic initiatives to educate and protect investors and to benchmark and foster financial capability for all Americans, especially underserved audiences. Ms. Walsh was the founding executive sponsor of FINRA’s Military Community Employee Resource Group. She serves on the Advisory Council to the Stanford Center on Longevity and represents FINRA on IOSCO’s standing policy committee on retail investor education, the Jump$tart Coalition for Personal Financial Literacy, NASAA’s Senior Investor Advisory Council and the Wharton Pension Research Council.

Prior to joining FINRA in May 2006, Ms. Walsh was Deputy Director of the Securities and Exchange Commission’s Office of Investor Education and Assistance (OIEA) and, before that, Special Counsel to the Director of OIEA. She also served as a senior attorney in the SEC’s Division of Enforcement, investigating and prosecuting violators of the federal securities laws. Before that, she practiced law as an associate with Hogan Lovells in Washington, D.C.

Ari Bargil:

Ari Bargil is an attorney with the Institute for Justice. He joined IJ’s Miami Office in September of 2012, and litigates constitutional cases protecting economic liberty, property rights, school choice, and free speech in both federal and state courts.

In 2019, Ari successfully defended two of Florida’s most popular school choice programs, the McKay Program for Students with Disabilities and the Florida Tax Credit Program, before the Florida Supreme Court. As a direct result of the victory, over 120,000 students in Florida have access to scholarships that empower them to attend the schools of their choice.

Ari also regularly defends property owners battling aggressive zoning regulations and excessive fines in state and federal court nationwide and litigates on behalf of entrepreneurs in cutting-edge First Amendment cases. He was co-counsel in a federal appellate court victory vindicating the right of a Florida dairy creamery to tell the truth on its labels, and he is currently litigating in federal appellate court to secure a holistic health coach’s right to share advice about nutrition with her clients. In 2017, Ari was honored by the Daily Business Review as one of South Florida’s “Most Effective Lawyers.”

In addition to litigation, Ari regularly testifies before state and local legislative bodies and committees on issues ranging from occupational licensing to property rights regulation. Ari has also spearheaded several successful legislative campaigns in Florida, including the effort to legalize the sale of 64-ounce “growlers” by craft breweries and the Florida Legislature’s passage of the Right to Garden Act—a reform which made it unlawful for local governments to ban residential vegetable gardens throughout the state.

Ari’s work has been featured by USA Today, NPR, Fox News, Washington Post, Miami Herald, Dallas Morning News and other national and local publications.

Christine Lazaro:

Christine Lazaro is Director of the Securities Arbitration Clinic at St. John’s University School of Law. She joined the faculty at St. John’s in 2007 as the Clinic’s Supervising Attorney. She is also a faculty advisor for the Corporate and Securities Law Society.

Prior to joining the Securities Arbitration Clinic, Professor Lazaro was an associate at the boutique law firm of Davidson & Grannum, LLP.  At the firm, she represented broker-dealers and individual brokers in disputes with clients in both arbitration and mediation.  She also handled employment law cases and debt collection cases.  Professor Lazaro was the primary attorney in the firm’s area of practice that dealt with advising broker-dealers regarding investment contracts they had with various municipalities and government entities.  Professor Lazaro is also of Counsel to the Law Offices of Brent A. Burns, LLC, where she consults on securities arbitration and regulatory matters.

Professor Lazaro is a member of the New York State and the American Bar Associations, and the Public Investors Arbitration Bar Association (PIABA). Professor Lazaro is a past President of PIABA and is a member of the Board of Directors.  She is also a co-chair of PIABA’S Fiduciary Standards Committee, and is a member of the Executive, Legislation, Securities Law Seminar, and SRO Committees. Additionally, Professor Lazaro is the co-chair of the Securities Disputes Committee in the Dispute Resolution Section of the New York State Bar Association and serves on the FINRA Investor Issues Advisory Committee. 

Panel 2: ESG Investing

The second panel will address the growing popularity of ESG funds among investors that want to align their investments with their personal values, and the questions/concerns that arise with ESG funds, including: 1) explaining what they are; 2) discussing the varying definitions and disclosure issues; 3) exploring if investors really give up better market performance if they invest in funds that align with their values; and 4) asking if the increased interest in ESG funds affect corporate change? 

Thomas Riesenberg:

Mr. Riesenberg is Senior Regulatory Advisor to Ceres, working on climate change issues. He previously worked as an advisor to EY Global’s Office of Public Policy on ESG regulatory issues. Before that he worked as the Director of Legal and Regulatory Policy at The Sustainability Accounting Standards Board pursuant to a secondment from EY. At SASB he worked on a range of US and non-US policy matters for nearly seven years. He served for more than 20 years as counsel to EY, including as the Deputy General Counsel responsible for regulatory matters, primarily involving the SEC and the PCAOB. Previously he served for seven years as an Assistant General Counsel at the U.S. Securities and Exchange Commission where he handled court of appeals and Supreme Court cases involving issues such as insider trading, broker-dealer regulation, and financial fraud. While at the SEC he received the Manuel Cohen Outstanding Younger Lawyer Award for his work on significant enforcement cases. He also worked as a law clerk for a federal district court judge in Washington, D.C., as a litigator on environmental matters at the U.S. Department of Justice, and as an associate at a major Washington, D.C. law firm.

Mr. Riesenberg graduated from the New York University School of Law, where he was a member of the Law Review and a Root-Tilden Scholar (full-tuition scholarship). He received a bachelor’s degree from Oberlin College, where he graduated with honors and was elected to Phi Beta Kappa. He is a former chair of the Law and Accounting Committee of the American Bar Association, former president of the Association of SEC Alumni, former treasurer of the SEC Historical Society, and a current member of the Advisory Board of the BNA Securities Regulation and Law Report. For seven years he was an adjunct professor of securities law at the Georgetown University Law Center. He is an elected member of the American Law Institute. He serves on the boards of several nonprofit organizations, including the D.C. Jewish Community Relations Council and the Washington Tennis & Education Foundation. He is the author of numerous articles on securities law and ESG disclosure issues.

Benjamin Edwards:

Benjamin Edwards joined the faculty of the William S. Boyd School of Law at the University of Nevada, Las Vegas in 2017. In addition to being the Director of the Public Policy Clinic, he researches and writes about business and securities law, corporate governance, arbitration, and consumer protection. Prior to teaching, Professor Edwards practiced as a securities litigator in the New York office of Skadden, Arps, Slate, Meagher & Flom LLP. At Skadden, he represented clients in complex civil litigation, including securities class actions arising out of the Madoff Ponzi scheme and litigation arising out of the 2008 financial crisis.

Max Schatzow:

Max Schatzow is a co-founder and partner of RIA Lawyers LLC—a boutique law firm that focuses almost exclusively on representing investment advisers with legal and regulatory issues. Prior to RIA Lawyers, Max worked at Morgan Lewis representing some of the largest financial institutions in the United States and at another law firm where he represented investment advisers and broker-dealers. Max is a business-minded regulatory lawyer that always tries to put himself in the client’s position. He assists clients in all aspects of forming, registering, owning, and operating an investment adviser. He prides himself in preparing clients and their compliance programs to avert regulatory issues, but also assists clients through examinations and enforcement issues. In addition, Max assists advisers that manage private investment funds. In his little spare time, Max enjoys the Peloton (both stationary and road), golf, craft beer, and spending time with his wife and two children.

February 28, 2022 in Compliance, Conferences, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Law Reviews, Law School, Lawyering, Legislation, Marcia Narine Weldon, Research/Scholarhip, Securities Regulation | Permalink | Comments (0)

Friday, January 7, 2022

AALS Annual Meeting 2022 Discussion Group on "A Very Online Economy"

We just wrapped up a fascinating discussion group titled "A Very Online Economy: Meme Trading, Bitcoin, and the Crisis of Trust and Value(s)--How Should the Law Respond?" as part of the AALS 2022 Annual Meeting. I co-moderated the group with Professor Martin Edwards (Belmont University School of Law). Here's the description:

Emergent forces emanating from social and financial technologies are challenging many underlying assumptions about the workings of markets, the nature of firms, and our social relationship with our economic institutions. Blockchain technologies challenge our assumptions about the need for centralization, trust, and financial institutions. Meme trading puts pressure on our assumptions about economic value and market processes. Environmental and social governance initiatives raise important questions about the relationship between economic institutions and social values. These issues will certainly drive policy debates about social and economic good in the coming years.

The group gathered some amazing presenters and commentators for the discussion, including:

The discussion was lively and informative, and I look forward to seeing the final versions of these projects in print! 

January 7, 2022 in Corporate Governance, Corporations, Financial Markets, John Anderson, Securities Regulation, Technology, Web/Tech | Permalink | Comments (0)

Wednesday, December 29, 2021

Now Available: FinTech: Law and Regulation (2nd edition)

As the year quickly draws to a close, I want to wish BLPB readers a Happy New Year and a wonderful start to 2022!  I also wanted to share some exciting end of the year news: the 2nd edition of FinTech: Law and Regulation (ed. Jelena Madir) is now available (here and here)!  I’m honored to have contributed a chapter, Blockchain in Financial Services, with coauthor Professor Kevin Werbach.  Below, I provide a summary of the book and its contents from the publisher's (Edward Elgar) website.

“This fully updated and revised second edition provides a practical examination of the opportunities and challenges presented by the rapid development of FinTech in recent years, particularly for regulators, who must decide how to apply current law to ever-changing concepts driven by continually advancing technologies. It addresses new legislative guidance on the treatment of cryptoassets and smart contracts, the European Commission’s Digital Finance Strategy and FinTech Action Plan, as well as analysing significant recent case law.”

Continue reading

December 29, 2021 in Call for Papers, Financial Markets | Permalink | Comments (0)