I wrote a paper on the SEC's ALJs, which I think are plenty independent and not at all unconstitutional. They cite federal judges and write sentences with the same degree of difficulty, and though the SEC usually wins before them, there are plenty of reasons for that.
It's forthcoming in the Texas Law Review, and here's the abstract. Do give it a look and let me know if you have any thoughts.
The Dodd-Frank Wall Street Reform Act allowed the Securities & Exchange Commission to bring almost any claim that it can file in federal court to its own Administrative Law Judges. The agency has since taken up this power against a panoply of alleged insider traders and other perpetrators of securities fraud. Many targets of SEC ALJ enforcement actions have sued on equal protection, due process, and separation of powers grounds, seeking to require the agency to sue them in court, if at all.
This article evaluates the SEC’s new ALJ policy both qualitatively and quantitatively, offering an in-depth perspective on how formal adjudication – the term for the sort of adjudication over which ALJs preside – works today. It argues that the suits challenging the SEC’s ALJ routing are without merit; agencies have almost absolute discretion as to who and how they prosecute, and administrative proceedings, which have a long history, do not threaten the Constitution. The controversy illuminates instead dueling traditions in the increasingly intertwined doctrines of corporate and administrative law; the corporate bar expects its judges to do equity, agencies, and their adjudicators, are more inclined to privilege procedural regularity.
Dan Katz (Michigan State), Michael James Bommarito, Tyler Soellinger (Michigan State), and Jim Chen (Michigan State) have posted a new paper that studies empirically the impact of SCOTUS opinions on the share prices of the winning and losing corporate parties. WSJ Blog blurb here. As corporate law professors know, the SCOTUS docket is not mainly corporate law cases or cases in which one corporation's prospects might be substantially changed (employment case, etc.), but the study did find 79 cases in the relevant period that seem to match changes in stock price equal to $140 billion.
Why do the authors think that's important? Obviously, in cases in which corporations get large securities fraud lawsuits dismissed or on the other hand, get a ruling that opens the door to a class action or multiple lawsuits, the share price could react. But what the authors are really interested is predicting that movement and exploiting it. Here is there information market website: https://fantasyscotus.lexpredict.com/. Here is their algorithm: http://arxiv.org/abs/1407.6333.
From a securities law standpoint, I can't help but wonder when predictive trading on court decisions begins to cross the "outside trading" line. No, the information isn't nonpublic -- the information is public, but only accessible through an enormous amount of computing power. Bud Fox following a corporate raider around all day and making very informed guesses as to his next target is one thing, but following every CEO around with invisible drones is another. At some point, does technology make information gathering cross the line? I don't have an answer for this, but I know that Larry Ribstein and Bruce Kobayashi hinted at the positive aspects of this in "Outsider Trading as Incentive Device," which responded to Ian Ayres and Steven Choi's "Internalizing Outsider Trading" and the concern that the ability to trade in similar ways would lead to excessive search costs. (None of the authors contemplated a scenario in which technology makes information that for all practical purposes was nonpublic and uses it for trading purposes.) I look forward to hearing more.
In what I think is the first appellate decision on the issue, the Seventh Circuit held that timing problems prevented courts from entertaining collateral attacks on SEC administrative proceedings. It means that defendants have to raise their constitutional claims before the ALJs, and then the SEC itself on appeal, before they can get into court on appeal from that.
These timing issues have always looked really problematic for the plaintiffs. Essentially, they have been arguing that they think the SEC is about to open an administrative case against them, and that a court should tell the SEC that it can't do that, because administrative cases are unconstitutional. Usually, claiming that you think the government is about to do something isn't a very good reason to sue the government. Why not wait and see? You'll save the court's time and keep it from issuing an advisory opinion.
Put that way, it's not surprising that a CEO anticipating administrative proceedings against her was told to make her constitutional arguments to the agency, if the agency does, in fact, file papers against her, before trying to get the courts involved.
On the other hand, the case that has ginned up these suits, Free Enterprise Fund v. PCAOB, let a couple of accountants make their constitutional claims against PCAOB before it had lifted a finger against them. So the Seventh Circuit basically said "we don't think the Court meant to get rid of the doctrines of standing, finality, and exhaustion in that case," which is sort of hand waving, but probably true.
Anyway, it increases the likelihood that we will soon get an initial decision from an SEC ALJ ruling whether SEC ALJs are unconstitutional. I'm very much looking forward to that. You can find a gloss on the opinion here, and a link to the actual opinion at the end of the gloss.
There's not too much new in the indictment for insider trading of the former partner of Philly firm Fox Rothchild. The partner didn't work on the deal, but he overheard a conversation between one who was working on the deal and the legal assistant they shared. And then he traded so unbelievably transparently you can barely believe that he was a lawyer. He bought shares in his wife's IRA account, and then he bought shares in his own IRA account. The next day, the merger was announced, the shares went up 80ish percent, and he instantly sold, making $75 grand. Which doesn't do his wife any favors, in the end.
The SEC’s complaint filed in federal court in Philadelphia names Sudfeld’s wife, Mary Jo Sudfeld, as a relief defendant for the purpose of recovering insider trading profits in her brokerage account through trades conducted by Sudfeld. The complaint charges Sudfeld with violating antifraud provisions of the federal securities laws and an SEC antifraud rule. The SEC seeks a permanent injunction and financial penalties against Sudfeld and return of allegedly ill-gotten gains and prejudgment interest from Sudfeld and Mary Jo Sudfeld.
That is insider trading of the most "please, catch me!" variety. But maybe this guy hasn't head of the duties of quasi-insiders, and thought he was an accidental tippee.
Over at DealBook, I have a piece up on the state of cost-benefit analysis at the SEC. Inadequacies in the CBA were how the SEC used to lose all its rulemakings in the D.C. Circuit; its latest rulemaking on clawbacks sets the stage for how seriously the agency takes cost-benefit analysis now, and how much it believes that analysis should be quantified. A taste:
Throughout the cost-benefit analysis, the agency warns that it is “often difficult to separate the costs and benefits,” and that various effects of the rule are “difficult to predict.”
I suspect the agency thinks it doesn’t need to blow the court of appeals away with some numbers to survive, though of course the S.E.C. can do more cost-benefit analysis in the final rule. It does, however, believe that a lengthy consideration of the costs and benefits of a rule should be part and parcel of any proposal.
For those who think that cost-benefit analysis slows the pace of regulation, this may not be good news. Economists might wish that numbers were being appended to the discussion.
But I am happy enough to see rules without numbers. Justifying rules only with regard to their costs and benefits is pretty routine. As routines develop, it may become difficult for regulators and judges to consider new sorts of costs, and unforeseen benefits contained, for example, by the simple expression of what the rule favors and what it discourages.
Go give it a look!
The front page of today's WSJ featured a story about Mylan NV's failure to disclose a potential conflict of interest transaction with Rodney Piatt, its vice chairman, lead independent director, and compensation-committee chief. On the surface it looks like a classic conflict, and corporate law students and professors alike know that's a big no-no. As a director, Piatt has a fiduciary duty to look out for the best interests of Mylan--i.e., to pay the least possible amount. Of course, if he's on the other side of the transaction, human nature is to try to get the most money possible. Ergo, conflict.
The WSJ article suggests that failure to disclose the transaction violates a securities law that requires disclosure of related party transactions. The company says there was no related party transaction because "The day before Mylan announced plans to build the new headquarters, a company managed and partly owned by Mr. Piatt sold a 7-acre site for $1 to an entity owned by a business partner in Southpointe II, according to property records reviewed by The Wall Street Journal. The partner’s firm sold the same land to Mylan for $2.9 million later the same day."
Yeah, it sounds fishy to me, too. But according to Mylan, "Mr. Piatt was not a party to either transaction” and “had no direct or indirect material interest in the transactions.” Clearly they're arguing it doesn't count as a related party transaction because Piatt is not a party.
OK, maybe. Maybe. But Mylan might have another securities law problem: its code of ethics, which specifically covers directors (p. 3). Codes of ethics tend to be broader in scope than related party transactions. Nobody (but me) ever thinks about them, but Sarbanes-Oxley required that ethics codes be disclosed--along with any waivers the board of directors grants directors and senior officers (For you history buffs, this provision was the result of Andy Fastow's related-party transactions with Enron, all blessed by the board via ethics waivers).
Mylan's has a lengthy section on conflicts of interest. From the introduction:
We must avoid personal interests that conflict with the interests of Mylan, or that might influence or appear to influence our judgment or actions in performing our duties. The word “appear” is most important. Even where there is no actual conflict of interest, the appearance of such a conflict is damaging because it can undermine trust among personnel and jeopardize the company’s standing with our customers, regulators, shareholders and others.
It's not clear what Piatt's relationship is to the business partner in Southpointe II to whom he sold the land for a dollar. But
Neither you nor any family member(s) may directly or indirectly participate in any business relationship with Mylan, other than your relationship as a director, officer, employee of Mylan, contractor or agent, unless such an arrangement has been approved by the OGC. Executive officers and directors must also obtain approval from the committee regarding such ar- rangements. Any such arrangement that has not been approved by the OGC or the Committee, as applicable, is a violation of the code and is prohibited.
Except as provided in this code, you are prohibited from acquiring any interest in a company that competes with Mylan or does business with Mylan, such as a vendor, supplier or customer, without the prior written consent of the OGC. Executive officers and members of the board must also obtain approval of the Committee before acquiring any such interest.
What's supposed to happen if there is the appearance of a conflict?
If a situation arises in which there is an actual, apparent or potential conflict of interest, you must disclose the matter to the OGC. If required, the OGC will escalate the matter to the Senior Executive Compliance Committee (committee).
If the committee finds that such conflict is not material and does not appear to be of a nature that it would influence the business decisions of those involved, the committee may grant a waiver in its sole discretion.
At Piatt's level, any such waiver should be disclosed as an 8-K, about which I know a little something. I didn't see one in December of 2013.
It's hard to find cases of where companies don't disclose waivers when they should have--you have to ferret out the nondisclosure first. It looks like the WSJ might have here.
Update: I forgot, Section 406 covers only the CEO, CFO, and CAO, so Piatt's waiver wouldn't have needed to be disclosed. He would still need to get one, arguably. And since the corporation has adopted a code of ethics that purports to apply to its board, if it is not following the required procedures that information would arguably be material.
The thing that gets me about codes of ethics is that they seem largely like empty corporatespeak. But they all address conflicts of interest. Conflicts of interest are the one thing that shareholders really might care about--because they're a sign that corporate insiders are really just out to line their pockets at the company's expense. But nobody seems to take the codes seriously, and so conflicts often get ignored. Or that's my hunch--I don't know, because aside form the top three financial officers, waivers don't have to be disclosed!
The rule, authorized by Dodd-Frank, would permit companies to claw back compensation from executives if things go south. Or, more specifically, the rule will "require national securities exchanges and national securities associations to establish listing standards that would require each issuer to implement and disclose a policy providing for the recovery of erroneously paid incentive-based compensation." Clawbacks would happen when, well: "the trigger for the recovery of excess incentive-based compensation would be when the issuer is required to prepare an accounting restatement as the result of a material error that affects a financial reporting measure based on which executive officers received incentive-based compensation."
The rule had the usual two dissenters, independent statements by each of the commissioners. The SEC is a divided agency. But I'm interested in how the staff hope to close the deal, assuming that the rule will be litigated.
First, even though this is a proposed rule, the agency is already responding to plenty of comments from prior concept releases, &c. Second, 50 of the 198 pages of the rule are devoted to the cost benefit analysis that so stymied the SEC when the DC Circuit had a majority of Republican judges. But the analysis isn't heavy on quantitative cost-benefit, but rather an assessment of the implications on a variety of affected components in the agency. I think the agency thinks it doesn't need to blow the court of appeals away with some numbers to survive, though of course the agency can do more cost-benefit analysis in the final rule.
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.
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?
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.
The WSJ has a story today that suggests that indeed it does.I'm not so sure, and I've been looking into the situation. Looking at the plain numbers doesn't account for selection effects - one reason the agency might take a case to an ALJ is because they've already settled it, and it's inexpensive to put the settlement on record before an in-house judge. So we should probably strip settled cases out of the analysis. But there's no question that the SEC is ramping up ALJ enforcement, and that it usually wins there.
Hence the recent spate of arguments that ALJs are unconstitutional. I'll have more to say on that, too, but it's worth remembering the "part of the furniture" theory of constitutional law as a first order reason to conclude that a government program is probably okay. If something has been around forever, and is important, it's probably constitutional. The Supreme Court has probably decided hundreds of cases that began with ALJ proceedings. You can expect it, and other Article III judges, to assume that the institution of the SEC ALJ should survive.
I'm also a week late on the Etsy IPO, and I trolled around the likely law prof blogs to see if anyone else had beat me to the punch (if I missed someone, please let me know and I'll update accordingly).
Etsy IPO'd last Thursday, pricing at $16 and opening at $30, raising $267 million. According the WSJ Blog, that's the most ever for a NY-based VC-backed firm.
But for my money the more interesting take came from the NYT, since it concerned organizational form. Etsy is a B-Corp-- but not a benefit corp. Here's Haskell Murray on the difference. Bottom line, a B-Corp is a certification thing, and you can be a for-profit B-Corp. A benefit corporation is a whole separate kind of entity, one organized not just for profit.
Here's the NYT on the importance of the B-Corp designation to Etsy:
Etsy declares in its public offering prospectus that it wants to change the decades-old conventional retail model of valuing profits over community. It states that its reputation depends on maintaining its B Corp status by continuing to offer employees stock options and paid time for volunteering, paying all part-time and temporary workers 40 percent above local living wages, teaching local women and minorities programming skills, and composting its food waste.
But wait, there's more. To maintain its B-Corp status, Etsy must reincorporate as a benefit corporation in a few years. B Lab's website says "companies must elect benefit corporation status within four years of the first effective date of the legislation or two years of initial certification, whichever is later." The NYT suggests a slightly longer glide-path: "B Lab is giving companies four years from the date any relevant state legislation is passed to comply with the state law or risk losing B Corp certification. Since Delaware passed that law in August 2013, Etsy has until 2017 to become a benefit corporation." Yet Etsy CEO Chad Dickerson is quoted as saying Etsy had no plans to reincorporate as a benefit corporation: “Regardless of certification, we plan to focus on delivering a strong business that also generates social good,” he said."
It will interesting to see how a publicly traded corporation like Etsy weighs the benefits of B-Corp certification against the risks and costs of moving to benefit corporation status. Risks like opening yourself up to 10b-5 and derivative shareholder suits if you fail to fulfill whatever social purpose you articulate in your articles of incorporation. Not to mention the securities law issues around stressing the importance of B-Corp status while seeming to suggest that it will lose that status in a few years.
Update 2: I knew Haskell Murray must have been on this, but I didn't look back far enough to see this post.
I don't totally get the advocacy play, but comics fans will enjoy the series of displays at the SEC's metro station - they are nice art, and they seek an SEC rule requiring disclosure of political contributions by publicly traded firms. Via Corporate Counsel, here's an example: