While reading this article I was pleased to find quotes from my good friend and colleague, Kent Barnett. I asked him to share with the Glom readers further insights on Judge May's recent ruling that the SEC's use of an ALJ in an insider trading case may be unconstitutional. Here's Kent with more:
Today's WSJ brings a page one headline: Tech Startups Play Numbers Game. The gravamen of the charge is that still-private companies are using unusual revenue-like/revenue-lite metrics like "billings" or "bookings" to paint a rosier picture than their finances warrant for would-be investors. Rob Beardon, entrepreneur-in-residence at UGA's Terry business school, was the article's lead example: His company Hortonworks forecast a "strong $100 million run rate" in 2014, but at Hortonworks' 2015 IPO the application of traditional accounting methods led to only $46 million of reported revenue.
The WSJ's tone is one of revelation and shock, but is this really surprising? Consider (with occasional color quotes from the WSJ article)
- Venture capitalists funds take rich people's money and invest it in private companies that are not subject to the 1933 and 1934 Act disclosure rules. These investments are by definition risky; associate with that risk is the prospect of a greater return than the public markets can provide.
- A bubble currently exists in the valuation of private tech companies.
- In a bubble, rational people become less rational: (From Benchmark partner Bill Gurley's blog, quoted in the WSJ "Late-stage investors, desperately afraid of missing out on acquiring shareholding positions in possible “unicorn” companies, have essentially abandoned their traditional risk analysis.")
- If private investors aren't doing their own diligence, they'll pay the price eventually.
- Entrepreneurs are always optimistic. That's why they're entrepreneurs. Of course they're going to paint a rosy picture ("Many tech-company executives say nontraditional numbers often are a better barometer of a firm’s progress at luring customers, outrunning competitors and pushing the company’s value higher.")
- Accountants don't want a barometer. They want the facts. (“Everyone loves [the non-traditional bookings metric] except the SEC,” [accounting consultant Barrett Daniels] says, adding that it is “easily inflated, and the auditors won’t review it.”)
So will this "numbers game" be the scandal du jour? The SEC doesn't generally concern itself ex-ante with fraud in private firms, but is "increasing its scrutiny of non-GAAP terms at young companies."
I don't this the SEC should concern itself much with this. The private markets are private for a reason--supposedly these investors can fend for themselves. If ever the future crowdfunded companies, in which Joe Public can invest, start touting their "bookings,"then the SEC should act.
Still, private venture-backed companies would do well to remember that puffery may be ok, but Rule 10b-5 makes it a federal securities violation to lie when you sell securities-- even if you're private.
The Washington Post has a story on the AIG and Fannie and Freddie cases, which, as you might remember, use the Takings Clause to go after the government for its financial crisis related efforts. In theory, that's not the worst way to hold the government accountable for breaking the china in its crisis response - damages after the fact rectify wrongs without getting courts in the way. And I've written about both cases, here and here.
Anyway, the Post has checked in on the cases, and the view is "you people should be worrying more about the possibility that the government may lose.
Greenberg is asking the court to award him and other AIG shareholders at least $23 billion from the Treasury. He says that’s to compensate them for the 80 percent of AIG stock that the Federal Reserve demanded as a condition for its bailout. Judge Thomas Wheeler has repeatedly signaled his agreement with Greenberg. A decision is expected any day.
In the Fannie and Freddie case, the decision is further off, with the trial set to begin in the fall. The hedge funds are challenging the government’s decision to confiscate all of the firms’ annual profits, even if those profits exceed the 10 percent dividend rate that the Treasury had initially demanded. This “profit sweep” effectively prevents the firms from ever returning the government’s $187 billion in capital and freeing themselves from government control.
Earlier this year, Judge Margaret Sweeney refused to dismiss the case and gave lawyers for the hedge funds the right to sift through the memos and e-mails of government officials involved. Within weeks, Fannie and Freddie shares, which had been trading at about $1.50, started trading as high as $3 based on rumors that the documents revealed inconsistencies in government officials’ statements.
They checked in with me on the article, so there's that, too.
Call for Papers
AALS Section on Securities Regulation - 2016 AALS Annual Meeting
January 6-10, 2016 New York, NY
The AALS Section on Securities Regulation invites papers for its program on “The Future of Securities Regulation: Innovation, Regulation and Enforcement.”
TOPIC DESCRIPTION: This panel discussion will explore the current trends and future implications in the securities regulation field including transactional and financial innovation, the regulation of investment funds, the intersection of the First Amendment and securities law, the debate over fee-shifting bylaws, the ever-expanding transactional exemptions including under Regulation D, and judicial interpretations of insider trading laws. The Executive Committee welcomes papers (theoretical, doctrinal, policy-oriented, empirical) on both the transactional and litigation sides of securities law and practice.
ELIGIBILITY: Full-time faculty members of AALS member law schools are eligible to submit papers. Pursuant to AALS rules, faculty at fee-paid law schools, foreign faculty, adjunct and visiting faculty (without a full-time position at an AALS member law school), graduate students, fellows, and non-law school faculty are not eligible to submit. Please note that all faculty members presenting at the program are responsible for paying their own annual meeting registration fee and travel expenses. NOTE FURTHER, AALS has announced reduced registration fees for junior faculty for the 2016 conference.
PAPER SUBMISSION PROCEDURE: Up to four papers may be selected from this call for papers. There is no formal requirement as to the form or length of proposals. However, more complete drafts will be given priority over abstracts, and presenters are expected to have a draft for commentators two weeks prior to the beginning of the AALS conference.
Papers will be selected by the Section's Executive Committee in a double-blind review. Please submit only anonymous papers by redacting from the submission the author's name and any references to the identity of the author. The title of the email submission should read: "Submission - 2016 AALS Section on Securities Regulation."
Please email submissions to the Section Chair Christine Hurt at: email@example.com on or before August 21, 2015.
We've been speaking about banker ethics that week, though it is still unclear what, exactly, supervisors want when they call for it. Maybe the network-of-regulatory-networks the Financial Stability Board will come up with an answer. The G-7 has just asked it to develop a code of ethics that would apply to all of the banks across the world.
“This kind of malpractice has got to do with the dominant company culture but not just that -- it’s also about the behavior of individuals, who should not be absolved from responsibility,” Bundesbank President Jens Weidmann said in the German city of Dresden on Friday, announcing the G-7’s lead. The code “should be a voluntary self-commitment made by the financial industry, an international initiative,” he said.
“Currently a certain number of disparate codes exist in different jurisdictions, and they were often ignored,” Banque de France Governor Christian Noyer said after the Dresden meeting. “We need to pull all this together, so that we have a code that is coherent and applicable everywhere.”
It will be interesting to see how voluntary this voluntary code is. And how the FSB is going to harmonize the cultures of, say, Japanese conglomerates and American four branchers. But it is either an example of how financial regulation is increasingly done at the global level ... or an example of regulators saying: we give up! All our rules are meaningless! Please be nicer!
My soon to be colleague Peter Conti-Brown and Brookings author (and future Glom guest) Philip Wallach are debating whether the Fed had the power to bail out Lehman Brothers in the middle of the financial crisis. The Fed's lawyers said, after the fact, that no, they didn't have the legal power to bail out Lehman. Peter says yes they did, Philip says no, and I'm with Peter on this one - the discretion that the Fed had to open up its discount window to anyone was massive. In fact, I'm not even sure that Dodd-Frank, which added some language to the section, really reduced Fed discretion much at all. It's a pretty interesting debate, though, and goes to how much you believe the law constrains financial regulators.
as I discuss at much greater length in my forthcoming book, The Power and Independence of the Federal Reserve, the idea that 13(3) presented any kind of a statutory barrier is pure spin. There’s no obvious hook for judicial review (and no independent mechanism for enforcement), and the authority given is completely broad. Wallach calls this authority “vague” and “ambiguous,” but I don’t see it: broad discretion is not vague for being broad. In relevant part, the statute as of 2008 provided that “in unusual and exigent circumstances,” five members of the Fed’s Board of Governors could lend money through the relevant Federal Reserve Bank to any “individual, partnership, or corporation” so long as the loan is “secured to the satisfaction of the Federal reserve bank.” Before making the loan, though, the relevant Reserve Bank has to “obtain evidence” that the individual, partnership, or corporation in question “is unable to secure adequate credit accommodations from other banking institutions.”
In other words, so long as the Reserve Bank was “satisfied” by the security offered and there is “evidence”—some, any, of undefined quality—the loan could occur.
I (and most observers) read the “satisfaction” requirement as meaning that the Fed can only lend against what it genuinely believes to be sound collateral—i.e., it must act as a (central) bank, and not as a stand-in fiscal authority. The Fed’s assessment of Lehman Brothers as deeply insolvent at the time of the crisis meant that it did not have the legal power to lend. Years later, we have some indication that this assessment may have been flawed, but I don’t take the evidence uncovered as anything like dispositive. As I note in the book, the Fed’s defenders make a strong substantive case that the Fed was right to see Lehman as beyond helping as AIG (rescued days later) was not.
And the debate will be going on over at the Yale J on Reg for the rest of the week. Do give it a look.
Jessica Kennedy at Vanderbilt has done research on what makes corporate officials behave unethically. Here she is, in an interview (disclosure: my department's former post-doc, now at Vanderbilt):
Previous research has often traced ethical misconduct to high-ranking people’s orders. It shows that power leads to bad behavior, in essence. Other studies have shown that the behavior of high-ranking people sets the tone in their groups — that it trickles down.
But I don’t think that presents a complete picture of how unethical practices emerge. In fact, such practices often emerge from groups. For example, prior research has found that people making decisions as a group are more willing to lie than when they are making decisions as individuals. What I found in multiple studies was that high-ranking people are more inclined than low-ranking people to accept what their group recommends to them, even when it represents a breach of ethics. That is, higher-ranking people are less likely to engage in principled dissent and actively oppose such recommendations than are lower-ranking individuals.
I've watched with interest the new vogue among regulators to insist that financial institutions behave more ethically. What does that mean? The language is often one of chastisement. Jessica's research suggests - and this is consistent with what banking supervisors often point to - that the problem really might be one of culture and groups, not that she is making regulatory recommendations. Anyway, it's an interesting compliance problem.
The FIFA case by the US is interesting because:
- It is a RICO case - so the government's using a statute designed to go after the mob to clean up an international organization.
- It is the definition of the extraterritorial application of American laws. To be sure, FIFA has availed itself of the American market, but only one American has been indicted in this case, and he looks like a minor player. It's not clear how much time the defendants (they're all from this hemisphere) spend in America. They are being indicted not because of what they have done to American victims, but rather how they have enriched themselves at the expense of FIFA, which has a relationship with America. Absent diplomatic immunity issues, the same sort of theory could be used to go after officials in a wide array of international organizations.
- Nonetheless, it looks like a typical white collar investigation. They've got an informant - Chuck Blazer - and now they've used him to go after a bunch of functionaries he knew. Surely they will try to get these defendants to turn on Sepp Blatter, the head of FIFA, and those close to him.
- For that reason, I could also see a deal done. If Blatter drops his re-election bid, this investigation could stop with some promised reforms and a few convictions.
- It looks like no government officials were bribed - this is not an FCPA case. It would be surprising, but I guess sometimes RICO alone is enough. The underlying counts are wire fraud - including the controversially expansive honest services wire fraud - and money laundering.
- Here's a somewhat related paper by Christina Parajon Skinner on disciplining international actors through RICO. Her case study is Donziger/Ecuador: Download Skinner on rico and io ethics
So, the Pitch Perfect series is not fun for the entire family (I learned this the hard way when my 7 year-old asked me what a b----- was), but it is a fun series for most of the family! I reluctantly saw the first one, but was pleasantly surprised. But, I'll have to say that our family loves a cappella music. Loves it. Goes to see university performances. Buys CDs and downloads. So, your mileage may vary, as they say.
So, an assortment of us made our way to see Pitch Perfect 2. I will admit that I liked it better than the first and actually better than the other sequel our family was waiting anxiously for this summer (Avengers 2). The challenge for the sequel is how to have a movie with a lot of performances, but not just copy the format of the first movie -- the Barden Bellas face off against their nemesis group, the Treble Makers, in the national championships. In the sequel, the Bellas have won the championships 3 years in a row, but take a startling plunge due to a wardrobe malfunction scandal. Suffering under a suspension, their only hope is to win the international championship to be reinstated, a feat no U.S. group has ever accomplished. Now that the Bellas have made nice with the Treble Makers, we need a new antagonist in the form of a German group "Das Sound Machine." The face-off is slightly reminiscent of Rocky Balboa v. Drago (albeit Russian). The Bellas have to regroup, get back to basics, and "find their sound" in order to stand a fighting chance.
Other subplots include Beca (Anna Kendrick) trying to break into music producing by taking an internship at a recording studio. The scenes with her boss are particularly fun. Unfortunately, her cute romance with Jesse is sort of a non-event in this movie, with the boyfriend basically providing occasional support but no interesting scenes. In addition, a new Bella arrives in the form of a "legacy" student who has dreamed of being a Bella only to find the group in shame and disarray. The funniest Bella, of course, is "Fat Amy" (Rebel Wilson) who steals the movie again, this time with her romance with Bumper, Treble Maker alum.
Stay in your seat until after the credits for a great "bonus," which again is better than the one after Avengers 2, even though the Marvel Cinematic Universe historically has made great use of the post-credits "button."
We rarely get to point to a story in the New York Post, but I've always enjoyed its business coverage. Anyway, last week Gotham's finest tabloid took a quick look at the fate of those convicted under the pre-Newman standard, using Michael Kimmelman, a part of the Galleon conspiracy, as part of the network, as a case study. The government is uninterested in reopening these cases just because Newman didn't go its way:
the government doesn’t think it matters, in large part because Kimelman never brought up the issue on appeal. His claim has been “procedurally defaulted,” the government said in court papers earlier this month.
During the trial, Judge Richard Sullivan did not tell jurors the government had to show that Kimelman knew the tippers received a substantial benefit.
The same instructions in the trial of Todd Newman and Anthony Chiasson led the appeals court to overturn their case — setting the new standard.
“The procedural default is irrelevant because under Newman, Kimelman is actually innocent,” said Kimelman lawyer Alexandra Shapiro in a recent filing.
Really, this is something that your average death penalty lawyer could answer pretty quickly. If the law changes, does that make you "actually innocent"? You get the idea - but the distance between finality and precision (or legal accuracy, at least) is always something that lawyers can fight about. Kimmelman's judge, by the way, is the tough on white collar crime judge who gave the jury the government's preferred instructions in Newman.
The SEC announced an indictment against a financial advisor that got a bunch of public Georgia pension funds to invest in its own affiliated product. Which I guess sounds kind of dodgy - you're obligated to offer advice in the best interests of your client, and yet you're pushing your own investment vehicle. The strange thing about the case, however, is that it isn't about that sort of breach of fiduciary duty. Instead, the SEC, a federal agency, is going after Gray and its principals because they failed to comply with Georgia law. From the SEC's release:
The SEC’s Enforcement Division alleges the investments violated Georgia law in the following ways:
- A Georgia public pension fund’s investment is limited to no more than 20 percent of the capital in an alternative fund. Two of the pension funds’ investments surpassed that limit.
- The law requires at least four other investors in an alternative fund at the time of a Georgia public pension fund’s investment. There were fewer than four other investors in GrayCo Alternative Partners II L.P. at the time of these investments.
- There must be at least $100 million in assets in an alternative fund at the time a Georgia public pension fund invests. GrayCo Alternative Partners II LP has never reached that amount.
Gray knew this was coming, and knew that the SEC wouldn't be taking them to court, but rather before one of its own judges. It had already filed suit alleging that the ALJ program is unconstitutional - and among the many problems with these types of suits, imagine the timing and ripeness challenges presented by litigation premised on "we think the SEC may be bringing administrative proceedings against us in the future."
Still, I think this case is interesting. Shouldn't Georgia be bringing it instead of the SEC?
Lawsky had a tough reputation, and was probably the most challenging state corporate regulator since Spitzer (the Times: " a polarizing four-year tenure that shook up the sleepy world of financial regulation in New York"). And I can say that I knew him when - we were in the same unit at DOJ. But really, I'm awfully impressed that 1. he is leaving to start his own firm, continuing the craze for boutiques that has animated investment bankers, and now, perhaps their former regulators? And 2. this excellent front page from the Village Voice.
Apparently, the new firm will specialize in digital security. Congratulations, Ben!
Here is an announcement that may interest some of our readers:
The Rutgers Center for Corporate Law and Governance, The University of Washington School of Law, and the Business and Human Rights Journal (Cambridge University Press) announce the first Business and Human Rights Junior Scholars Conference, to be held September 18, 2015 at the Rutgers School of Law – Newark in Newark, New Jersey, just outside of New York City. The Conference will pair approximately ten junior scholars writing at the intersection of business and human rights issues with senior scholars in the field. Junior scholars will have an opportunity to present their papers and receive feedback from senior scholars. Upon request, participants’ papers may be considered for publication in the Business and Human Rights Journal (BHRJ), published by Cambridge University Press.
Invited senior scholars include Anita Ramasastry, Nien-he Hsieh, George Brenkert, Tom Donaldson, Denis Arnold, Pat Werhane, and James Gathii. All junior scholars will be tenure-track professors who are either untenured or have been tenured in the past three years. The Conference is interdisciplinary; scholars from all disciplines are invited to apply, including law, business, human rights, and global affairs. The papers must be unpublished at the time of presentation.
To apply, please submit an abstract of no more than 250 words to firstname.lastname@example.org and email@example.com with the subject line Business & Human Rights Conference Proposal. Please include your name, affiliation, contact information, and curriculum vitae.
The deadline for submission is June 15, 2015. Scholars whose submissions are selected for the symposium will be notified no later than July 15, 2015. We encourage early submissions, as selections will be made on a rolling basis.
About the BHRJ
The BHRJ provides an authoritative platform for scholarly debate on all issues concerning the intersection of business and human rights in an open, critical and interdisciplinary manner. It seeks to advance the academic discussion on business and human rights as well as promote concern for human rights in business practice.
BHRJ strives for the broadest possible scope, authorship and readership. Its scope encompasses interface of any type of business enterprise with human rights, environmental rights, labour rights and the collective rights of vulnerable groups. The Editors welcome theoretical, empirical and policy / reform-oriented perspectives and encourage submissions from academics and practitioners in all global regions and all relevant disciplines.
A dialogue beyond academia is fostered as peer-reviewed articles are published alongside shorter ‘Developments in the Field’ items that include policy, legal and regulatory developments, as well as case studies and insight pieces.
I used the word "melee" in the title because it is one of the words I saw journalists use to describe the melee/brawl/shootout/riot/gunfight/gang war that occurred at the Twin Peaks restaurant on I-35 in Waco, Texas. (For those of you non-Texans, Waco is equidistant from Dallas and Austin on I-35.) According to reports, two motorcycle gangs, the Bandidos and the Cossacks, were having a "meeting" there when a fight in the bathroom and/or in the parking lot spread into the restaurant, the patio area, and the parking lot, resulting in the deaths of 9 people and in injuries to 18 more. (Some reports give an account of a coalition meeting with up to five gangs represented.) Around 170 bikers have been arrested. None of the diners, employees, bystanders or police officers were among the injured or killed. A lof ot folks on social media are talking about interesting civil rights and criminal aspects of the case, but there is also a fascinating corporate/contracts aspect to the case.
Twin Peaks is (according to Google maps) a "sports pub with scantily clad waitresses," but more important to this post, a franchise. (Apparently, after doing some research, I've discovered that the word for this type of establishment is "breastaurant." Nice.) According to Entrepreneur.com, in 2014 there were 34 TP restaurants, and 20 were company-owned. Franchises are not cheap ($50k/year) and require a substantial outlay and proof of liquidity ($1.5 million a store net worth and $500k liquidity), but TP franchises seem to have a good reputation online for being a good buy. Until possibly this week.
Last semester, Gordon and I (and Matt Jennejohn and Clark Asay) taught a colloquium on Law & Entrepreneurship. One of our fantastic students wrote her paper on the reputational hits a franchisee takes when a rogue franchisee damages the brand. Examples she gave were mostly of health, safety and labor problems, such as when the franchisee down the street gets bad publicity from having a horribly filthy restaurant. My read of the problem was that the franchisor, particularly when the franchisor owns many of the stores itself, has a strong incentive to monitor all franchisees and contract for control and/or damages to mitigate the possibility of brand-damage. I believe we are seeing this played out in the TP case.
Shortly after the shoot-out (a strangely mild phrase, evoking thoughts of a Six Flags theme park ride), TP revoked the franchise from the Waco establishment, widely publicizing the decision and distancing the brand from the actions of the Waco restaurant management. Why is any of this the fault of TP-Waco? According to Waco police, TP-Waco had been warned about hosting the biker "meetings" and encouraging well-known organized criminal gangs from hanging out there. I have not seen any identification of the owner(s) of TP-Waco and do not know if there are any familial or business connections between the owner(s) and a motorcycle gang, so the incentive of TP-Waco to encourage biker clientele is unclear. In fact, the Waco police contacted TP (national) and advised them of the situation, and TP (national) contacted TP-Waco. According to TP (national), it had no power to physically close TP-Waco on the day of the meeting, cancel the "patio reservation," or change any of its decisions. Its remedy was to revoke the franchise after the fact. Now, TP (national) says it is revising its franchise agreements to give it more power to act earlier -- I would love to see a copy of the new franchise agreement!
Anyway, our student's paper highlighted this very concern. Now, other TP franchisees surely will see lost business as patrons will associate the brand with violence or at least an unsavory biker culture. Not only did something awful happen there, but the management is being painted in the media as being an active participant. TP-Dallas has already sent out a press release trying to mitigate brand-damage, focusing on the fact that no patrons or bystanders were hurt. So, if TP-Dallas loses business, what can it do? I've looked everywhere to see if business interruption insurance covers this, and I can't find an insurance product for this type of loss. However, I have found evidence that franchisees often sue franchisors for a number of things, including "errors and omissions" in the franchise disclosure documents. The disclosure documents aren't public, but the TP website does stress that franchises are only given to a select few candidates who are very qualified. While criminal law types monitor the ongoing investigation, the boring corporate types will monitor the franchise situation!
One way to enact your regulatory agenda is to pass a rule. But another is to commit yourself to some program of regulatory reform as part of a settlement with an outside party. Some congressional Republicans are increasingly worried that this sort of hands-tying is increasingly being resorted to by environmental regulators, hence the introduction of the Sunshine for Regulatory Decrees and Settlements Act of 2015. Financial regulators blow a lot of statutory deadlines, leaving them vulnerable to litigation by an angry NGO, but so far haven't been accused of sue and settle, as far as I know. But perhaps it is only a matter of time. RegBlog has a nice symposium up on sue and settle, here's a taste:
When agencies acquiesce to plaintiffs’ demands, they may give the litigating organizations a potentially outsized influence over the agency’s policies and allocation of resources. ... Dan Walters ... noted that sue-and-settle rarely occurs, “at least in its worst possible form.” Furthermore, he argued that, perhaps counterintuitively, such “settlements add to the democratic character of what is otherwise a very shadowy forum” called rulemaking.... Jamie Conrad, a highly-regarded practitioner with years of experience in Washington, D.C,  takes issue with Walters’ downplaying of sue-and-settle’s potential threats to the legitimacy of the rulemaking process.
Give it a look.