May 21, 2014
Fee-Shifting Bylaws: In Case Nothing Else Will Deter Plaintiffs Shareholder Suits
Posted by Christine Hurt

Earlier in May, the Delaware Supreme Court decided a certified question from the District of Delaware as to whether a Delaware corporation could adopt a bylaw whereby any member in a nonstock corporation would pay legal fees of the corporation if it instituted litigation against it and was not wholly successful.  As you might have guessed, the answer was yes, and this also applies to any Delaware corporation.  Here are Kevin LaCroix at D&O Diary and the HLS Forum with the gory factual details.  A few humble thoughts to add to the mix:

What sorts of companies will adopt these loser-pays bylaws?  Presumably, shareholders could balk, particularly if the director-amended bylaws can be amended by shareholder consent.  Companies might believe that this additional deterrent is unnecessary given 102(b)(7) carveouts and simply abstain.  Or, companies might believe it to be a costless measure that adds an incremental deterrent factor, particularly in merger litigation.  Considering the flood of 102(b)(7) charter amendment provisions, a tidal wave of fee-shifting bylaws might not be surprising.

Are these bylaws always permissible?  the opinion said that the bylaws were facially valid, but might be impermissible given the circumstances.  Which circumstances?  I can imagine a Blasius-like circumstance in which a shareholder group is in the middle of a tender offer or a proxy fight and threatening to seek an injunction and the board adopts a fee-shifting amendment.  Can the bylaw apply to litigation concerning subject matter that happened prior to the bylaw adoption?  It also seems a bit unseemly that such a provision could be used to deter litigation over self-dealing or conflicts of interest.

What about multi-jurisdictional litigaton?  Say a shareholder (ok, a plaintiff's lawyer) files a shareholder suit in jurisdiction 1 and attempts to stay identical litigation in jurisdiction 2.  The case proceeds in jurisdiction 2, but is dismissed in jurisdiction 1.  Does the shareholder have to pay costs of the defendant to dismiss in jurisdiction 1?  That would be interesting and definitely change incentives.

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May 13, 2014
SSRN Top Securities Downloads Of Late
Posted by David Zaring

It has been some time since we've done a download list, and it does seem that SSRN has gone off the boil a bit as a source of both downloads, and a source of good information about interesting new articles.  Still, these below do look like they could deserve a look!


RECENT TOP PAPERS for all papers first announced in the last 60 days  
14 Mar 2014 through 13 May 2014

RankDownloadsPaper Title
1 316 The Equity Risk Premium in 2014 
John R. Graham and Campbell R. Harvey 
Duke University and Duke University - Fuqua School of Business 
Date posted to database: 8 Apr 2014 
Last Revised: 8 Apr 2014
2 199 The Futility of Cost Benefit Analysis in Financial Disclosure Regulation 
Omri Ben-Shahar and Carl E. Schneider 
University of Chicago Law School and University of Michigan Law School 
Date posted to database: 23 Mar 2014 
Last Revised: 25 Mar 2014
3 173 Do Hedge Funds Trade on Private Information? Evidence from Upcoming Changes in Analysts’ Stock Recommendations 
April KleinAnthony Saunders and Yu Ting Forester Wong 
New York University (NYU) - Department of Accounting, Taxation & Business Law, New York University - Leonard N. Stern School of Business and Columbia Business School - Accounting, Business Law & Taxation 
Date posted to database: 8 Apr 2014 
Last Revised: 8 Apr 2014
4 171 Do the Securities Laws Matter? The Rise of the Leveraged Loan Market 
Elisabeth de Fontenay 
Duke University - School of Law 
Date posted to database: 4 Apr 2014 
Last Revised: 10 Apr 2014
5 147 Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law 
Leo E. Strine 
Government of the State of Delaware - Supreme Court of Delaware 
Date posted to database: 8 Apr 2014 
Last Revised: 8 Apr 2014
6 137 CEOs and Presidents 
Tom C. W. Lin 
Temple University - James E. Beasley School of Law 
Date posted to database: 25 Apr 2014 
Last Revised: 7 May 2014
7 121 Contractual Innovation in Venture Capital 
John F. Coyle and Joseph M. Green 
University of North Carolina School of Law and Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP 
Date posted to database: 30 Mar 2014 
Last Revised: 1 May 2014
8 98 Evasive Shareholder Meetings 
Yuanzhi Li and David Yermack 
Temple University - Department of Finance and New York University (NYU) - Stern School of Business 
Date posted to database: 17 Mar 2014 
Last Revised: 21 Apr 2014
9 97 Culpability and Modern Crime 
Samuel W. Buell 
Duke University School of Law 
Date posted to database: 12 Apr 2014 
Last Revised: 12 Apr 2014
10 91 Proposed Crowdfunding Regulations Under the Jobs Act: Please, SEC, Revise Your Proposed Regulations in Order to Promote Small Business Capital Formation 
Rutheford B. Campbell 
University of Kentucky - College of Law 
Date posted to database: 9 Mar 2014 
Last Revised: 9 Mar 2014

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May 09, 2014
America's First Prospectus
Posted by David Zaring

Over at the DC Bar, SEC staffer James Lopez took a look at how the first IPO prospectus in the United States measured up to the requirements imposed by the commision today.  That would have been in 1791, for the Society for Establishing Useful Manufactures (SUM), which was going to build a manufacturing district.  A taste:

today’s IPO prospectus includes a discussion of the most significant factors that make the offering speculative or risky, pursuant to Item 503 of Reg. S–K. The SUM prospectus’ third paragraph consists of the following sentence: “The dearness of labour and the want of Capital are the two great objections to the success of manufactures in the United States.” Well, then, that’s clear and concise. In a few additional paragraphs the SUM prospectus focuses on each of these challenges in detail. For example, as for needing labor it states that “emigrants may be engaged on reasonable terms in countries where labour is cheap, and brought over to the United States,” and that “women and even children in the populous parts of the Country may be rendered auxiliary to undertakings of this nature.”

HT: Corp Counsel.

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April 15, 2014
Goodbye Conflict Minerals Rule
Posted by David Zaring

The DC Circuit rather shockingly threw out the SEC's conflict minerals rule ONLY because it compelled publicly traded companies to speak about the issue in their securities filings, which it concluded violated the First Amendment.  EDIT: This means that the parts of the rule that require reporting but not a statement that goods are "not DRC conflict free," might still be okay.  Bainbridge has takes here and here, Jonathan Adler here, Matt Levine here.  

But, you are thinking, the SEC compels companies to do a million things in their securities filings!  Does the very existence of a disclosure regime violate the First Amendment?  The court's novel theory was that it is okay to mandate disclosures that aim to prevent consumer deception (so the books of publicly traded companies could be opened to investors), but any other goal must have more than a rational basis to be sustainable.

It is a crazy theory.  Warning labels, origin labels, nutrition labels, mandatory agricultural marketing schemes, they don't involve consumer deception, and they're okay.  And maybe this reveals a lack of adoration for the First Amendment, but if Congress could prohibit companies from using conflict minerals, which it surely can, then requiring them instead to disclose the use is both less burdensome and possibly more efficient.  Why would we want a legal system that does not permit disclosure regimes, thereby requiring command and control?

Some other observations:

  • One judge wanted the court to wait for a ruling in a related case going en banc before the now democratically controlled circuit, and the two majority judges declined to do so because now the SEC and the petitioners could participate in the en banc.  Unless the new Obama judges on the court cannot hear the en banc, this seems like a request for a quick reversal.
  • Also interesting, the court didn't bullet proof the opinion.  The SEC survived the adlaw challenges, and the very controversial cost-benefit analysis requirement the DC Circuit has started imposing, though that is likely to change very soon, on the agency.  There is only one ground for reversal here: disclosure is unconstitutional.
  • There is a difference between speech and conduct in the First Amendment, but the other big thing the SEC does in foreign policy is corrupt practices prosecutions (bribes paid to foreign government officials, that is).  Could that be affected by the holding of this opinion, were it to stand?  It sure isn't consumer protection.
  • One of my many pet theories about why people care about constitutional law, though they often overdo it, is the sense that stare decisis is only sort of a good way to think about the subject.  Conservative judges clearly love commercial speech, and have been using it to reverse some settled doctrines that have been in place for decades.  I doubt a single securities lawyer thought that this was a plausible holding by the Court.  Some smarter on the subject than I were clearly surprised.  Let's see if it lasts.

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March 28, 2014
Laying Blame And The Gupta Appeal
Posted by David Zaring

Over at DealBook, I've got a look at the low-key rejection of Rajat Gupta's criminal appeal:

Judge Jed Rakoff, who presided over Mr. Gupta’s trial, demanded in another case that the government proffer “cold, hard, solid facts, established either by admissions or by trials” in enforcement proceedings against financial firms. He has called for more prosecutions over the crisis, and expressed a desire to see wrongdoing exposed in court. Other trial judges have also expressed some sympathy for public sanctions expressed through judicial orders.

But powerful and influential appellate judges have indicated less interest in sending this sort of a message. The Court of Appeals for the Second Circuit indicated in another case that it thought that Judge Rakoff had been too insistent on admissions of wrongdoing. And, as the opinion in Mr. Gupta’s appeal suggests, the court seems disinclined to make strong statements about appropriate business conduct when it could do so.

For more, head that way!

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March 08, 2014
Destructive Coordination in Securities Contracts
Posted by Greg Shill

Image: Flickr

In my last post—also a shameless plug for my recent article, “Boilerplate Shock”—I argued that boilerplate terms governing securities could serve as a trigger that transforms an isolated credit event into the risk of a broader systemic failure. I’ll now briefly explain why I see this danger—which I call “boilerplate shock”—as a general problem in securities regulation, not just some quirky feature of Eurozone sovereign debt (the focus of the paper and post). Any market where securities are governed by uniform boilerplate terms is vulnerable to boilerplate shock.

The nature of this phenomenon—systemic risk—is of course familiar, but its source in contract language is a little unintuitive. How could private contracts unravel an entire securities market or the world economy?

Coordination around uniform standards. 

In the back of our mind most of us probably still conceive of contracting as an activity that occurs among two, or perhaps a few, individuals or firms. But when standard terms are used by virtually all actors within a given market, it’s worth considering the collective impact of those terms as a distinct phenomenon.

Coordination’s benefits are well known. Consider uniform traffic signals. But coordination can also compound the effects of bad individual decisions.

As Charles Whitehead has argued, widespread “destructive coordination” among banks during the precrisis days helped generate systemic risks. When the credit markets froze, for example, firms using the same risk management formulas reacted in the same way at the same time. This helped transform isolated events into systemic ones—e.g., Lehman, the canonical example of a failure that triggered a de facto coordinated panic.

A similar risk, I argue, is present where participants in a securities market rely on the same standardized contract terms. Whether they were intended to or not, these terms will often control what happens in the event of certain legal emergencies, like a country departing the euro or Lehman declaring bankruptcy.

For example, if an effort by Greece to pay its bonds in “new drachmas” is rejected because of Boilerplate Contract Terms A and B, the market will surely be concerned that Terms A and B also govern the bonds of similarly situated borrowers, like Spain, Italy, etc. You’ll see that the borrowing premium the “peripheral” euro countries (the uppermost five lines: Ireland, Italy, Greece (biggest spike), Portugal, Spain) paid versus richer euro countries (Germany, France, the Netherlands, the three lowest lines) zoomed higher as worry over a Greece exit gripped markets in late 2011/early 2012, and again (to a lesser extent) because of Cyprus exit talk in early 2013:

Eurozone Debt Chart 1-1-10 - 7-13-13

Bloomberg. Click to enlarge.

Moreover, this panic occurred against a backdrop of unduly rosy assumptions (namely, that a departing euro country could convert its bonds into a new currency and thereby avoid default, a likely contagion trigger). I argue that the uniformity of boilerplate across these bonds would intensify these problems significantly since it’s likely to result in a declaration of default.

To my mind, this demonstrates that boilerplate securities contracts, in the aggregate, can be systemically significant. “Boilerplate Shock” introduces this concept and offers a modest proposal to mitigate its dangers in the Eurozone.

Beyond the euro, what about the risks of boilerplate shock in general?

Boilerplate shock is probably an inherent and permanent risk in any securities market.

Securities contracts are quintessential candidates for boilerplate. They are used by sophisticated parties for repeat or similar transactions and are drafted quickly—sometimes in three and a half minutes. The (correct) assumption is that they are more efficient for the parties that use them.

I’d like to begin thinking about how contracts can be drafted with a view to systemic risk mitigation, or at least to avoid exacerbating existing risks. But I think this is a hard problem that lacks an off-the-shelf solution:

  • The risk is also an externality: it is severe because of its collective impact. The parties do not bear the primary risk that uniform contracts will result in a meltdown, and in the unlikely event a crash happens (1) no individual party will be to blame and (2) at least one party to the initial transaction (the initial purchaser of a bond, for example) will probably no longer hold the asset, because most systemically significant securities are actively traded on the secondary market.

But banning or discouraging boilerplate is not the answer:

  • The risk that a bunch of assets governed by the same terms will plummet in value is not only an externality. Risk allocation among parties might improve if scrutiny of existing securities boilerplate improves. The terms can evolve.

  • A requirement to craft unique, artisanal terms—disclosures, subordination provisions ("flip clauses"), choice of governing law—for each individual securities transaction would be criminally inefficient.

  • A requirement to craft unique contract terms might even be unjustified on risk-management terms alone, because it would increase drafting errors.

It's tricky to mitigate the risks of securities boilerplate.

Some options for places to start:

  1. Validation by third parties: perhaps issuers could use risk-rated contract templates. For example, see credit ratings…but see credit ratings.
  2. Culture: inculcate systemic risk mitigation as a professional norm among private sector lawyers? In principle, this could work. The number of lawyers who draft these contracts is pretty small. In practice, one could envision many complications.
  3. Insurance: encourage the development of derivatives to account for the possibility of boilerplate shock? Like some of the other solutions, this one presumes some agreement on what terms create the risk of boilerplate shock. It could also encourage new forms of moral hazard.
  4. Mandatory regulation: some public entity could be tasked with the mission of proactively identifying and combating the risk of boilerplate shock in contract practices. Arguably a natural choice given that the risk is an externality. Nevertheless, I’m a little skeptical. First of all, who would do it? A domestic regulator, like the SEC or CFTC, that might be dodged on jurisdictional grounds? An international institution, which is arguably more subject to capture? More generally, regulation seems like a heavy-handed first choice.

In sum, when standardized and aggregated, choices that determine legal risks—e.g., contract terms designating governing law, payment priority—can create the same hazards as choices about business risks. This suggests that contract terms should be taken seriously as possible sources of systemic risk alongside more familiar sources, like leverage and credit quality.

Securities contracts as a source of systemic risk—what do you think?

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March 07, 2014
More Monies, More Problems
Posted by Greg Shill

Duck tales    








© Disney, “Duck Tales”

I expressed concern in my last post that uniform contract terms could destabilize securities markets in unexpected ways. In a recent paper, I dub this risk “Boilerplate Shock.” The paper uses boilerplate terms in Eurozone sovereign bonds as a case study, but I argue that any market in which a lot of securities are governed by uniform contract terms is vulnerable to boilerplate shock. In this post, I will focus on the Eurozone and my proposed solution to the risk of boilerplate shock there.

One major problem is that no one really knows how to deal with sovereign debt obligations denominated in a currency that still exists but is no longer used by the debtor. A partial breakup of the European Monetary Union would trigger some question marks in commercial law and private international law (among other things).

In the Eurozone sovereign lending market, bond contracts typically contain standardized language specifying:

(a)  choice of governing law (often foreign), and
(b)  currency of payment (euros).

The combined effect of these clauses, I argue, is to render any country that departs the euro more likely to default on its debt. Whatever the impact of the departure itself, a forced default would make things much worse for Europe and the world economy.

Leading scholars have concluded or strongly suggested that a sovereign that changes currencies can redenominate (convert) its bonds to its new currency even where the contract is governed by foreign law (e.g., Philip Wood (p. 177), Michael Gruson (p. 456), Arthur Nussbaum (pp. 353-59), Robert Hockett (passim)). As a descriptive matter, I believe this to be a mistaken interpretation of New York (and probably English) private international law and commercial law (see “Boilerplate Shock” pp. 47-67). But normatively, I agree: a sovereign should be able to redenominate its bonds under certain circumstances. Among other things, the alternative would make currency union breakups far more dangerous than they already are.

In brief:

  • The prevailing consensus underestimates the risk that a departing Eurozone member’s attempt to redenominate its sovereign bonds into a new currency will be ruled a default.

  • Since the bonds of other struggling euro countries are largely governed by the same boilerplate terms ((a) and (b) above), this misapprehension has the potential to be particularly damaging. In addition to surprising the market (which appears to incorporate this consensus), it is likely to spread beyond the immediate debtor to the bonds of similarly situated countries that have issued under the same terms.

  • Same for CDSs (which are likewise often governed by foreign law, usually New York).

  • Thus, given the widespread use of terms (a) and (b), a ruling that a departing country cannot pay its euro-denominated contracts in a new currency could cause the market to demand unsustainable premiums from other weak debtors.

  • This could cause Eurozone countries to lose market access. Greece is not TBTF in any sense, but some of its neighbors are—and are also too big for the EU (including the ECB) and IMF to bail out. Italy (the world’s 9th largest economy) and Spain (13th) come to mind.

Thus, if my commercial law/private international law analysis is right, these boilerplate contracts could end up playing quite a big role in the event of any euro breakup. 

To mitigate this risk of boilerplate shock, I suggest a new rule of contract interpretation. The proposal is detailed at pp. 67-71 of the article. I suggest commercially significant jurisdictions adopt it by statute. Here is a quick summary.

Any sovereign that:

  1. Belongs to an international monetary union, and
  2. Issues bonds in the currency of that monetary union subsequent to the adoption of this rule, and
  3. Leaves the monetary union and introduces its own currency,

shall retain the right to redenominate its bond obligations into its new currency, UNLESS the sovereign has affirmatively waived the right to redenominate its bonds.

You’ll notice this is a default rule—merely a presumption of the right to redenominate—not a mandatory rule. It is also prospective-only: it does not apply to existing issuances. It also does not protect sovereigns that issue in foreign currency (e.g., Argentina), only those that are monetary union members and issue in the common currency (e.g., France).

The reason for these limitations is to minimize unintended consequences and near-term disruption to the market, but also to embody the relatively modest objectives of the rule. It is an information-forcing default rule that is intended to facilitate better risk management by parties. It is not a “save the world” rule.

The challenge, as I’ll discuss in my next post on the paper, is not that redenomination would be ruled impermissible when it ought to be available (otherwise, that might suggest a mandatory “pro-redenomination” rule). It is that the likely effect of these boilerplate terms—to prohibit redenomination—was almost certainly not bargained for and is largely unknown to parties. This market failure has, in turn, created latent risks to the broader financial system and the existing legal tools are poorly suited to address them.

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March 06, 2014
Halliburton II: Follow Up From Jill Fisch
Posted by David Zaring

The following post comes to us from Jill Fisch, the Perry Golkin Professor of Law at the University of Pennsylvania:

Just a few more thoughts about the event studies and question II in Halliburton.  As I noted in my prior post, the level of discussion on the feasibility and mechanics of event studies was disappointing.  I have explained the limitations with using event studies to address the question of price impact or price distortion for purposes of Basic.  See Jill E. Fisch, The Trouble with Basic: Price Distortion after Halliburton, 90 Wash. U. L. Rev. 895, 919-21 (2013).  In particular, a statement or series of statements that falsely confirm existing market expectations will not move stock price at the time it is made.  An event study is incapable of measuring the effect that a counterfactual accurate disclosure would have had on the market, had it been made.  A substantial number of securities fraud lawsuits present exactly this factual context.  Basic itself was such a case.  Basic denied the existence of merger negotiations for over a year during which time it was, in fact, involved in such negotiations.  Basic’s lies had little or no effect on the stock price (indeed, the price rose after two of the three denials).  When the merger was subsequently announced, the stock price rose dramatically.  The argument in Basic was that, had the merger negotiations been accurately disclosed at an earlier time, the stock price would have been higher.  What the stock price would have been, in October 1977, if Basic had not lied, is a question that event study methodology cannot answer.  This, however, is the test that Professors Henderson and Pritchard seek to have the Court impose through a requirement that plaintiffs prove price impact at class certification. 

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Halliburton II: Jill Fisch On Early Reactions To The Oral Argument
Posted by David Zaring

The following post comes to us from Jill Fisch, the Perry Golkin Professor of Law at the University of Pennsylvania:

I was at the Supreme Court this morning to hear the oral argument in the Halliburton case. The debate was lively and the Justices were engaged. Two big surprises. First, the Justices devoted very little attention to the question of whether Basic should be overruled. This was a disappointment to some of the conservative lawyers who were watching the argument with me. Although Aaron Streett led off aggressively in his argument, as in Petitioner’s Brief, with the statement that Basic was wrong when it was decided and more wrong now, the Justices did not seem to have much appetite for discussing this issue. Of course that doesn’t mean they won’t vote to overrule – it is impossible to read the Court from the questions asked at oral argument – but there was very little discussion on economic theory, fraud on the market, congressional intent, etc. Justice Kagan stopped Streett early on when he tried to argue that the Court said 10(b) was just like section 18, and asked wasn’t section 9 a closer analogy, but that was about it.

There was some discussion about congressional acquiescence. Streett argued that Congress hadn’t decided for or against Basic in the PSLRA. Roberts seemed mildly interested in this, but David Boies had a pretty good answer in terms of not just citing the PSLRA but also SLUSA and noting that the legislation would make little sense if class actions were eliminated. The biggest issue here was Justice Alito raising section 203 of the PSLRA in which Congress says nothing in the statute is intended to affect whether there is a private right of action. Justice Scalia critically noted that the parties did not even address section 203 in their briefs.

When Streett tried to talk about the economic arguments, saying that the economic premises for Basic have changed, CJ Roberts asked “How do I review the economic literature?” He then asked, somewhat skeptically whether Streett was suggesting that the Court “jettison” Basic because economists believe the efficient capital markets hypothesis is no longer true. Streett had trouble answering that. Several other Justices noted that the economic debate over the degree of market efficiency was beside the point, stating that prices generally respond to information. Streett did not disagree. Streett also argued that Basic was no longer right because today’s traders don’t rely on the integrity of market price, citing hedge funds, index funds and program traders. David Boies made use of this point when his turn came around, arguing that these new types of traders make market prices respond even more quickly to information and noting that the only information that program traders have is market price.

The second major surprise was the degree of attention that the Justices devoted to question II in the petition for cert. The Justices seemed quite taken by the position advocated by Professors Pritchard and Henderson (which they termed the “law professors’ position) (too bad for the rest of us law professors) that plaintiffs be required to prove price impact, at the class certification stage, through an event study. Several Justices characterized modifying Basic to require that plaintiffs prove price impact as a “middle ground.” They repeatedly asked detailed questions about event studies and why requiring event studies at class certification would be a big deal, especially since they are already used to establish market efficiency in some courts, as well as to prove loss causation. Justice Sotomayor for example, asked why proving price impact would be so difficult

Malcolm Stewart, arguing for the SEC, focused exclusively on retaining Basic, but was happy to sell the plaintiff’s down the river on requiring proof of price impact. Perhaps the most damaging point came when he was asked by Justice Kennedy whether the plaintiffs would be hurt by a requirement that they prove price impact at class certification. Stewart said that the plaintiffs would not be hurt and might even be helped because they would be focusing on the effect of the fraud on a particular stock and not on the market generally.

Two points from the oral argument were particularly troubling. First, as Stewart’s answer demonstrated, the argument was permeated with a limited understanding of how event studies work and the complexities involved in using an event study to measure price impact, particularly in the case of misrepresentations that falsely confirm continued good news. Several of the Justices seemed to think that an event study is an easy and reliable way to ascertain price impact; so if it is available, why not require it? CJ Roberts even asked Malcolm Stewart if event studies were around at the time of Basic. David Boies failed to explain the fact that, in many FOTM cases, there is no price effect at the time of the false statement and that an event study is faced with the complex or possibly scientifically impossible task of ascertaining how price would have reacted in the counterfactual situation in which the truth had been disclosed earlier. The big picture discussion of event studies also overlooked logistical issues that could turn out to be quite significant in the lower courts such as burden of proof – what happens if the economists cannot say whether or not the price was distorted to a sufficient degree of statistical significance? Boies did try to explain that the loss causation event study looks at a different event – the corrective disclosure – which is often a cleaner event for purposes of the event study methodology in that it is less likely to be affected by confounding information.

Second, Streett suggested and appeared to persuade the Justices that class certification was the end of the game – that if a class is certified, it is almost a sure win or an inevitable settlement because of the in terrorem effect of class actions. He repeatedly argued that, because the NYSE is an efficient market and therefore market efficiency is easy to prove for all NYSE-listed companies, relying on efficiency alone without also requiring price impact is not enough. Sotomayor appeared quite troubled by the fact that less than 1% of securities fraud cases go to trial and then asked David Boies what percentage of cases involve a court rejecting class certification, seeming to suggest that it is problematic if cases were not weeded out by the class certification stage. No one raised the fact that the PSLRA pleading requirement coupled with the motion to dismiss together effectively weed out a substantial number of cases at an early stage, prior to discovery and its effect on the incentives to settle. Similarly none of the lawyers focused on why price impact must be litigated at class certification or at trial – why not, alternatively, in the context of a motion for summary judgment – although Justice Ginsburg asked what difference it made at what stage price impact is litigated.

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March 04, 2014
Roundtable on Halliburton II
Posted by Erik Gerding

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.  

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March 03, 2014
The Risks of "Boilerplate Shock" in the Eurozone and Beyond
Posted by Greg Shill

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.

Permalink | Comparative Law| Contracts| Economics| Europe| European Union| Finance| Financial Crisis| Financial Institutions| Globalization/Trade| Law & Economics| Legal Scholarship| Securities| SSRN | TrackBack (0) | Bookmark

The Director As Whistleblower
Posted by David Zaring

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.

Permalink | Accounting| Securities| White Collar Crime | Comments (0) | TrackBack (0) | Bookmark

February 25, 2014
Could Your Holdings Survive the Failure of the NYSE?
Posted by Greg Shill

This morning, the Wall Street Journal is reporting that Mt. Gox—until this month the world's leading market for buying and selling Bitcoin—has "disappear[ed]" from the web:

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).

So, why use Bitcoin—which may well implode (see, e.g., herehere, herehere)—instead of a traditional state-backed currency, which in many ways is clearly superior?

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.

Permalink | Businesses of Note| Crime and Criminal Law| Current Affairs| Economics| Entrepreneurs| Entrepreneurship| Finance| Financial Institutions| Innovation| Internet| Investing| Securities| Technology | Comments (2) | TrackBack (0) | Bookmark

February 10, 2014
I <3 Securities Regulators
Posted by Urska Velikonja

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?

Permalink | Conferences| Securities| Taxation | Comments (0) | TrackBack (0) | Bookmark

February 03, 2014
Kind Of Like Clinical Work
Posted by David Zaring

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.

Permalink | Administrative Law| Securities | Comments (0) | TrackBack (0) | Bookmark

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