Although the SEC has created 236 fair funds, there is one that hogged all of the attention: the WorldCom fair fund. WorldCom filed for bankruptcy protection soon after it revealed a massive accounting fraud back in 2002. The SEC fined the company $2.25 billion and collected, as an unsecured creditor, $750 million from the bankruptcy estate. It then distributed that amount to harmed shareholders through a fair fund. In effect, WorldCom's unsecured creditors ended up compensating its shareholders, turning bankruptcy priority upside down.
How could this happen? The Bankruptcy Code subordinates shareholders' claims for damages related to securities fraud to claims by the debtor's unsecured creditors. Because bankrupt firms are, by definition, insolvent, the Code effectively precludes equity holders with securities fraud claims from collecting anything from the bankrupt company. As a result, securities class actions against bankrupt companies are ordinarily dismissed. The automatic stay does not preclude the SEC from pursuing an enforcement action agains the bankrupt firm, but stops the SEC from collecting any money judgment. The SEC's claim for civil fine and disgorgement is treated as an unsecured creditor claim and is distributed pro rata, along with other unsecured creditors. However, the Bankruptcy Code does not preclude the SEC from distributing monetary sanctions collected from the bankrupt company to defrauded shareholders. The ultimate result is that unsecured creditors recover less in bankruptcy, while shareholders receive more than they would without the fair fund provision.
This result upset many, in particular since bankruptcy filings are not uncommon among companies subject to enforcement proceedings for securities violations. But as it turns out, WorldCom is the exception, not the rule for fair fund distributions. 31 companies that were primary defendants in my fair funds study filed for bankruptcy within 2 years of the SEC's enforcement action. Of those, 16 were in accounting fraud cases where priority conflicts between creditors and shareholders are particularly likely (others were unregistered offerings of securities, where defrauded investors are the creditors). The SEC imposed a monetary penalty against the company and distributed it to defrauded shareholders through a fair fund in only 2 such cases: WorldCom and Nortel Networks. All other bankrupt companies either paid nothing to settle with the SEC or the SEC did not even initiate an enforcement action against them. Nortel paid $35 million to the SEC 14 months before it filed for bankruptcy. While its payment may have reduced unsecured creditors' ultimate recoveries, it did so far less directly than in WorldCom.
Instead of targeting companies, the SEC targeted individual defendants, auditors and investment banks when the primary defendant was bankrupt. It collected $280 million from individuals and $492 million from secondary defendants, and distributed these amounts to shareholders through a fair fund. While the WorldCom fair fund cast a dark shadow over the SEC's distribution efforts, it is the exception, not the rule. It also demonstrates the relative flexibility of public securities enforcement compared with private securities litigation.
In Fiduciary Discretion (with Jordan Lee), we argue, among other things, that courts often define the boundaries of fiduciary duty by reference to industry customs and social norms. In our next article, Loyalty Across Time, we claim that, although common law courts strive to conform to the doctrine of stare decisis, their reliance on customs and norms as guides to appropriate fiduciary behavior ensures that the meaning of “loyalty” changes over time. Thus, the requirements imposed by the duty of loyalty vary not only from one relationship context to the next, as many scholars have recognized, but also across time in similar relationships.
We are looking for examples in various areas of law relating to these propositions. We have been concentrating on employment law and corporate law, but the application of fiduciary principles covers a vast territory, and we would be interested in examples from other areas of law. Of course, if you disagree that the meaning of “loyalty” changes over time, we would be interested to know that, too.
The SEC has long had the authority to distribute monetary penalties collected from securities violators to harmed investors. Initially, the SEC could distribute only ill-gotten profits that defendants gained from securities violations, but not any additional civil fines that the SEC ordered defendants to pay. Section 308(a) of the Sarbanes-Oxley Act allowed the SEC to add civil fines to disgorgements and distribute both through fair funds. The SEC could distribute the civil fine only if that defendant also paid disgorgement. Section 929B of the Dodd-Frank Act removed that requirement, so now the SEC can distribute civil fines even in cases where the defendant does not profit from the violation (e.g., J.P. Morgan paid a $200 million civil fine to the SEC for misrepresentations related to the London Whale fiasco, but no disgorgement, and the full amount will be distributed through a fair fund).
Most people know next to nothing about fair funds. Even securities law professors tend to know very little, mostly assuming that fair funds are the smaller, feebler version of securities litigation. I wanted to find out whether the perception matched reality, so I looked at all fair funds created to date (236). The funds are in the process of distributing $14.33 billion since 2002, which is more than the SEC's budget for the same period, but less than securities class action settlements ($60 billion). The largest fair funds were created in accounting fraud cases (AIG, Fannie Mae, Time Warner), as were the largest class action settlements (WorldCom, Enron, Tyco). So far, reality seems to confirm perception.
While the evidence suggests that fair funds are indeed smaller than securities litigation, they are not a version of securities litigation. Securities litigation overwhelmingly compensates investors for accounting fraud (90% of settlement dollars). Not so for fair funds. 44.1% of distributed monetary sanctions compensate investors for accounting improprieties. Of that amount, individual and secondary defendants (auditor and investment banks) paid 19.6% out-of-pocket. Other large fair fund categories include investment advisor cases, broker-dealer violations and securities offering cases (e.g., CDO-related misrepresentations). The table below provides more detail.
I will have a separate post about parallel private litigation. But to preview, securities class actions were filed in 65.4% of fair fund cases and settled for non-zero monetary damages in 45.6% of cases. Most of those were in accounting fraud cases. Not only are class actions much more often filed in accounting fraud cases than in all other cases, they are also far more likely to survive the motion to dismiss. So there are really two types of securities violations: accounting frauds and all others. Stay tuned for more details.
We write to ask two small (but important) favors of you that are directly related to law schools' pedagogical mission as well as the rapidly changing future of legal education.
As you may know, an ABA task force has recently proposed to establish minimum requirements within ABA-accredited law schools for "experiential" learning related to building practical skills and competencies. (Similar proposals are percolating up from state bar association task forces as well.) We believe this endeavor to be an intriguing and important invitation for law schools to re-imagine how they deliver legal education, and on this basis we are generally supportive. At the same time, a challenging question that the ABA and other task forces face is the question of what topics constitute "skills and competencies." Within business law, this challenge is perhaps greatest for attorneys whose practice is principally "transactional" in nature (in contrast to work that is oriented around litigation). It is unclear how much input transactionally-oriented business law practitioners (attorneys, other professionals, educators) have had on the process of drafting the proposed guidelines, or whether there has been much systematic analysis of what topics constitute important "skills" for entering transactional attorneys.
To address these gaps, we have developed an on-line survey instrument to help gauge what sorts of core competencies established professionals in transactional practice areas consider important. We hope the results of the survey will help both practitioners and legal educators assess (and if necessary, work to amend) the current proposed guidelines. Although largely directed to practicing attorneys, the survey is also open to other professionals who work closely with practicing attorneys in transactional practices (such as bankers, accountants, financial advisers, etc.).
Here are the two favors we ask of you:
(1) Please take a few moments yourself to fill out the survey. It will not take longer than 5-10 minutes of your time.
(2) Please ask your colleagues, partners, associates, co-workers, and other professional contacts to consider filling out the survey.
The survey is available on-line, at
When complete, results of the survey will be made available on the website for the Berkeley Center for Law, Business and the Economy (BCLBE), at http://www.law.berkeley.edu/bclbe.htm.
We just received word that Professor Mike Dooley of the University of Virginia Law School died last night from complications from his long battle with cancer. Among his other professional accomplishments, Mike was the Official Reporter for the Model Business Corporation Act for nearly 30 years. I did not know him well, but we met a few times, and he was unfailingly engaging and kind.
Many of us have cited his influential article (with John Hetherington) entitled Illiquidity and Exploitation: A Proposed Statutory Solution to the Remaining Close Corporation Problem, 63 Va. L. Rev. 1 (1977). That article was the basis for a reform of the MBCA, providing for a buyout remedy in cases of oppression.
He also wrote an oft-cited artilce with Norm Veasey entitled The Role of the Board in Derivative Litigation: Delaware Law and the Current ALI Proposals Compared, 44 Bus. Law. 503, 522 (1989), which contains this well-known defense of the business judgment rule:
The power to hold to account is the power to interfere and, ultimately, the power to decide. If stockholders are given too easy access to courts, the effect is to transfer decisionmaking power from the board to the stockholders or, more realistically, to one or few stockholders whose interests may not coincide with those of the larger body of stockholders. By limiting judicial review of board decisions, the business judgment rule preserves the statutory scheme of centralizing authority in the board of directors. In doing so, it also preserves the value of centralized decisionmaking for the stockholders and protects them against unwarranted interference in that process by one of their number. Although it is customary to think of the business judgment rule as protecting directors from stockholders, it ultimately serves the more important function of protecting stockholders from themselves.
Nicely written. You will be missed, Professor Dooley.
What you'll hear from me, as a general matter, is a story about the increasing convergence on matters financial regulatory across borders. But this is not to say that this convergence will be a story of cosmopolitan triumphalism, sans bumps, disputes, and difficulties.
Take auditor rotation, which is the shorthand for "the government requires you to fire your auditor and hire a different one everyone so often, lest your auditor become captured, or you start speaking to it in a strange shorthand outsiders can't understand." It's something that will really make a difference to the lives of CFOs and their reports everywhere. It will also either disrupt the multi-billion dollar accounting business, or end competition in the sector. And the EU now requires it every 10 years or so, while the US has dropped its auditor rotation plans. You might even call the emerging approaches to auditor independence completely inconsistent with one another.
The interesting question will be whether the EU makes foreign listed companies rotate auditors if they solicit or somehow end up with a substantial number of European investors (the current answer appears to be no, but stay tuned). If it does that, it will be yet another example of the way that the EU makes regulatory policy for the rest of the world. HT: Corp Counsel
Like Usha, I, too, am so over this cold adversity here in the South. Unfortunately, the cold adversity is not done with me:
One of the more common comments in workshops about corporate and securities papers is whether the author discussed the matter with the SEC, the Department of Justice, etc. Almost uniformly, the author will respond that she has not, either because it never occurred to her or because it seemed like something that would be hard to do.
I have been told in the past to discuss my work with the SEC and corporate insiders, including about a paper that I workshopped at the Fifth Conglomerate Junior Scholars Workshop back in 2010. (Can we bring it back, please?) And I did not heed the advice then. But for my current project on the SEC's fair fund distributions -- about which I will say more in my next posts -- I needed and wanted to talk to someone on the inside, specifically the person leading the SEC's Office of Distributions which oversees distributions of collected monetary sanctions to harmed investors.
The Office of Distributions turns out to be a tiny office that employs 5 attorneys, 4 paralegals and 3 support personnel. It is so small, in fact, that it does not appear on the SEC's organizational charts and the SEC does not feature the Office's leadership on its website, as it does for other units. In other words, it was impossible to find an e-mail or a phone number to call. I used my very limited contacts in the Commission and asked nicely for help. It took some time, but just before Christmas I spoke with the Assistant Director heading the Office of Distributions. It was, by any standard, a remarkably pleasant conversation, and so worthwhile. The Assistant Director explained how the Office works and what it can and cannot do, confirmed many of the things I found through painstaking (and expensive!) database research, and supplied additional information that I would not have known to look for otherwise. I would strongly recommend it.
Next time, when I am at a talk and the presenter responds that s/he did not attempt to discuss the research topic with the agency, department, court, etc., it will be hard not to discount the research and judge the presenter. Because it only takes good manners and a little bit of tenacity, but is definitely worth the effort. Or, explained in terms that we who read this blog understand, the cost-benefit analysis is strongly positive.
Ronald Coase had some ideas about why speech is given more protection from government intervention than economic activity:
The paradox is that government intervention which is so harmful in the one sphere [speech] becomes beneficial in the other [economics activity].... What is the explanation for the paradox? ... The market for ideas is the market in which the intellectual conducts his trade. The explanation of the paradox is self-interest and self-esteem. Self-esteem leads the intellectuals to magnify the importance of their own market. That others should be regulated seems natural, particularly as many of the intellectuals see themselves as doing the regulating. But self-interest combines with self-esteem to ensure that, while others are regulated, regulation should not apply to them. And so it is possible to live with these contradictory views about the role of government in these two markets. It is the conclusion that matters. It may not be a nice explanation, but I can think of no other for this strange situation.
Ronald H. Coase, The Economics of the First Amendment: The Market for Goods and the Market for Ideas, 64 AM. ECON. REV. PROC. 384, 386 (1974).
There are some powerful counters to this argument (e.g., speech is a public good that is likely to be underproduced, especially if not protected vigorously), but I just thought it was interesting that Coase had written this article on the First Amendment.
From Aaron Director, The Parity of the Economic Market Place, 7 J.L. & ECON. 1, 2 (1964):
Laissez faire has never been more than a slogan in defense of the proposition that every extension of state activity should be examined under a presumption of error. The main tradition of economic liberalism has always assumed a well-established system of law and order designed to harness self-interest to serve the welfare of all.
Director didn't write much, but he wrote well.
Like Urska, that's how I've been the past week. No school, 3 children at home, Tuesday-Thursday. Cooped up because of ice 2 of those days. It was brutal, I'm not going to lie to you.
Two technological innovations made the weather burdens a tiny bit easier to bear. First, an app: Fitstar, which aims to deliver a personalized workout based on a fitness test and nearly continuous feedback you provide as to your goals and how hard or easy you perceive each exercise to be. I am not a fitness freak by any means, but I do like to exercise at least every other day. Ideally I am outside running, but a torn meniscus had me searching for other options all fall. Even now, blessedly cleared to run again, there are some times when weather keeps you indoors. Enter Fitstar, which gives you a pretty good, and varied, workout without the need for space, weights, etc. It helped keep me sane this past week.
Second, school closings perforce means that I'm behind on my lectures. In my Lifecycle of the Corporation class in particular that's a problem, since it's a seminar with a pretty tight schedule. So Thursday after the kids went down I recorded a lecture that approximates the introduction to IPOs class. It's not perfect, since there's no student interaction, and the production value is a bit lacking, but I think it gets the job done.
An unlooked-for benefit is that I am implementing, at least for one class, the flipped classroom that has intrigued me so much in theory, but for which I've lacked the initiative to try on my own. I used the Photobooth function on my Mac and was able to upload the resultant video to TWEN with only a minor amount of inconvenience. Generally I'm a late adopter, but needs must.
Finally, let me emphasize, although the uses of technology might be sweet, I am all done with cold weather adversity. All done.
So, I'm officially dorky because I heard the news of Jos. A. Bank announcing that it's acquiring Eddie Bauer, and I immediately thought, "Oooh, Valentine's Day merger news, just like Verizon and MCI in 2005." Yeah, that was me.
And the Men's Wearhouse/JAB/EB triangle is just as weird as the Verizon/MCI/Quest triangle. So, to recap, here is a timeline from Reuters. Highlights:
October 9, 2013 -- JAB offers to buy MW for $48/share or $2.3B. MW board rejects the offer.
Nov. 15, 2013 -- JAB withdraws offer, even after mutual shareholder urges MW to consider.
Nov. 26 -- MW offers to purchase JAB for $1.5B; $55/share.
Dec. 23 -- JAB rejects offer; MW threatens proxy contest for director seats.
Jan. 6 -- MW launches tender offer for $56.87/sh; mutual shareholder Eminence Capital threatens lawsuit/proxy contest against JAB board if they refuse to entertain the offer.
Jan. 14 -- JAB announces friendly acquisition of privately-held EB for $825 million.
The JAB/EB deal is fairly interesting because it seems one-sided. Here is the agreement. JAB can terminate if they get a "Superior Offer" that includes a Change of Control, with a termination fee of $48 or $55 million, depending. EB can also terminate if JAB gets a tender offer and JAB neither rejects or recommends it. Usually, we're worried about the Seller wriggling away with a better offer. Here, not so much. EB may be perfectly willing to pretend to be JAB's Valentine's date until MW goes away (for about $50 million). It will be interesting to see if this is a bluff.
A good M&A question is why this strategy? Using a whole bunch fo cash/debt to thwart MW's takeover plans. JAB, a Delaware corporation, has a poison pill, and we know that poison pills will be routinely upheld by the Delaware courts. The poison pill should be good against the tender offer and probably the proxy fight unless the institutional shareholders have enough shares to vote together against the JAB board. (Eminence Capital owns 5% of JAB and 10% of MW.)
Since Mary Jo White took over at the SEC, the agency has announced that it will strengthen its efforts to prosecute financial reporting fraud. In July, the SEC created the Financial Reporting and Audit Task force and the Center for Risk and Quantitative Analytics, described as an "internal think-tank." The plan is to enhance the Commisson's use of econometric analysis to detect possible financial reporting fraud. It is about time, in particular since accounting fraud is a really inefficient way to steal.
Eveyone knows that stock prices of firms that reveal accounting improprieties decline. The range of that decline varies, but is usually significant. Studies report mean stock-price declines between 8% and 39%, and everything in between. What fewer people know is that unmasking fraud at one firm also has a small, but statistically significant effect on stock prices of its competitors. Three recent empirical studies put the 3-day cumulative abnormal return of rival stock prices around the announcement date at 0.34%, 0.5% and 0.54%. In the aggregate, however, rivals lose four-times as much in market capitalization as the firm that is caught cooking the books.
There are several explanations for why rivals are affected by fraud by industry peers. First, firms copy each other. When Apple comes out with a tablet and it sells well, its rivals are likely to follow suit. In similar vein, rivals sometimes copy fraudulent accounting. Second, a restatement of earnings suggests that the entire industry's prospects are not as good as we thought. Finally, while they are manipulating their earnings, fraud-committing firms change their current investments, and rivals copy firms that appear to be successful. A restatement reveals that firms in the industry misdirected investments, which forces an adjustment in the stock prices after fraud is unmasked.
In securities regulation, we like to see the regulator tread carefully. As one widely-used textbook cautions, "onerous disclosure obligations and their accompanying liability are like rain--they fall on the good and the bad alike." But it turns out that fraud, too, harms both honest and dishonest firms.
Matt follows up on his posts about funding legal scholarship with a post on professor-produced publications that are sold, with the profits going (mainly) to the publisher and (in smaller quantities) to the professor-author. Some of the questions that emanate from this model are (1) why law schools/universities don't require these works to be "work for hire" with the profits going to the law school; (2) why professors engage in this type of time-intensive writing; and (3) [my question] wouldn't a direct-to-student model be better?
Work for hire. In my second year of teaching legal writing, my co-author and I sold a programming for teaching the Bluebook to Lexis. I remember a tenured colleague sneering at me that the profits should go to the university. Well, the university never called, and I never called them. I'm now at a university that has seen faculty create some extraordinarily lucrative products without much, if any, remuneration. I just don't think that universities are great about tech transfer or commercializing professor works, even when the profits are worth the hassle. Some universities are better about creating structures for professors and their universities to share in profits of lucrative discoveries. Books may just fall into a category of "not worth it on average." If the average book royalties professors received were halved with their institution, professors may not produce them. Because these books create some marketing/branding/prestige for their institutions, universities may be happy to let publishers pay the university employees for their production.
Incentives. Going to the first point, the incentives are fairly "on the line" for many professor publications. Casebook profits vary widely depending on whether its suited for a course that is widely taught and widely taken or for a niche course. I'm sure monographs also vary widely between "purchased by a few libraries but given as complimentary copies" and trade publications that end up on the best seller list, with most toward the former. I've heard proflific monograph authors tell me that they aren't looking for profitable sales; they just want the book on law professor shelves. And, once upon a time, university tenure standards required books to be a full professor because that's what people write in other disciplines.
The direct-to-student model for casebooks. I've been thinking about this since I discovered how much a new edition of the Torts book I use cost (gasp). So, currently, I can use my work time to write a casebook that is then sold to law students, including mine, who pay $200/ea, and I get $20/ea. For doing my job. (I know, others deviate from this model, including paying their own students back their royalties .) But why not just self-publish? I spend my summer coming up with my own materials (as many do for their own courses anyway) and make them free for my students online? All the cases are available on the internet, and so are all the statutes/Restatement sections/etc. The only thing missing is the commentary and the questions (which I usually skip). This could save students $1000/semester. I'm teaching a course for the first time this semester, BA II, and I put together my own materials -- cases, law review articles, public disclosure documents. It takes a lot of time, but it's not crazy. What about first-time professors? Well, I would be happy to share my materials. In fact, all the Torts professors here could combine forces. Just a thought.