Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Monday, July 15, 2019

Gerding on Securitization

Erik F. Gerding has posted Testimony of Erik F. Gerding Before the U.S. House of Representatives Subcommittee on Consumer Protection and Financial Institutions on 'Emerging Threats to Stability: Considering the Systemic Risk of Leveraged Lending' on SSRN with the following abstract:

Risk is building in the leveraged loan and collateralized loan obligation (“CLO”) markets. These two markets are connected: leveraged loans are being repackaged into CLOs just as mortgages and mortgage-backed securities were used to create collateralized debt obligations (“CDOs”), the financial products at the heart of the financial crisis 11 years ago.

There are important differences but also troubling parallels between the leveraged loan/CLO markets and the earlier mortgage/CDO markets.

One alarming similarity is the decline in leveraged loan underwriting standards: the market is now dominated by “covenant-lite loans.” Covenant-lite loans permit greater leverage by borrowers and remove an early warning system for lenders.

Purchases of CLOs by banks and other regulated financial institutions made in order to game crucial regulatory capital requirements (“regulatory capital arbitrage”) remain a significant concern
.
Like mortgages and CDOs, leveraged loans and CLOs form a pipeline or system. Disruptions at either end of the system can cause financial havoc on the other end and then ricochet back. This is akin to a coiled spring or “crisis accordion.”

Losses or disruptions in the leveraged loan/CLO markets, even if they do not approach the levels of mortgages/CDOs in the global financial crisis could still be significant, e.g., amplifying a recession. We should be humble about our ability to predict the upper bound of financial market disruptions or crises.

Some tranches of CLO securities appear not to trade actively. Many CLO securities trade on opaque markets lacking transparent prices. A lack of trading of CLO securities undermines the economic rationale of these securities, as well as their safety and favorable regulatory treatment. A lack of transparent prices means that neither the marketplace nor regulators can rely on prices to police risk-taking in the CLO market.

Regulators must monitor and analyze data on leveraged loans and CLO markets. The OFR needs cooperation from other financial regulators in assessing risk in these markets. Lack of data sharing among financial regulators remains a crucial weakness. The OFR needs an independent source of funding. Regulators need minimum standards in their examinations with respect to assessing bank exposure to leveraged loans.
I also recommend:

- Stress testing of financial markets, not just individual institutions;
- Requiring financial regulators to conduct war games to prepare for market disruptions;
- Underscoring that the burden is on financial institutions to prove that leveraged loans and CLOs are safe rather than on regulators to prove that they are unsafe.

If data gathering reveals significant systemic risk in leveraged lending/CLO markets, regulators should use a mix of tools, including limiting bank investments in CLOs, enhanced and countercyclical capital requirements, and the Volcker Rule “covered funds” provisions.

July 15, 2019 | Permalink | Comments (0)

Gubler on Insider Trading

Zachary James Gubler has posted Insider Trading As Fraud on SSRN with the following abstract:

Federal insider-trading law consists, for the most part, of federal common law rooted in a statutory regime that prohibits fraud in connection with the purchase or sale of securities. Commentators have long lamented this fact, viewing the law’s grounding in an anti-fraud statute as a quirk of history with little to recommend it. After all, what does fraud have to do with insider trading?

A lot, it turns out. In this article, I develop a theory explaining and defending the fraud-based nature of federal insider trading law. Specifically, I argue that Rule 10b-5, the anti-fraud rule in question, should be understood as altering the common law rule barring parties from contracting for fraud liability. As contract scholars have shown, this common law rule prevents contracting parties from effectively deterring certain hard-to-detect breaches of which insider trading is but one example. Rule 10b-5, I argue, reverses the common law rule, allowing contracting parties to contract for fraud liability and the accompanying extra-compensatory damages for insider trading.

The implications of this new theory of insider trading law are significant. First, this theory helps us explain the law as it’s been received, something that competing theories simply can’t do. Second, it implies that insider trading liability under Rule 10b-5 should not be limited to fiduciaries but should include trading by at least some non-fiduciaries as well. Third, this theory provides courts with a tractable way of determining the scope of Rule 10b-5 – they must ask whether the trader and the information source are likely to have contracted for insider trading liability under Rule 10b-5, an inquiry that turns in part on the availability of alternatives to fraud liability for deterring insider trading. Fourth, and finally, the contractual fraud theory of insider trading law implies that, interpreting these implicit contracts over information, the SEC can cast a broader liability net than courts. Consequently, this theory explains not just the Supreme Court’s insider trading jurisprudence but also rules promulgated by the SEC, like rule 10b5-2, which are thought to go beyond the limits of the Court’s interpretation of the statute. This theory implies that the SEC is well within its authority to adopt Rule 10b5-2, a proposition that has been called into question by some federal courts.

July 15, 2019 | Permalink | Comments (0)

Podgor on Cryptocurrencies

Ellen S. Podgor has posted Cryptocurrencies and Securities Fraud: In Need of Legal Guidance on SSRN with the following abstract:

The specificity of statutes is important when the statute provides for criminal penalties. This Essay examines a cryptocurrency fraud prosecution, looking at the issue of whether cryptocurrency is included in securities fraud statutes. It also looks at proposed legislation that would omit cryptocurrency as a security, but then calls for enhanced regulation and tax relief. Additional clarification is needed to ascertain whether cryptocurrency fraud can be prosecuted under current securities fraud statutes. This Essay questions such prosecutions when the location of key definitions rest within agency regulations. Although specificity may not be needed to account for every imaginable type of fraud, when it comes to cryptocurrencies, Congress needs to provide more direction.

July 15, 2019 | Permalink | Comments (0)

Friday, July 12, 2019

Roiter on ETFs

Eric D. Roiter has posted Exchange-Traded Funds: Neither Fish Nor Fowl on SSRN with the following abstract:

This article first explains the design of ETFs, traces their growth, and reviews trading and investment strategies. The article next examines the regulatory framework within which ETFs must be made to fit, the record of exemptive relief granted by the SEC, and the agency’s protracted efforts to adopt rules for ETFs.

July 12, 2019 | Permalink | Comments (0)

Klausner, Hegland, LeVine & Leonard on Section 11 Litigation

Michael Klausner, Jason Hegland, Carin LeVine, and Sarah Leonard have posted State Section 11 Litigation in the Post-Cyan Environment on SSRN with the following abstract:

In Cyan, Inc. v. Beaver County Employees Retirement Fund, decided roughly a year ago, the Supreme Court interpreted the Securities Litigation Uniform Standards Act of 1998 (SLUSA) to allow state courts to hear cases under Section 11 of the Securities Act. The result has been a dramatic increase in the filing of Section 11 cases in state court, for which there is often a parallel case brought in federal court against the same defendant based on the same allegations. To understand the practical implications of Cyan, we analyze data on Section 11 cases filed since 2011, a point at which several circuits had ruled that Section 11 cases could be brought in state court. Our key findings are the following: state courts have dismissed Section 11 cases at less than half the rate of federal courts; when parallel cases are filed in state and federal court against the same defendant, settlements occurred over 80% of the time; even if a federal case is dismissed, a parallel state case will often settle.

July 12, 2019 | Permalink | Comments (0)

Horton on Direct Listing

Brent J. Horton has posted Spotify's Direct Listing: Is it a Recipe for Gatekeeper Failure? on SSRN with the following abstract:

On April 3, 2018, Spotify Technology S.A. — a music streaming company valued in excess of $20 billion — went public by direct listing on the New York Stock Exchange (NYSE). A direct listing is distinguishable from the more traditional initial public offering (IPO) in a number of ways, but the most important for purposes of this Article is that it foregoes the traditional underwriter.

First, this Article explains direct listings, why a company would choose to go public by direct listing, and the mechanics of a direct listing. Second, this Article explains that a direct listing — with its reliance on a financial advisor to shepherd the transaction to completion (as opposed to the underwriter-shepherded IPO) — is a danger to investors. In a traditional IPO, underwriters are incentivized to act as gatekeepers. Underwriters allow worthy companies to enter the public exchanges, and, conversely, exclude unworthy companies.

Financial advisors to a direct listing do not have the same incentives to act as gatekeepers. Financial advisors do not market or sell shares in a direct listing, and as such, are less likely to be held reputationally responsible for a flop. Neither do financial advisors face Securities Act liability, which would make them think twice before thrusting a troubled company on potential investors. The fact that financial advisors are less likely to be effective gatekeepers is an important finding. Several tech unicorns are likely to go public soon — they will attract billions of dollars of investors’ money — and are considering doing so by direct listing (Airbnb, Pinterest, and Uber are the prime candidates).

Finally, this Article assumes that direct listings are here to stay. As such, this Article presents for discussion some ideas for making direct listings safer for investors. The first, is to align the profitability of the financial advisor with the profitability of the company that is direct listing (deferred fees tied to long-term company performance is one possibility). Or second, financial advisors could be required to “opt in” to liability under Section 11 of the Securities Act of 1933.

July 12, 2019 | Permalink | Comments (0)

New Securities Law Articles in Print

The following law review articles relating to securities regulation are now available in paper format:

Steven A. Bank & George S. Georgiev, Securities Disclosure as Soundbite: The Case of CEO Pay Ratios, 60 B.C. L. Rev. 1123 (2019).

Paul H. Edelman, Wei Jiang & Randall S. Thomas, Will Tenure Voting Give Corporate Managers Lifetime Tenure?, 97 Tex. L. Rev. 991 (2019).

Nicole G. Iannarone, Rethinking Automated Investment Adviser Disclosure, 50 U. Tol. L. Rev. 433 (2019).

Andrea L. Seidt, Noula Zaharis & Charles Jarrett, Paying Attention to that Man Behind the Curtain: State Securities Regulators’ Early Conversations with Robo-Advisers, 50 U. Tol. L. Rev. 501 (2019).

July 12, 2019 | Permalink | Comments (0)

Tuesday, July 9, 2019

Passador & Riganti on Disclosure

Maria Lucia Passador and Federico Riganti have posted Less is More in the Age of Information Overload: The Paradigm Shift from a Shareholder- To a Stakeholder-Oriented Market on SSRN with the following abstract:

This paper aims to examine the innovations introduced by Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 and its transposition measures in Italy (considering the Legislative Decree No. 254 of 30 December 2016, and the recent regulation by the national Supervisory Authority) and in other European countries, as part of a wider research work on non-financial information statements (“NFSs”) and listed companies operating within the European markets. It is designed to verify the effectiveness of the tools offered, with the intent of developing a system which can (i) combine, also through the NFSs, long-term profitability, social justice, and environmental protection, and thus (ii) prevent risks to sustainability and (iii) increase the confidence of investors and consumers.

The article is structured in several parts, striving to examining the European regulation, focusing on the NFS comparative and Italian scenario, by offering a descriptive and empirical analysis of the matter, as well as offering some systemic conclusions, in particular with reference to social interest and to the most suitable way to disclose such information.

Ultimately, the paper is intended to provide the reader with a critical overview of the current non-financial information framework, as it applies at European and at Member State level. Nevertheless, in a forward-looking sense, this piece seeks to understand whether, and how, the issue of non-financial statements can actually (i) modify the actual corporate dialectic within companies required to disclose non-financial information; (ii) improve the accountability of such companies, as well as from the point of view of corporate social responsibility (“CSR”); and (iii) involve investors, primarily institutional ones, in the “life” of those companies which are subject to the NFS regime.

July 9, 2019 | Permalink | Comments (0)

Spiegeleer & Schoutens on Green Bonds

Jan De Spiegeleer and Wim Schoutens have posted Sustainable Capital Instruments and Their Role in Prudential Policy: Reverse Green Bonds on SSRN with the following abstract:

In this paper we introduce a new variant on the more traditional green climate bond. Green bonds are standard corporate bonds created to finance environmentally beneficial projects. The concept of a Reverse Green Bond is very similar to contingent convertibles (CoCos) issued by financial institutions since 2009. Reverse Green bonds are hence different compared to the traditional vanilla Green Bonds and offer a higher yield. Investors in this asset class carry the extra risk to miss out on a coupon payment or even forgo the complete face-value of the bond if the issuer misses a pre-agreed climate trigger. For Reverse Green Bonds, such a coupon cancellation would not constitute a default-event. Hitting the climate trigger has also a consequence for the issuer. The skipped coupon or missing face value of the issue will be paid out into a climate fund by the issuer of the Reverse Green Bond. In this paper, we work out a valuation model for these securities and elaborate on their role in prudential policy.

 

July 9, 2019 | Permalink | Comments (0)

Goncalves, Kräussl & Levin on Financial Market "Speed Bumps"

Jorge Goncalves, Roman Kräussl and Vladimir Levin have posted Do 'Speed Bumps' Prevent Accidents in Financial Markets? on SSRN with the following abstract:

Is it true that speed bumps level the playing field, make financial markets more stable and reduce negative externalities of high frequency trading (HFT) firms? We examine how the implementation of a particular speed bump - Midpoint Extended Life order (M-ELO) on Nasdaq impacted financial markets stability in terms of occurrences of mini-flash crashes in individual securities. We use high frequency order book message data around the implementation date and apply difference-in-differences analysis to estimate the average treatment effect of the speed bump on market stability and liquidity provision. The results suggest that the introduction of the M-ELO decreases the average number of crashes on Nasdaq compared to other exchanges by 4.7%. Liquidity provision by HFT firms also improves. These findings imply that technology-based solutions by exchanges are feasible alternatives to regulatory intervention towards safer markets.

July 9, 2019 | Permalink | Comments (0)

Knüpfer, Rantapuska & Sarvimäki on Portfolio Choice

Samuli Knüpfer, Elias Henrikki Rantapuska and Matti Sarvimäki have posted Why Does Portfolio Choice Correlate Across Generations on SSRN with the following abstract: 

We find that investors tend to hold the same securities as their parents. Instrumental variables that exploit social networks and a natural experiment based on mergers allow us to attribute the security-choice correlation to social influence within families. This influence runs not only from parents to children, but also in the opposite direction. Security holdings correlate more when family members are more likely to communicate and when they are more susceptible to social influence. The identical security holdings that social influence generates largely explain why risk-return profiles of household portfolios correlate across generations.

July 9, 2019 | Permalink | Comments (0)

Monday, July 8, 2019

Park on Insider Trading

Tai Park has posted Newman/Martoma: The Insider Trading Law's Impasse and the Promise of Congressional Action on SSRN with the following abstract:

The prohibition against insider trading is a judge-made law that has evolved for over 50 years, and reached a critical impasse in two recent decisions in the Second Circuit Court of Appeals: United States v. Newman and United States v. Martoma. Judges of the Second Circuit sharply divided over what conduct constitutes improper trading on material nonpublic information, leaving the law in profound disarray. At bottom, the disagreement stems from a decades-old split within the judiciary about how to ensure a fair securities marketplace while enabling institutional analysts to probe for corporate information in furtherance of efficient market valuation of securities. In 1983, the Supreme Court in SEC v. Dirks sought to strike a balance between these two interests by holding that trading on material nonpublic information is not illegal unless the information was disclosed in exchange for a personal benefit. But the effort to balance two competing economic and moral interests should never have been the province of the judiciary, nor did its formulation ever win uniform consensus among the judges. After decades of struggle, the Newman/Martoma impasse is the consequence. Congress appears finally poised to pass a law of insider trading that would break the deadlock, but the bill under consideration apparently ignores the market efficiency interests that undergirded the personal benefit element of insider trading. The Article suggests that before passing any law, Congress must undertake an empirical review of the impact that the insider trading bill would have on an efficient market to ensure that the final law is not only clear but good for the health of the capital markets.

July 8, 2019 | Permalink | Comments (0)

Mulholland, Barker, Williams & Eccles on Climate Risk

Ellie Mulholland, Sarah Barker, Cynthia A. Williams and Robert G. Eccles have posted Climate Change and Directors' Duties: Closing the Gap Between Legal Obligation and Enforcement Practice on SSRN with the following abstract:

Until relatively recently, climate change was the purview of corporate social responsibility departments, to the extent it was considered at all. Siloed from finance teams, senior management and the board, it was seen as a non-financial, ethical and purely environmental matter. A public position on climate was beneficial for reputational purposes only, with conventional wisdom that climate change could not affect the financial bottom line, let alone lead to circumstances sufficient to impose personal liabilities on directors or senior management.

Yet this is no longer the case. Having reached global consensus in the Paris Agreement to keep the increase in global average temperature to ‘well below’ 2°C and to pursue efforts to limit it to 1.5°C, the world’s governments and private sector leaders are taking steps to deliver the required mitigation and adaptation measures. Advances in our understanding of the potential catastrophic impacts of climate change were brought to the fore in 2018 with the special report on the impacts of global warming of 1.5°C by the Intergovernmental Panel on Climate Change.

In light of these and other developments, it is now widely understood that the impacts of climate change pose foreseeable, and often material, risks to the financial performance and prospects of companies. Some of the most devastating of these impacts will be felt beyond mainstream investment and business time horizons. The extent of these impacts on future generations are dependent on the near-term actions of our current generation, which we have little incentive to fix, making climate change a ‘tragedy of the horizon’. Yet many of the risks will arise within mainstream planning and investment horizons and are already materialising today: 2017 had the highest ever costs from global weather disasters, with almost two-thirds of the US$320 billion loss uninsured. Climate change is beginning to visibly disrupt business models across a range of sectors and geographies.

This paper outlines why climate change is now a core corporate governance issue. Directors now need to add a base level of climate competency to their governance skill set, as is necessary to guide their companies through the physical impacts of climate change and the transition to the net-zero emissions economy set out in the goals of the Paris Agreement. And for most, if not all, directors climate competence is not optional; governance failures and misleading disclosures relating to climate change may be actionable against individuals and companies. Focusing on key common law jurisdictions, this paper shows that existing corporate and securities laws are conceptually capable of being applied to failures to govern and disclose climate risk. While there is generally a gap between the law on the books and its enforcement against directors, this paper argues that the climate change litigation gap is likely to close in the relatively near future. This has led to the development of a number of tools to assist boards and their committees to navigate the new governance and disclosure expectations and to take up the opportunities created by climate disruption on business.

 

July 8, 2019 | Permalink | Comments (0)

Gurrea-Martínez on Dual-Class Shares

Aurelio Gurrea-Martínez has posted Theory, Evidence, and Policy on Dual-Class Shares: A Country-Specific Response to a Global Debate on SSRN with the following abstract:

Dual-class shares have become one of the most controversial issues in today´s capital markets and corporate governance debates around the world. Namely, it is not clear whether companies should be allowed to go public with dual-class shares and, if so, which restrictions (if any) should be imposed. Three primary regulatory models have been adopted to deal with dual-class shares: (i) prohibitions, existing in countries like the United Kingdom, Germany, Spain, Colombia, or Argentina; (ii) the permissive model adopted in several jurisdictions, including Canada, Sweden, the Netherlands, and particularly the United States; and (iii) the restrictive approach recently implemented in Hong Kong and Singapore. This paper argues that, despite the global nature of this debate, regulators should be careful when analysing foreign studies and approaches, since the optimal regulatory model to deal with dual-class shares will depend on a variety of local factors. Namely, it will be argued that, in countries with sophisticated markets and regulators, strong legal protection to minority investors, and low private benefits of control, regulators should allow companies going public with dual-class shares with no restrictions or minor regulatory intervention (e.g., event-based sunset clauses). By contrast, in countries without sophisticated markets and regulators, high private benefits of control, and weak legal protection to minority investors, dual-class shares should be prohibited or subject to higher restrictions (e.g., time-based sunset clauses and stringent corporate governance rules). Intermediate solutions should be adopted for countries with mixed features. Therefore, the key question to be addressed from a policy perspective is not whether companies should be allowed to go public with dual-class shares, as many authors and regulators seem to be discussing, but whether dual-class class shares should be allowed and, if so, under which conditions, taking into account the particular features of a country.

July 8, 2019 | Permalink | Comments (0)

Panisi, Buckley & Arner on Blockchain and Public Companies

Federico Panisi, Ross P. Buckley and Douglas W. Arner have posted Blockchain and Public Companies: A Revolution in Share Ownership Transparency, Proxy-Voting and Corporate Governance? on SSRN with the following abstract:

Under the traditional paradigm, the shareholder was the one in whose name company shares were registered. However, for public companies in the US, this system became highly inefficient by the 1960s due to high numbers of transactions. As a result, shares began to be “immobilized” at central securities depositories (“CSD”s) and held through the Indirect Holding System (“IHS”), with share transactions settled through “book entries,” first in the US and then in other major markets. Although market liquidity benefited, the system broke the direct relationship between companies and shareholders, introducing also a discrepancy between “recorded shareholders” and “beneficial shareholders.” Communication solutions were developed to bridge this discrepancy and allow “beneficial shareholders” to cast their votes through proxies. However, they currently rely on highly intermediated “pass-it-along” architectures, which cause several inefficiencies, the costs of which are borne by the shareholders themselves and raise questions in the context of collateralization. By increasing share “ownership transparency,” blockchain has the capacity to streamline the entire share ownership architecture. Indeed, blockchain could enable the tracking of share ownership through the complete settlement cycle, enhancing the “shareholder democracy” of listed companies, and benefiting their corporate governance and the market in their shares. However, blockchain also brings risks, including those related to greater ownership transparency. Consequently, a management system for the digital identity of share transactions is necessary to foster the benefits of such blockchain-based voting architectures, while reducing the risks.

July 8, 2019 | Permalink | Comments (0)

Friday, July 5, 2019

Schwartz on Shareholder Primacy

Jeff Schwartz has posted De Facto Shareholder Primacy on SSRN with the following abstract:

For generations, scholars have debated the purpose of corporations. Should they maximize shareholder value or balance shareholder interests against the corporation’s broader social and economic impact? A longstanding and fundamental premise of this debate is that, ultimately, it is up to corporations to decide. But this understanding is obsolete. Securities law robs corporations of this choice. Once corporations go public, the securities laws effectively require that they maximize share price at the expense of all other goals. This Article is the first to identify the profound impact that the securities laws have on the purpose of public firms — a phenomenon that it calls “de facto shareholder primacy.”

The Article makes three primary contributions to the literature. First, it provides a rich and layered account of de facto shareholder primacy. The phenomenon is not the result of considered legislation and regulatory decision. Rather, hedge-fund activists leverage the transparency that the securities laws afford to identify, and force companies to adopt, strategies that increase share prices. Their activities cast a shadow over the public market. Because firms must maximize share prices or face costly, disruptive, and protracted battles with activist hedge funds, they preemptively focus solely on stock values. The activists’ novel and opportunistic use of the securities laws has transformed the regulatory apparatus into a powerful lever of shareholder primacy. Second, this Article shows how this distortion of the regulations causes harm. The activities of activists bring the laws into conflict with principles of federalism and private ordering, which hurts entrepreneurs, investors, and equity markets. Finally, to address these concerns, the Article recommends a small change to the securities laws that would end hedge-fund activism and thereby disentangle the securities laws from corporate purpose.

 

July 5, 2019 | Permalink | Comments (0)

Park on Securities Law and Short-Termism

James J. Park has posted Do The Securities Laws Promote Short-Termism? on SSRN with the following abstract:

Since 1970, the Securities & Exchange Commission (SEC) has required public companies to file disclosures reporting their quarterly financial performance. This mandatory quarterly reporting system has recently been criticized as incentivizing corporations to deliver short-term results rather than developing sustainable, long-term strategies. This Article examines the origins of quarterly reporting to assess whether the SEC should reduce the frequency of periodic reports. It concludes that much of the pressure on public companies to deliver short-term results came as the market increasingly focused on projections issued by research analysts. This finding suggests that rather than reducing periodic disclosure, increasing company disclosure relating to projections would be a more effective reform. The issue of quarterly reporting highlights the contrast between securities and corporate law. The tendency of securities law to favor transacting investors only has a modest impact on public companies because corporate law gives managers discretion to balance short-term and long-term interests. Strong securities law can be checked by weak corporate law.

July 5, 2019 | Permalink | Comments (0)

Kaal & Evans on Blockchain and Securities Offerings

Wulf A. Kaal and Samuel Evans have posted Blockchain-Based Securities Offerings on SSRN with the following abstract:

Blockchain technology has the potential to supplement the existing infrastructure for securities offerings. After examining the shortcomings of historical attempts, the article analyses the redeeming features of blockchain-based securities offerings including lower overall cost structure, substantially reduced settlement cycle, counter-party risk and systemic risk reduction, enhanced transparency, among others. The authors examine the tradeoffs between opportunities and risks of blockchain-based securities offerings.

July 5, 2019 | Permalink | Comments (0)

Solomon & Soltes on Disclosure of Securities Fraud Investigations

David H. Solomon and Eugene F. Soltes have posted Is 'Not Guilty' the Same as 'Innocent'? Evidence from SEC Financial Fraud Investigations on SSRN with the following abstract:

The Securities and Exchange Commission (SEC) routinely investigates firms for financial fraud, but investors only learn about regulators’ concerns if managers voluntarily disclose news of the investigation, or regulators sanction the firm. We investigate the effects of disclosing investigations using confidential records on all opened investigations, regardless of outcome. Markets exhibit some ability to identify which investigations will eventually lead to sanctions. Nonetheless, even when no charges are ultimately brought, firms that voluntarily disclose an investigation have significant negative returns, underperforming non-sanctioned firms that stayed silent by 12.7% for a year after the investigation begins. Consistent with limited investor attention, disclosing in a more prominent manner is associated with worse returns. CEOs who disclose an investigation are also 14% more likely to experience turnover. Our results are consistent with transparency about bad news being punished, rather than rewarded, by financial and labor markets.

July 5, 2019 | Permalink | Comments (0)

Wednesday, July 3, 2019

Sharfman on Shareholder Voting

Bernard S. Sharfman has posted Enhancing the Value of Shareholder Voting Recommendations on SSRN with the following abstract:

This writing addresses a fundamental issue in corporate governance. If institutional investors such as investment advisers to mutual funds have a fiduciary duty to vote the shares of stock that they owned on behalf of their investors, then how do we practically achieve informing them on how to vote their proxies without requiring each institutional investor to read massive amounts of information on the hundreds or thousands of companies they have invested in for the thousands, tens of thousands, or even hundreds of thousands of votes they are confronted with each year?

A critical step in resolving this issue is maximizing the ability of institutional investors to avail themselves of voting recommendations that are made on an informed basis and with the expectation that they will lead to shareholder wealth maximization. One way to achieve this maximization is to make sure that the voting recommendations provided by proxy advisors are truly informed ones. This leads to the recommendation that the proxy advisor should be held to the standard of an information trader. Another way is for the SEC to recognize the value of board recommendations and explicitly state that their use will allow investment advisers to meet their fiduciary duties when voting their proxies.

July 3, 2019 | Permalink | Comments (0)

Chaffee on Cryptocurrencies

Eric C. Chaffee has posted The Heavy Burden of Thin Regulation: Lessons Learned from the SEC’s Regulation of Cryptocurrencies on SSRN with the following abstract:

The Trump administration has taken a strong stance against regulation. This includes not only ratcheting down the level of regulation and enforcement in general, but it also entails a strong dislike of the absolute number of regulations in existence. For example, within two weeks of taking office, President Trump issued his Executive Order on Reducing Regulation and Controlling Regulatory Costs, which provides in part: “Unless prohibited by law, whenever an executive department or agency... publicly proposes for notice and comment or otherwise promulgates a new regulation, it shall identify at least two existing regulations to be repealed.” In a certain regard, this policy of reducing the absolute number of regulations is laudable. The administrative state and the regulation associated with it have expanded massively since the first half of last century. A reduced volume of regulation means that lawyers and society at large can be better versed in their legal obligations and potentially be less encumbered in their activities. With that said, “thin regulation,” as it will be termed, does have its downsides, including potential gaps in regulation, improper regulatory coverage, due process issues relating to notice, legitimacy concerns, and increased risk of market collapse relating to the regulated subject matter.

To understand the problems with thin regulation, the best place to begin is with an emerging issue and to explore how President Trump’s policy of thin regulation interfaces with it. To that end, the recent advent of cryptocurrencies offers an excellent case study of the dangers of thin regulation. Although the United States Securities and Exchange Commission (SEC) has undertaken efforts to act in this area, the gaps that exist illustrate the problems with thin regulation. Essentially, the SEC has tried to force cryptocurrencies into an existing regulatory structure that does not sufficiently mitigate the dangers that cryptocurrencies create. This essay explores the problems created by the lack of cohesive regulation in this area and demonstrates that the value of a thin regulatory approach is outweighed by the value of a well-reasoned, narrowly tailored approach — which I will term “bespoke regulation.”

July 3, 2019 | Permalink | Comments (0)

Hirst & Kastiel on Corporate Governance

Scott Hirst and Kobi Kastiel have posted Corporate Governance by Index Exclusion on SSRN with the following abstract:

Investors have long been unhappy with certain governance arrangements adopted by companies undertaking initial public offerings, such as dual-class voting structures. Traditional sources of corporate governance rules—the Securities and Exchange Commission, state law, and exchange listing rules—do not constrain these arrangements. As a result, investors have turned to a new source of governance rules: index providers.

This Article provides a comprehensive analysis of index exclusion rules and their likely effects on insiders’ decision-making. We show that efforts to portray index providers as the new sheriffs of the U.S. capital markets are overstated. Index providers face complex and conflicting interests, which make them reluctant regulators, at best. We put forward an analysis of insider incentives in light of index exclusions and apply it to one of the most important applications of index exclusion rules to date, the recent decision by index providers to exclude from their indexes certain companies with dual-class share structures. We conclude that the efficacy of index exclusions in preventing disfavored arrangements such as dual-class structures is likely to be limited, but not zero.

Index exclusions are a corporate governance experiment, one that has important lessons. We examine these lessons, and the way forward for corporate governance. These lessons are all the more important because of the central place of index funds, and therefore index providers, in our capital markets.

July 3, 2019 | Permalink | Comments (0)

Nickerson on Direct Listing

Benjamin Nickerson has posted The Underlying Underwriter: An Analysis of the Spotify Direct Listing on SSRN with the following abstract:

In April 2018, music streaming giant Spotify disrupted the traditional initial public offering model and became a publicly traded company through a novel process known as a direct listing. Eschewing standard Wall Street practice, Spotify did not raise new money through the offering and instead simply made its existing shares available for purchase by the public. Spotify worked throughout 2017 and 2018 alongside legal counsel and investment banks and in communication with the Securities and Exchange Commission to facilitate the unorthodox approach. Major technology companies are now adopting a similar approach.

In recognition of these developments, this Comment has two aims: to shed light on the statutory contours of a direct listing and to contribute to the legal understanding of underwriter liability. As this financial innovation unfolds, an important question remains: Who is liable as an “underwriter” in a direct listing for purposes of liability under Section 11 of the Securities Act? This Comment argues that the investment banks Spotify retained as financial advisors qualify as statutory underwriters notwithstanding language in the registration statement to the contrary. By walking through the precise statutory elements of a direct listing and by calling attention to latent liabilities in the process, this Comment seeks to set forth a path for future technology unicorns to follow the Spotify playlist.

July 3, 2019 | Permalink | Comments (0)

Cain, Fisch, Davidoff Solomon & Thomas on Merger Litigation

Matthew D. Cain, Jill E. Fisch, Steven Davidoff Solomon and Randall S. Thomas have posted Mootness Fees on SSRN with the following abstract:

We examine the latest development in merger litigation: the mootness fee. Utilizing a hand-collected sample of 2,320 unique deals from 2003-2018, we find that Delaware’s crackdown on merger litigation substantially altered the merger litigation landscape. Although merger litigation rates remain high, and in 2018 83% of deals experienced litigation, plaintiffs’ lawyers have fled Delaware. In 2018 only 5% of completed deals experienced merger litigation in Delaware compared to 50%-60% in prior years. These cases have migrated to federal court where in 2018 92% of deals with litigation experienced a filing. We find that at least 65% of these federal filings resulted in voluntary dismissal of the case after a supplemental disclosure coupled with the payment of a mootness fee to plaintiffs’ attorneys.

These mootness dismissals, in most cases, occur without an adversarial process, meaningful judicial oversight or an evaluation of whether the complaint even states a colorable claim. Many of these supplemental disclosures provide little or no value to plaintiff shareholders. We argue that these payments are a form of blackmail antithetical to the spirit and principles of civil procedure and that they perpetuate litigation that imposes substantial costs on the judicial system and public companies.

The article proposes that courts address these concerns by requiring transparency of mootness fees and overseeing the circumstances in which such fees are paid. We argue that the Federal Rules of Civil Procedure should be amended to require disclosure and judicial approval of the payment of a mootness fee when a proposed class action is voluntarily dismissed. We further argue that courts should only approve the payment of such a fee when the supplemental disclosures that moot the litigation are “clearly material.”

July 3, 2019 | Permalink | Comments (0)

New Securities Law Article in Print

The following law review article relating to securities regulation is now available in paper format:

Shaanan Cohney, David Hoffman, Jeremy Sklaroff & David Wishnick, Coin-Operated Capitalism, 119 Colum. L. Rev. 591 (2019). 

July 3, 2019 | Permalink | Comments (0)