Securities Law Prof Blog

Bisetti, Nocera, Favero & Tebaldi on Longevity and Asset Allocation

Emilio Bisetti, Giacomo Nocera, Carlo A. Favero, and Claudio Tebaldi have posted A Multivariate Model of Strategic Asset Allocation with Longevity Risk on SSRN with the following abstract:

This paper proposes a framework to evaluate the impact of longevity-linked securities on the risk-return trade-off for traditional portfolios. Generalized unexpected raise in life expectancy is a source of aggregate risk in the insurance sector balance sheets. Longevity-linked securities are a natural instrument to reallocate these risks by making them tradable in the financial market. This paper extends the strategic asset allocation model of Campbell and Viceira (2005) to include a longevity-linked investment in addition to equity and fixed income securities and describe the resulting term structure of risk-return trade-offs. The model highlights an unexpected predictability pattern of the survival probability estimates. The empirical valuation of the market price of longevity risk, based on prices for standardized annuities publicly offered by US insurance companies, confirms that longevity linked securities offer cheap funding opportunities to asset managers willing to leverage their investment portfolio.

Barry, Hatfield & Kominers on Empty Voting

Jordan M. Barry, John William Hatfield, and Scott Duke Kominers have posted Shareholder Decisionmaking in the Presence of Empty Voting and Hidden Ownership on SSRN with the following abstract:

We consider securities markets in which economic interests in firms and shareholder voting rights are traded independently; such markets allow for "empty voters" who hold voting rights in a firm that exceed their economic interests. We demonstrate that, in such settings, competitive equilibria generally do not exist and may be inefficient even when they do exist. As the competitive equilibrium solution concept does not provide useful predictions in the presence of empty voting, we focus on cooperative game-theoretic "core outcomes." We show that core outcomes always exist, are always efficient, and can be reached from any initial allocation through voluntary trading; moreover, at a core outcome, agents have efficient incentives with regards to information revelation.

Coates on Mergers, Acquisitions, and Restructuring

John C. Coates, IV has posted Mergers, Acquisitions and Restructuring: Types, Regulation, and Patterns of Practice on SSRN with the following abstract:

An important component of corporate governance is the regulation of significant transactions – mergers, acquisitions, and restructuring. This paper (a chapter in Oxford Handbook on Corporate Law and Governance, forthcoming) reviews how M&A and restructuring are regulated by corporate and securities law, listing standards, antitrust and foreign investment law, and industry-specific regulation. Drawing on real-world examples from the world’s two largest M&A markets (the US and the UK) and a representative developing nation (India), major types of M&A transactions are reviewed, and six goals of M&A regulation are summarized – to (1) clarify authority, (2) reduce costs, (3) constrain conflicts of interest, (4) protect dispersed owners, (5) deter looting, asset-stripping and excessive leverage, and (6) cope with side effects. Modes of regulation either (a) facilitate M&A – collective action and call-right statutes – or (b) constrain M&A – disclosure laws, approval requirements, augmented duties, fairness requirements, regulation of terms, process and deal-related debt, and bans or structural limits. The paper synthesizes empirical research on types of transactions chosen, effects of law on M&A, and effects of M&A. Throughout, similarities and differences across transaction types and countries are noted. The paper concludes with observations about what these variations imply and how law affects economic activity.

Steinitz on Securitizing Legal Claims

Maya Steinitz has posted Incorporating Legal Claims on SSRN with the following abstract:

Recent years have seen an explosion of interest in commercial litigation funding which is regarded as a new phenomenon in the United States. Whereas the judicial, legislative and scholarly treatment of litigation finance has regarded litigation finance first and foremost as a form of champerty and sought to regulate it through rules of legal professional responsibility (hereinafter, the ‘legal ethics paradigm’) this Article suggests that the problems created by litigation finance are all facets of the classic problems created by ‘the separation of ownership and control’ that have been a focus of business law since the advent of the corporate form. Therefore, an ‘incorporation paradigm,’ offered here, is more appropriate. ‘Incorporating legal claims’ means conceiving of the claim as an asset with an existence wholly separate from the plaintiff. This can be done by issuing securities tied to litigation proceed rights. Such securities can be issued with or without the use of various business entities.

Indeed, in certain real life deals, previously overlooked by scholars, creative lawyers used securities tied to litigation proceed rights. The Article analyzes and then expands upon such instances of financial–legal innovation suggesting how various business entities can be used to deal with the core challenges presented by the separation of ownership of and control over legal claims. Specifically, the litigation funding problems being addressed by the incorporation of legal claims are (1) extreme agency problems; (2) extreme information asymmetries; (3) extreme uncertainty; and (4) commodification. In addition, the Article discusses how incorporation of legal claims can reduce various costs that litigation imposes in other transactions, such as mergers & acquisitions.

Nelson & Pritchard on Disclosure of Risk Factors

Karen K. Nelson and Adam C. Pritchard have posted Carrot or Stick? The Shift from Voluntary to Mandatory Disclosure of Risk Factors on SSRN with the following abstract:

This study investigates risk factor disclosures under the voluntary, incentive-based disclosure regime provided by the safe harbor provision of the Private Securities Litigation Reform Act and the SEC’s subsequent disclosure mandate. Firms subject to greater litigation risk disclose more risk factors, update the language more from year-to-year, and use more readable language than firms with lower litigation risk. These differences in the quality of disclosure are pronounced in the voluntary disclosure regime, but converge following the SEC mandate. Consistent with these findings, the risk factor disclosures of high litigation risk firms are significantly more informative about systematic and idiosyncratic firm risk when disclosure is voluntary but not when disclosure is mandated. Overall, the results suggest that for some firms voluntary disclosure of risk factors is not a substitute for a regulatory mandate.

Lubben on Clearinghouses

Stephen J. Lubben has posted Nationalize the Clearinghouses! on SSRN with the following abstract:

Given the vital place of clearinghouses in Dodd-Frank, it is perhaps surprising that Dodd-Frank makes no provision for the failure of a clearinghouse. Indeed, it is arguable that the United States is not in compliance with its commitment to the G-20 on this point.

Clearinghouses are presently excluded from the new Orderly Liquidation Authority under title II, title II and titles VII and VIII do not work well together in any event, and the notion that a derivatives clearinghouse might file a regular bankruptcy petition is farcical, given that Congress previously decided to exclude derivatives, and most securities trades, from the most important parts of the Bankruptcy Code. A clearinghouse might file, but there would be little point.

And because clearinghouses are oddly defined as "commodities brokers" under the Bankruptcy Code, they are only permitted to file a chapter 7 liquidation cases.

In this paper I suggest two likely outcomes upon the onset of clearinghouse financial distress. First, Congress will be tempted to adopt an ad hoc statutory solution. The fate of Fannie Mae and Freddie Mac, the two mortgage companies who were placed in a conservatorship in September 2008, shortly after Congress had created that possibility under the Housing and Economic Recovery Act of 2008, looms large here. But ad hoc solutions simply exacerbate uncertainty in times of financial distress, and are subject to litigation risk too. And the sudden creation of a specialized resolution process is really not anything more than a bailout, since any solution will require massive capital injections to save the clearinghouses. Again consider the mortgage companies, and the U.S. Treasury’s large preferred share holdings therein.

So there will be a temptation to engage in direct bailout, despite Dodd-Frank’s claim to have ended bailouts. Bailouts of individual financial institutions may end, but bailouts of clearinghouses might become more common in a post-Dodd-Frank world. Given that most clearinghouses are themselves publicly traded companies, with strong connections to all the major banks, there are good reasons to wonder if we will not simply be bailing out a new type of financial institution in the future.

What to do? I suggest that the government should nationalize the clearinghouses upon failure, and the intention to exercise this option should be made clear ex ante. That is, the government should expressly state that clearinghouses designated under title VIII of Dodd-Frank that ultimately fail will be nationalized, with specific consequences to investors, and an expectation of member participation in the recapitalization of the clearinghouse, once that becomes systemically viable. This should provide stakeholders in the clearinghouses with strong incentives to oversee the clearinghouse’s management, and avoid such a fate.

Commissioner Aguilar on Protecting Older Investors

On July 10, 2014 at a meeting of the Investor Advisory Committee in Washington, D.C., Commissioner Luis A. Aguilar delivered remarks on Combating the Financial Exploitation of Older Adults.

 

 

This Week in Securities Litigation

The SEC Actions Blog has compiled This Week In Securities Litigation (Week ending July 11, 2014).

New in Print

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

Oscar Bernal, Astrid Herinckx & Ariane Szafarz, Which Short-Selling Regulation Is the Least Damaging to Market Efficiency? Evidence from Europe, 37 Int'l Rev. L. & Econ. 244 (2014).

Latoya C. Brown, Rise of Intercontinental Exchange and Implications of its Merger with NYSE Euronext, 32 J.L. & Com. 109 (2013).

Jeffrey M. Colon, Oil and Water:  Mixing Taxable and Tax-Exempt Shareholders in Mutual Funds, 45 Loy. U. Chi. L.J. 773 (2014).

David Hamid, Note, Substance vs. Form:  Rethinking the Scope of Dodd-Frank's End-User Clearing Exception in Light of Systemic Risk, 12 Cardozo Pub. L. Pol'y & Ethics J. 183 (2013).

Debby Van Geyt, Philippe Van Cauwenberge & Heidi Vander Bauwhede, Does High-Quality Corporate Communication Reduce Insider Trading Profitability?, 37 Int'l Rev. L. & Econ. 1 (2014).

Thomas John Walker, et al., The Role of Aviation Laws and Legal Liability in Aviation Disasters:  A financial Market Perspective, 37 Int'l Rev. L. & Econ. 57 (2014).

Third Annual Institute for Investor Protection Conference: Strategies for Investigating and Pleading Securities Fraud Claims. Introduction by Michael J. Kaufman; keynote address by Mark Whitacre; remarks by Wendy Gerwick Couture and Hon. Jed. S. Rakoff; essay by Geoffrey Christopher Rapp; articles by Gideon Mark, Marc I. Steinberg, Charles W. Murdock, Sharon Nelles, Hilary Huber, Steven A. Ramirez and John M. Wunderlich. 45 Loy. U. Chi. L.J. 525-772 (2014).

Basel Committee on Banking Supervision and IOSCO Task Force Conducts a Survey on Securitization Markets

Details available here.

New in Print

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

Neil Auerbach, The Future of Clean Energy Finance, 20 N.Y.U. Envtl. L.J. 363 (2014).

Chad Bonstead, Comment, Removing the FCPA Facilitation Payments Exception:  Enforcement Tools for a Cleaner Business As Usual, 36 Hous. J. Int'l L. 503 (2014).

Alexandros Seretakis, Taming the Locusts? Embattled Hedge Funds in the E.U., 10 N.Y.U. J.L. & Bus. 115 (2013).

Tyce Walters, Comment, Regulatory Lies and Section 6 (c)(2):  The Promise and Pitfalls of the CFTC's New False Statement Authority, 32 Yale L. & Pol'y Rev. 335 (2013).

This Week in Securities Litigation

The SEC Actions Blog has compiled This Week In Securities Litigation (Week ending July 3, 2014).

Xu, Zhou, Bin & Jin on Directors' Duties in China

Guangdong Xu, Tianshu Zhou, Zeng Bin, and Shi Jin have posted Directors’ Duties in China on SSRN with the following abstract:

This paper examines the development of the legal framework regarding fiduciary duties of directors in China. The concept of fiduciary duty was introduced by the 2005 revisions to China’s Corporate Law. The implementation of fiduciary duties in China has encountered considerable obstacles because of the inherent weakness of the legal system. The legal texts are simple, vague and rigid. In the enforcement process, formalized judgments have placed limitations on precedent creation, thus reducing the deterrent effect, and the judicial system has shown reluctance to intervene in matters related to directors’ duties in listed companies. There have been improvements, however. In a limited number of judicial decisions, courts have attempted to more clearly define the meaning of directors’ fiduciary duties. In the penalty decisions of the China Securities Regulatory Commission (CSRC), the duties of directors have been interpreted in a more sophisticated manner.

Aitken, Aspris, Foley & Harris on Algorithmic Trading

Michael J. Aitken, Angelo Aspris, Sean Foley, and Frederick H. deB. Harris have posted The Effects of Algorithmic Trading on Security Market Quality on SSRN with the following abstract:

We estimate in a systems framework the effect of algorithmic trading on security market quality, defined to include market manipulation at the close, information leakage prior to price-sensitive announcements, and effective spreads. Using cancellation proxies to identify AT, we show that greater AT can reduce market manipulation and information leakage as well as spreads. The data cover all securities on the London Stock Exchange and on NYSE-Euronext Paris four years before and after MiFID1. MiFID1 increased leakage and spreads with mixed effects on market manipulation. We address robustness to end-of-quarter reporting deadlines, analyze the over-identifying restrictions, and perform both Hausman and Stock-Yogo tests of the exogeneity and strength of our AT instruments.

Campbell on Small Business Capital Formation

Rutheford B. Campbell Jr. has posted The New Regulation of Small Business Capital Formation: The Impact - If Any - Of the Jobs Act on SSRN with the following abstract:

An efficient access to external capital by businesses is essential to a market economy. Small businesses, which amount to a vital component of our market economy, face not only structural and economic disadvantages but also legal obstacles in their search for essential, external capital.

The Titles II, III and IV of the Jobs Act were designed, at least apparently, to ameliorate inefficient legal rules governing small businesses’ access to external capital. While the act itself is not without challenges and significant misdirection, it offered the Commission an opportunity to construct regulatory regimes that materially enhance efficient, small business capital formation. The Commission, however, has failed to take full advantage of this opportunity.

Title II of the Jobs Act, as implemented by Commission regulations, changes Regulation D to permit a broad solicitation for investors in Rule 506 offerings. That change amounts to an efficient improvement that will provide some benefit to small businesses in search of external capital. A requirement for the exemption provided by the revised Rule 506, however, is that sales must be restricted to accredited investors only, and that by definition is a limited source of capital for small businesses.

Without significant changes to the Commission’s proposed rules implementing Title III (crowdfunding), the crowdfunding exemption will be less available for small business issuers than efficiency would require. The Commission’s proposed rules are plagued by excessive disclosure requirements for small offerings, integration complications, and unmanageable risks created by actions of intermediaries.

Without significant changes to the Commission’s proposed rules implementing Title IV (popularly called Regulation A-Plus), the exemption provided by Regulation A-Plus will be essentially unavailable for small businesses. This is due to excessive disclosure requirements for small offerings and, more importantly, the failure to provide an effective preemption of state authority over small Regulation A-Plus offerings.

The problems regarding the proposed crowdfunding regulations and the proposed Regulation A-Plus regulations are fixable, if the Commission has the will.

 

Merrill, Nadauld, Stulz & Sherlund on Mortgage Backed Securities

Craig B. Merrill, Taylor Nadauld, Rene M. Stulz, and Shane M. Sherlund have posted Were There Fire Sales in the RMBS Market? on SSRN with the following abstract:

Many observers have argued that the fall in RMBS prices during the crisis was partly caused by fire sales. We provide an explanation for why financial institutions may have engaged in fire sales using a unique dataset of RMBS transactions for insurance companies. We show that risk-sensitive capital requirements and mark-to-market accounting can jointly create incentives for capital-constrained financial institutions to engage in fire sales of stressed securities because the increased risk can make it too expensive to hold such securities. Further, we find that, in general, RMBS prices behaved as would be expected in the presence of fire sales.

Chu on Shareholder Litigation

Yongqiang Chu has posted Shareholder Litigation and the Cost of Bank Loans -- Evidence from a Natural Experiment on SSRN with the following abstract:

I study how the threat of shareholder litigation affects the cost of bank loans using a natural experiment based on a ruling by the Ninth Circuit Court of Appeals that makes class action shareholder litigation more difficult. I find that increasing the difficulty of securities class action suit decreases loan spreads, and the effect is stronger for firms closer to bankruptcy. The result is consistent with the argument that shareholder litigation can lead to wealth extraction from lenders in bankruptcy. I also find that the ruling increases loan spreads for firms with better credit quality and weaker corporate governance mechanisms, which is consistent with the argument that the threat of shareholder litigation can help discipline managers.

Koehler on the FCPA

Mike Koehler has posted Foreign Corrupt Practices Act Ripples on SSRN with the following abstract:

An obvious reason to comply with the Foreign Corrupt Practices Act (“FCPA”) is that non-compliance can expose a company to a criminal or civil FCPA enforcement action by the Department of Justice (“DOJ”) and/or the Securities and Exchange Commission (“SEC”). However, this Article highlights that settlement amounts in an actual FCPA enforcement action are often only a relatively minor component of the overall financial consequences that can result from FCPA scrutiny or enforcement in this new era.

By coining a new term of art - the “three buckets” of FCPA financial exposure - and through various case studies and examples, this Article demonstrates how FCPA scrutiny and enforcement can impact a company’s business operations and strategy in a variety of ways from: pre and post-enforcement action professional fees and expenses; to market capitalization; to cost of capital; to merger and acquisition activity; to impeding or distracting a company from achieving other business objectives; to private shareholder litigation; to offensive use of the FCPA by a competitor or adversary to achieve a business objective or to further advance a litigating position.

This Article thus shifts the FCPA conversation away from a purely legal issue to its more proper designation as a general business issue that needs to be on the radar screen of business managers operating in the global marketplace. By highlighting the many ripples of FCPA scrutiny and enforcement, it is hoped that more business managers can view the importance of FCPA compliance more holistically and not merely through the narrow lens of actual enforcement actions.

 

Jiang, Wang & Wang on the Ratings of MBS and ABS

John (Xuefeng) Jiang, Isabel Yanyan Wang, and Kailong (Philip) Wang have posted Former Rating Analysts and the Ratings of MBS and ABS: Evidence from LinkedIn on SSRN with the following abstract:

Using self-posted profiles on LinkedIn, we identify 391 rating analysts who previously work in the structured finance divisions of Moody’s, S&P or Fitch but later join issuers of mortgage-backed securities (MBS) and asset-backed securities (ABS) from 1997 to 2007. We find that MBS and ABS issued by firms that employ more former rating analysts suffer larger downgrades subsequently, implying that these former analysts help issuers inflate the initial ratings. Further analyses suggest former analysts influence ratings through their specialized knowledge in structured finance. We also find investors in AAA rated securities do not price the risk of rating inflation induced by former analysts.

Hu on Disclosure

Henry T. C. Hu has posted Disclosure Universes and Modes of Information: Banks, Innovation, and Divergent Regulatory Quests on SSRN with the following abstract:

In 2013, a new system for mandatory public disclosure came into effect, the first since the creation of the Securities and Exchange Commission (SEC) in 1934. Today, major banks and certain other entities must make disclosures mandated not only by the SEC, but also by a new system developed by the Federal Reserve Board and other U.S. bank regulators acting in the shadow of the Basel Committee on Banking Supervision and the Dodd-Frank Act. Already, this parallel system, which stemmed in large part from a belief that disclosures as to the complex risks flowing from modern financial innovation were manifestly inadequate, dwarfs the SEC system in sophistication as to the quantitative aspects of market risk and the impact of economic stress.

The overall morphology of mandatory public information has changed in elemental ways, spanning two parallel regulatory universes with divergent ends and means. The SEC system is directed at the interests of investors and market efficiency, while the bank regulator system is directed at the well-being of the entities themselves and the stability of the financial system. The regulatory means diverge as well, not only as to specific risk-related disclosures, but even as to overarching concepts like "materiality" and the availability of private enforcement.

This Article is the first academic work to consider the new morphology of public information. Refining the conceptual framework for "information" introduced in a prior (2012) work ("Too Complex to Depict?"), I set out three approaches to information. First, the longstanding approach to information is termed the "descriptive mode," one that relies on "intermediary depictions" of objective reality. An intermediary — such as a corporation issuing shares — stands between objective reality and the investor. The corporation observes and analyzes the objective reality, crafts a depiction of the pertinent aspects, and transmits its depiction to investors. With revolutionary advances in computer- and web-related technologies, investors need no longer rely exclusively on the descriptive mode and its intermediary depictions. The "transfer mode" allows "pure information" about the objective reality to be transmitted directly to investors. The "hybrid mode" draws on elements of both of the other modes, and investors rely on “moderately pure information.”

This Article also offers pathways for reform. In terms of modes, the most incremental step would be to improve the implementation of the descriptive mode, especially at the SEC. The key SEC disclosure requirements have been substantially frozen even as banking and financial innovation have undergone epochal changes. More fundamentally, regulators have invested almost entirely in the descriptive mode. Giving full consideration to all three modes — modal "informational neutrality" — would lead to a more diversified portfolio of informational strategies, one better suited to the informational challenges of financial innovation. The Article outlines examples of transfer and hybrid mode strategies and the need to address longstanding issues associated with confidential treatment requests and the Freedom of Information Act.

Reforms are also necessary at the level of the morphology. In the long run, the existence of parallel universes with divergent regulatory quests is unsustainable. The regulatory objectives of the two systems not only diverge, but sometimes conflict. A disclosure the SEC system deems essential for investor protection and market efficiency can be contrary to the bank well-being and financial system stability goals of the bank regulator system (and of the new Financial Stability Oversight Council). In the short run, boundary-setting and a modest form of "informational neutrality" across regulatory systems (including as to judicial review of rule-making) can promote coordination.