As Broc Romanek observes, that is indeed rare:
Supreme Court Delivers Two Securities Law Decisions in Single Week!
Last week, the Supreme Court delivered two decisions impacting the securities law. Even one in a term is rare. Some say that securities defendants won one and lost one. Others say differently (for eg. see this blogby Lane Powell's Doug Greene). We have been posting dozens of memos on both Gabelli v. SEC andAmgen v. Connecticut Retirement Plans and Trust Funds in our "Securities Litigation" Practice Area.
The Gabelli court found that five-year statute of limitations period for federal enforcement actions seeking civil penalties begins to run "when the fraud is complete," not when it is discovered by the government (unlike the standard for private plaintiffs). And the Amgen court found that plaintiffs don't need to establish that allegedly false statements were material to the market before they can gain class certification.
Either the SEC is living in its own little bubble world or else the Commission is operating under some masochistic urge to embarrass itself. The Supreme Court simultaneously burst the SEC’s bubble and embarrassed the agency in its yesterday’s decision in Gabelli v. Securities and Exchange Commission. The Court rejected the SEC’s proffered interpretation of 28 U.S.C. § 2462, a general statute of limitations that governs many penalty provisions throughout the federal code.
Amgen is interesting because three justices are annoyed that the materiality requirement in the securities laws has bascially been dispensed with. That's three justices who don't have much use for precedent in this area:
In an unsurprising decision, the Court declined to raise the bar for the certification of securities class actions by requiring plaintiffs to establish the materiality of alleged misstatements to invoke the fraud-on-the-market theory in support of class certification. Instead, it remains sufficient for plaintiffs to simply plead materiality, and establish the traditional requirements of Rule 23 at the certification stage.
A federal district court just rules that Applee improperly bundled together too many different proposals into one proxy question, handing David Einhorn's Greenlight Capital a win - but what kind of a win was it? Won't Apple just redo the proxy? Yes, probably, says Larry Cunningham, whom we're mostly outsourcing to here:
The technical procedural machinery of corporate governance often works in strange ways to give shareholders avenues of redress that substantive fiduciary duty law cannot handle. Statutes, regulations, charters, bylaws, and contracts set the rules and allocate power in ways that all must respect. Apple’s proposed charter amendment has nothing to do with the wisdom or prudence of what to do with all that $140 billion in cash. But Einhorn and the Apple board do have differing business judgments and both are allowed to use all that machinery to battle for the policy they favor.
In a way, Einhorn and Apple’s CEO are both right. Einhorn won this technical round but the substantive power about the dividend policy remains firmly in the board’s hands.
The opinion is also interesting, because it awarded a preliminary injunction. In the Second Circuit, those are common in proxy contexts (or so the opinion averred), but they aren't easy to get just as a general matter. The district court gave this one because it concluded, and I'm quoting here, the plaintiffs had a "better than 50%" chance of prevailing on the merits. That's not a very hard test to meet!
I enjoy having my former secured transactions professor in the Senate, but I've never quite understood the appeal of bringing in agency heads and yelling at them, long though that legislative tradition is. Here's what Elizabeth Warren asked a smattering of financial regulators in her first oversight hearing, along with their answers:
Q: “If they can break the law and drag in billions in profits and then turn around and settle paying out of those profits, then they don’t have much incentive to follow the law,....The question I really want to ask is about how tough you are.”
[ED: If I was a regulator I'd be tempted to respond with a "super-duper-tough" here.]
Thomas Curry, OCC: “We do not have to bring people to trial ... to achieve our supervisory goals.”
Elise Walter, SEC: “We truly believe that we have a very vigorous enforcement program,”
Q: “Can you identify the last time you took the Wall Street banks to trial?”
Walter: ...“get back to you with the specific information,” ... “we do litigate.”I'm not sure asking someone how tough they are is a question really looking for an answer. Yes, there's a point of view here - Warren wants the agencies to file more cases against bankers. And OCC even provided some information: sounds like they will not be filing more cases. But Anne O'Connell has a paper that suggests that the more oversight hearings, the shorter the tenure of agency officials (or so I recall, it's unpublished, though referred to in note 23 of this). This sort of thing seems to me to be a bit too offten like unpleasant kabuki theater.
Today, the SEC will convene a much-anticipated roundtable examining the current regime of penny-priced tick sizes on U.S. stock markets. A principal purpose of the roundtable is to explore whether the transition to penny-priced quotations in 2001 (known as “decimalization”) has harmed liquidity in the securities of small and middle-sized companies. The general theory, initially advanced in this Grant Thornton white paper, is that when securities were quoted in sixteenths of a dollar, trading spreads were kept artificially wide given the fact that bid-ask spreads could be no less than $0.0625 per share, creating large profit margins for dealers making markets in U.S. equities. Such market-making profits, so the argument goes, were then used to support trading operations and analyst research in thinly-traded securities and the securities of newly-public firms. In this fashion, the argument continues, the higher trading costs associated with fractional-quoting were actually part of a healthy ecosystem for nurturing the market for IPO stocks and smaller company securities more generally.
According to this theory, one way to bring back the IPO market is to undo the harm decimalization caused this ecosystem by increasing the tick size, or minimum price variation (MPV), when quoting the securities of smaller issuers. It is an argument that has gained considerable support over the past year, as reflected in both Section 106(b) of the JOBS Act (which required the SEC to study the effects of decimalization on the liquidity of smaller firms) and the draft recommendations of the SEC Advisory Committee on Small and Emerging Companies (which recommends a “meaningful increase in tick size as a necessary step toward encouraging the reestablishment of an infrastructure designed to increase liquidity for small public companies.”) And based on the agenda for today’s roundtable, a reasonable bet would be to see some form of pilot study being implemented in which the securities of certain firms must be quoted in an increment greater than $0.01.
While it is heartening to see the SEC take an empirically-driven approach to capital market reform, new research by Justin McCrary and myself underscores the need for the SEC to assess this issue especially carefully and for any policy changes to take place within an incremental framework. In our working paper, Shall We Haggle in Pennies at the Speed of Light or in Nickels in the Dark? How Minimum Price Variation Regulates High Frequency Trading and Dark Liquidity, we document how modification of the penny-based system of stock trading will likely have simultaneous and opposite effects on the incidence of both high frequency trading (HFT) and the trading of undisplayed (or “dark”) liquidity (what we refer to as “trading hidden liquidity” or THL). Specifically, in the event of an increase in the MPV, our research strongly suggests we can expect to see both an increase in off-exchange trading in venues such as dark pools and a decrease in HFT.
Although often conflated within the popular press, HFT and THL reflect two distinct types of trading strategies that have distinct consequences for price discovery and market liquidity. In terms of strategy, traders focusing on HFT typically seek to profit from discrete, short-lived pricing inefficiencies by rapidly bidding on and selling securities, customarily through pre-programmed algorithms. The emergence of so-called “maker/taker” fee structures at stock exchanges—whereby limit order providers are paid a “maker” rebate and traders using market orders are assessed a “taker” fee—creates an additional profit opportunity for such traders provided they can position their limit orders at the top of exchanges’ order books. For firms engaged in HFT, minimizing the latency of processing information and entering orders is therefore of paramount importance to profitability. In contrast, a firm focusing on THL will generally seek to profit by providing liquidity to investors without the necessity of publishing public bids or paying exchange access fees, thus minimizing the price impact and cost of the transaction. Access to investors looking for liquidity—rather than speed of trading per se—is accordingly a primary goal of those engaged in THL.
Despite the recent focus on changing tick sizes, there has been remarkably little focus on how each of these strategies is intimately connected with the rules governing the MPV. As was revealed following decimalization, smaller tick sizes have led to both a surge in market message traffic as prices dispersed across more price points as well as a dramatic reduction in quoted spreads. Both developments favor algorithmic trading strategies capable of processing quickly large flows of order messages, while reducing the costs of rapidly trading in and out of positions. With respect to THL, larger tick sizes create the opportunity for larger spreads and, consequently, larger profits for those firms that can capture them by trading against marketable orders from individuals and institutions seeking immediate liquidity. In this regard, dark pools and broker-dealer internalizers are aided by a technical rule concerning how the penny-pricing requirement is actually implemented: Although it is prohibited for anyone to quote (i.e., post an order) at other than a penny-increment, it is perfectly fine to execute a trade in subpenny increments. Using this flexibility to execute subpenny trades, a dark pool or internalizer can thus offer price improvement over the National Best Bid or Offer (NBBO) available at conventional stock exchanges (even if the improvement is as little as $0.0001 per share). In this fashion, dark pools and broker-dealer internalizers have both the incentive and the means to trade directly with incoming marketable orders rather than route them to exchanges.
To examine empirically how changes in the MPV might have these effects on the incidence of HFT and THL we turned to a peculiar quirk in the ban on sub-penny pricing described in the previous paragraph. In particular, the ban on sub-penny quotations (Rule 612 of Regulation NMS) only applies to equity orders priced at or above $1.00 per share, thus creating a sharp distinction in tick size regulation between those orders priced just above $1.00 per share and those priced just below it. Using a regression discontinuity (RD) research design, we can therefore identify in a clean, parsimonious way how changes in tick size regulations can affect the incidence of these two forms of trading. For our data, we used the NYSE’s Trade and Quote (TAQ) database, focusing on the 300 million trades and the 3 billion updates to exchanges’ best published bids and asks made during 2011 for securities that traded below $2.00 per share at some point in 2011.
Overall, our results are strongly consistent with the hypothesized effect of MPV on both THL and HFT. To measure THL, we examined for each completed trade the market center at which it occurred, using trades reported to a FINRA Trade Reporting Facility (TRF) as our measure for THL. The figure below presents our RD estimates of the effect of subpenny quoting on the incidence of such off-exchange trading. In the figure, the x-axis represents a transaction’s reported trade price truncated to two-decimal places, and the circles represent the fraction of all reported trades reported to a FINRA TRF at each such price. The solid line plots fitted values from a regression of the fraction of TRF trades on a fourth-order polynomial in two-decimal price (the point estimate and standard error are in the legend). As the figure indicates, trades executed at prices immediately above $1.00 per share revealed a sharp increase of 8 percentage points in the percent of trades reported to a TRF facility. Because all other market centers reflect stock exchanges, this translates to a corresponding decrease of 8 percentage points in the incidence of transactions on the public exchanges.
With respect to HFT, we examined (among other things) the incidence of “strategic runs” within the quotation data at each price point truncated to two-decimal places. Notably, the TAQ data does not permit tracking individual orders since it covers only updates to each exchange’s best bid or offer (BBO), but evidence of such strategic runs nevertheless appears in the TAQ data to the extent they affect an exchange’s BBO, which is continually updated by the exchanges to reflect the new orders that change it. Accordingly, we measure for each second of the trading day the rate of BBO updates for each security in our sample (a “security-second”). As might be expected in the (for modern financial markets) relatively quiet corner of penny stocks, the vast majority of security-seconds experienced no update of an exchange’s BBO. In particular, over 90% of the security-seconds in the sample showed no BBO updates, with higher-priced orders generally being more likely to have at least one BBO update per second. As shown in the figure below, RD analysis of security-seconds having at least one BBO update by two-decimal order price reveals that this trend was generally continuous at the $1.00 cut-off.
In contrast, analysis of those security-seconds where a BBO was updated with significant frequency reveals a sharp increase in the incidence of such strategic runs below the cut-off. The next figure, for instance, provides our RD estimates for the incidence of security-seconds where the BBO was updated at least fifty times per second. Consistent with the previous figure, the rate of these strategic runs generally declines from $2.00 to $1.00 where it reveals a discontinuous upward jump from .02% of all security-seconds to .1% of all security seconds, highlighting the negative relationship between the size of the MPV and the incidence of HFT.
In sum, these findings suggest that current proposals to increase the MPV may very well entail significant, unanticipated structural changes in the nature of how equity trading occurs on U.S. markets. To be sure, many of these changes in trading such as the higher incidence of THL would actually be consistent with a core objective of Section 106(b) of the JOBS Act insofar as they would increase the profitability of market-making in affected stocks. However, our finding that these market-making profits are generally captured by dark pools and internalizers causes us to question how these enhanced profits will translate into additional analyst coverage and sales support for emerging growth companies. For instance, most dark pools and the two largest internalizers by volume—Citadel Investments and Knight Capital—do not offer sell-side analysis or advisory services. Moreover, the new retail price improvement (RPI) programs at major U.S. stock exchanges—which seek to allow exchanges to compete with internalizers through establishing de facto dark pools to capture trading spreads—only further undermine the theorized benefits for IPO firms of larger tick sizes given that the beneficiaries of such programs (i.e., stock exchanges and RPI participants) are also not known to provide market support for emerging growth companies. To the extent the SEC chooses to implement a pilot program modifying tick sizes, coupling such a program with increased disclosures concerning which broker-dealers are reporting trades to a FINRA TRF could help ascertain whether the appropriate market participants are benefiting from the wider spreads.
Columbia has just gone live with a blog that looks modeled somewhat off of Harvard's Corporate Governance Forum, and it's got some good contributions already. Here's a post by Don Langevoort, and of course John Coffee is participating. Here's what they're going for:
Well worth a look. Welcome to the blogosphere!
Thanks to Miriam Baer's FB post, I saw this Washington Post article saying that Mary Jo White would be nominated as the next head of the SEC. She is a former prosecutor for the SDNY, so she has her "tough on Wall Street" bona fides. Stay tuned. I guess I'll stop waiting for a phone call.
In the recent edition of The Atlantic, Frank Partnoy (law & finance professor at the Univ. of San Diego who recently wrote Wait: The Art and Science of Delay) and Jesse Eisinger (a journalist with ProPublica and columnist for the New York Times DealBook) authored What’s Inside America’s Banks?. They present an extensive analysis of the public disclosures made by major banks. The centerpiece of the article was an effort by Partnoy and Eisinger to unpack and understand the annual statement of Wells Fargo, a large bank that has been less associated with complex derivatives and trading activities than firms such as JP Morgan, Citi, and Goldman Sachs. They conclude that the public securities disclosure makes it impossible to understand adequately the risk-taking of even a more “traditional” large bank.
Frank agreed to engage in the following e-mail q&a on the article:
Q: You paint a pretty bleak picture of opaque disclosure and potential hidden time bombs lurking in the balance sheets of big banks. How does this problem compare to the toxic assets hidden in Japan’s zombie banks in the 1990s after their real estate bubble collapsed?
A: It’s a great comparison, and the degree and type of opacity are very similar. For example, I wrote in F.I.A.S.C.O. about the AMIT deals we were selling to Japanese banks back then, and looking back from today I think that the games played during the real estate bubble echo the games played in Japan during the 1990s. (And the zombie point is also a good one; we actually used that word in an early draft of the piece.)
Q: Is this a post-crisis phenomenon? Is it a function of banks trying to hide bad assets from before the bubble burst? Did the problem start there?
A: Yes, and I think it’s a friendly amendment to Charles Kindleberger’s work on crises, or even Hyman Minsky’s. As the bubble builds, credit expands, and risk increases, and inevitably the banks at the center of the expansion increasingly hide their risky assets. The assets aren’t necessarily bad – at least not at first – but they are hidden because they are risky. Then there is a dislocation and a panic as the assets “become” bad and ultimately the losses are disclosed.
Q: Is the opaque disclosure a sign that the United States runs the risk of a zombified banking sector like Japan’s?
A: That remains unclear. Bank stocks have performed well recently, in part because of the faith in the implicit U.S. government guarantee. Japanese banks weren’t as fortunate. But we think the risk is a real one, and it was a major reason why we wanted to write the piece. I don’t know if the right metaphor is zombie or rot or something else, but historically opacity has been at the center of major financial problems, especially over the long term.
Q: Do you have a sense whether the problem is as acute for large banks overseas – the Barclays, UBSs, and Deutsche Banks of Europe?
A: The gap between disclosure and reality is not nearly as wide in Europe, though banks there have plenty of other problems. For example, European regulators and bankers continue to rely heavily on credit ratings; that is a huge ongoing problem and will almost certainly result in massive misallocation of capital and future crises.
Q: You don’t seem to have much confidence in the ability of regulators or even bank management to understand the risks these banks are taking despite having nonpublic information. Is there other evidence of this besides the London Whale tale of JP Morgan?
A: Oh, there are so many. Regulators have failed to comprehend the risks at banks over and over during the previous two decades. My book Infectious Greed documents many of those incidents from the 1980s through 2003. As for more recent examples, the recent revelations about what Fed officials thought in 2007 is notable. So are the regulators’ positions about risks at Citigroup in late 2007 and early 2008. I attended several conferences with regulators during 2007-08 and was surprised by how little they knew about Structured Investment Vehicles. And so on. Kids, you really need to get out more.
Q: Why did Warren Buffett invest in banks after the crisis? What could he figure out that you (or other investment fund managers you interviewed) couldn’t? Did he have special access? Why is Berskshire Hathaway still invested in Wells Fargo if the disclosure is so opaque?
A: Buffett obviously has special access and his bet turned out to be a good one last year. He’s experienced investing in companies with opaque derivatives exposure, going back to General Re, and while sometimes he is warning that derivatives are financial weapons of mass destruction he is also often profiting from them. The key to Buffett’s investing style has always been timing – he is a genius at managing delay, waiting for the “fat pitch,” and I suspect he’ll know when it’s the right time to unload bank stocks so that he doesn’t get burned again. He understands that just because something is a black box doesn’t necessarily mean you should avoid it. Even buying into a pyramid scheme can be very profitable if you get the timing right.
Q: Why wouldn’t the market address this? Wouldn’t one large bank collect new investors and be able to sell equity above book value by offering better disclosure?
A: Oh, you’re right – how silly of me. The market addresses all such problems. Never mind.
(But seriously, imagine what our economy would look like today if the markets actually had worked. What if all of the major banks had failed in 2008 and Google, Microsoft, Amazon, and Walmart had stepped in to provide basic financial functions?)
Q: If this opacity scares away equity investors, why isn’t it also scaring away the creditors and derivative counterparties of these big banks? Why aren’t they demanding more margin or collateral or higher effective interest rates? Do these counterparties assume that the problem would have to be large enough to threaten the big bank?
A: Implicit government guarantees. And even so, they are demanding more collateral and clearer contractual arrangements, which are creating another set of problems. Also, there is some truth to the notion that the banks are so large and diversified today that creditors and counterparties probably aren’t at huge risk of failure. Catastrophe yes, but maybe nothing so big to cause insolvency. JPMorgan’s $6 billion loss was a nit.
Q: You offer a detailed indictment of Levels 2 and 3 of fair value accounting. What did you make of the outcry during the financial crisis that mark-to-market accounting was exacerbating the crisis by causing fire sales? Might some of the reforms you suggest, including improving fair value disclosure, have nasty procyclical effects?
A: No, quite the opposite. The outcry during the crisis was about marking down assets to more realistic levels – obviously bank managers didn’t want to do that. But if managers had understood they would be required to mark assets down immediately when they declined in value, they would have been less likely to buy them during a bubble – hence, an anti-cyclical effect. The smartest investors and managers say that if you can’t mark something every day, you shouldn’t buy it. Period.
Q: Your analysis of Wells Fargo’s “customer accommodation” trading focuses on some of the fudged language in the disclosure, namely that this trading might not be driven by actual customer demands, but “expected” customer order flow. You also write that
“Some traders can disguise speculative positions as “hedges” and claim their purpose is to reduce risk, when in fact the traders are purposely taking on more risk to make a profit.”
Does this mean that you are skeptical of the Volcker rule’s effectiveness in reducing risk-taking because the built-in statutory exceptions to proprietary trading are too easily manipulable?
A: Absolutely. I use the metaphor of a piece of Swiss cheese with holes that get bigger and bigger – until it is gone.
Q: Are you really limiting your proposed fixes to better disclosure and more vigorous securities enforcement? Or are you saying, as Felix Salmon blogged, that banks need to become much simpler? Do you agree with his assessment that moving back to a simpler age of banking or a simpler age of disclosure is quixotic?
A: I think getting simpler would be a result of better disclosure and enforcement. And I have very little confidence that regulators could draft a set of “simplicity rules” to pare down what banks are permitted to do and what they are not, especially in the face of the financial services lobby. I don’t think ex post adjudication in a principles-based regime is quixotic. If anything it’s a more sophisticated way of impounding market information in regulatory decisions. But good use of the word “quixotic.”
Q: Doesn’t disclosure still have the “you can lead a horse to water…” problem? Would even sophisticated investors demand or make use of the disclosure you envision? How do you know?
A: True. Some of the reception to our piece has made me wonder whether some supposedly “sophisticated” investors are in fact not wearing any clothes. On the Wells Fargo earnings call after our piece was published, one person asked about it, but the various investors and analysts seemed placated by the CEO’s response that Wells Fargo is “pretty plain vanilla” and “I’ve never seen us be more transparent.” There’s been virtually no follow-up about the bank’s Variable Interest Entity disclosures, for example. But I think there are enough truly sophisticated investors out there, and they have huge amounts of wealth under management – as long as they drink, the other horses eventually should come along. And the most sophisticated investors tend to pile on very effectively once even one of their ilk has made a good case. Which is why managers hate (and fear) them so much.
Q: Are you coming out in favor of principles in the old rules vs. principles debate on accounting standards? Aren’t simple, broad standards also subject to gamesmanship?
A: Yes, I am. It is much more difficult to game broad standards when they are adjudicated ex post. This after-the-fact element is just as important as rules vs. principles.
Q: How much promise do you think technology offers in improving the quality of disclosure (for example, the SEC’s XBRL initiative)? [Editorial note: this is my latest research project]
A: It’s a fantastic project, and I wish you the best with it. In theory, technology can vastly improve the quality of disclosure. But one problem with systematizing disclosure is that you can miss crucial angles that are “outside-the-box” or more like narrative. What would XBRL have done with Enron’s footnote 16?
Q: If you were to offer a few concrete suggestions for the new SEC Chair on improving disclosure and enforcement, what would they be?
A: Keep it simple and be willing to be vague. Single out financial firm disclosure as a hot topic, and make it clear that banks must make better disclosures of risks and worst-case scenarios, or face consequences. Get the board members of the major banks to sign on to these initiatives, through a series of early meetings and then a highly-publicized roundtable. Keep trying to win “should have known” cases, especially against employees of financial firms. Good luck!
Matt Levine over at Dealbreaker suspects that the answer is yes:
The paradigmatic SEC investigation – “find an insider trader through phone records” – is about drilling down, not broadening out. It starts from a suggestive general pattern – “boy SAC makes a lot of money” – and looks for the one specific fact to nail somebody. The financial regulators you’d really want would start from specific facts and look for the general pattern. They’d spend years looking for broad problems with systems, not phone records to prove a single instance of wrongdoing by a single person. These SEC lawyers – the ones held up as models of SEC enforcement, the ones responsible for the SEC’s one post-crisis success story – should have been finding Bin Laden, not overseeing a financial system.
Kinnucan is the expert network operator who refused to wear a wire and was indicted for insider trading. He was just sentenced to four years in prison, and he did things that expert networks do:
He admitted to supplying customers with confidential data about companies including SanDisk and Flextronics. Prosecutors said Mr. Kinnucan had built a deep network of sources at public companies by paying them cash and providing them with illegal tips.
It does sound fishy, doesn't it? But that's kind of what expert networks do, as the Wall Street Journal has been saying for a while:
Generally speaking, expert-network firms link industry experts with hedge-fund managers and other professional traders for a fee.
Expert-networking firms started springing up in the early part of the last decade, after the SEC attempted to crack down on the practice of companies selectively disclosing information to analysts and other. Writes the WSJ’s Greg Zuckerman and Susan Pulliam in this 2010 story:
In 2000, the Securities and Exchange Commission attempted to make markets fairer by introducing rules barring companies from selectively disclosing material information to favored investors and analysts, a common practice during the 1990s technology bubble.
The SEC rule, Regulation Fair Disclosure, barred investor-relations professionals and other senior executives at public companies from selectively disclosing market-moving information to analysts and investors. The SEC said Reg FD would “bring all investors, regardless of the size of their holdings, into the information loop.”
But a back-door method was discovered to help big investors find an edge: companies offering to match “experts,” such as midlevel executives at various companies, with investors.
Indeed, the network experts continue to crop up in this continuing wave of insider-trading cases.
I'm not sure if these outfits are now doomed, but it must take some strong nerves to operate one these days. It's anecdotal, but my students at Wharton, fwiw, report turning to these networks quite a bit before coming for their MBAs.
To encourage corporate employees to come forward with complaints without fear of retribution by their managers, the SEC established rules that provide for whistleblowers to become eligible for certain financial rewards—between 10 and 30 percent of the total sanction—if the information they provide the SEC leads to successful monetary sanctions of more than $1 million. The Dodd-Frank Act also affords whistleblowers expanded legal protection, giving them the right to sue their employer for retaliating against them.
It looks like the DC Circuit will say no, in a case of interest to those bemused by the massive number of deferred prosecution agreements signed by corporations in white collar crime/securities violation situations. Sometime those DPAs include corporate monitoring requirements. One enterprising reporter requested AIG's consent decree monitor reports after the firm went belly-up, hopeful that it would tell her something about the financial crisis:
AIG agreed to the final judgment in Washington federal district court in November 2004 with the SEC without admitting or denying the allegations, rooted in transactions between AIG and PNC Bank. The company agreed to give up $46.3 million in profit in the SEC civil action. DOJ entered a deferred prosecution agreement with AIG that same month in federal district court in Pennsylvania.
The terms of the deal with the SEC required AIG to hire an independent consultant to, among other things, keep tabs on the work of AIG's "transaction review committee." The committee was tasked with reviewing transactions that "involved heightened legal or regulatory risk because of the dangers of questionable accounting by counterparties," AIG lawyers said in court papers.
It would be interesting to know what that consultant thought about all of AIG's unhedged credit insurance activity, wouldn't it? But is it a judicial record? Even though the court never saw it? It sounds like the DC Circuit will not conclude that keeping the report in camera is akin to holding private trials. And more's the pity for those who want to know more about the collapse of AIG ... or the usefulness of corporate monitoring consent decrees.
One can go back and forth on the merits of the SEC's obsession with insider trading, but the Martoma SAC Capital case looks pretty damning. You don't want to prejudge. But it looks like:
a) an SAC analyst obtained inside information from a tipper breaching his fiduciary duty to his employer (who had hired him to do a study on a new drug)
b) the analyst must have known that the tipper was breaching his fiduciary duty (though he denies that he has done anything wrong).
c) the analyst, on the basis of the information, told Cohen to trade the stock.
d) Cohen did so.
That sounds like a slum dunk case that SAC Capital committed insider trading, if only a corporation (or partnership or whatever) could do so. The only question is whether Cohen himself (as opposed to his hedge fund) knew that the advice he was getting was based on inside information, right? The idea would be that he didn't ask his analyst what the basis was for his recommendation that he dump a centimillion dollar stake in a stock? Culpable intent is an O'Hagan requirement, as I (and Brian Carr) understand it. I like to defer to others when it comes to 10b-5, so if you have any advice in the comments, I'd be happy to hear it.
Below is the Times's nifty graphic on the other issues faced by SAC, if you haven't seen it.
Post-JOBS Act, where do all the various transaction exemptions – Reg. D., Reg. A, the new crowdfunding exemption -- fit into the menu of options for issuers? Moreover, where do these exemptions fit into the still-shifting regulatory architecture of investor protection?
I’ve been thinking about these questions since the University of Colorado Law School hosted a roundtable on the JOBS Act on October 2. The roundtable brought together a wide swath of the startup community, including legal practitioners, entrepreneurs, investors (including from the venture capital community), startup incubators, and accountants. The roundtable, like previous roundtables at Harvard, NYU, and Stanford, aimed to provide feedback to officials from the SEC and the Department of Treasury on the impacts of the JOBS Act, as well as advice to the SEC as the Commission writes the rules to implement the statute.
Our roundtable (which was co-moderated by my dynamo colleague Brad Bernthal and me) focused on the so-called new so-called Regulation A+ exemption, as well as the new shareholder thresholds for registration under the ’34 Act.
For me, the roundtable offered an opportunity to look not only at individual transaction exemptions but to consider the whole constellation of exemptions together. From my perspective, Regulation D continues to look the most attractive to issuers, particularly in light of the SEC moving to relax general solicitation rules for 506 offerings.
But does the still-emerging architecture of transaction exemptions make sense from a policy perspective? Legal scholars have longed questioned the rationality of the existing structure of transaction exemptions. For example, are the income and net worth standards baked into the accredited investor standard good proxies for investor sophistication? Or do they function more as rough assurance that investors could better withstand a complete loss of investment?
If parts of the old rules were difficult to square, there is a large risk that the new rules will be completely under-theorized. Scholarship on transaction exemptions has struck me as having one of the highest ratios of value to quantity of scholarship. In other words, transaction exemptions impact a significant portion of capital-raising in the country, but seem to attract fewer scholars than IPOs and securities litigation. It would seem to be a good area for scholars to invest. Scholarship in this area seems to pay dividends for a long time. (E.g., Bradford’s 1996 economic analysis of transaction exemptions). As another example, consider the long history of work by Rutheford Campbell on Regulation A from the 1970s to the present.
There is a downside to an open field for scholars, namely that scholarship won’t adequately shape legislation and rulemaking, but instead will engage in post-hoc criticism and rationalization. This runs the risk of an even crazier tangle of rules forged in the cauldron of interest group politics rather than a well-thought-out regulatory scheme with a good “fit” between the exemption and the ability of investors to process information and bear risk. I’ve expressed concern that the rush to improve small business access to capital in the JOBS Act may be turning some of the economic logic of securities exemptions on its head: small issuers with the least amount of liquidity are less likely to enjoy information efficiencies in the trading of their stock. So granting various disclosure exemptions to “emerging growth companies” (a legislative euphemism for small companies that may be neither emerging nor have prospects for growth), means less public information for the companies on which market prices are least likely to impound information. This seems like an up-side-down Frank Gehry approach to re-designing the architecture of transaction exemptions.
Jeff Schwartz (Utah) has a radically different take, however, on transaction exemptions. His forthcoming Cardozo Law Review article, envisions a “life cycle” approach. Here is his abstract:
This Article argues that U.S. equity markets fail to offer a satisfactory listing venue for emerging firms. I contend that this lacuna is a manifestation of a flawed structure of equity-market regulation and that this void undermines entrepreneurship, jeopardizes the future of U.S. equity markets, and weakens the broader U.S. economy. To close this gap and respond to these concerns, I recommend a new theoretical structure for regulating equity markets. Under the “lifecycle model” I propose, regulations would adapt to firms as they age. The key change would be to establish a market specifically for newly-public young firms, where they would be subject to a regulatory regime that is strict enough to protect investors yet flexible enough to accommodate innovation and growth. As firms age, they would be moved to different markets, each set up to meet the unique regulatory challenges firms pose as they mature. This template is designed to offer entrepreneurial firms an attractive platform on which to list their shares while placing equity-market regulation on sound theoretical footing. In a brief Epilogue, I assess the implications of the recently-enacted JOBS Act on this argument and conclude that the case for reform based on the lifecycle model is undiminished.
Schwartz’s ideas are worthy of a long debate.
Soccer teams regularly go out of business, but a big one that appears to have dodged what seemed like an exceedingly likely bullet, is Real Oviedo. RO is historically big, by Spanish standards. It is the team of Mata, Michu, and Cazorla, for those readers who enjoy the English Premier League, and has fallen on hard times, now laboring in the Segunda Division B and, until very recently, moments away from liquidation.
Except. Prompted by, among others, the excellent Guardian Spanish soccer correspondent Sid Lowe, Real Oviedo has offered shares of the team, worldwide, via the internet, at 14 bucks a pop. They've sold them to Americans, to Britons, to, well, anyone - and 10,000 people have bought in. RO has realized 1.57 million euros from the offering, mostly from people who have never been to Spain, much less Asturias or gritty Oviedo.
Is Real Oviedo offering securities that must be registered with the SEC? Is it offering a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise? One senses that it may be churlish to answer the question.
And at any rate, the issue may be moot, or suited more for an exam question than anything else. Carlos Slim - the richest man in the world - seems to have ridden to Real Oviedo's rescue.
- Here's a ton of guidance from the SEC and DOJ on Foreign Corrupt Practices investigations, the new boom area for DC practitioners, and principal headache of the multinational. JPMorgan is the latest firm to be ensnared; my sense is that financial firms have generally had a better run than most when it comes to avoiding prosecution. HT
- And here's ISS's new approach to 2013 votes. It isn't going to go entirely for labelling the pledging of stock to be a problematic company pay practice; it is also going to wait before recommending a vote against boards that ignore shareholder proposals that pass with a majority vote. But both look like they're in the offing. HT