July 13, 2015
Cost Benefit Analysis at the SEC
Posted by David Zaring

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!

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July 07, 2015
Mylan's other securities law problem
Posted by Usha Rodrigues

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!

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July 06, 2015
The SEC's Clawback Rule
Posted by David Zaring

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.

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June 10, 2015
The SEC's Inferiority Complex
Posted by Usha Rodrigues

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:

In, what is to my knowledge, an unprecedented decision this week, a federal district court in Atlanta preliminarily enjoined the SEC from proceeding with an enforcement action before an Administrative Law Judge (ALJ) because the ALJ’s appointment violated the U.S. Constitution.  
The court held (as I have argued elsewhere) that ALJs are not mere employees, but instead “inferior officers of the United States,” whose appointments are subject to the Appointments Clause. That clause requires that inferior officers be appointed in one of four ways: through presidential appointment and senatorial confirmation or through appointment “by the President alone, in the Courts of Law, or in the Heads of Departments.”  Here, the relevant appointment mechanism is the last one—appointment by the head of a department. According to the court’s opinion, the ALJ was not appointed by the SEC Commissioners (the head of the department), but instead by a Chief ALJ.
Is this sky going to fall for the SEC if ALJs were not appointed properly? Not based on my initial take. From what I can tell, there is an easy fix: the SEC merely needs to have the Commissioners reappoint current ALJs and approve future ALJs that the Chief ALJ selects. (But I hope that those with more knowledge about the SEC can correct me if I’m wrong.)
Congress does not need to take any legislative action; the SEC already has authority under Section 4(b) of the ’34 Act to appoint “officers . . . and other employees.” The problem here is that, despite the SEC’s broad legislative authority to delegate functions under Section 4A(a), the delegation of appointment power is unconstitutional. That does not mean, of course, that the SEC must interview and review the CVs of ALJ candidates going forward. Instead, for future ALJs, the SEC can simply preclude the Chief ALJ’s selection from becoming effective without the Commissioners’ approval. Indeed, retaining final say on appointments is not only constitutionally required but also expressly permitted by Section 4A(b), which says that the SEC retains discretion to review delegated actions. For current ALJs, the SEC can simply reappoint them. Agencies have done so successfully in the face of past Appointments Clause violations. SeeEdmond v. United States.
So, in light of the easy fix, is this decision much ado about nothing? No.
First, this is the only decision of which I’m aware that (correctly, I think) holds that ALJs are inferior officers. Most ALJs are likely appointed by heads of departments, and thus their appointments are valid regardless of their status. But other ALJs may be appointed by agencies that are not departments, such as the CFPB or FERC (as I’ve argued elsewhere). If so, their appointments would violate the Appointments Clause.
Second, the decision shows how little attention agencies may be giving to appointments internally, even if statutory authority otherwise permits a constitutional appointment. The SEC’s experience suggests that the heads of departments should, as a matter of default agency design, be required to sign off on all hiring for federal officials who may be deemed inferior officers. For agencies that list of officials may be relatively lengthy, considering that courts have held that the following were inferior officers:  district-court clerks, clerks within certain executive departments, assistant surgeons, cadet-engineers, election monitors, federal marshals, military judges, and general counsel for the Department of Transportation. Approving hiring decisions may be more onerous than agencies would like, but the Appointments Clause requires that minimal involvement by the head of the department.

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Private Lies, Public Harm?
Posted by Usha Rodrigues

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.


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May 26, 2015
A Chastened Post-Newman USAO Isn't Yet Embracing Mercy
Posted by David Zaring

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.

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May 22, 2015
SEC Villians Of The Week?
Posted by David Zaring

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?

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May 19, 2015
When Will The SEC Start Doing Sue & Settle?
Posted by David Zaring

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.


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May 07, 2015
Does the SEC Always Win Before Its ALJs?
Posted by David Zaring

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.

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April 23, 2015
Blog I Meant to Write #2: Etsy IPO
Posted by Usha Rodrigues

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 formEtsy 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: Thanks to Stefan Padfield for this from Race to the Bottom's J. Robert Brown Jr

Update 2: I knew Haskell Murray must have been on this, but I didn't look back far enough to see this post.

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April 21, 2015
Seen At The SEC Subway Station
Posted by David Zaring

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:


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April 13, 2015
The SEC's 700 Page Long Song Of Itself
Posted by David Zaring

When you join a transnational regulatory network, you have to report to the network that you're acting consistently with its principles, that you have the powers that it expects you to have, and that you're a worthy member of the club.  The SEC just made its case to its peers through a 700 page Q&A that is worth a look, though it exemplifies the differences in the way a lawyer or a social scientist might approach the question "what do you do?"  The SEC is full of lawyers, and so this report includes not so many numbers, but plenty of discussion of regulatory powers, and representative matters that show how those power are exercised.

However there is some aggregate data. For example, the SEC keeps track and categorizes the sorts of cases that it brings. In 2013, the agency was, for example, mostly likely to initiate a securities offering proceeding, which it did 103 times, followed by 68 reporting and disclosure cases, 50 market manipulation cases, and, bringing up the rear, only 44 insider trading cases (the agency was only asked about these categories, the reporting is on page 184 et seq. Did I know this?  More pump and dump proceedings than insider trading cases?  Anyway, it's that sort of thing that will surely have you reading the whole 700 pages, just as I did. 

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April 01, 2015
Oral History of Drexel Burnham Lambert
Posted by David Zaring

They didn't even get Milken or some of the other most august alumni of the firm to participate (Ken Moelis, though!), and it's still a really great read.

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March 26, 2015
The Latest Attempt To Slow The Revolving Door At The SEC
Posted by David Zaring

I have argued in a paper that the revolving door seems much less problematic than conventional wisdom would have it.  And Ed DeHaan, Simi Kedia, and their co-authors have found that SEC lawyers who go through the door usually try to show off when at the agency by bringing and winning bigger cases.

But Congressman Stephen Lynch isn't so sure about that door, and has introduced the SEC Revolving Door Restriction Act of 2015 to put some brakes on it.  His press release:

H.R. 1463, the SEC Revolving Door Restriction Act of 2015, amends the Securities Exchange Act of 1934 to prevent former employees of the SEC from seeking employment with companies against which they participated in enforcement actions in the preceding 18 months. H.R. 1463 defines enforcement action as court actions, administrative proceedings, or Commission opinions. Former employees must seek an ethics opinion from the SEC if they are interested in seeking employment within a year of their termination at the SEC with a company that was subject to an SEC enforcement action in which they participated.

I'm actually not too sure what this adds to the typical revolving door restriction.  Federal prosecutors can never work on matters on which they worked while in government service.  And they are barred from representing clients for at least one year.  This lengthens that limitation to 18 months, but at the White House, it's already 2 years for lobbying.  

The agency isn't too excited about this, as they have observed over at Jim Hamilton's World of Securities Regulation:

Delaying staffers’ employment in the private sector would affect a significant number of SEC employees, who have a long tradition of leaving government service to join the defense bar. At the 2015 SEC Speaks conference, when current and former agency staff members were asked by Chair Mary Jo White to stand, at least two thirds of the room took to their feet.

But it doesn't seem to add much to the regs already in place.  Even POGO, the NGO that seems to be behind the introduction of the bill, acknowledges - indeed, it collects data on - previous ethics restrictions: "SEC regulations require former employees to file [ethics] statements if they intend to represent an employer or client before the agency within two years of their SEC employment."  This even gives them the out of a waiver.  But you can look over the text of the bill and let me know if you see anything more than a more specific ban of agency officials working on matters post-employment that they handled pre-termination.

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March 13, 2015
Securities Law Exam: Is This Legal?
Posted by David Zaring

Via Matt Levine, you should really read this excellent profile of a proprietor of a pawn shop for penny stocks.  A tremendous underwriting workaround.

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