The Supreme Court scheduled oral argument for tomorrow in Halliburton Co. v. Erica P. John Fund, Inc. (aka "Halliburton II"). This could well prove to be one of the most important securities law cases of the last 30 years, as the Court will reconsider the fraud-on-the-market presumption of Basic.
To hash through all the issues of the case -- from class certification to behavioral finance and efficient markets to statutory interpretation and stare decisis to alternative antifraud rules -- we will be having an online roundtable today and tomorrow featuring some of our regular contributors as well as a few guests.
By now, the risk that a distressed European nation such as Greece might leave the Eurozone and thereby spark global economic calamity is well known. Regular readers of this blog may even privately relish the prominence of the issue. Not since the days of the gold standard has international monetary policy come so close to being a socially acceptable topic of dinner conversation.
As I noted in my first post, observers rightly perceive the Eurozone sovereign debt crisis to be driven by political and economic forces. But many consequences of a euro breakup would be determined by law, including sources of American (specifically New York) private law.
This is a complex issue. I try to address it more fully in a new article, "Boilerplate Shock," which I've just posted on SSRN.
In brief, and to continue picking on Greece, one key question in the event of a euro breakup would be: would a court recognize an attempt by Greece to convert its euro-denominated debt into its new currency, or would it instead insist that Greece pay in euros, the currency of contract? The answer is important because, as a practical matter, requiring payment in euro would be tantamount to forcing a default.
That's the familiar narrative, anyway. And I agree. But I believe that the ubiquity of boilerplate terms in these bonds—specifically, clauses selecting governing law (usually foreign) and currency of payment (euro)—is likely to make any dispute over redenomination even more damaging than this suggests.
In the article, I argue that the sparse literature on the question of redenominating sovereign bonds overlooks some sources—especially cases interpreting New York contract law and private international law—that, if extended to Eurozone sovereign bonds, could surprise the market and cause serious global repercussions. I argue that the reason for this is not only that the dominant view overlooks what are likely controlling sources of law. It is that standardization of contract terms across the Eurozone sovereign lending market makes the stakes of surprise that much higher.
If Greece's attempt to redenominate its bonds is declared a default, then the fact that the operative terms in Italian, Spanish, Irish, etc. sovereign bonds are the same or similar makes markets likely to demand unsustainable premiums from those countries. Capital and investor flight could be very rapid. We have seen several previews of this movie over the past few years in the Eurozone, and each time official-sector bailout institutions have saved the day. But the European Union/European Central Bank and IMF probably do not have the resources to stop a broad-based bank run of this nature, to say nothing of the political support necessary to attempt it.
Maybe none of that will happen. Nevertheless, the potential for uniform contract terms to create risk not just to individual third parties but to securities markets seems likely to grow at least as fast as those markets. Using Eurozone sovereign bonds as a case study, I introduce the term "boilerplate shock" to describe the potential for standardized contract terms—when they come to govern the entire market for a given security—to transform an isolated default on a single contract into a threat to the market of which it is a part, and, possibly, to the economy in general. My larger objective here is to foster a discussion of the potential for securities law and private-sector securities lawyers to manage (or alternatively, to contribute to) systemic risk.
I've posted an abstract below and will be returning to the subject. I look forward your comments.
Boilerplate Shock abstract:
No nation was spared in the recent global downturn, but several Eurozone countries arguably took the hardest punch, and they are still down. Doubts about the solvency of Greece, Spain, and some of their neighbors are making it more likely that the euro will break up. Observers fear a single departure and sovereign debt default might set off a “bank run” on the common European currency, with devastating regional and global consequences.
What mechanisms are available to address—or ideally, to prevent—such a disaster?
One unlikely candidate is boilerplate language in the contracts that govern sovereign bonds. As suggested by the term “boilerplate,” these are provisions that have not been given a great deal of thought. And yet they have the potential to be a powerful tool in confronting the threat of a global economic conflagration—or in fanning the flames.
Scholars currently believe that a country departing the Eurozone could convert its debt obligations to a new currency, thereby rendering its debt burden manageable and staving off default. However, this Article argues that these boilerplate terms—specifically, clauses specifying the law that governs the bond and the currency in which it will be paid—would likely prevent such a result. Instead, the courts most likely to interpret these terms would probably declare a departing country’s effort to repay a sovereign bond in its new currency a default.
A default would inflict damage far beyond the immediate parties. Not only would it surprise the market, it would be taken to predict the future of other struggling European countries’ debt obligations, because they are largely governed by the same boilerplate terms. The possibility of such a result therefore increases the risk that a single nation’s departure from the euro will bring down the currency and trigger a global meltdown.
To mitigate this risk, this Article proposes a new rule of contract interpretation that would allow a sovereign bond to be paid in the borrower’s new currency under certain circumstances. It also introduces the phrase “boilerplate shock” to describe the potential for standardized contract terms drafted by lawyers—when they come to dominate the entire market for a given security—to transform an isolated default on a single contract into a threat to the broader economy. Beyond the immediate crisis in the Eurozone, the Article urges scholars, policymakers, and practitioners to address the potential for boilerplate shock in securities markets to damage the global economy.
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With a hat tip to Corp Counsel, this story about Milton Webster, board member of the Chinese firm AgFeed, who blew the whistle on his company, is really unique. He was a member of the audit committee! He thought that a name brand law firm was more conflicted than solution-oriented! He resigned, and then went to the authorities (or, at least, the paintiffs)! I don't think I've ever heard of a member of the firm's audit committee dropping a dime on the firm he directs. You'll want to read this probe by Francine McKenna, but here's the Bloomberg long read as well.
The Bitcoin exchange Mt. Gox appeared to be undergoing more convulsions Tuesday [February 25], as its website became unavailable and trading there appeared to have stopped, signaling a new stage in troubles that have dented the image of the virtual currency. . . .
Investors have been unable to withdraw funds from Mt. Gox since the beginning of this month. The exchange has said that a flaw in the bitcoin software allowed transaction records to be altered, potentially making possible fraudulent withdrawals. No allegations have been made of wrongdoing by the exchange, but the potential for theft has raised concern that the exchange wouldn't be able to meet its obligations.
The apparent collapse of Mt. Gox is just the latest shock to hit Bitcoin, the price of which is now off more than 50% from its December 2013 peak:
For those better acquainted with the dead-tree/dead-president variety of money, Bitcoin is a virtual currency not backed by any government. Rather than being printed or minted by a central bank, Bitcoins are created by a computer algorithm in a process known as "mining" and are stored online or on your computer. They are bought and sold on various exchanges, including until recently Mt. Gox (whose troubles have been reported for a few weeks now).
There are many reasons, some of them even lawful. Bitcoins can be regarded as a medium of exchange, an investment, a political statement...or a way of avoiding capital controls and other pesky laws like bans on drug trafficking and human smuggling.
But the criminal potential of Bitcoin is probably overstated. The Chinese have gotten wise to its use for avoiding capital controls. Using Bitcoin for criminal or fraudulent activity would be difficult at scale (PDF). The Walter White method is still far and away the best way to ensure your criminal proceeds retain their value and anonymity.
I don't share the utopian fervor for Bitcoin expressed in tech and libertarian circles (see, e.g., this supposedly non-utopian cri de coeur), but it may have some positive potential as a decentralized and lower-cost electronic payments system. We'll see if that ever gets off the ground.
In the meantime, the Mt. Gox collapse is pretty huge news for Bitcoinland. Unlike the NYSE (the failure of which would be hard even to imagine), Mt. Gox does not benefit from any systemic significance and thus is unlikely to receive a lot of official-sector help. The situation has some early adopters running for the Bitcoin exits, like this leading Bitcoin evangelist.
Despite (because of?) my agnosticism on the currency, I'll be writing more about Bitcoin soon. (Mainly, I wanted to stake a claim to being the first to write about Bitcoin on The Conglomerate.) If your Palo Alto cocktail party can't wait, however, this explainer (PDF) from the ever-impressive Chicago Fed should tide you over.
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Thanks, Usha, for the introduction. Let Us rule!
I am delighted to join The Conglomerate for a brief stint. I am an enthusiastic follower of the blog and an occasional commenter, so I am thrilled to have the microphone for the next two weeks.
I have some specific topics I plan to post about but I would like to start off the discussion with a meta question. I have been writing about securities law and going to conferences for a few years, inlcuding those of the law & economics variety. At these events, I often cross paths with tax professors, and I have noticed one curious difference between tax and corporate & securities folk: tax professors like tax collectors. Overwhelmingly so. They recognize that the IRS is not perfect, but when in doubt, they generally side with the IRS, not taxpayers.
Not so for corporate and securities professors. At every milestone anniversary of the creation of the SEC someone proposes that the Commission be abolished. So I am wondering why? It could be that my samples are biased. Or it could be that both sets of people like regulators, but corporate & securities people are just grumpier and less likely to express nice things about securities regulators. Or perhaps the difference is real.
Whatever the reason, I am going to reveal my personal bias here: I like securities regulators. That does not imply that I love every idea that comes out of the SEC. But as between the regulated entities and the SEC, my default is to side with the securities regulator. What is yours?
The SEC just charged a finance professor from Florida State and an engineering professor from Florida A&M with naked short selling, which the professors might have been doing as a kind of protest against a practice that doesn't have a very good case for illegality behind it.
But I've heard it said that it's not the crime, it's the cover-up, and the two professors spent a lot of time covering up what they were doing. Moreover, part of their point of their shorts was to not take on the expense of covering, too, which for good or ill, is something all shorts are required to do. Anyway, here's the SEC:
Colak and Kostov set their scheme in motion in early 2010 and went on to sell more than $800 million worth of call options in more than 20 companies. Their trading strategy involved purchasing and writing two pairs of options for the same underlying stock, and targeting options in hard-to-borrow securities in which the price of the put options was higher than the price of the call options. Colak and Kostov profited by avoiding the cost of instituting and maintaining the short positions caused by their paired options trading.
Sound bad? Well, the SEC didn't get an admission of guilt out of the two, and all told, they had to pay the agency $400,000 to settle the case. So not exactly throwing away the key. Not good for business school professors to be accused of violating the securities law, though. HT: Securities Docket.
UPDATE: Here's Matt Levine with a nice explanation, more careful than anything you see above, or how the scheme was meant to work, and the regulatory arbitrage implications thereof, vel non.
Over at the FCPA Professor blog, Mike Koehler has a take on the year the SEC has had with bribery, an increasingly important remit for the agency's enforcement lawyers. The topline - action is slightly up from last year, but down from its peak a couple of years ago. Some intriguing details:
The range of SEC FCPA enforcement actions in 2013 was, on the high end, $153 million in the Total enforcement action, and on the low end, $735,000 in the Ralph Lauren enforcement action. Of the $300 million the SEC collected in 2013 corporate FCPA enforcement actions, approximately $219 million (73%) were in two enforcement actions (Total – $153 million and Weatherford – $66 million).
Two corporate FCPA enforcement actions from 2013 were SEC only (Philips Electronics and Stryker).
Of the 8 corporate enforcement actions from 2013, 3 enforcement actions were administrative actions (Philips Electronics, Total, and Stryker) and 1 action (Ralph Lauren) was a non-prosecution agreement. In other words, there was no judicial scrutiny of 50% of SEC FCPA enforcement actions from 2013. The settlement amounts in these actions comprised approximately 57% of the SEC’s $300 million collected in 2013 corporate FCPA enforcement actions.
In 2013, the SEC collected approximately $208 million in disgorgement and prejudgment interest in enforcement actions that did not charge anti-bribery violations (either administrative actions that did not charge any FCPA violations or settled civil complaints that did not charge anti-bribery violations). In other words, approximately 69% of the $300 million the SEC collected in 2013 FCPA enforcement actions was no-charged bribery disgorgement.
After over four years of work, my book Law, Bubbles, and Financial Regulation came out at the end of 2013. You can read a longer description of the book at the Harvard Corporate Governance blog. Blurbs from Liaquat Ahamed, Michael Barr, Margaret Blair, Frank Partnoy, and Nouriel Roubini are on the Routledge’s web site and the book's Amazon page. The introductory chapter is available for free on ssrn.
Look for a Conglomerate book club on the book on the first week of February!
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Two conservative judges on the DC Circuit have expressed concerns that the rule is too broad (I guess this would be a Chevron problem) and impinges on free speech (laughable, but a constitutional problem with the statute, I guess). And the federal regulators had been doing so well! HT: Corporate Counsel
I'm unworried about the revolving door (these guys are, if you want a different view), but one of the traditional ways to slow it has been to require cooling off periods before former government employees can represent clients before their former colleagues. These periods get longer the higher up the food chain one goes; the SEC, however, has long received an exemption from them for its litigators, because it used the revolving door as an enticement for recruitment.
Times are tough for lawyers, however, and the SEC no longer has these recruting problems, and so requested that the exemption be removed. Hey presto - it happened, in a rule that is being passed without going through notice and comment (which isn't really very kosher, especially if the intital exemption did go through notice and comment).
If anything, the most interesting aspect of this development was the basis for the exemption itself, which was so that the SEC could tell senior lawyers that they could supercharge their private sector earning potential if they took high-level enforcement jobs. At this point, maybe everyone knows this, and cooling off periods haven't hurt the private sector earning potential of senior prosecutors at Justice any either.
But it also shows that a benefit, once given, can always be taken away.
I chuckled when I read this DealBook article about how Fantex Holdings intends to open an online marketplace for investors to buy and sell interests in professional athletes. I laughed because I had been involved with a few of these types of schemes when I worked at the SEC in the Chief Counsel's office. Way back then, the issuers argued that interests in athletes were not "securities" and thus didn't need to be registered. As I recall, those no-action requests went nowhere as the "not a security" arguments were not persuasive.
But Fantex is taking a different approach. On October 17th, it filed a Form S-1 (which has since beenamended), for an IPO in the NFL player Arian Foster - with the intention of selling about $10.5 million worth of "tracking stock," representing a 20% interest in his future brand income. In exchange, Arian would receive $10 million; the balance will cover the costs of the deal. In addition, five pieces of free writing prospectuses were filed - the components of Fantex's site and other selling documents. The Fantex platform itself has filed as a broker-dealer.
A few weeks ago, the faculty here gave a lunchtime discussion of various SCOTUS cases in the 2013OT. As a corporate law professor, there's never a lot to choose from, and this year's skimpy offering was no different. I chose the consolidated cases of Chadbourne & Parke LLP v. Troice; Proskauer Rose LLP v. Troice and Willis of Colorado Inc. v. Troice. (Documents courtesy of Scotusblog.) Though the names do not suggest it, these are the private securities lawsuits stemming from Allen Stanford's Ponzi Scheme. Mr. Stanford is serving 100 years in prison right now and probably doesn't have a lot of extra cash lying around, so investors have chosen to sue these other entities. Because federal securities law is not very amenable to securities fraud lawsuits against aiders and abetters (like these defendants would be), these cases were brought under state law.
Unfortunately, federal securities law, and the Private Securities Litigation Reform Act, is not that easy to bypass. Defendants wanted the case dismissed under the Securities Litigation Uniform Standards Act, which pre-empts class actions in which plaintiffs allege a misrepresentation in connection with the purchase or sale of a "covered security." As you can tell from my quotation marks and boldface, plaintiffs counter that the fraud was not in connection with a "covered security."
What was the fraud? Stanford touted certificates of deposit (CD) accounts that paid 10% (what?) at Stanford International Bank, based in Antigua. Now, CDs at U.S. banks aren't considered securities at all, but the SEC and the DOJ argued that Stanford committed securities fraud in the purchase and sale of a security anyway. However, these charges were dropped in favor of wire fraud, obstruction and money laundering, and he was convicted on those counts.
That being said, no one is arguing that the CDs aren't a "security." But, plaintiffs argue that the CDs aren't a "covered security." A covered security is one that is listed on a regulated national exchange and traded nationally. The CDs are definitely not covered securities. But, SIB represented that the accounts were backed by "safe, liquid investments" and that monies were "invested in a well-diversified portfolio of highly marketable securities issued by stable governments, strong multinational companies and major international banks." Defendants argue that this is enough to meet the "in connection with" standard -- the monies were supposed to be used to purchase covered securities at some point. (The money was never used to purchase anything, but no one is taking the "phantom securities aren't securities" angle in this post-Madoff era!) In addition, defendants make the argument, and the SEC was using this argument in the Stanford case, that at least one plaintiff sold covered securities to invest in the CDs. If the defendants are right, then the case is dismissed under SLUSA and cannot continue in any court as a class action.
Here is the transcript of the oral arguments on the first day of the term. Other commentators seem to think it was split and that defendants may win. I wasn't there, but the transcript seems to suggest that the justices were very skeptical of the reach of the defendants arguments. Both the "in connection with" argument and the "selling covered securities to purchase the fraud" arguments seem to bring up spectres of ordinary purchases becoming securities fraud fodder. I.e., if I sell stock to buy a house, the seller better not say anything misleading or its securities fraud for you! I hope the plaintiffs win for this and other reasons.
It's unlikely, but not impossible. Twitter was a big lobbying force for the JOBS Act provision that changed the Section 12(g) of the Exchange Act's threshold from 500 to 2000 investors. And we know from this prospectus that it went public with 755 shareholders (p. 155) of record. But 12(g) has a second threshold: you have to register under the Exchange Act if you have 500 or more unaccredited shareholders. I was curious whether Twitter would break out the number of unaccredited shareholders in its prospectus, but it doesn't. To be fair, I don't suggest it has to: the regulations don't require it, at least as far as I know.
We know Twitter was approaching that magic 500 number when JOBS was passed, but JOBS changed the rules regarding counting: employee stockholders who gain their shares via vesting of stock options don't count in the tally. Presumably once Twitter excluded these stockholders it was well under the 500 unaccredited threshold. But it would be interesting to know.
Tuesday's WSJ had an article on changes in the private secondary market. Long time readers know that I've been interested in this space for quite some time. Here are some nuggets, plus my take:
- Auction volumes are way down, and the number of companies whose shares are available for purchase is, too.
- Post-Facebook IPO, SecondMarket has laid off 40% of its staff
- The other major player, SharesPost, has created a joint venture with Nasdaq OM and will launch Nasdaq Private Market later this year.
- Companies are looking for mutual fund and hedge fund investors that can aggregate individual investors (think Goldman's failed pre-Facebook investment vehicle)
None of this surprises me. (Indeed, here's a little prescience for you) The puzzling thing in the wild west that was the pre-Facebook IPO secondary market was that companies allowed so much trading of their shares--trading that inmost cases required their explicit permission. According to the WSJ, after Facebook's IPO debacle, companies woke up to the risks: "Firms feared online trading could bring in too many investors, lead to speculative swings in share price affecting companies' stock-based incentives for employees, and spread information about privately held companies too widely."
Conspicuously absent from the article is any indication that the loosening of Section 12(g) of the Exchange Act, which requires Exchange Act filings once a corporation reaches 2000 (pre-JOBS, 500) shareholders, has made any difference at all. Look for more on this from me. Eventually.
We've been following the debate between Lucian Bebchuk and Martin Lipton on the value of activist shareholders with interest, and it still seems as if the protagonists see the world very differently. The debate has been occasioned by a paper from Bebchuk and his co-authors arguing, essentially, that activist shareholders increase returns to investors:
We find no evidence that interventions are followed by declines in operating performance in the long term; to the contrary, activist interventions are followed by improved operating performance during the five-year period following these interventions. These improvements in long-term performance, we find, are present also when focusing on the two subsets of activist interventions that are most resisted and criticized – first, interventions that lower or constrain long-term investments by enhancing leverage, beefing up shareholder payouts, or reducing investments and, second, adversarial interventions employing hostile tactics.
We also find no evidence that the initial positive stock price spike accompanying activist interventions fails to appreciate their long-term costs and therefore tends to be followed by negative abnormal returns in the long term; the data is consistent with the initial spike reflecting correctly the intervention’s long-term consequences. Similarly, we find no evidence for pump-and-dump patterns in which the exit of an activist is followed by abnormal long-term negative returns. Finally, we find no evidence for concerns that activist interventions during the years preceding the financial crisis rendered companies more vulnerable and that the targeted companies therefore were more adversely affected by the crisis.
In this round, Lipton offers a literature review of the case for the other side, which is motivated by the plausible assumption that activist shareholders tend not to buy and hold:
numerous empirical studies over the years have produced results that conflict with those Prof. Bebchuk espouses. These other studies generally find that activism has a negative effect or no effect on long-term value, particularly when controlling for the skewing impact of a takeover of the target (which generally occurs at a premium regardless of whether the target is the subject of activism).
Some of the studies cited are quite old, and not all of the journals are top-drawer. But others seem quite on point. Perhaps the disputants will next be able to identify some empirical propositions with which they agree, and others with which they do not (other than, you know, sample selection).