Archive for the ‘Securities Regulation’ Category

Vanderbilt Law Review En Banc – Roundtable: The JOBS Act and SEC Rulemaking

posted by Vanderbilt Law Review

Vanderbilt Law Review En Banc is pleased to present our Spring 2013 Roundtable, which considers the SEC’s rulemaking authority under the JOBS Act of April 2012.

Practicing securities attorney Douglas Ellenoff, and Professors Usha Rodrigues and Andrew Schwartz each consider the public policy rationales of the JOBS Act, its legislative history, congressional intent, and practical considerations in order to offer some friendly advice to new Chairman Mary Jo White and the Commission.

Mr. Ellenoff and Prof. Schwartz focus on the rules required or allowed relating to crowdfunding under Title III of the Act, while Prof. Rodrigues examines the lifting of the ban on solicitation and advertising of securities offered to accredited investors under Title II. We hope you find this Roundtable informative and engaging.

Roundtable Essays

Making Crowdfunding CREDIBLE
Douglas S. Ellenoff · 66 Vand. L. Rev. En Banc 19 (2013)

In Search of Safe Harbor: Suggestions for the New Rule 506(c)
Usha Rodrigues · 66 Vand. L. Rev. En Banc 29 (2013)

Keep It Light, Chairman White: SEC Rulemaking Under the CROWDFUND Act
Andrew A. Schwartz · 66 Vand. L. Rev. En Banc 43 (2013)

  May 10, 2013 at 9:41 pm   Posted in: Law Rev (Vanderbilt), Securities, Securities Regulation   Print This Post   No Comments

Call for Papers: National Business Law Scholars Conference

posted by Lawrence Cunningham

I am delighted to pass along the following notice from the organizers of the National Business Law Scholars Conference.  I’m also honored to report that they have asked me to deliver the keynote at this year’s conference, and I look forward to doing so.  

Deadline Extended to May 31

We have received an enthusiastic response to the Call for Papers for the National Business Law Scholars Conference, scheduled for June 12-13, at The Ohio State University School of Law.  We will have additional openings for anyone who would like to make a presentation but has not yet responded.  Thus, we have extended the deadline to MAY 31st.  See the Call for Papers, re-posted below with the extended deadline date, for details on how to submit:

National Business Law Scholars Conference: Call-for-Papers

The National Business Law Scholars Conference (NBLSC)  will be held on Wednesday, June 12th and Thursday, June 13th at The Ohio State University Michael E. Moritz College of Law in Columbus, Ohio.  This is the fourth annual meeting of the NBLSC, a conference which annually draws together dozens of legal scholars from across the United States and around the world.  We welcome all on-topic submissions and will attempt to provide the opportunity for everyone to actively participate.  Junior scholars and those considering entering the legal academy are especially encouraged to participate.

To submit a presentation, email Professor Eric C. Chaffee at echaffee1@udayton.edu with an abstract or paper by MAY 31, 2013.  Please title the email “NBLSC Submission – {Name}”.  If you would like to attend, but not present, email Professor Chaffee with an email entitled “NBLSC Attendance”.  Please specify in your email whether you are willing to serve as a commentator or moderator.  A conference schedule will be circulated in late May.

Conference Organizers:

Barbara Black (University of Cincinnati)
Eric C. Chaffee (University of Dayton)
Steven M. Davidoff (The Ohio State University)

  April 17, 2013 at 9:56 am   Posted in: Accounting, Administrative Announcements, Conferences, Corporate Finance, Corporate Law, Securities, Securities Regulation   Print This Post   No Comments

Auditing’s Snafu: Foreign Secrecy and Impaired Audits

posted by Lawrence Cunningham

Many US companies maintain substantial global operations, with increasing volumes of business done in China; many foreign companies are listed on US securities exchanges.  This cross-border expansion makes the reliability of financial reports created in foreign locales increasingly important.  Yet, in tandem with this cross-border expansion, there have been increasing assertions abroad, including in China, that local secrecy laws restrict access to the work papers of auditors, frustrating the ability of US federal authorities to enforce US securities laws designed to promote financial reporting integrity.

The snafu was joined this week in a case where the SEC is seeking access to audit work papers of a Deloitte affiliate in Shagnhai but the firm refuses.  The firm’s lawyers cite Morrison v. National Australia Bank, the 2010 SCOTUS ruling that, absent explicit language, federal statutes are seen as intended to apply within the US, not be extraterritorial.  It said that the federal securities laws lacked such explication.   

Furthermore, for Deloitte to comply with the SEC’s requests, the lawyers said, would risk committing a serious crime under Chinese law, one punishable by imprisonment. Deloitte’s lawyers say that the combination of Morrison and Chinese secrecy laws puts the records beyond the SEC’s reach.

Lawyers for the SEC object that these points cannot possibly be seen to limit the SEC’s administrative subpoena power under which it has demanded the Deloitte documents. But, during oral argument, the SEC’s lawyers did not acquit themselves well, according to one report, as they could not readily cite the precise legal authority supporting their position. 

Deloitte says there isn’t one and that the appropriate procedure to handle such cross-border securities matters is by diplomacy not enforcement. In this view, the SEC is wrong to proceed against Deloitte in court but must dispatch appropriate US officials to broker a resolution with Chinese regulatory counterparts.

The stakes are high for both sides in the case, of course, and for investors and students of auditing. After all,  audits endow financial statements with credibility. Shareholders are willing to pay for audits in exchange for that credence value.  But if an auditor’s work papers are top secret, inaccessible even to a regulatory overseer, how much of an audit’s credence value is lost? Is it still rational for shareholders to condone paying the auditor’s fee?

When the credibility of financial statements are in doubt, investors should shun their issuer and sell the stock.  A critical mass of shareholders of companies affected by this snafu might do well to follow that old-fashioned Wall Street Rule. If they did, then, along with such companies, the need to resort to either a diplomatic or enforcement solution would disappear. Read the rest of this post »

  March 15, 2013 at 4:22 pm   Posted in: Accounting, Administrative Law, Corporate Law, Securities Regulation   Print This Post   No Comments

Note to Senate: Ask Mary Jo White About DPAs

posted by Lawrence Cunningham

To show he is getting tougher on Wall Street, President Obama has nominated Mary Jo White, the former head of the U.S. Attorney’s office in New York, as chair of the SEC. White oversaw the prosecutions of John Gotti and the terrorists responsible for the 1993 World Trade Center bombings and is a veteran of white collar criminal prosecutions and defense.

Many Americans applaud such displays of toughness, worried that “too big to fail” means “too big to jail.” That is, criminal indictment of a large financial institution threatens its existence and, along with it, economic recovery.

But prosecutors are getting tough on big banks, evident in the recent LIBOR interest rate rigging cases, such as that against Royal Bank of Scotland announced this week, and the money laundering case at HSBC made at year-end. Prosecutors resolved these cases by obtaining admissions of guilt and large fines in exchange for deferring prosecution under agreements that require good corporate behavior for several years.

Under such deferred prosecution agreements, or DPAs, prosecutors flex their muscles by imposing extensive internal reforms at the company. Their goal is to change corporate culture to promote greater accountability and likelihood of compliance with law. Some terms, however, may go overboard, and there is reason to worry about unintended consequences.

Such deals typically require the company to hire an army of compliance officers to roam the company in search of rogues and to train employees in the best practices of compliance programming. In many cases, DPAs require hiring an outside consultant to direct additional steps to be taken and an independent monitor to watch over all the changes during the probation period.

But installing such personnel and programs is no guarantee of succeeding in promoting any particular culture or result. Corporations differ in their histories, philosophies, and business models, negating the possibility of a one-size-fits-all approach to altering culture in desired ways.   (For a dramatic example of the danger, consider the experience at AIG from 2005 to 2008, which I document in the new book The AIG Story, and which is summarized in this week’s review of the book in the Wall Street Journal.)  Prosecutors often do not understand corporate governance well enough to direct reforms and they rarely explain their reasons when they impose such changes. 

Prosecutors should enforce the law and hold people and institutions accountable for violations. When prudent they should settle a matter on terms that may include internal corporate reforms. But they also must make an effort to assure that the reforms they propose will work with the valid parts of the corporate cultures where they are implanted. Failure to do so can be disastrous. When the Senate evaluates Ms. White’s nomination for SEC chair, Senators would do well to ask what she thinks about using DPAs to reform corporate culture.

  February 8, 2013 at 9:26 am   Posted in: Corporate Law, Criminal Law, Criminal Procedure, Current Events, Securities Regulation   Print This Post   3 Comments

Are Hackers Inefficient?

posted by Peter Swire

It’s been a very interesting first day at the Security and Human Behavior 2012 conference, chaired by computer security guru Bruce Schneier.

A number of speakers agreed on a basic description of computer security vulnerabilities: (1) there is a long run-up period where vulnerabilities exist but are not exploited; and (2) an exploit is developed and other attackers adopt it rapidly.

That raises the question — are the hackers (collectively) being efficient? The analogy is to the debate in economics about the Efficient Capital Markets Hypothesis (ECMH).  The ECMH essentially says that you cannot expect to get above-normal returns — the market is efficient and you can’t beat the market.  (Since the 2008 crash there has been lots of new doubt about the ECMH among mainstream economists.)

The long period of non-attacks at least raises the possibility that there is “inefficiently low investment in hacking.”  I use “inefficient” here in a special sense — the market is “inefficient” if there are attack strategies for the hackers that are likely to get a high risk-adjusted return.  When there are so many vulnerabilities that are not attacked, the idea is that hackers collectively quite possibly are leaving money on the table.

Of course, a certain level of non-attacks is rational.  Suppose you expect to spend $1000 in time and effort to write an attack, and the expected pay-off is only $700.  Then we rationally don’t see that attack.  But the large number of existing vulnerabilities at least hints that if you spend $1000 then you might expect a big pay-off, such as $5000. After all, the attacks get used a lot once they are publicized, showing a potential pay-off.

I actually wrote about the ECMH and computer security in a 2004 article called “A Model for When Disclosure Helps Security: What is Different About Computer and Network Security?”  But it was a short discussion at the end of a piece that people read for other reasons.  The computer security folks at the conference today hadn’t worked through the comparison and seemed intrigued — I think it might be a fruitful way to think about vulnerabilities and hacker behavior.

  June 4, 2012 at 5:56 pm  Tags: Efficient Markets; cybersecurity; vulnerabilities  Posted in: Economic Analysis of Law, Securities Regulation, Technology, Uncategorized   Print This Post   7 Comments

Call for Papers: Dodd-Frank

posted by Lawrence Cunningham

Call for Papers:

Financial Institutions and Consumer Financial Services Section

AALS Annual Meeting – January 2012

Rubber Hits Road: Implementing Dodd-Frank amid Reform Fatigue

This program will take place one and a half years after the Dodd-Frank Act was signed into law. The law left many of the details of financial reform to be filled in by regulators, raising the risk of capture. Some of the most important rule makings have begun in earnest; others have stalled as reform fatigue sets in. Meanwhile, reform efforts in Europe and international regulatory initiatives remain works-in-progress.

What lessons can we draw from the implementation of Dodd-Frank so far? What have been the greatest achievements and the greatest disappointments as the legislative process has given way to the administrative? What devils have lain hidden in the details of the Federal Register? What aspects of reform have been largely forgotten? What does the path of financial reform say about legislative and regulatory process? What lessons can be drawn from the reform efforts in Europe and elsewhere? Does the focus on regulating institutions detract from a focus on regulating financial instruments, markets or economic functions and risks?

More ominously, is the crisis truly over? Are we at grave risk of fighting the last war? Has reform missed the mark altogether? This meeting is part of a project to engage the legal academy in sustained theoretical and policy contributions to financial regulation. It also presents an opportunity to look at specific rulemakings in detail, as well as to address larger questions about the course of reform after laws are made.

Call for papers:

Law teachers and other scholars are invited to submit manuscripts or abstracts dealing with any aspect of the foregoing topics. Junior faculty members are particularly encouraged to submit manuscripts or abstracts. A review committee consisting of Section officers will select one or more papers or proposals and will invite the author(s) of each selected submission to present their work at the program session in Washington, D.C. in January 2012.

Abstracts should be comprehensive enough to allow the review committee to meaningfully evaluate the aims and likely content of papers they propose. Please send manuscripts or abstracts to the Program Chair (Erik Gerding, University of Colorado) at profgerding@gmail.com no later than August 30, 2010. Please place the name and contact information of authors only on the cover page of submissions.

Please forward this Call for Papers to anyone who might be interested.

  June 15, 2011 at 7:54 am   Posted in: Administrative Announcements, Conferences, Corporate Finance, Corporate Law, Current Events, Securities, Securities Regulation   Print This Post   No Comments

Targeting Odious Top Pay Contracts

posted by Lawrence Cunningham

Cross-posted at Harvard Law School’s Corporate Governance blog, this summarizes in some detail my new paper on applying simple contract principles to police odioius executive pay contracts:

Executive pay has skyrocketed in recent decades, in absolute terms and compared to average wages. The area of largest growth has been in stock-based components, including stock options, often tending to focus on the short-term, with associated risks we’ve seen. A vigorous academic debate has run for more than a decade, becoming a popular political discussion amid the financial crisis exposing arcane debate to public scrutiny.

Growth could be laudable, explained as creating proper incentives to align manager interests with shareholder interests and to promote optimal risk taking. In this view, if there is a problem, it is narrow and limited. Critics are skeptical whether this story holds up. They worry that managerial power has strengthened to enable top executives to control setting their own compensation. In this view, the problem is pervasive and warrants a comprehensive response—and proposals abound.

I come down in the middle. There are problems in at least an important number of cases, and current proposals to redress them are unlikely to work. So I seek a new approach—contract unconscionability—to police extreme cases. The proposal must surmount some hurdles but isn’t as radical as it sounds.

A good way to summarize the debate highlights a three-pronged theory that promotes much of prevailing executive compensation, especially stock-based components, and contrasts it with limits on each prong.

First: in optimal contracting theory, boards design manager contracts to minimize agency costs. But when managers dominate the process, the managerial power thesis suggests this ideal may not be met.

Second: with efficient stock markets, stock price is a good proxy for the shareholder interest and a mirror of managerial performance. But stock price can differ from business value for sustained periods, fogging both.

Third: stock-based pay could align managerial incentives with shareholder interests if designed right and markets work well. But otherwise they create perverse effects. Read the rest of this post »

  April 13, 2011 at 12:09 pm   Posted in: Contract Law & Beyond, Corporate Finance, Corporate Law, Securities, Securities Regulation   Print This Post   One Comment

Law & Econ’s Influence on Law & Accounting

posted by Lawrence Cunningham

The hottest book of the century, on corporate law, is in production, thanks to editors Brett McDonnell and Claire Hill, both of Minnesota. As part of a series investigating the economics of particular legal subjects, overseen by Richard Posner and Francesco Perisi, this Research Handbook on the Economics of Corporate Law, promises a comprehensive canvass of the broadest definition of this field of law as it has been structured by economic theories over the past forty years.

My contribution addresses the influence of law and economics on the sub-field of law and accounting, which I suggest takes the form of “two steps forward one step back.”  You can read a draft of my chapter (comments welcome!), available free here, accompanied by the following abstract:

Theory can have profound effects on practice, some intended and desirable, others unintended and undesirable. That’s the story of the influence the field of law and economics has had on the domain of law and accounting. That influence comes primarily from agency theory and modern finance theory, specifically through the efficient capital market hypothesis and capital asset pricing model. Those theories have forged considerable change in federal securities regulation, accounting standard setting, state corporation law, and financial auditing. Affected areas include the nature of disclosure, the measure of financial concepts, the limits of shareholder protection, and the scope of auditor duty.

Analysis reveals how agency theory and finance theory often but not always point to the same policy implications; it reveals how finance theory’s assumptions and limitations are often but not always respected in policy development. As a result, while these theories sometimes produced policy changes that were both intended and desirable, some policy changes were both unintended and undesirable while others were intended but undesirable.  Examination stresses the power of ideas and how they are used and cautions creators and users of ideas to take care to appreciate the limits of theory when shaping practice. That’s vital since the effects of law and economics on law and accounting remain debated in many contexts.

Other contributions to the book similarly available in draft form are by Matt Bodie (St. Louis), David Walker (BU) and Charles Whitehead (Cornell).  The following scholars are also contributing chapters: Bobby Ahdieh (Emory), Steve Bainbridge (UCLA), Margaret Blair (Vandy), Rob Daines (Stanford), Steve Davidoff (Ohio State), Jill Fisch (Penn), Tamar Frankel (BU), Ron Gilson (Stanford/Columbia), Jeff Gordon (Columbia), Sean Griffith (Fordham), Don Langevoort (GT), Ian Lee (Toronto), Richard Painter (Minnesota), Frank Partnoy (SD), Gordon Smith (BYU), Randall Thomas (Vandy), and Bob Thompson (GT).

  March 4, 2011 at 9:46 am   Posted in: Accounting, Behavioral Law and Economics, Corporate Finance, Corporate Law, Jurisprudence, Legal Theory, Securities Regulation   Print This Post   No Comments

GW’s Junior Scholars Finalists

posted by Lawrence Cunningham

Thanks to my colleague, Lisa Fairfax, GW has finalized the program for this year’s Junior Faculty Business and Financial Law Workshop and Prize (detailed here).   Of the more than 100 papers submitted, the following dozen presenters were chosen.  [Commentators appear in brackets; I've shortened some paper titles.]  

 The workshop will take place at GW on April 1 and 2, 2011.  We are delighted by the submissions, congratulate those chosen, and stress that making the selections was difficult because of the volume of amazing papers.  We encourage everyone interested to attend and look forward to the weekend.

Adam Leviton (Georgetown), In Defense of Bailouts [George Geis (Virginia) & Art Wilmarth (GW)]

Jodie Kirshner (Cambridge), A Transatlantic Perspective on Regional Dynamics and Societa Eurpoea [Francesca Bignami (GW) & Theresa Gabaldon (GW)]

Alan White (Valparaiso), Welfare Economics and Regulation of Small-Loan Credit: Lessons from Microlending in Developing Nations [Michael Pagano (Villanova) & Lawrence Mitchell (GW)]

Nicola Sharpe (Illinois), Corporate Board Performance and Organizational Strategy [Deborah Demott (Duke) & Michael Abramowicz (GW)]

Julie Hill (Houston), The Rise of Ad Hoc Bank Capital Requirements [Anna Gelpern (American) & John Buchman (E*Trade Bank & GW Adjunct)]

Michael Simkovic (Seton Hall), The Effects of Ownership and Stock Liquidity on the Timing of Repurchase Transactions [Richard Booth (Villanova) & Henry Butler (Mason)]

Michelle Harner (Maryland), Activist Distressed Debtors [Donna Nagy (Indiana Bloomington) & Lisa Fairfax (GW)]

Saule Omarova (UNC), The Federal Reserve Board’s Use of Exemptive Power [Patricia McCoy (Connecticut) & Arthur Wilmarth (GW)]

Heather Hughes (American), Suburban Sprawl, Finance Law and Environmental Harm [Scott Kieff (GW) & Lawrence Cunningham (GW)]

Robert Jackson (Columbia), Private Equity and Executive Compensation [Norman Veasey (Weil Gotshal) & William Bratton (Penn)]

Brian Quinn (BC), Putting Your Money Where Your Mouth Is: Post Closing Price Adjustments in Merger Agreements? [Gordon Smith (BYU) & John Pollack (Schulte Roth)]

Mehrsa Baradaran (BYU), Reconsidering Wal-Mart’s Bank [Heidi Schooner (Catholic) & Renee Jones (BC)]

This is one of many events sponsored by GW’s Center for Law, Economics and Finance.

  February 28, 2011 at 8:53 pm   Posted in: Corporate Finance, Corporate Law, Law School, Law School (Hiring & Laterals), Law School (Law Reviews), Law School (Scholarship), Law School (Teaching), Law Talk, Securities, Securities Regulation   Print This Post   One Comment

Some Sense on Top Pay

posted by Lawrence Cunningham

Executive pay continues to spark heated debate: some want it curtailed across the board, the impetus of recent federal law, while others want no legal  oversight whatsoever, the effect of Delaware corporate law.   Contract law may provide an optimal solution, narrower than the overly broad federal regime yet targeting egregious cases ignored by Delaware.  

Thanks to readers of this blog for comments, forthcoming in the Iowa Law Review is my paper, now available on SSRN, “A New Legal Theory to Test Executive Pay: Contractual Unconscionability.”  The paper is available for free downloading here.  The abstract follows below.

Lucrative pay to corporate managers remains controversial yet continues to evade judicial scrutiny for legitimacy. Although many arrangements likely would pass the most rigorous scrutiny, it seems equally clear that some would not. Some agreements are not the product of arm’s-length bargaining, can rivet managers on short-term stock prices at the destruction of long-term business value, and can misalign manager–shareholder interests.

Yet even such objectionable arrangements are immune from serious legal oversight. In theory, they are open to judicial review under corporate law, but shareholders challenging pay contracts face formidable procedural hurdles in derivative litigation and substantive obstacles from corporation law’s business judgment rule and the anemic doctrine of waste. A new legal theory would be useful to check board excesses in the population of clearly objectionable cases.

Read the rest of this post »

  February 15, 2011 at 12:51 pm   Posted in: Contract Law & Beyond, Corporate Law, Current Events, Law Rev (Iowa), Securities Regulation   Print This Post   3 Comments

Surveillance of the War Games of Finance

posted by Frank Pasquale

Some of America’s greatest economists spent World War II devising formulas for optimal bombing. Milton Friedman, for instance, had to determine whether an anti-aircraft shell should burst into 600 small pieces or 20 big pieces in order to best accomplish a mission. Many translated their work into finance’s portfolio selection theory, which was “all about balancing risk and return.”* As Friedman said, “The logical character of the problem was the same. . . . How much power do you want to sacrifice in order to have a greater probability of hitting? [Finance theory involves] exactly the same thing: How much return do you want to sacrifice in order to increase the probability that you will get what you planned for?”

Today’s finance theorists probably have not spent much time on the battlefield. But they can still have fun with ballistics trajectories, in touchscreen video games like Angry Birds. To play, you use a virtual slingshot to launch squawking birds at pigs holed up in encampments made of glass, wood, and stone. The virtual materials in the game don’t act much like real structures; that’s not the point (who really cares whether a real vaulted bluebird would displace a girder)? Rather, you gradually learn from the game itself the strategies that cause optimal destruction, blissfully unmoored from the messiness of actual materials science.

From Wars to Games to High Finance

Stock trading now appears to be similarly deracinated, concerned less with actual fundamentals than with windows of opportunity for sudden arbitrage. In “Algorithms Take Control of Wall Street,” the indispensable econoblogger Felix Salmon (and Jon Stokes) extend a line of recent articles on high frequency trading. (I collect some earlier contributions here; this piece on news-reading technology also gives the flavor of the innovations they’re describing.) They define prop trading, algorithmic trading, and predatory trading, and tell the story of a former head of American Century Ventures who built a “neural network” to optimize his picks. They also discuss the unanticipated consequences of runaway algorithmic interactions.
Read the rest of this post »

  December 31, 2010 at 11:21 am   Posted in: Financial Institutions, Securities Regulation, Uncategorized   Print This Post   No Comments

Hockett on the Financial Crisis

posted by Frank Pasquale

There is a growing consensus that our mortgage markets are fundamentally broken. In a recent article in The American Prospect, Robert Kuttner surveys a number of leading legal academics’ prescriptions for the foreclosure crisis:

Katherine Porter, a law professor at the University of Iowa and an expert in mortgage servicing, recently testified to the Congressional Oversight Panel for the Troubled Asset Relief Program (TARP) that according to lawyers for both home-owners and banks, “a very large number (perhaps virtually all) securitized loans made in the boom period in the mid-2000s contain serious paperwork flaws, did not meet underwriting or other requirements of the trust, and have not been serviced properly as to default and foreclosure.” . . . .

One remedy, proposed by professor Adam Levitin of the Georgetown Law Center, would create a new chapter of the bankruptcy code and allow a home-owner to come before a bankruptcy judge and get the mortgage reduced to the present value of the home. The process would also clear the title. Another proposal, by professor Howell Jackson of Harvard Law School, would use government’s power of eminent domain to take securitized mortgages, compensate the holder at the securities’ (much reduced) fair market value, and use the savings to turn the paper back into whole mortgages with steep reductions in interest and principal. This would also allow millions of people to keep their home and help stem the broad decline in housing values.

I think each of these ideas is valuable. I’d also like to see them complement a broad set of proposals articulated by Robert Hockett in a recent piece in the Washington University Law Review. Hockett’s proposals are worth quoting at length, since he keenly grasps the historical dimensions of this crisis:
Read the rest of this post »

  December 23, 2010 at 11:22 am   Posted in: Financial Institutions, Property Law, Securities, Securities Regulation, Uncategorized   Print This Post   One Comment

Why Big Banks Fail to Act in Their Own Self Interest

posted by Frank Pasquale

In an earlier post, I characterized some financial institutions as “shadowy and unstable ensembles of desks and divisions whose main goal is slipping by whatever bonus-maximizing scheme won’t set off alarms among risk managers and regulators.” Too harsh? Well, today ProPublica’s Jake Bernstein and Jesse Eisinger offer offer yet another confirmation of value-destroying skulduggery at the core of contemporary finance. They explain how payments of a few million in “bonuses” to employees running one division of Merrill Lynch helped those running another division “offload” billions of dollars in toxic assets to their own firm:

Two years before the financial crisis hit . . . [n]o one, not even the bank’s own traders, wanted to buy the supposedly safe portions of the mortgage-backed securities Merrill was creating. Bank executives came up with a fix . . . .They formed a new group within Merrill, which took on the bank’s money-losing securities. But how to get the group to accept deals that were otherwise unprofitable? They paid them. The division creating the securities passed portions of their bonuses to the new group, according to two former Merrill executives with detailed knowledge of the arrangement.

The executives said this group, which earned millions in bonuses, played a crucial role in keeping the money machine moving long after it should have ground to a halt. “It was uneconomic for the traders” — that is, buyers at Merrill — “to take these things,” says one former Merrill executive with knowledge of how it worked. Within Merrill Lynch, some traders called it a “million for a billion” — meaning a million dollars in bonus money for every billion taken on in Merrill mortgage securities. Others referred to it as “the subsidy.” One former executive called it bribery. The group was being compensated for how much it took, not whether it made money.

The three men at the top of the scheme made about $6 million each that year, and there were probably some handsomely paid lieutenants beneath them. Surely, there must have been someone who objected to such deals? There was: “a Merrill trader [who refused to go along] . . . was sidelined and eventually fired.” The power in the firm was held by those who could make quick money in big deals. Has anything changed about the structure of these firms since the crisis to alter that dynamic?
Read the rest of this post »

  December 23, 2010 at 9:38 am   Posted in: Financial Institutions, Securities Regulation, Tax, Uncategorized   Print This Post   No Comments

Cuomo Sues E&Y: Auditing Profession At Risk

posted by Lawrence Cunningham

Ernst & Young, one of the Big-4 auditing firms left in the world, faces a grave lawsuit filed a couple of hours ago by New York’s Andrew Cuomo, the incoming governor’s last major act as state attorney general.  The lawsuit is based on fraudulent accounting committed by Lehman Brothers, the failed investment bank, that E&Y either overlooked or condoned, as I explained last March.  

The AG seeks unspecified damages the audit failure caused, certainly running to the hundreds of millions and easily reaching into the billions.  Given that E&Y does not have external insurance to cover such losses, but self-insures, the lawsuit could put the firm’s survival at risk.   Even so, settlement talks, going off-and-on since March, failed, suggesting that the firm is banking on being exonerated.  That is quite a gamble. 

As I told the New York Times and readers of this blog in March, if the case impairs E&Y’s viability as a going concern, a corporate financial reporting crisis should be expected.  It would be acute compared to the modest scramble that corporate America faced after government prosecutors a decade ago drove from the profession the Big-5 firm, Arthur Andersen, auditor of Enron Corp.   Then, 1/5 of companies needed to find a new auditor and most were able to count on one of the remaining four with little trouble. 

Today, 1/4 of public companies would be obliged to find a replacement auditor; thanks to rules stated in the federal response to Enron, the Sarbanes-Oxley Act of 2002, about 1/3 of those would be unable to engage any of the 3 remaining firms because of conflicts of interest (those other firms provide internal control or tax advisory services making them ineligible to render financial audits).   Amid such a crisis,  and with only 3 available firms, the existing structure of the auditing profession would be unsustainable.     

It would be reassuring if the Securities and Exchange Commission could tell the nation that is has foreseen this contingency and developed plans for addressing it, as urged last March and in 2006.  Alas, I am not sure that it is prepared to do either.

  December 21, 2010 at 2:57 pm   Posted in: Accounting, Current Events, Securities, Securities Regulation   Print This Post   No Comments

Finance Sector as Ultimate Risk Manager?

posted by Frank Pasquale

David A. Moss’s When All Else Fails: Government as the Ultimate Risk Manager should be a vital guide to our future. Moss describes programs ranging from social security to bankruptcy as backstops of support for all classes. As volatility in prices, employment levels, and wages climbs, we should be exploring new “automatic stabilizers” to guarantee every family a “social minimum.” Instead, we appear to be privatizing and financializing risk via opaque institutions whose only mandate is to increase their own profits.

Consider, for instance, this vignette from Louise Story’s excellent reporting on derivatives trading:
Read the rest of this post »

  December 16, 2010 at 11:03 am   Posted in: Economic Analysis of Law, Financial Institutions, Politics, Securities, Securities Regulation, Uncategorized   Print This Post   8 Comments

Rule of Law in Russia

posted by Frank Pasquale

This presentation by Bill Browder at the Stanford Graduate School of Business is a pretty astonishing account of the Russian economy over the past two decades. I am familiar with the usual story of oligarch profiteering, but Browder’s experience shows how even the ostensibly sound legal arrangements of today can quickly unfold into a nightmare for investors. As the Stanford GSB news puts it,

Browder soared to fame and fortune investing in Russian equities amid the chaos and corruption of the post-Soviet economy. His hallmark: finding hidden values in Russian companies and driving up their share prices by exposing corporate malfeasance and mismanagement. His widely publicized campaigns for shareholder rights and corporate governance helped propel the Hermitage Fund from $25 million in 1996 to $4 billion a decade later. But eventually the U.S.-born financier ran afoul of the Russian government, which banned him from the country in 2005 as a threat to national security.

According to Browder, “Anyone who would make a long-term investment in Russia right now, almost at any valuation, is completely out of their mind. . . .My situation is not unusual. For every me, there are 100 others suffering in silence.” And for a “bigger picture” presentation about the “disembedded markets” and the types of forces Browder was a victim of, Nancy Fraser’s Storrs Lecture podcast on “Predatory Protections, Tragic Tradeoffs, and Dangerous Liaisons: Dilemmas of Justice in the Context of Capitalist Crisis” is also well worth listening to.

  October 28, 2010 at 10:16 am   Posted in: Corporate Finance, Corporate Law, Corruption, Economic Analysis of Law, Law and Inequality, Securities Regulation   Print This Post   One Comment

Where Have You Gone, Hernando de Soto?

posted by Frank Pasquale

Remember Randy “Duke” Cunningham’s “bribe list” pricing—”$50,000 for every $1 million in appropriated funds he would obtain?” There are now allegations that certain firms offered to “fabricat[e] documents out of whole cloth” to lubricate the foreclosure machine. For a mere $95, one could “recreate entire collateral file,” which is all “the documents the trustee (or the custodian as an agent of the trustee) needs to have pursuant to its obligations under the pooling and servicing agreement on behalf of the mortgage backed security holder [including] the original of the note (the borrower IOU), copies of the mortgage (the lien on the property), the securitization agreement, and title insurance.” Yves Smith draws some interesting implications:

Amar Bhide, in a 1994 Harvard Business Review article, said the US capital markets were the deepest and most liquid in major part because they were recognized around the world as being the fairest and best policed. As remarkable as it may seem now, his statement was seem as an obvious truth back then. In a mere decade, we managed to allow a “free markets” ideology on steroids to gut investor and borrower protection. The result is a train wreck in US residential mortgage securities, the biggest asset class in the world. The problems are too widespread for the authorities to pretend they don’t exist, and there is no obvious way to put this Humpty Dumpty back together.

Smith’s global perspective reminds me of two items. I once heard that, in the wake of Bush v. Gore, a representative of the OAS began a meeting by saying something along the lines of: “We are now to hear from a fragile democracy, one that has suffered severe strains but which looks capable of attaining legitimate procedures for governance. Would the United States representative please come to the dais?” And policymakers who prescribe the titling work of Hernando de Soto for Latin America might want to apply it a bit more carefully at home.

  October 3, 2010 at 5:56 pm   Posted in: Contract Law & Beyond, Property Law, Securities, Securities Regulation, Uncategorized   Print This Post   One Comment

On the Colloquy: The Credit Crisis, Refusal-to-Deal, Procreation & the Constitution, and Open Records vs. Death-Related Privacy Rights

posted by Northwestern University Law Review

This summer started off with a three part series from Professor Olufunmilayo B. Arewa looking at the credit crisis and possible changes that would focus on averting future market failures, rather than continuing to create regulations that only address past ones.  Part I of Prof. Arewa’s looks at the failure of risk management within the financial industry.  Part II analyzes the regulatory failures that contributed to the credit crisis as well as potential reforms.  Part III concludes by addressing recent legislation and whether it will actually help solve these very real problems.

Next, Professors Alan Devlin and Michael Jacobs take on an issue at the “heart of a highly divisive, international debate over the proper application of antitrust laws” – what should be done when a dominant firm refuses to share its intellectual property, even at monopoly prices.

Professor Carter Dillard then discussed the circumstances in which it may be morally permissible, and possibly even legally permissible, for a state to intervene and prohibit procreation.

Rounding out the summer was Professor Clay Calvert’s article looking at journalists’ use of open record laws and death-related privacy rights.  Calvert questions whether journalists have a responsibility beyond simply reporting dying words and graphic images.  He concludes that, at the very least, journalists should listen to the impact their reporting has on surviving family members.

  September 5, 2010 at 1:15 pm  Tags: Antitrust, Constitutional Law, copyright, discrimination, financial crisis, free speech, Intellectual Property, Privacy, trademark  Posted in: Antitrust, Bioethics, Civil Rights, Constitutional Law, Corporate Finance, First Amendment, Intellectual Property, Privacy, Securities, Securities Regulation   Print This Post   No Comments

Dodd-Frank on Pay: Neutrality, Signaling, and Exposé

posted by Lawrence Cunningham

Neutrality, signaling and exposé are the tonics served up on executive compensation in the new law nominally aimed against Wall Street and for consumers. The 848-page statute also named for its sponsors, Senator Dodd and Representative Frank, makes public companies put neutral committees at the pay-setting helm, lets shareholders cast precatory votes on the results, and shines a potentially embarrassing spotlight on prevailing pay realities and ratios.  It puts a heavy hand on big bank pay setting.

Those incrementally averse to regulation will be appalled while those fearing serious flaws in pay practices enthralled. But neither group seems right, as these efforts reflect real problems, yet they are not likely to achieve their objectives. Even so, here’s a run-down of our new federal executive compensation laws, and predicted effects.

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  July 28, 2010 at 8:26 pm   Posted in: Contract Law & Beyond, Corporate Law, Securities Regulation   Print This Post   No Comments

Goldman’s $550 Million SEC Settlement

posted by Lawrence Cunningham

The SEC announced this afternoon that Goldman Sachs agreed to settle, for $550 million, the civil lawsuit against it alleging materially misleading disclosures in circulars for some mortgage-backed securities it hawked.  As I wrote on this blog, in a post of April 19 called SEC v. Goldman as a Simple Case, the case was simple. 

In a bruising Consent to a Final Judgment in the federal case against it, Goldman acknowledges the point I made that makes the case simple.  Its marketing circular said the reference portfolio was “selected by” the independent firm, ACA Management LLC, when in fact Paulson & Co. Inc., an interested party, played a role in that selection. 

Within 30 days, Goldman must pay investors it misled by the marketing materials: $150 million to Deutsche Bank and $100 million to the Royal Bank of Scotland (known as ABN AMRO Bank when it bought Goldman’s securities).  It must pay another $300 million to the SEC.  

The SEC’s press release headlined that this amount set a ”record” for the agency and is non-trivial even for a firm of Goldman’s size.   Its enforcement chief, Bob Khuzami, boasted that “half a billion dollars is the largest penalty ever assessed against a financial services firm in the history of the SEC.”

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  July 15, 2010 at 5:59 pm   Posted in: Corporate Finance, Current Events, Securities, Securities Regulation   Print This Post   2 Comments

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