Securities Law Prof Blog

Aflac Board Adopts Say on Pay

The insurance company Aflac is the first company voluntarily to adopt an advisory shareholder vote on executive compensation, beginning in 2009.  A Washington Post column says that the company agreed to it because it prides itself on never having had a shareholder's proposal on its proxy statement.  The article also highlights some of the votes on "say on pay" proposals at recent shareholders meetings.  See WPost, Aflac Looks Smart on Pay.

Seventh Circuit Tippee Liability Conviction

The Seventh Circuit recently decided, in U.S. v. Evans, that a tippee can be found guilty of insider trading even though the tipper was acquitted in an earlier trial.  The tipper was a financial analyst at Credit Suisse who apparently missed the orientation program about confidentiality and talked a lot about his work to his friends.  The tippee, a college buddy, traded profitably in stocks of four companies involved in deals that Credit Suisse was working on.  At the first trial, the jury acquitted the tipper on both substantive and conspiracy charges and acquitted the tippee on the conspiracy charge, but deadlocked on the substantive charges against the tippee.  The government retried the tippee and won a conviction.  On appeal the Seventh Circuit recognized the applicability of the Dirks two-part test for tippee liability, which requires, first and foremost, a breach of duty on the part of the insider and, secondly, the tippee's knowledge of the breach (or, at least, he should have known).  Since the jury had acquitted the tipper, that would seem to foreclose tippee liability.  The court, however, theorized that the tipper could have leaked the information negligently to his friend and thus would have lacked the requisite scienter in leaking the information to his friend.  According to the Seventh Circuit, it was not essential to the tippee's conviction that the tipper know that his leaking of confidential information was improper.  Indeed, the tippee could have induced the tippee's disclosure and then taken advantage of it, so he can be guilty of insider trading when the tipper is not.  Frankly, the court's logic sounds wrong to me.  While it is an attractive theory if, for example, the tippee plies the tipper with liquor so that he blurts out the company secrets and the tippee then trades on the information, I don't see how the first requirement of Dirks -- the breach of the duty -- is met.  How is this case different from Dirks itself -- where the tippee is off the hook because the tipper is found to have done nothing wrong? 

Milhaupt & Pister on Law and Capitalism

An abstract of Law and Capitalism: What Corporate Crises Reveal About Legal Systems and Economic Development Around the World , by CURTIS J. MILHAUPT and KATHARINA PISTOR was recently posted on SSRN:

This book explores the relationship between legal systems and economic development by examining, through a methodology we call the institutional autopsy, a series of high profile corporate governance crises around the world over the past six years. We begin by exposing hidden assumptions in the prevailing view on the relationship between law and markets, and provide a new analytical framework for understanding this question. Our framework moves away from the canonical distinction between common law and civil law regimes. It emphasizes the constant, iterative, rolling relationship between law and markets, and suggests that how a given country's legal system rolls with economic changes depends significantly on its organization rather than its formal characteristics or legal origin. We find that legal systems around the world differ significantly along two crucial organizational dimensions: their degree of centralization of the lawmaking and enforcement processes, and the primary function law serves in support of market activity, ranging from protective functions to coordinative functions.

We use this analytical framework to understand why countries as diverse as the United States, Germany, Japan, Korea, China, and Russia have all experienced corporate crises in recent years, and to analyze the different institutional responses to these crises. These case studies provide insights into the diversity of legal systems and institutional arrangements that support capitalist activity over time and across a range of societies. They also suggest that systemic legal change is rarely achieved by changes in formal law alone, but is the result of changes in the composition and identity of core constituencies within a given system who use (or avoid) law to advance their position in the market. Among other things, our study suggests the need for new thinking about how and why legal systems change, the limits of convergence even in a world where national laws increasingly look alike, and a new emphasis on the demand for law in the process of legal adaptation and change.

Steinberg & Wang on Insider Trading

Insider Trading Treatise (Second Edition) (excerpt from Vol. 1), The Practising Law Institute
SMU Dedman School of Law Legal Studies Research Paper No. 00-1, was recently posted on SSRN.  Here is the abstract:

Professors Marc I. Steinberg and William K.S. Wang have coauthored the Second Edition of their Insider Trading Treatise published by The Practising Law Institute. The Treatise provides in depth analysis of the law of insider trading. An excerpt from Chapter One of the Treatise follows and is reprinted with permission of the Practising Law Institute.

Perspectives on The Past Week's Stories

The biggest stories include the SEC's deregulatory efforts on behalf of small companies.  The SEC has been under tremendous pressure to exempt small public companies from SOX section 404.  Instead, on Wednesday, it approved interpretive guidance that it expects will allow for reduced costs in implementing internal controls, particularly at smaller public companies.  The SEC says that companies should focus on what really matters -- risk and materiality.  It also said that smaller companies, which become subject to SOX 404 this year for the first time, should benefit from the "scalability" (I didn't know that was a word!) and flexibility of the new approach.  PCAOB provided similar relief for auditors at its Thursday meeting.

The SEC this week also proposed rules on capital-raising by small companies.  The proposed rules address recommendations made by the SEC's Advisory Committee on Smaller Public Companies and include:  a new system of securities regulation for smaller public companies (up to $75 million in public float); availability of shelf registration to companies with a float below $75 million; and a shortened holding period of six months under Rule 144 for restricted securities.

The other big news item is China's decision to invest in something other than U.S. Treasury bills.  It will purchase $3 billion of non-voting securities in private equity firm The Blackstone Group.  This will constitute a less than 10% stake in the firm, which is going public soon.

Dombalagian on Regulating Information

Licensing the Word on the Street: The SEC's Role in Regulating Information, by ONNIG H. DOMBALAGIAN, Tulane Law School, was recently posted on SSRN.  Here is the abstract:

Information is said to be the lifeblood of financial markets. Securities markets rely on corporate disclosures, quotes, prices, and indices, as well as the market structures, products and standards that give them meaning, for the efficient allocation of capital. The availability of and access to such information on reasonable terms is one of the essential characteristics of strong financial markets. And yet because information is a commodity, policymakers must balance the desire to provide access to such public goods against the need to maintain appropriate incentives for information producers.

The Securities and Exchange Commission faces the primary challenge of regulating the balance between the commercial and social value of information in securities markets. In some areas, the Commission has all but extinguished private rights. In other areas, it has deferred to federal or state intellectual property doctrines. In yet other areas, the SEC has created intricate entitlements tailored to historical market structures. Against this backdrop, self-regulatory bodies, securities intermediaries, and other entities have staked out proprietary claims in their information products as permitted by state and federal law.

Today, with the demutualization of the New York Stock Exchange and the Nasdaq Stock Market, as well as the completed and impending mergers of various national and international exchanges, we are rapidly moving away from the paradigm of the dominant national exchange to the reality of competing national and global trading venues. These changes in securities market structure are likely to generate numerous disputes over the allocation of rights and interests in securities information. It is thus increasingly urgent that the Commission articulate some statement of policy to govern the regulation of information rights.

Johnson & Brunet on Securiites Arbitration

Substantive Fairness in Securities Arbitration, by JENNIFER J. JOHNSON and EDWARD BRUNET, Lewis & Clark College - Law School, was recently posted on SSRN.  Here is the abstract:

Securities arbitration today is premised on the cliche that arbitrators will apply undefined "fair and equitable" standards of decision. We contend that fairness and equity cannot exist in a vacuum and that the rule of law provides the only sensible standard to guide securities arbitrators. Moreover, we argue that the rule of law provides the legitimizing foundation under which securities arbitration must occur.

We will develop two related propositions in this essay. The first is that to achieve fairness, securities arbitration needs procedures that apply substantive legal principles. We call this the need for substantive fairness.The second proposition, much more embedded in the real world, asserts that application of substantive law occurs sporadically and inconsistently in present-day securities arbitration.

We first set forth a theory of substantive adjudicatory fairness relying on mainstream modern legal philosophers such as John Rawls, Lon Fuller, Harry Jones, and Joseph Raz. In addition to unequivocally advocating a rule of law approach for adjudication, these theorists emphasize the relationship of the application of legal rules to notions of fair notice.

This essay next chronicles and critiques developments regarding standards of decision in modern securities arbitration. We examine the work of securities arbitration administrators and regulators as it relates to the goal of substantive fairness. We show that NASD has equivocated between allowing the arbitrators complete discretion to decide cases on any grounds they choose and providing directives for selected questions that only sometimes facilitate the application of legal principles. NASD has flirted with substantive law but intentionally avoided fully embracing it. We advocate a change in securities arbitration -- that of publically and systematically mandating application of the rule of law in NASD awards. Such a change is long overdue and would facilitate a shift to a fairer, less standardless arbitration of customer-broker dispute resolution.

A Slow News Day

Both the New York Times and the Wall St. Journal have long articles on big stories that do not, however, contain much new information.  If these stories particularly interest you or you think there's a detail you have missed, the Times highlights the dueling lawsuits at Dow Chemical relating to the conmpany's firing of two executives for allegedly shopping the company to private equity firms without board authorization; see A Duel at Dow Chemical.  The WSJ focuses on former SEC Chief Accountant Lynn Turner's recent departure from Glass Lewis because the firm was sold to a Chinese media company, Xinhua Financial.  Turner learned about the sale when he received an angry phone call from former SEC Chair Arthur Levitt asking Turner about it.  See A Star's Bombshell Exit From Glass Lewis.

SEC Prevails in Accounting Fraud Case Involving Insurance

Timothy Harcharik, director of risk management at Brightpoint Inc., was found liable for violating the securities laws because of his involvement in the company's use of insurance to hide the company's losses.  AIG previously settled DOJ and SEC charges that it sold insurance products to companies, including Brightpoint, to inflate earnings.  See NYTimes, S.E.C. Wins Verdict on Insurance Abuse

SEC's Donohue Speaks on Hedge Fund Regulation

Andrew J. Donohue, Director, Division of Investment Management, U.S. Securities and Exchange Commission, spoke at a SIFMA conference on regulatory developments in the hedge fund industry.

Overstock Directors Resign Because of Lawsuit

Two directors have now resigned from Overstock.com Inc.'s board of directors because of CEO Patrick Byrnes's $3.5 billion lawsuit against several major brokerage firms alleging a market manipulation scheme that drove down the price of the company's stock.  Ray Groves was the latest, resigning Thursday.  Byrnes calls the lawsuit his "jihad," other executives have spoken out against the lawsuit, including Byrnes's father, who had been chair.  See WSJ, Overstock Director Resigns,Citing Suit Against Brokers.

SEC Investigation into Dow Chemical

Remember the recent firing by Dow Chemical of two longtime executives, Romeo Kreinberg and J. Pedro Reinhard, for allegedly engaging in unauthorized talks to sell the company?  That has led to suits and counter-suits between Dow Chemical and the former executives.  Now the SEC has opened an inquiry into the matter and is also investigating suspicious trading in the stock of both Dow Chemical and DuPont last fall when Dow Chemical was making undisclosed overtures to take over DuPont.  See NYTimes, Investigation Is Said to Open on Dow Chemical.

PCAOB Eases Auditing Standard on internal Controls

PCAOB voted to reduce the costs of auditors' internal controls reviews mandated by Sarbanes Oxley section 404.  The changes are subject to SEC approval, which earlier this week issued management guidance reducing the burdens of complying with section 404.  See WSJ, Sarbanes-Oxley Audit Rules Likely to Ease.

NYSE Proposal to End Broker Voting Excludes Mutual Funds

Last fall the NYSE proposed a controversial change that would change current practice and bar brokers from voting shares when shareholders do not in uncontested directors' elections. Yesterday it announced that it has been revised to exclude mutual funds, in response to objections by the mutual fund industry based on the increased costs that would result from requiring shareholder solicitation to vote.  Smaller companies, however, who raised similar concerns, are not exempted from the proposal.  See WSJ, Mutual Funds Sway NYSE on Vote Plan.

NASDAQ Will Acquire Nordic Exchange

NASDAQ failed in its attempt to buy the London Stock Exchange, so instead it's buying Nordic exchange operator OMX AB?  OMX operates exchanges in Scandanavia and the Baltic region and also operates trading systems for other exchanges, including the Hong Kong exchange.  The acquisition may be a prelude to a renewed effort by NASDAQ to acquire LSE.  See WSJ, For Nasdaq, a Nordic Track.

House Continues Investigation into Sallie Mae Stock Sale

The House Education Committee has been investigating Sallie Mae head Alfred Lord's sale of 400,000 shares in February, just days before President Bush announced cuts in government subsidies and a resulting drop in the stock price.  Yesterday it released a Sallie Mae document disclosing a December meeting between Sallie Mae mid-level executives and government budget officials.  The company maintains that budget cuts were not discussed, Lord was not briefed on the meeting, and the timing of the stock sale was coincidence.  In recent months Sallie Mae agreed to a private equity deal for $25 billion.  It also replaced its CEO Thomas Fitzpatrick in an effort to improve its dealings with the Democratic majority.  See WPost, OMB Talks Preceded Sallie Mae Stock Sale. 

SEC Proposed Rules for Smaller Company Capital-Raising

PROPOSED  MODERNIZATION  OF  SMALLER   COMPANY   CAPITAL-RAISING   AND DISCLOSURE REQUIREMENTS:

On May 23, the Commission proposed a series of six  measures  to  modernize  and  improve  its capital  raising  and reporting requirements for smaller companies. Many  of  the  proposals address key recommendations made by the SEC's  Advisory  Committee  on Smaller Public Companies in its final report. They include:

        * A new  system  of  securities  regulation  for  smaller  public companies that would make scaled regulation available to  a  much larger group of smaller public companies;

        * Modified eligibility requirements so companies  with  a  public float below $75 million can take advantage  of  the  benefits  of shelf registration;

        * A new exemption from Securities Act  registration  requirements for sales of securities to a newly defined category of "qualified purchasers" in which limited advertising would be permitted;

        * Shortened holding periods under Securities  Act  Rule  144  for restricted securities to  reduce  the  cost  of  capital  and  to increase access to capital;

        * New exemptions  for  compensatory  employee  stock  options  so Exchange Act registration requirements  would  not  be  triggered solely by a company's compensation decisions; and

        * Electronic filing of the form filed by companies making private or limited offerings to ease burdens  for  filers  and  make  the information filed more readily available.

Roundtable with Former SEC Chairs

I wanted to find out what Chair Cox and five former SEC chairs talked about in last night's Roundtable.  The only account I could find is posted on CFO.com which says they chatted about international accounting standards and hedge funds and agreed that problems with hedge funds are sure to come.

Corp Fin Guidance Updated

The SEC's Division of Corporation Finance has updated its guidance under Exchange Act Section 16 and Related Rules and Forms.

SEC Announces Roundtable on Selective Mutual Recognition

The Securities and Exchange Commission announced today that it will host a roundtable discussion in June on the topic of selective mutual recognition. Selective mutual recognition would involve the SEC permitting certain types of foreign financial intermediaries to provide services to U.S. investors under an abbreviated registration system, provided those entities are supervised in a foreign jurisdiction under a securities regulatory regime substantially comparable (but not necessarily identical) to that in the United States. The roundtable will explore whether selective mutual recognition would benefit U.S. investors by providing greater cross-border access to foreign investment opportunities while preserving investor protection.

The roundtable will take place on June 12, 2007, and will consist of a series of panels designed to reflect the views of different constituencies, including investors, exchanges, and broker-dealers. A separate panel also will consider the issue of how the SEC can best assess regulatory comparability and convergence.