Securities Law Prof Blog

Jeng on the JOBS Act

The JOBS Act: Rule 506, Crowdfunding, and the Balance between Efficient Capital Formation and Investor Protection, by Daniel H. Jeng, Boston University School of Law, was recently posted on SSRN.  Here is the abstract:

With great fanfare, the Jumpstart Our Business Startups Act, popularly known as the "JOBS Act", passed through Congress and, on April 15, 2012, earned President Obama's approval. This paper offers a review of the Act, delving into its historical background, purpose, and important titles. Title II amends Rule 506 of Regulation D to lift the prohibition of general solicitation and general advertising. Title III enables "equity crowdfunding", a novel and controversial fundraising method. These two titles expand capital formation channels to both accredited investors and to the "ordinary American investor". The struggle to strike the optimal balance between efficient capital formation and strong investor protection animates both Title II and Title III provisions as well as rule-making by the Securities and Exchange Commission. This paper offers four qualities that characterize the "ideal JOBS Act startup": 1) a smaller capital requirement; 2) a shorter timeline for success and product development; 3) a simple fundamental idea and business model; and 4) the elusive human element.

Choudhary et al. on Compliance with SEC Disclosure Rules

Boards, Auditors, Attorneys, and Compliance with Mandatory SEC Disclosure Rules, by Preeti Choudhary, Georgetown University; Jason D. Schloetzer, Georgetown University - McDonough School of Business; and Jason Sturgess, Georgetown University - Robert Emmett McDonough School of Business, was recently posted on SSRN.  Here is the abstract:

We survey the empirical literature on the determinants of firms’ compliance with mandatory SEC disclosure rules. We begin with a discussion of the role of boards of directors, public accounting firms, and corporate attorneys in the preparation and review of mandatory disclosures. We then organize current research into three broad types of variation in compliance: completeness, timeliness, and readability. Our review highlights three interesting areas for future research: (1) studies that examine the relations between completeness, timeliness, and readability within the same research design, (2) studies that assess whether boards of directors, public accounting firms, and corporate attorneys view disclosure compliance as a general firm policy, and (3) studies that investigate the influence of corporate attorneys on mandatory disclosure, as well as studies of disclosure issues that require collaboration between auditors and corporate attorneys. As a first step to address the latter agenda, we provide new empirical evidence regarding the impact of corporate attorneys on disclosure compliance.

Roe on Short-Termism

Corporate Short-Termism - In the Boardroom and in the Courtroom, by Mark J. Roe, Harvard Law School; European Corporate Governance Institute (ECGI), was recently posted on SSRN.  Here is the abstract:
 
A long-held view in corporate circles has been that furious rapid trading in stock markets has been increasing in recent decades, justifying more judicial measures that shield managers and boards from shareholder influence, so that boards and managers are freer to pursue sensible long-term strategies in their investment and management policies.

Here, I evaluate the evidence in favor of that view and find it insufficient to justify insulating boards from markets further. While there’s evidence of short-term distortions, the view is countered by several under-analyzed aspects of the American economy, each of which alone could trump the board isolation prescription. Together they make the case for further judicial isolation of boards from markets untenable. First, even if the financial markets were, net, short-term oriented, one must evaluate the American economy from a system-wide perspective. As long as venture capital markets, private equity markets, and other conduits mitigate, or reverse, much of any short-term tendencies in public markets, then the purported problem is local but not systemic. Second, the evidence that the stock market is, net, short-termist is inconclusive, with considerable evidence that stock market sectors often overvalue the long term. Third, mechanisms inside the corporation are important sources of short-term distortions and the impact of these internal short-term favoring mechanisms would be exacerbated by further judicial insulation of boards from markets. Fourth, courts are not well positioned to make this kind of basic economic policy, which if determined to be a serious problem is better addressed with policy tools wider than those available to courts. And, fifth, the widely held view that short-term trading has increased dramatically in recent decades may over-interpret the data; the duration for holdings of many of the country’s major stockholders, such as mutual funds like Fidelity and Vanguard, and major pension funds, does not seem to have shortened. Rather, a high-velocity trading fringe has emerged, and its rise affects average holding periods, but not the holding period for the country’s ongoing major stockholding institutions.

The view that stock market short-termism should affect corporate lawmaking fits snugly with two other widely supported views. One is that managers must be isolated from stock markets to run the firm well. Whatever the value of this view, short-termism provides no further support for managerial insulation from financial markets. The insulation argument must stand or fall on its own. Similarly, those who argue that employees, customers, and other stakeholders are due more consideration in corporate governance point to pernicious short-termism to further support their view. Again, the best view of the evidence is that the pro-stakeholder view must stand on its own. It gains no further evidence-based, conceptual support from a purported short-termism in financial markets. Overall, system-wide short-termism in public firms is something to watch for carefully, but not something that today should affect corporate lawmaking.

Morley on Separation of Investments and Management

The Separation of Investments and Management, by John Morley, University of Virginia School of Law, was recently posted on SSRN.  Here is the abstract:

This paper suggests a basic shift in the way we think about investment funds. The essence of these funds and their regulation lies not just in the nature of their investments, as is widely supposed, but also and more importantly in the nature of their organization. All types of investment funds — including hedge funds, private equity funds, venture capital funds, mutual funds, exchange-traded funds and closed-end funds — adopt a structure that I term “the separation of investments and management.” Investment enterprises place all of their investment assets into a “fund” with one set of owners, and all of their managers, workers and operational assets into a “management company” or “adviser” with a different set of owners. Investment funds also radically limit investors’ control, sometimes eliminating voting rights and boards of directors entirely. This pattern of organization has never been clearly explained or identified as a common feature of investment funds, but it has often worried and confused commentators and was recently the subject of a case in the U.S. Supreme Court. This paper explains this pattern by showing how it limits fund investors’ control over their managers and exposure to their managers’ profits and liabilities. Investors benefit from these limits for a combination of reasons having to do with exit rights, risk management and the economies of scale that managers can achieve by operating multiple funds. This pattern of organization is a large part of what defines investment funds and animates their regulation.

SEC Settles Insider Trading Charges Involving Nexen's Acquisition by CNOOC

The SEC announced that a Chinese businessman and his wife whose trading accounts were frozen last year as part of an insider trading case have agreed to settle charges that they loaded up on the securities of Nexen Inc. while in possession of nonpublic information about an impending announcement that the company was being acquired by China-based CNOOC Ltd.

The SEC obtained an emergency court order in July 2012 to freeze multiple Hong Kong and Singapore-based trading accounts just days after the Nexen acquisition was announced and suspicious trading in Nexen stock was detected. The SEC’s complaint alleged that in the days leading up to the announcement, Hong Kong-based firm Well Advantage Limited and other unknown traders purchased Nexen stock based on confidential details about the acquisition.

The SEC’s investigation has identified Ren Feng and his wife Zeng Huiyu as previously unknown traders charged in the complaint as well as Ren’s private investment company CT Prime Assets Limited and four of Zeng’s brokerage customers on whose behalf she traded. They made a combined $2.3 million in illegal profits from Nexen stock trades made by Ren and Zeng.

The settlement, which is subject to court approval, requires the traders to pay more than $3.3 million combined.

In October 2012, the SEC announced a settlement with Well Advantage, which agreed to pay more than $14.2 million to settle the insider trading charges. U.S. District Court Judge Richard J. Sullivan of the Southern District of New York approved that settlement.

 

Senior SAC Advisor Arrested in Insider Trading Investigation

Federal authorities in Manhattan arrested Michael Steinberg, a portfolio manager at New York-based hedge fund advisory firm Sigma Capital Management, and the SEC brought a separate civil enforcement action against him.  The charges in both actions stem from the investigation into trading on inside information in Dell and Nvidia Corp.  St einberg is the most senior employee in Steven Cohen's hedge fund to be arrested

The SEC alleges that Steinberg's illegal conduct generated more than $6 million in profits and avoided losses. Steinberg received illegal tips from Jon Horvath, an analyst who reported to him at Sigma Capital. Horvath was charged last year among several hedge fund managers and analysts as part of the broader investigation into expert networks and the trading activities of hedge funds.

 

SEC Announces Agenda for April 16 Roundtable on Fixed Income Markets

The SEC announced the agenda for its April 16 roundtable to discuss potential ways to improve the transparency and efficiency of fixed income markets. Panelists will be announced at a later date.

The roundtable will be divided into four panels.

The first panel will address current market structure for municipal securities, and the second panel will discuss current market structure for corporate bonds and asset-backed securities.

The third panel will focus on whether potential steps can be taken to improve the transparency, liquidity, or efficiency of the market structure for municipal securities. The fourth panel will focus on whether potential steps can be taken to improve the transparency, liquidity, or efficiency of the market structure for corporate bonds and asset-backed securities.

Judge Holds up Approval of SAC Settlement Because of Citigroup Appeal

Judge Victor Marrero, a federal district judge in the S.D.N.Y., said he needed more time to consider a $602 million settlement between the SEC and the hedge fund, SAC Capital Advisors LP, intended to resolve insider-trading allegations.   The judge said he was concerned about the potential impact of SEC v. Citigroup, an appeal now pending before the Second Circuit, in which the SEC and Citigroup challenge the district court's refusal to approve the settlement.  He suggested he might condition his approval of the SAC settlement on the outcome of that decision.  WSJ, Judge Needs More Time to Weigh SAC Settlement .

SEC and Morgan Keegan Directors Settle Enforcement Action

Investment News reports that the SEC has agreed in principle with eight former directors of five Morgan Keegan mutual funds to settle a civil enforcement action brought last December.  In the closely watched action, the SEC charged that the directors failed to exercise their responsibility to ensure accurate valuations of the assets in the funds, which included holdings in subprime mortgage-backed securities.  Investors in the funds lost more than $1 billion when the funds collapsed during the fiscal crisis.  InvNews, SEC settles high-profile case involving former directors of Morgan Keegan funds

SEC Charges Hedge Fund Analyst and Tech Executive with Insider Trading in Advance of Merger

The SEC charged Matthew Teeple, a California-based hedge fund analyst, with insider trading in advance of a merger of two technology companies based on nonpublic information he received from his friend, David Riley, an an executive at one of the companies. The SEC also charged Riley and another trader in the $29 million insider trading scheme.

According to the SEC, Teeple was tipped in advance of a July 2008 announcement that Foundry Networks Inc. had agreed to be acquired by Brocade Communication Systems Inc. for approximately $3 billion. Teeple’s source was Foundry’s chief information officer David Riley. Teeple then caused the San Francisco-based hedge fund advisory firm where he works to buy Foundry shares in large quantities in the days leading up to the public announcement, and the hedge funds managed by the firm reaped millions of dollars in profits when Foundry’s stock value increased upon the news. Teeple also tipped a Denver-based investment professional John Johnson whom he befriended through a previous working relationship, and Johnson made illegal trades based on the nonpublic information. Riley also tipped Teeple in advance of at least two other major announcements by Foundry, and Teeple’s firm traded on the nonpublic information to make profits or avoid losses.

In a separate action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Teeple, Riley, and Johnson.

Court Grants Class Certification to Mutual Fund Investors Based on Affiliated Ute Presumption

A recent opinion from the S.D.N.Y. granted class certification to a class of investors in several mutual funds in the Smith Barney Family of Funds because the plaintiffs successfully invoked the Affiliated Ute presumption of reliance.  The allegations stemmed from a previous SEC settlement alleging that the Funds failed to disclose that they did not pass along cost savings achieved by reducing transfer agent fees to the Funds, but instead allowed an affiliated firm to pocket the difference.  In re Smith Barney Transfer Agent Litigation (05 Civ. 7583 (WHP) dec. Mar. 21, 2013) (Download SmithBarney.032113[1])  

Defendant argued that class certification was unwarranted because there was no class-wide reliance presumption available.  Plaintiffs conceded that the fraud-on-the market presumption was not available because the securities did not trade in an efficient market and instead relied on the less commonly invoked Affiliated Ute presumption,  which is available only in claims "involving primarily a failure to disclose." As the court observed, the distinction between misstatements and omissions is often illusory.  Noting that the Affiliated Ute presumption is a "pragmatic one," the court found that the heart of plaintiffs' claim is the failure to disclose the transfer agent scheme that generated profits for the affiliate at the Funds' expense.  Moreover, class representatives had testified that disclosure of the transfer agent scheme would have affected their investment decisions.

As part of the earlier settlement,  the SEC had established a Fair Fund and distributed more than $100 million to the Funds.  Defendant argued that the claims of named plaintiffs who participated in the Fair Fund distribution were atypical.  The court, however, rejected this argument; typicality focuses on the nature of plaintiffs' claims, not on possible defenses to the claims.  In addition, while the securities law prohibits double recovery, there is no evidence that the named plaintiffs had been fully compensated.

Rebutting the FOTM Presumption in an Efficient Market

Judge Scheindlin (S.D.N.Y.) addressed an important securities law issue that is the subject of academic debate more often than the basis of a judicial opinion: how to rebut the fraud on the market (FOTM) presumption of reliance.  GAMCO Investors, Inc. v. Vivendi, S.A. (09 Civ. 7962 (SAS) decided Feb. 28, 2013) (Download VivendiSDNYopinion) presented that issue in a case where Vivendi was collaterally estopped from denying any of the elements of plaintiffs' section 10(b) claims except for reliance; plaintiffs were entitled to the FOTM presumption of reliance; and neither truth on the market nor allegations of no price impact were available as defenses to the presumption.  Moreover, the parties agreed that during the relevant period plaintiffs did not possess non-public corrective information about Vivendi's misstatements; the plaintiffs did not directly rely on Vivendi's material misstatements; during the relevant period, the market for Vivendi's ADS's was efficient.  In short, the only issue was whether Vivendi could rebut the FOTM presumption of reliance.  A bench trial was held on this issue, after which the court concluded that indeed Vivendi had successfully rebutted the presumption because the plaintiffs "did not rely on the inflated market value of Vivendi ADS's as an 'unbiased assessment of [their] value.'"

The plaintiffs, a number of companies affiliated with Gabelli Asset Management, Inc.,purchased Vivendi securities during a period when Vivendi made misstatements to cover up its liquidity crisis.  Plaintiffs allege that the misstatements inflated the market price of Vivendi ADS's and consequently harmed the plaintiffs when they relied on the inflated price in making their purchases.  The court, however, found that plaintiffs' investment philosophy was based on the intrinsic "Private Market Values" of a company, i.e., "the price that an informed industrialist would be willing to pay for it, if each of its segments were valued independently in a private market sale."  Plaintiffs' investment philosophy was to invest in companies whose PMVs are substantially higher than their market capitalizations.

The court specifically found that plaintiffs believed that Vivendi's liquidity crisis was a short-term concern that made it a more attractive investment because it reduced the market price of Vivendi securities without reducing its PMV. Consistent with this, plaintiffs were increasing their Vivendi holdings during the period when corrective disclosures about the liquidity crisis were introduced into the marketplace. Accordingly, Vivendi's liqudity crisis was irrelevant to plaintiffs' decision to purchase Vivendi securities.

The court cautioned that this was an "extraordinary case" because Vivendi was able to rebut the FOTM presumption in an efficient market by establishing that plaintiffs did not, in fact, rely on the inflated market value of the securities and that "it cannot be said that but for Vivendi's misstatements and omissions about its liquidity condition, Plaintiffs would not have transacted in Vivendi ADS's."  The court further stated that the holding was "sharply limited to its unusual facts, and should not be taken to suggest that sophisticated institutional investors or value-based investors are not entitled to the [FOTM] presumption in general."

Sitkoff on Fiduciary Obligations of Financial Advisors

The Fiduciary Obligations of Financial Advisors Under the Law of Agency, by Robert H. Sitkoff, Harvard Law School, was recently posted on SSRN.  Here is the abstract:

This paper considers how agency fiduciary law might be applied to a financial advisor with discretionary trading authority over a client's account. It (i) surveys the agency problem to which the fiduciary obligation is directed; (ii) examines the legal context by considering how the fiduciary obligation undertakes to mitigate this problem; and (iii) examines several potential applications of agency fiduciary law to financial advisors, including principal trades and the role of informed consent by the client, organizing the discussion under the great fiduciary rubrics of loyalty and care. This paper was sponsored by Federated Investors, Inc.

Fleischer & Staudt on The Supercharged IPO

The Supercharged IPO, by Victor Fleischer, University of Colorado Law School; University of San Diego, and Nancy C. Staudt, USC Gould School of Law, was recently posted on SSRN.. Here is the abstract:
 
A new innovation on the IPO landscape has emerged in the last two decades, allowing owner-founders to extract billions of dollars from newly-public companies. These IPOs — labeled supercharged IPOs — have been the subject of widespread debate and controversy: lawyers, financial experts, journalists, and Members of Congress have all weighed in on the topic. Some have argued that supercharged IPOs are a “brilliant, just brilliant,” while others have argued they are “underhanded” and “bizarre.”

In this article, we explore the supercharged IPO and explain how and why this new deal structure differs from the more traditional IPO. We then outline various theories of financial innovation and note that the extant literature provides useful explanations for why supercharged IPOs emerged and spread so quickly across industries and geographic areas. The literature also provides support for both legitimate and opportunistic uses of the supercharged IPO.

With the help of a large-N quantitative study — the first of its kind — we investigate the adoption and diffusion of this new innovation. We find that the reason parties have begun to supercharge their IPO is not linked to a desire to steal from naïve investors, but rather for tax planning purposes. Supercharged IPOs enable both owner-founders and public investors to save substantial amounts of money in federal and state taxes. With respect to the spread of the innovation, we find that elite lawyers, especially those located in New York City, are largely responsible for the changes that we observe on the IPO landscape. We conclude our study by demonstrating how our empirical findings can be used to 1) advance the literature on innovation, 2) assist firms going public in the future, and 3) shape legal reform down the road.

Bruner on Director's Duty of Care

Is the Corporate Director's Duty of Care a 'Fiduciary' Duty? Does it Matter?, by Christopher M. Bruner, Washington and Lee University - School of Law, was recently posted on SSRN.  Here is the abstract:

 While reference to "fiduciary duties" (plural) is routinely employed in the United States as a convenient short-hand for a corporate director's duties of care and loyalty, other common-law countries generally treat loyalty as the sole "fiduciary duty." This contrast prompts some important questions about the doctrinal structure for duty of care analysis adopted in Delaware, the principal jurisdiction of incorporation for U.S. public companies. Specifically, has the evolution of Delaware's convoluted and problematic framework for evaluating disinterested board conduct been facilitated by styling care a "fiduciary" duty? If so, then how should Delaware lawmakers and judges respond moving forward?

I argue that styling care a "fiduciary" duty has impacted Delaware's duty of care analysis in ways that are not uniformly positive. Historically, loyalty has been aggressively enforced, while care has hardly been enforced at all - the former approach aiming to deter conflicts of interest through probing analysis of "entire fairness," while the latter aims to promote entrepreneurial risk-taking through a hands-off judicial posture embodied in the business judgment rule. Conflation of these differing concepts as "fiduciary duties," however, has facilitated a tendency toward over-enforcement of care, periodically threatening to impair entrepreneurial risk-taking until arrested by a countervailing legislative or judicial response. Additionally, their conflation threatens to erode the duty of loyalty by fueling the contractarian argument that the sole utility of such "fiduciary duties" is to fill contractual gaps, and that corporations therefore ought to possess latitude to "opt out" of loyalty to the degree already permitted with respect to care.

While I concede that there may be good reasons not to abruptly recharacterize Delaware's duty of care as "non-fiduciary," I conclude that the analytical problems described in this essay can otherwise be remedied only through a statutory provision more clearly distinguishing these differing duties and enforcement strategies. Specifically, I advocate a statutory damages rule declaring once and for all that monetary damages may be imposed on a corporate director for care, but not loyalty, breaches - an approach effectively discarding much of Delaware's multi-layered and convoluted mode of care analysis, while insulating the duty of loyalty from future erosion.

Gender Parity as an Investment Strategy

There have been conflicting claims about whether the presence of women on corporate boards and in senior management improve the corporate bottom line.  Morgan Stanley is betting that it does; it is starting a "parity portfolio" that will invest in companies that have female representation on boards and cites research that "companies with significant female representation on boards and in senior leadership have stronger financials (return to shareholders, return on assets, return on equity, profit margins) than those that lack gender diversity in leadership."   According to a NY Times Dealbook column, this means companies with at least three women on their boards.  It strikes me that the portfolio won't be investing in a lot of companies!  

Taub on the London Whale

Jennifer Taub (Vermont Law School) recently posted an insightful blog on the Senate Committee hearing on the JP Morgan Chase London Whale trading loss and the disturbing truths about the post-financial crisis state of risk management controls, too-big-to-fail and regulatory constraints.  Check it out here.

FINRA Proposes to Amend Rule Regarding Public Release of Disciplinary Complaints

FINRA has filed with the SEC a proposed rule change amending FINRA Rule 8313 (Release of Disciplinary Complaints, Decisions and Other Information) to make more information about disciplinary proceedings available to the public.  The SEC has put the proposal out for public comment. (Download 34-69178[1])

The proposed rule change generally would establish general standards for the release of disciplinary information to the public that would provide greater information about FINRA's disciplinary actions.  It would also clarify the scope of information subject to Rule 8313.

Rule 8313(a) currently provides that in response to a request FINRA shall release any identified disciplinary complaint or decision to the requesting party.  Absent a specific request for an identified complaint or decision, the rule provides publicity thresholds for the release of information to the public.  Thus, disciplinary information currently available in the FINRA Disciplinary Actions online database is limited by Rule 8313's publicity thresholds.  The proposed amendment would eliminate the publicity thresholds and in their place adopt general standards for the public release of the information and increase access to information about disciplinary actions.  Specifically, proposed Rule 8313(a)(1) would provide that FINRA shall release to the public a copy of, and at FINRA's discretion information with respect to, any disciplinary complaint or disciplinary decision issued by FINRA.  Subject to limited exceptions, FINRA would release the information in unredacted form. (Download 34-69178-ex5[1])

Civil and Criminal Charges Brought Against Rengan Rajaratnam for Insider Trading

On Thursday the SEC charged Rajarengan “Rengan” Rajaratnam for his role in the massive insider trading scheme for which his older brother Raj Rajaratnam has been convicted.  According to the SEC, from 2006 to 2008, Rengan Rajaratnam repeatedly received inside information from his brother and reaped more than $3 million in illicit gains for himself and hedge funds that he managed at Galleon and Sedna Capital Management, a hedge fund advisory firm that he co-founded. In addition to illegally trading on inside tips, the SEC alleges that Rengan Rajaratnam was an active participant in his brother’s scheme to cultivate highly placed sources and extract confidential information for an unfair advantage over other traders.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Rengan Rajaratnam.

The SEC has now charged 33 defendants in its Galleon-related enforcement actions. The insider trading occurred in the securities of more than 15 companies for illicit gains totaling more than $96 million.

Former Oregon Gubernatorial Candidate Charged with Investor Fraud Involving Pre-IPO Shares of Facebook

This is a weird story:  Both the U.S. Attorney and the SEC have brought charges against Craig Berkman, a former Oregon gubernatorial candidate, alleging that he defrauded investors seeking to acquire highly coveted pre-IPO shares of Facebook and other social media companies.  According to the authorities, Berkman touted to investors that he had special access to scarce sources of pre-IPO stock in Facebook, LinkedIn, Groupon, and Zynga. Instead of purchasing shares on investors’ behalf as promised, Berkman misused their investments to make Ponzi-like payments to earlier investors, fund personal expenses, and pay off claims against him in a bankruptcy case.

The SEC also charged John B. Kern of Charleston, S.C., for his participation in the fraud as legal counsel to some of Berkman’s companies. When investors in Berkman’s phony Facebook fund began questioning what happened to their money after Facebook’s IPO occurred, Kern falsely assured them that their money was used to purchase pre-IPO Facebook stock being held for them by unnamed counterparties.

According to the SEC’s order instituting administrative proceedings, Berkman raised at least $13.2 million from 120 investors by selling membership interests in limited liability companies that he controlled and misappropriated virtually all investor funds that he raised.

The SEC’s order details a recidivist history for Berkman. The Oregon Division of Finance and Securities issued a cease-and-desist order and $50,000 fine against Berkman in 2001 for offering and selling convertible promissory notes without a brokerage license to Oregon residents. In June 2008, an Oregon jury found Berkman liable in a private action for breach of fiduciary duty, conversion of investor funds, and misrepresentation to investors arising from Berkman’s involvement with a series of purported venture capital funds known as Synectic Ventures. The court entered a $28 million judgment against Berkman. In March 2009, Synectic filed an involuntary Chapter 7 bankruptcy petition against Berkman in Florida for his unpaid debts arising from the 2008 court judgment. The parties to the bankruptcy proceeding reached a settlement with Berkman.