The idea will no doubt send shudders through the sleepiest corners of the securities industry.  But the Globe reports that the question is being litigated as we speak. 

While we're rounding up, thanks to the indispensible Securities Mosaic, I've learned in a busy week about just how bad UBS has it, with jailings and $37 million paybacks.  And how Prawfsblawg is going for laughs re: contract law and professoring...

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Congratulations to Troy Paredes, Washington University Law School professor and the next nominee to be commissioner of the SEC.  Troy has achieved a lot in a little time, including some 18 odd articles, and an editorship on the mammoth, 11 volume, Loss, Seligman, and Paredes Securities Regulation treatise.  But we assume he's proudest of his guest stint at this here blog - a stint that may have fast-tracked his candidacy.  Congratulations, Troy!

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Not sure if it's because of a dearth of commissioners, because there's apparently a global financial crisis going on, or because of those Sudan divestment safe harbor regs, but the SEC, by its own account, is taking twice as long to rule on appeals from ALJ and SRO adjudications than it did a year ago.  Check out these charts (and, as Gordon and I were just lamenting to one another, if it was a bit easier to take pdf pix and put them in Typepad, we'd reproduce them on this page all nice and pretty for you).  Anyway, the median age of pending appeals from ALJs is 419 days, up from 210 in the prior semi-year, while the median age of pending appeals from SROs is 325 up from 284.  All this while the number of pending appeals has increased only slightly or stayed flat.

 

 

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Ethiopis Tafara, the SEC's international chief, testified today that:

the SEC has in place several rules that require disclosure of certain sovereign wealth fund activities and sovereign business activities that could raise many of the concerns we hear in our own and other markets. None of these disclosure requirements was designed with sovereign wealth funds or sovereign businesses in mind, but they are nonetheless of value in this context to the extent that many of the concerns that sovereign investing raises are similar to concerns about other types of investment.

Are SWFs so different from other big funds?  CFIUS might think so, but anyone, at home or abroad, might choose to act in a non-profit maximizing way for a little while (to help the party you support, for example, or the country whose favor you are trying to gain).  And in the long run, everyone who does so should be subject to market discipline.  So a lot turns on the idea that the sovereigns may prevent their own regulators from cooperating with the SEC on investigations.  I wonder if that is an important enough problem to require legislation.

On the other hand, providing SWFs with tax advantages ... that's a bit more mysterious.

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This fall the Virginia Law Review is hosting a symposium to mark the 75th anniversary of the SEC. It's an all-star lineup: Jack Coffee, Jim Cox, Don Langevoort, Adam Pritchard, Hillary Sale, Joel Seligman, and Bob Thompson. I hope they throw a nice party because the SEC is unlikely to be around for the 100th anniversary.

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On the one hand, it seems like an evergreen story, like "Diplomats Consider the Growing Power of China," or "Nation Skeptical of Overseas Entanglements":

Staff lawyers in the S.E.C. enforcement division say high turnover, tight budgets and a new, looser attitude toward corporate wrongdoing are sapping morale. The staffing and budget of the S.E.C. have lagged far behind the explosive growth of the markets the commission must police.

Which was how the Washington Star was putting it in 1939, according to our time machine.   On the other hand, the enforcement budget is down, and so's employment, if not by much, so maybe something really is going on.

But if the SEC, like any enforcement agency, deters wrongdoing partly by scaring people with its imposing computer-aided maps and transaction-tracking programs, then maybe stories like these don't do the agency much good. 

For while in the States, the SEC might get an "underfunded, overwhelmed" rap, that's not the view of everyone.  See, e.g., opinionated British righties.  In concluding that the current financial crisis represented the cratering of off-balance sheet bank assets, the New Statesman thought that maybe the SEC would have to bail out the Fed: "No wonder that the fearsome American regulator, the Securities and Exchange Commission, is checking for illegality."

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I grew up eating at The Cheesecake Factory, so I was somewhat disappointed when I heard that the Calabasas, California company had attained the dubious honor of making CalPERS' 2008 Focus List of underperforming companies.  They sell great cheesecake, but according to CalPERS, the company has underperformed its peers by 140.5 percent over the last 5 years.  CalPERS objects to the company's staggered board and supermajority voting requirements for certain bylaw amendments, and the pension fund has a pending shareholder proposal to eliminate its staggered boards.  The four other companies that made the list--all with staggered boards that CalPERS opposes--are:

Hilb Rogal & Hobbs, an insurance brokerage based in Glen Allen, VA;

Invacare, a healthcare equipment supplier from Elyria, OH; 

La-Z-Boy (remember The Price is Right?) of Monroe, Michigan; and

Standard Pacific, which sells household durables and homebuilding supplies, from Irvine, CA.

Interestingly, according to a 2007 report by Wilshire Associates, Focus List companies have annual excess returns of -13.3% below their respective benchmarks for the five years before CalPERS involvement, but enjoy positive annual excess returns averaging 12.2% in the five years following.  Perhaps there is an investment strategy here?  See Riskmetrics for additional commentary.

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is here.

God bless that venerable institution.  Here's Mark Thoma and Ed Glaeser, et al. debating whether the imposition of regulation, particularly regulation from Basel, led to the current crisis.  Seems unlikely given that Basel wasn't about regulating investment banks like Bear (though they did have "better than Basel I" capital requirements imposed by the SEC), but it's still pretty interesting.  HT: MR

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Last Sunday's NYT reported on an idea that regulators and legislators have been kicking around to keep people in their homes and save the housing markets--negative equity certificates.  (Also see an earlier WaPo story).  These certificates would be available to existing mortgage lenders willing to refinance upside-down mortgages--loans whose outstanding balance exceeds the current value of the home.  Under the plan, a government-insured refinancing would reduce the outstanding mortgage balance to the current home value.  The original lender, in addition to getting paid the current value of its collateral from the refinancing, would receive a negative equity certificate.  This certificate would entitle the holder to any appreciation in home value realized when the the owner sells--up to the amount of the original loan.  In effect, the old lender gets any prospective upside in exchange for stripping its loan down to the current market value of the home.  Proponents anticipate that a trading market would develop for these certificates.

According to NYT, Treasury Secretary Henry Paulson's latest pronouncement would limit the plan to homeowners who are paying on their mortgages pre-reset, but who may be otherwise be tempted to abandon their homes once their interest rates jump.

At first blush, it seems like an interesting idea.  The borrower gets to stay in her house without taking the credit hit of foreclosure.  The original lender gets potential upside--which might be tradeable--without having to incur the costs of foreclosure, resale, and interim maintenance.  And it's better than getting stripped down in bankruptcy--a prospective modification to the Bankruptcy Code that was (until recently) working its way through Congress--where the lender gets no upside.  But several problems come to mind:

1. Valuation.  How do we decide the market value of the home at refinance time?  I know, we can get an appraisal!  Just like the last time we got a mortgage on this house . . . .

2.  Loan servicers.  I thought one of the original precipitators of the mortgage meltdown was that for mortgages sold and bundled into pools for purposes of securitization, the servicers did not have clear authority to commit to workouts.  So foreclosure was the only readily available option.  If this is still true, then it's unclear how this latest proposal will help.

3.  Homeowner incentives.  With all the potential home appreciation captured in the negative equity certificate, the homeowner is basically a renter, with all that that implies.  The homeowner has no more incentive to invest in maintenance than renter.  In fact, the homeowner is worse off than a renter, since she can't call the landlord to fix the plumbing.  Perhaps the terms of the certificate could be modified to give the homeowner some piece of the upside to counter this problem.  Law scholars (e.g., Lee Fennell) have suggested the possibility of separating home-specific risk from market risk, leaving home-specific risk to the owner and selling market risk to investors.  But the mechanics for implementing this idea seem pretty complicated.  In any event, it's hard to figure how a simple split of the upside could be large enough to incentivize the homeowner and still small enough to be acceptable to the lender, who could own all the upside (net of attendant costs) through foreclosure.

4.  Screening for sham sale.  Presumably, the negative equity certificate covers only the first sale post-refinance.  This would give homeowners some incentive to engage in sham sales to shed the overhang of the negative equity certificate in order to own the upside.  Lenders will balk without some mechanism to police for this.

5.  Tax and accounting consequences.  I hesitate to offer any opinion on tax and accounting issues, except to raise the possibility that lenders may have to take a write down either when they do the refinance or sell the negative equity certificate (which might not be different from the foreclosure scenario either).

6.  Irony.  Let's solve a (somewhat) derivatives-driven crisis with . . . another derivative!  We could bundle them, get an investment-grade rating from one of the big rating agencies, and sell NECBSs (Negative-Equity-Certificate-Backed Securities) to institutional investors!

For a thorough vetting of the proposal, check out Calculated Risk, especially the comments.

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When I speak with my Law & Entrepreneurship students about monitoring in the venture capital context, I always make a point of observing that continuous monitoring of portfolio companies by venture capitalists is not cost effective. That's one reason venture capitalists invest in stages. Each round of investment provides an opportunity for intermittent monitoring.

Makes sense, right? Now consider this from today's W$J:

For the first time in more than a decade, the Federal Reserve has set up shop inside brokerages to monitor their financial condition, perhaps the beginning of an expanded role for the central bank and additional regulation for Wall Street.

This revelation comes on the heels of Ben Bernanke's visit to Congress, where he discussed the Bear Stearns transaction:

The Fed last month threw Bear Stearns a $30 billion lifeline to pave the way for its rapid sale to J.P. Morgan Chase & Co. and to prevent a destructive ripple effect on Wall Street....

The Fed has offered little detail about the collateral backing the loan. J.P. Morgan is responsible for the first $1 billion in losses from a pool of $30 billion in assets. The Treasury Department recently told the Senate Finance Committee that the collateral consists primarily of mortgage-backed securities and related hedge-fund investments but has offered no other details.

Mr. Bernanke said the collateral consists entirely of investment-grade assets that are "entirely current and performing." He added that the Fed's investment adviser, money manager BlackRock Inc., is "reasonably confident that we would be able to recover the full amount" if the assets are sold on a "measured" basis rather than at once. Later, he also expressed confidence "that we'll be able to recover all the principal and indeed some interest, and there's some chance of even upside beyond that."

Did you know the Fed had an investment advisor? And that Bernanke was hoping to make money off the Bear Stearns investment?! The Fed is looking like a venture capitalist. A very hands-on venture capitalist.

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Henry Paulson is proposing to reconstruct our financial regulatory institutions from scratch. According to the executive summary, this report has been in the works for a year: "Treasury began this current study of regulatory structure after convening a conference on capital markets competitiveness in March 2007." But the recent drama on Wall Street ensures an extra degree of salience:

Market conditions today provide a pertinent backdrop for this report's release, reinforcing the direct relationship between strong consumer protection and market stability on the one hand and capital markets competitiveness on the other and highlighting the need for examining the U.S. regulatory structure.

The proposal includes short-, intermediate- and long-term proposals, but the ultimate goal is regulatory efficiency, which will be achieved by consolidating federal power in the hands of three regulatory agencies. Each agency would be responsible for one of the following objectives:

• Market stability regulation to address overall conditions of financial market stability that could impact the real economy (the Federal Reserve);

• Prudential financial regulation to address issues of limited market discipline caused by government guarantees (the Prudential Financial Regulatory Agency); and

• Business conduct regulation (linked to consumer protection regulation) to address standards for business practices (the Conduct of Business Regulatory Agency).

Paulson refers to this structure as the "optimal" regulatory framework. The SEC's current responsibilities would be assumed by the CBRA.

The most interesting part of the executive summary is the paragraph in which Paulson explains other regulatory models:

Treasury considered four broad conceptual options in this review. First, the United States could maintain the current approach of the [Gramm-Leach-Bliley Act of 1999] that is broadly based on functional regulation divided by historical industry segments of banking, insurance, securities, and futures. Second, the United States could move to a more functional based system regulating the activities of financial services firms as opposed to industry segments. Third, the United States could move to a single regulator for all financial services as adopted in the United Kingdom. Finally, the United States could move to an objectives based regulatory approach focusing on the goals of regulation as adopted in Australia and the Netherlands.

The executive summary doesn't explain why the objectives-based approach would be optimal for the U.S. That is a conversation worth having. Elizabeth Brown started us down that road here at Conglomerate two years ago, and the British system has some fans in high places here in the U.S. Something tells me that this discussion is going to gain some increased attention in the next few years.

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After Bear went south, the Basel Committee on Banking Supervision announced that it would be revisiting its "Sound Practices for Managing Liquidity in Banking Organizations" guidance.  The SEC then wrote the committee, in what looks to me like an effort prove that it was on the ball.  I may sound like a broken record on this, but the SEC didn't used to have to justify its broker dealer supervision to the central bankers of other countries.  It does now, though.  A taste of what the agency said:

Bear Stearns' registered broker-dealers were comfortably in compliance with the SEC's net capital requirements, and in addition that Bear Stearns' capital exceeded relevant supervisory standards at the holding company level. Specifically, throughout the week of March 10 until the closing of the JP Morgan Chase transaction on Sunday March 16, Bear Stearns had a capital ratio of well in excess of the 10% level used by the Federal Reserve Board in its "well-capitalized" standard. 

...the holding company had a pool of high quality, highly liquid assets of over $18 billion as of the morning of March 11. This was consistent with what the SEC had seen over the preceding weeks, during which SEC staff - both on-site and at headquarters - monitored the capital and liquidity positions of all the CSEs, in the case of Bear Stearns on a daily basis.

In accordance with customary industry practice, Bear Stearns relied day-to-day on its ability to obtain short-term financing through borrowing on a secured basis. Beginning late Monday, March 10, and increasingly through the week, rumors spread about liquidity problems at Bear Stearns, which eroded investor confidence in the firm. Notwithstanding that Bear Stearns continued to have high quality collateral to provide as security for borrowings, market counterparties became less willing to enter into collateralized funding arrangements with Bear Stearns.

After the jump, you can see how the SEC measured Bear's liquidity, up from $8.4 billion at the end of January to $21 billion by March 6, down to $2 billion during Bear's very bad final week.

From Cox's letter to Basel:

BSSC Net Capital ($ billion)

                                                               

	Required	Excess
31-Dec	1.26	3.38
31-Jan	1.30	2.92
14-Mar	1.27	>2.00 (estimated)

BS&Co. Net Capital ($ billion)

                                               

	Required	Excess
31-Jan	0.56	2.71
14-Mar	0.58	>2.00 (estimated)

Liquidity Pool ($ billion)

                                                                                                                                                                                                                                                                                                                       

31-Jan	8.4
4-Feb	12.8
5-Feb	15.8
6-Feb	17
7-Feb	16.1
22-Feb	15
23-Feb	15
24-Feb	15
25-Feb	18
26-Feb	19
27-Feb	19
28-Feb	19
29-Feb	19
1-Mar	19
2-Mar	19
3-Mar	20
4-Mar	20.1
5-Mar	21
6-Mar	21
7-Mar	18
8-Mar	18
9-Mar	18
10-Mar	18.1 (15.1 adjusted for customer protection rule)
11-Mar	11.5 (15.8  adjusted for customer protection rule)
12-Mar	12.4
13-Mar	2

Holding Company Capital Ratio

31-Dec	13.7%
31-Jan	14.4%
29-Feb	13.5% (estimated)

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Last week, I wondered whether Bear Stearns' CEO Alan Schwartz was telling the truth when he assured the markets that "there is absolutely no truth to the rumors of liquidity problems." Today, we learn from the NY Post that SEC Chairman Christopher Cox has Schwartz's back: "The fate of Bear Stearns was a lack of confidence, not a lack of capital."

That makes these videos of Jim Cramer all the more interesting. First, here is Cramer on Tuesday, March 11, when BSC was trading at $62.97/share.

This is Jim Cramer on Monday, March 17, after Bear announced that it had entering a merger agreement with JP Morgan for $2/share.

Cramer has been raked over the coals for this performance, but in light of Cox's comments, Cramer has a much more sensible defense to his initial remarks: I was right on the liquidity issue! Of course, he has completely blown that defense with the lameness of his subsequent comments, when he suggested that he wasn't talking about the common stockholders.

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As regular readers know, I focus on regulatory things, and to me, the big news in the Bear Stearns story is the Fed's rather unilateral expansion of its regulatory ambit to cover investment banks and other large Wall Street institutions.  There's an SEC turf angle to this story, and there's even a Schmidtian take.  But we've been thinking historically, and it's worth noting that the Fed has always been tied to Wall Street, not Main Street.  It's gotten involved in Main Street, splitting regulation over local banks with the states and Treasury.  But the institution was started to support big banks.  The Fed's influence over Wall Street changed with the Great Depression and the creation of the SEC.  And it looks, from this vantage point at least, like one implication of the Bear Stearns bailout and the move to make credit available to other financial institutions is that the Fed is reasserting by regulation its long unstated role as the chief overseer of the financial markets.

Not to be too anodyne and regulatory turf oriented.  The bailout isn't without costs, of course.  Lisa told you about the impact on employees, look at these pieces taking similar views.

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Yesterday while I was freaking out about the apparent abdication of responsibility by Bear Stearns' directors, Larry Ribstein was observing that it's not over 'til it's over -- that is, the Bear  shareholders still have to approve the deal. Meanwhile, Steve Davidoff was looking at the merger agreement and commenting on an unusual provision that he calls "Bear's Put." Here is the provision:

Restructuring Efforts. If Company shall have failed to obtain the requisite vote or votes of its stockholders for the consummation of the transactions contemplated by this Agreement at a duly held meeting of its stockholders or at any adjournment or postponement thereof, then, unless this Agreement shall have been terminated pursuant to its terms, each of the parties shall in good faith use its reasonable best efforts to negotiate a restructuring of the transaction provided for herein (it being understood that neither party shall have any obligation to alter or change the amount or kind of the Merger Consideration, or the Tax treatment of the Merger, in a manner adverse to such party or its stockholders) and to resubmit the transaction to Company’s stockholders for approval, with the timing of such resubmission to be determined at the reasonable request of Parent.

And here is Steve's analysis:

Bear’s shareholders will have a vote on the transaction. However, if Bear’s shareholders vote down the agreement, the companies have the obligation under Section 6.10 of the agreement to negotiate a restructuring of the transaction but not a change in the consideration and to resubmit it to Bear’s shareholders for approval. This obligation lasts until the agreement is terminated. The way the agreement works in these circumstances Bear could not terminate the agreement until the drop-dead date of March 16, 2009

The provision appears drafted quickly, and it is unclear what type of restructuring would happen (perhaps an asset purchase?), but it effectively gives Bear shareholders a put right for a year to JPMorgan. During that time Bear’s shareholders could theoretically keep voting while waiting for a better option. Whether this would actually work is uncertain, and commentators were skeptical that one would come along, but a year is a long time. About a year ago, the largest private equity buyout of all time, that of TXU for $43.7 billion, was announced. Remember that?

In any event, I’m not sure that, in normal times, the Delaware courts would uphold this type of arrangement — a repeat force-the-vote provision — but this is not a normal deal.

As of today, this provision suddenly got more interesting, as Bear's shares are now trading at almost $6 -- three times the original purchase price. Some of that increase is explained by the fact that the Morgan deal is denominated in stock and Morgan's stock price has increased since Sunday. But what about the remaining premium? Are investors expecting a new bidder? (For competing hypotheses, see here.)

That's where the provision on "Restructuring Efforts" would become more interesting. Morgan has negotiated for the right to go back to Bear's shareholders with a restructured transaction. And they can do this until the merger agreement expires a year from now!* Today this looks less like "Bear's Put" and more like "Morgan's Call" (well, not exactly, but that sentence has nice symmetry).

Would the Delaware courts enforce this provision? The directors of Bear Stearns provided for a fiduciary out in the event of a superior proposal, but that "out" merely allows the board to change its recommendation to Bear's shareholders. Morgan still has its rights under the provision quoted above, which means that a competing bidder is foreclosed for the next year.

This provision has an effect similar to a "no hands" poison pill, which the Delaware Supreme Court invalidated in Quickturn Design Systems, Inc. v. Shapiro, 721 A.2d 1281 (Del. 1998). That effect would be to preclude a takeover for a specified period of time. In the case of Bear Stearns, the mechanism for producing this effect is a deal protection provision in a merger agreement, not a poison pill, but the Delaware Supreme Court's decision in Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003) tells us that this is a distinction without a difference.

Even if Quickturn wouldn't decide the matter, Omnicare might seal the merger agreement's fate. The Bear Stearns-Morgan deal is not exactly like Omnicare, where the parties effectively ensured the result, but the Bear Stearns directors may have crossed the line by "completely prevent[ing] the board from discharging its fiduciary responsibilities to the minority stockholders when [a competing bidder] presented its superior transaction."

UPDATE: It's possible that the Delaware courts would recognize this circumstance as sufficiently unusual to justify the offending provision. As Steve observes above, "this is not a normal deal." The wild card here is the Fed, which inserted itself into negotiations fairly aggressively, by all reports. Does that excuse Bear Stearns' board from its obligation to shareholders? No. Though I can't swear that the Delaware judges would view it this way.

* Can they take multiple bites at this apple? The merger agreement is not clear, but the calendar works against them, as each bite requires substantial lead time.

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Wow! Bear Stearns is being sold at $2/share to JP Morgan. Below is the stock chart for Bear Stearns over the past year ... as of Friday. Notice that it ended on $30/share. Shave $28/share off of that price, and be happy about it, says JP Morgan. The W$J quoted an anonymous source on the negotiations: "At the end of the day, what Bear Stearns was looking at was either taking $2 a share or going bust. Those were the only options." (Hmm. Did this anonymous source work for JP Morgan by any chance?)

Remember just last week when Bear Stearns was assuring the market that it could weather this storm? If I were an equity holder in Bear Stearns, I would be pretty miffed right now. Apparently, the Fed carried a big stick at the negotiations:

The deal already is prompting howls of protest from Bear Stearns shareholders, since the New York company last week indicated that its book value was still close to its reported level of about $84 share at the end of the fiscal year. "Why is this better for shareholders of Bear Stearns than a Chapter 11 filing?" one Bear shareholder asked J.P. Morgan executives in a conference call last night.

J.P. Morgan referred the question to Bear Stearns executives, who weren't on the conference call. In a statement, Bear Stearns Chief Executive Alan Schwartz said the deal "represents the best outcome for all of our constituencies based upon the current circumstances."

One person familiar with the sale process said federal officials delivered a decisive prod to the firm's directors. "The government said you have to do a deal today," this person said. "We may not be there tomorrow to back you up."

The Fed, according to a person familiar with the matter, didn't care so much about the equity holders and was trying to prevent a bankruptcy filing that could have sent shock waves through the markets.

"Best outcome for all of our constituencies"? Bear Stearns is a Delaware corporation, and when the directors of a Delaware corporation are deciding whether to sell the company, generally speaking they are charged with a very narrow decision rule: get the "best value reasonably available to the stockholders."

In this instance, the invocation of "constituencies" suggests that Bear Stearns is positioning this as a decision made "in the vicinity of insolvency," where the scope of director duties is often said to expand to include creditors. (Larry and Steve have argued that this misperceives the nature of director duties in the zone of insolvency, and while I tend toward this view myself, here I am merely commenting on Schwartz's choice of words.)

The Bear Stearns decision is faintly reminiscent of the decision at the heart of Odyssey Partners, L.P. v. Fleming Companies, Inc., 735 A.2d 386 (Del. Ch. 1999), in which minority shareholders argued that the majority shareholder should have pursued bankruptcy rather than foreclosure. Vice Chancellor Lamb offered several reasons for rejecting this claim, including the following:

In arguing that the defendant directors' failure to file for bankruptcy law protection was a violation of the board's fiduciary duties to the stockholders, plaintiffs overlook that the board was obligated to consider and protect interests other than those of the stockholders. When bankruptcy and foreclosure are compared, and the effects of both on the shareholders, creditors and other corporate constituencies balanced, the decision to proceed with the foreclosure cannot be said to have been made in bad faith or a manner that was disloyal ..., taken as a whole. Moreover, the record is clear that the directors, with the possible exception of Banks, reasonably believed that a bankruptcy filing would produce negative returns for all of the ... constituencies, including [the] stockholders.

In the case of Bear Stearns, there is no hint of self-dealing, which means that the director action would be evaluated under the business judgment rule. Equity holders will be upset, but Delaware corporate law will not come to the rescue.

One last thing: the story quoted above reported that the Fed wanted Bear Stearns to avoid a "bankruptcy filing that could have sent shock waves through the markets." Perhaps this purchase by JP Morgan will provide some assurance to the markets, but based on the trading in Asia at this hour, the shock waves are reverberating.

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It's amazing to think that the fifth largest investment bank in the US could basically disappear in a day, or, perhaps more charitably, a week.  Dealbreaker thinks it's because they block blogs.  Here's Dealbook on potential buyers.  What are you supposed to do if a regulator?  The Fed brokers bailouts, while the SEC goes to those meetings.  UPDATE: Here's the Division on Trading and Markets with a slightly less cursory account of what the SEC did.  It still didn't do much.)  Two observations:

• It's interesting that while what BSC does is create and trade securities, it is the banking regulators who ride to the rescue, not the SEC.  So it has always been.  Should SEC officials get more of a look in?  I'm surprised to say that I've never heard the agency make that case for an expansion of regulatory turf, but perhaps Conglomerate's readers can remind me otherwise.
• BSC's claim that "we were fundamentally sound on Monday, we just got pounded by everyone else all week," is very Long Term Capital Management, no?

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In the midst of a laundry list of proposed changes for foreign issuers filing in the US - my rough takeaway on those is: now that you can file under IFRS or GAAP, if you choose GAAP, you really have to choose it, not some watered down GAAP-for-foreigners - the SEC revealed that it's considering bestowing a modest research boon on the corporate governance effects crowd.  It may

Amend Form 20-F to require annual disclosure of the significant differences in the corporate governance practices of listed foreign private issuers compared to the corporate governance practices applicable to domestic companies under the relevant exchange’s listing standards

That's a little less exciting than it sounds.  The US exchanges already require this "significant difference" disclosure on the corporate website or in the annual report.  Now the SEC wants to mandate this disclosure in the annual report:

Foreign private issuers frequently opt to provide this disclosure on their websites, rather than in their annual reports. We are proposing to require disclosure of this information in the Form 20-F annual reports filed by all foreign private issuers whose securities are listed on a U.S. exchange. This would consolidate all of the relevant corporate governance disclosure about a listed company in one central location.

But, I suppose, it does make it easy for researchers to know where to look when they begin their coding projects.

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Tomorrow I will be teaching Rule 144 in my Securities Regulation class, and it was not until I began focusing on the Rule again that I remembered that the SEC had recently amended the Rule.  And the changes, which among other things shorten the holding period for certain resales of restricted securities, went into effect on February 15^th.  Good to know.  There is nothing like rulemaking to ensure that your lecture is not stale.

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Last year when the SEC decided against adopting a rule that would have allowed shareholders access to the corporation’s proxy statement in order to nominate candidates, SEC Chairman Cox stated that the decision did not signal the end of the proxy access debate. In fact, Cox promised to revisit the issue of proxy access in 2008. Both proponents and opponents of proxy access viewed the promise with skepticism. And their skepticism stemmed from the same issue—that is, the SEC’s failure to adopt a proxy access rule, particularly in light of its decision to embrace a rule permitting corporations to exclude bylaws encompassing procedures for such proposals, seemed to be a pretty definitive statement against proxy access. Moreover, despite increased shareholder activism, it seemed that the political climate at the SEC simply was not conducive to the SEC’s adoption of a proxy access rule. Hence, I think most believed that the SEC would seek to allow the proxy access issue to quietly drift away. And yet, in a recent speech regarding the SEC’s upcoming agenda for 2008, Cox pinpointed proxy access as one of the SEC’s priorities for rulemaking. According to COX, the Division of Corporate Finance would continue its work on the proxy process and would continue to pursue the “fundamental objective of making the federally-regulated proxy system fit better with the state-authorized rights of shareholders to determine the directors of he companies they own.” To be sure, it is not clear that such a pursuit is the same as the pursuit of proxy access. Nor is it clear that such a pursuit could ever culminate in the adoption of a proxy access rule, particularly given historical and more recent defeats of such a rule. Yet Cox’s statement does suggest that the issue of proxy access in some form will continue to be a part of the governance conversation.

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You'd think that most countries would be happy to get fresh billions in foreign investments.  But that hasn't been the reaction to sovereign wealth funds, the hot topic at Davos and in a series of law review articles coming your way.  Quick takeaways from bloggers here, here, here, and here.  The SEC has its own suspicions about the funds, and yesterday, Linda Chatman Thomsen, the director of the enforcement division, tried to explain why.  Looks like the chief worries are the potential for insider trading and the prospect of rendering foreign regulators uncooperative:

we are concerned that some sovereign wealth funds, or persons associated with them, like some hedge funds, or persons associated with them, may undermine market integrity by engaging in insider trading or other market abuses. Sovereign wealth funds, like hedge funds, are relatively opaque. Also, sovereign wealth funds, like hedge funds, have, by virtue of their substantial assets, substantial power in our financial markets. However, in addition to this financial power, sovereign wealth funds, unlike hedge funds, have power derived from being governmental entities, which may give them access to government officials and information that is not available to other investors. There is the potential for these powerful market participants to obtain material non-public information, either by virtue of their financial and governmental powers or by use of those powers, to engage in illegal insider trading using that information.
[snip]
Given the inherent difficulties of conducting a cross-border investigation halfway around the world, this kind of cooperation is essential for our effectiveness and the need for the cooperation is increasing. In the context of sovereign wealth funds, we are concerned that if the government from which we seek assistance is also controlling the entity under investigation, the nature and extent of cooperation could be compromised. Indeed, in other contexts, we have seen less than optimal cooperation when foreign governments have an interest in the issue or person we are investigating.

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The latest backdating victim: the former CEO of Monster.com, Andrew McKelvey.  McKelvey can no long serve as an officer of a public company and owes the SEC $275 grand.  And he didn't even benefit (much) from the backdated options, which went to his staff.  Here's a taste from the press-release-of-victory:

McKelvey caused Monster to misrepresent in its periodic filings and proxy statements filed with the Commission that all stock options were granted at the fair market value of the stock on the date of the award, when that was not the case. McKelvey also caused Monster to file materially misstated financial statements with the Commission in its Forms 10-K and 10-Q that did not recognize compensation expense for the company's stock option grants, as required by generally accepted accounting principles. As a result, Monster overstated its aggregate pretax operating income by approximately $339.5 million, for fiscal years 1997 through 2005. Although McKelvey did not receive backdated options, he benefited from the scheme by granting backdated options to four individuals that he personally employed, including three pilots and a mechanic.

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Today in Securities Regulation we briefly talked about valuation of going concerns.  We even compared the problems with valuating a continuing firm with the problems of calculating the economic value of a human in a wrongful death case.  Well, now I have the perfect hybrid -- Real Sports Investments, LLC is selling "contracts" for shares in minor league sports athletes.  (Well, only one right now.)  "Members" in RSI can buy shares in an athlete, and these shares will entitle the bearer to a percentage of the athlete's future annual "major league salary."  An athlete may only sell 20%  (so as to leave the athlete some incentive) and will then pay to RSI 20% of salary/bonuses once the athlete is in the major leagues.  RSI then divides that 20% among the holders of the shares.  Members may also sell the shares, but only to other members.  The website calls these payments "dividends," but the payments are not only fixed but carry with them a breach of contract claim if not made.  Therefore, these shares seem more like preferred shares (if anything), with really, really strong dividend rights.

Should the player quit or retire for reasons other than career-ending injury in the first two years of the contract, then the player must repay the amount received by RSI, plus interest.  In addition, should the player be banned for using prohibited substances at any time, then the player must repay also.  If the player is injured, however, then there is no repayment.  Also, if the player never goes to the major leagues, then no amounts are ever paid.  The risk of both injury and failure seem to be spread here, however imperfectly.

We have not gotten to the point in the course yet where we discuss what is a security, but I think I will save this hypo for that time.  Of course, the website states that this is not a security.  The owners of the site seem to think they've hit on the perfect "investment" -- it's not a security, and it's not gambling either.  I'm not sure.  If the owners want to maintain that the site does not host online gambling, then it should take this FAQ off of its site:

Why would I ever play fantasy Sports again when I can invest in the real thing?

I do not know. 

HT: Tyler Cowen at Marginal Revolution

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That's what everyone is wondering about Tuesday's stock market. Asia and Europe are down big again. The Dow Jones Stock Futures are pointing to a 500+ point drop. Yikes!

If you are losing sleep over this, you might as well join Paul Kedrosky.

UPDATE: The Dow dropped 460 points after the opening bell, but it has recovered most of that ground. The Fed waged a preemptive strike, slashing the federal funds rate and discount rate by .75%, the biggest cuts in interest rates since August 1982. Perhaps even more interesting: most rate cuts may be on the way.

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While US markets rest for MLK Day, stock markets around the world are tumbling over fears of a U.S. recession. The FT is describing a "panic":

Indian shares tumbled as much 11 per cent before recovering a little to end the day 7.4 per cent down, Hong Kong closed 5.5 per cent down – its biggest fall since the aftermath of the September 11 attacks – and Japan’s Nikkei average slid by nearly 4 per cent to its lowest level for more than two years.

Share prices in mainland China fell by 5.14 per cent, their biggest one-day drop in nearly six months. Investors in China worried that the country’s apparent immunity to credit problems in the US may be ending.

Chinese banking stocks were hurt on Monday by speculation they will have to make much larger writedowns on holdings of US subprime mortgage securities than originally thought.

Leading European markets suffered their worst one-day percentage points falls since September 11, 2001. The Xetra Dax slumped 7.2 per cent to 6,790.19, while the CAC-40 dropped 6.8 per cent to 4,744.45. The Madrid stock market closed down 7.5 per cent at 12,625.8, its worst one-day percentage points fall since 1991.

In London, the FTSE 100 lost 5.5 per cent to 5,578.2, its biggest ever slide in points terms since the index was formed in 1983.

In my Securities Regulation course, we begin each class with a brief look at the markets, and we discuss possible causes and effects. How do you explain this? Again, the FT:

Some analysts said equity markets have finally realised that the credit market turmoil is spilling over into the real economy. The sharp sell-off in Asia and Europe was not prompted by one immediate catalyst and the US market was closed for holiday.

Translation: we have no idea what happened.

Both the FT and the W$J point to Fitch's downgrading of ratings on bond-insurance companies as one source of concern, but no one seems to think this was the principal or only trigger. W$J also cites  a "general fear of economic slowdown."

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Two interesting recent empirical papers address the issue of information leakage from private lenders that affects securities trading and takeovers.  Private lenders receive confidential information about their borrowers as part of their lending activities.  These papers document channels through which this private information leaks into securities markets and the market for corporate control.

One paper, Institutional Investors and Loan Market Information Spillover, by Victoria Ivashina (HBS) and Zheng Sun (Stern), marshalls evidence that private lenders also trade on this information, though not in the securities of the borrower but in the securities of firms in the same industry, or firms whose earnings or stock returns highly correlate with those of the borrower.  Institutional investors who buy commercial loans do better in the stock market than those who don't.

The second paper, Bank Debt and Corporate Governance, by Victoria Ivashina, Vinay Nair (Wharton), Anthony Saunders (Stern), Nadia Massoud (York), and Roger Stover (Iowa State), finds evidence that banks facilitate takeovers by producing information as part of their lending activities and then transmitting this information to potential acquirers.  In particular, (a) greater bank lending "intensity" for a firm (as measured by the number, amount, and maturity of loans by a bank to a borrower, among other things) improves the likelihood that the firm will be the target of a takeover bid; (b) a firm with lending relationships with banks that have more clients in the same industry are more likely to receive a takeover bid; (c) the bank lending intensity effect is stronger where the target and acquirer have a relationship with the same bank; and (d) potential acquirers who switch to a new relationship bank are more likely to bid for other clients of the new bank.

Interesting stuff!

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Tellabs is the Private Securities Litigation Reform Act case that the Supreme Court heard last year, and remanded to the 7th Circuit for reconsideration.  It looked like a win for corporate America then, but less so as of today.  The Chicago court, per Judge Posner, just took another look.  Concluding that "it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud," the court found, once again, that the plaintiffs done just that, and met the Supreme Court's sorta specific pleading standard.  Some commentary comparing this year's Stoneridge to last year's Tellabs can be found here and here. HT: Secruities Mosaic.

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Looks like a win for corporate America, here's Scotusblog with an overview, here's Elizabeth Nowicki with a dissent, some cavils, and a caveat, and here's Bainbridge with praise.  Also see the links at Volokh, if you're headed that way.

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As things quiet down for the holidays, the short posts keep coming.  The SEC has released the text of the final rule permitting foreign issuers to use foreign accounting standards when selling to US investors.  I still say it's a sea change, here's Larry Cunningham with much more insight.

Here's what the SEC said in the preamble of the final rule: "The Commission is adopting rules to accept from foreign private issuers in their filings with the Commission financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) without reconciliation to generally accepted accounting principles (“GAAP”) as used in the United States."  HT: Securities Mosaic

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In a 12/12/07 editorial ("Closing the GAAP"), the WSJ addressed the possible move from GAAP to IFRS, pointing out that GAAP is more rules-based and IFRS is more principles-based.  There is much to say, and much has been said, about rules vs. principles in accounting.  I want to underscore just one thing: with principles comes more discretion and with more discretion comes a greater chance that issuers, their officers, their accountants/auditors, etc. will be found to have "gotten it wrong," particularly in hindsight.  Accordingly, doesn't any discussion of rules vs. principles (whether in the context of a shift from GAAP to IFRS or otherwise) have to include a broader discussion of securities enforcement and litigation?

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Although Enron, WorldCom, etc. are in the rearview mirror, the SEC remains very busy.  One initiative that has received relatively little attention in legal academic circles (at least by my count) is so-called XBRL (or interactive data).  In short, XBRL provides a way for information to be "tagged" so that it is easier for users to manipulate as they see fit.  With XBRL, users of information can readily re-fashion an issuer's financials, or that's the hope.  Without question, XBRL poses several challenges.  That said, XBRL is an important move in that it has the potential to make company filings more understandable, thus enhancing transparency. 

XBRL is really just part of a broader development.  Not only is the Commission advancing XBRL, but the shift from GAAP to IFRS appears to be underway, at least to some extent.  Further, the SEC's Advisory Committee on Improvements to Financial Reporting is considering a number of items.  The bottom line?  Under Chairman Cox, financial reporting could dramatically change -- in terms of both its form and substance.  Although topics such as shareholder access get more attention, the changes to financial reporting could have a much more significant impact on securities markets.  Stay tuned.

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First, let me thank the folks at the Conglomerate for inviting me to guest blog. I’m a regular reader and look forward to having a chance to share some thoughts.

Let me start with an observation: The “private” securities market is becoming larger and larger and ever more important. For example, the growth in private equity has received much attention lately (in part as a result of claims that companies have gone/stayed private to avoid regulatory burdens (e.g., SOX)). The hedge fund industry is now well over a trillion dollar industry, having ballooned in recent years. In addition, the Rule 144A market is huge, and more active secondary trading of Rule 144A offerings is expected in the future. Brian Cartwright, the SEC’s general counsel, made similar observations in an interesting speech on “The Future of Securities Regulation” that he delivered on October 24, 2007 at Penn Law School (a copy of his speech is available on the SEC’s Web site).

This leads me to the following question: How will the growth of the private market for securities (or, to use Cartwright’s term, continuing “deretailization”) impact securities regulation going forward? Will calls for regulating private pools of capital intensify? One reason people have called for hedge fund regulation is because the industry has grown so considerably. Alternatively, we have seen calls to reduce the burdens on public companies – in effect, to scale back some of the SOX-era reforms and to address securities class actions. Further, will there be growing calls to ease the Investment Company Act burdens that presently limit the ability of mutual funds to engage in hedge-fund-like strategies?

In considering all of this, one can’t overlook that retail investors may become increasingly discontent as they come to appreciate more fully that there is one market for them (public offerings and mutual funds) and another market that only wealthy individuals and institutions can play in. The comments on the SEC’s “accredited natural person” proposal (which proposed adding an investment standard for individual investors to qualify as “accredited” when investing in hedge funds) suggests retail investors want the same opportunities as wealthy individuals and large institutions.

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In addition to the SEC's recent rule change permitting IFRS financial statements by foreign private issuers, here are a few other noteworthy developments:

1.    Rule 144 changes:   The SEC voted to  shorten the holding period for restricted securities of reporting companies from one year to six months.  Also for sales by non-affiliates, volume limits, manner of sale requirements, and other restrictions are eliminated, except for the requirement of current public information until the securities have been held for one year.  For affiliate sales of debt securities, the Commission eliminated the manner of sale requirements and eased the volume limits.

2.    Proxy access:  The SEC codified its intepretation of Rule 14a-8(i)(8) allowing issuers to exclude proxy access shareholder proposals.  In a party-line vote, Commissioner Annette Nazareth dissented.

3.    Terrorism disclosures:    The SEC recently issued a concept release seeking public comment on its efforts to monitor and facilitate public access to company disclosures regarding business activities with State Sponsors of Terrorism (Cuba, Iran, North Korea, Sudan, and Syria).

4.     ISS 2008 Proxy Advisory Policy Updates:  Proxy advisory firm ISS Governance Services (fka Institutional Shareholder Services) recently announced its US and international policy updates regarding its proxy voting recommendations.

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Thanks for inviting me to guest blog!  I'm a regular reader of the Conglomerate, so I'm looking forward to contributing to the dialogue over the next few weeks. 

As Gordon said in his kind introduction, my area of scholarship is securities fraud, so it seems only appropriate that my first post is about our old friend, Rule 10b-5.  For some time now, I've been interested in the relationship between private actions brought under Rule 10b-5 and under state antifraud provisions.  The Securities Litigation Uniform Standards Act of 1998 expressly preempts state securities fraud class actions involving nationally-traded securities.  Thus, at first glance, SLUSA doesn't seem to leave much room for state law as a remedy for false corporate disclosures.  However, since state law is ordinarily more attractive than Rule 10b-5, plaintiff attorneys have been quite creative in finding ways to avoid the preemptive force of SLUSA.  For some plaintiffs, the latest way around SLUSA has been to "opt out" of the class action to pursue an individual action under state law in state court.

Anecdotally, it seems as if a fair number of institutional investors have opted out of class actions brought in connection with several large securities frauds, and these plaintiffs have claimed that they negotiated larger settlements than they would have received had they remained in the class action.  There doesn't seem to be a clearinghouse for individual securities fraud actions similar to Stanford's Securities Class Action Clearinghouse, so it's difficult to tell if this trend will continue.  If it does, opting out seems to raise some interesting issues.  Do opt outs undercut the goals of SLUSA?  How does opting out jive with the lead plaintiff provision of the Private Securities Litigation Act of 1995, which envisions active participation by large stockholders in class actions?  And, in any case, do we want to have a system that allows certain plaintiffs -- i.e., institutional investors -- their choice of law and/or forum, while forcing smaller plaintiffs into federal court with its unattractive procedural requirements? 

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SEC Chair Christopher Cox applies the lessons of Japanese feudal history to international securities regulation:

[Tokyo] was a castle city and once the headquartes of the shogun, Tokugawa Ieyasu. You might recall that the history of his rise to power was fictionalized in James Clavell's novel Shogun. Tokugawa is a fascinating historical figure: He came to power after years of civil war, and established a system that led to centuries of peace, and the flowering of culture and art. But his was also an odd system, by modern standards, that included strict rules governing virtually every aspect of life.

Some of his rules had unintended consequences. For example, at a time when Japanese gunsmiths were producing some of the finest muskets in the world, Tokugawa centralized all firearms production in a single city. That effectively destroyed the firearms industry — which is probably what Tokugawa intended, because it had the direct consequence of keeping other feudal lords from acquiring the weapons to overthrow his rule. But it also ended up doing something he didn't intend: putting a crimp on technical innovation in Japan. That's because Japanese gunsmiths had developed very sophisticated metal working and mechanical techniques with potentially broad application.

That wasn't the only thing Tokugawa did that had unintended consequences. In order to protect Japan from the aggression of foreign colonial powers, he cut off Japan from almost all foreign contact, including prohibiting Japanese citizens from traveling abroad. That policy was successful in what it was intended to accomplish; but it also had the indirect effect of cutting off Japan from the explosion of economic and technological development that we now call the Industrial Revolution.

Tokugawa's policies offer many lessons for securities regulators today.

But that's only his view.  What if there were four different ways of seeing the exact same event?  Something to think about, when you're reading the whole thing.

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It's official enough to warrant a press release.  The SEC just voted to permit foreign companies to comply with SEC disclosure requirements by filing accounting statements under international accounting standards, rather than US GAAP.

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