Archive for the ‘Securities Regulation’ Category
Lawyers: Don’t Trade on Inside Information!
posted by Lawrence Cunningham
In my corporations classes, I urge my students planning a career in corporate and securities law to resist the ubiquitous opportunities and occasional temptations to trade on the basis of material non-public information. I offer in terrorum encouragement by emphasizing that all trades are tracked and that enforcement authorities periodically review them for unusual patterns. Those are traced back to professional advisors, including law firms, having been involved in related deals. It is not difficult for authorities to catch these violations.
Along with dozens of others apparently caught up in the ongoing insider trading scandal at Galleon, today, an associate at the prestigious firm, Ropes & Gray, is alleged to have violated securities laws by using confidential information obtained from clients to profit in securities trades. Lawyers, as fiduciaries, who obtain material information through client representation, violate their fiduciary obligations and hence federal securities laws when they trade on it. See United States v. O’Hagan, 541 U.S. 642 (1997).
Over at the Wall Street Journal blog, Ashby Jones is asking how common insider trading is among lawyers. This is obviously a difficult empirical question. I can add, however, that (a) in the four years that I practiced law at Cravath, Swaine & Moore, one of my fellow-associates engaged in this activity (with his brother) and authorities prosecuted him (in 1995) for it and (b) during the two years before that when I was a paralegal at Skadden, Arps, one of the associates for whom I worked did so (with his sister) and he was likewise caught (in 1990).
In addition, the famous case embracing the so-called misappropriation theory of insider trading, United States v. O’Hagan, 541 U.S. 642 (1997), involved a lawyer—a partner at Dorsey & Whitney, representing Grand Met in its acquisition of Pillsbury, who generated nearly $4 million in unlawful trading gains from the knowledge.
I repeat to my students, past and present, and all lawyers: do not do this!
November 5, 2009 at 3:50 pm
Posted in: Current Events, Law Practice, Legal Ethics, Securities Regulation
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House Financial Committee Busy
posted by Lawrence Cunningham
The Staff of the House Financial Services Committee is extremely busy and doing a very good job of keeping its role in the legislative process transparent. A reasonable run down of current activity in financial regulation reform appears here. (You can even sign up to get email alerts.)
These bills are elaborate, complex and defy tidy characterization. All are likely to change, some significantly, as the legislative process grinds along. The Senate Banking Committee is unlikely to produce anything equivalent until well into November.
In general, however, together the House FSC’s work would make for sweeping change. The bills would:
(1) create three new federal agencies: a Federal Oversight Council, a Consumer Financial Protection Agency and an Office of Federal Insurance;
(2) considerably expand powers of the Securities Exchange Commission, including by subjecting rating agencies to considerable regulation and oversight by the SEC plus eliminate an exemption to the Investment Company Act of 1940 for private financial advisors.; and
(3) expand the mandate and powers of the Commodity Futures Trading Commission concerning regulation of derivative securities.
These pending Committee steps, of course, are in addition to bills the House passed earlier this year, including the summer’s Corporate and Financial Institution Compensation Fairness Act of 2009, embracing shareholder say on executive compensation to a certain extent.
At this link, you can access pending bills totaling just about 1,000 pages. Following is an additional breakdown: Read the rest of this post »
October 28, 2009 at 2:22 pm
Posted in: Consumer Protection Law, Corporate Finance, Current Events, Securities, Securities Regulation
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GW Fin Reg Conference Nov. 6
posted by Lawrence Cunningham
As financial regulation reform reaches its apogee, we at GWU are delighted to host a roundtable on Friday Nov. 6 at the Law School (2000 H Street, NW, Washington, DC). An outline of the Program, co-sponsored by the Institute for Law and Economic Policy, follows, along with how to register. Note that participation of some panelists is subject to the legislative calendar. Read the rest of this post »
October 26, 2009 at 11:22 am
Posted in: Current Events, Law School (Scholarship), Securities Regulation
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Smart or Not So Smart Money; The Limits on Derivatives and Regulating Them
posted by Deven Desai
The New York Times op-ed by Calvin Trillin, Wall Street Smarts, has a parable-like quality with the two characters meeting and exchanging wisdom. The lesson offered by the wiseman: “The financial system nearly collapsed,” he said, “because smart guys had started working on Wall Street.” The piece goes on to explain why that is a good explanation. It seems that the not-so-smart sat at the top of the heap and ran the companies: “Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that.” There is also an claim about what is enough and what is greed in this tale. I leave it to others to debate or verify these ideas (our own Mr. Cunningham has been a favorite for me on these issues). Now, a paper by some folks at Princeton may show that not even the smart guys knew what they were doing.
As Andrew Appel explores in his post Intractability of Financial Derivatives, the computer science world’s Intractability Theory may better explain the derivative world than other theories. (the theory is used for DRM, cryptography, and more). The paper is Computational Complexity and Information Asymmetry in Financial Products (pdf) by Sanjeev Arora, Boaz Barak, Markus Brunnermeier, and Rong Ge.
For those who are interested in the topic and/or understand the math and theory behind the risk shifting involved in this area, check out Andrew’s post. He does a great job explaining how the paper applies to a CDO (collateralized debt obligation). If you need a little more to understand why this paper and its ideas are important, consider Andrew’s take away
In principle, an alert buyer can detect tampering even if he doesn’t know which asset classes are the lemons: he simply examines all 1000 CDOs and looks for a suspicious overrepresentation of some of the asset classes in some of the CDOs. What Arora et al. show is that is an NP-complete problem (”densest subgraph”). This problem is believed to be computationally intractable; thus, even the most alert buyer can’t have enough computational power to do the analysis.
Arora et al. show it’s even worse than that: even after the buyer has lost a lot of money (because enough mortgages defaulted to devalue his “senior tranche”), he can’t prove that that tampering occurred: he can’t prove that the distribution of lemons wasn’t random. This makes it hard to get recourse in court; it also makes it hard to regulate CDOs.
UPDATE: It appears from the comments to Andrew’s post that CDO and derivatives are not precisely the same thing. In addition, the comments explore the limits of the study. It is a good discussion.
ALSO check out the FAQ for the paper. It addresses many issues that the initiated may want to probe.
October 18, 2009 at 9:17 am
Tags: computer science, derivatives, securities law
Posted in: Corporate Finance, Corporate Law, Securities, Securities Regulation
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Bernie Madoff and the Unfortunate Consequences of Celebrity Bias
posted by Danielle Citron
Celebrity is intoxicating. We have long been willing to play the fool to the rich and powerful, even if that means turning a blind eye to signs of trickery. In the late 1980s, a 37-year-old con artist convinced Duke University administrators and students that he hailed from the wealthy Rothschild family of France despite the fact that he spoke no French, drove a run-down car, and offered clipped out magazine articles to show his family’s homes. During a two-year charade, the imposter borrowed (stole) thousands of dollars from Duke and joined a fraternity. (I was an Duke undergraduate at the time, but alas did not know him). More recently, Christopher Chichester tricked many into believing that he was a Rockefeller despite his gauche manners and outrageous claims (e.g, that he owned “the key to Rockefeller Center”). As Clark Rockefeller, he gained admission to exclusive clubs and married a partner at McKinsey Consulting. Only after Mr. Chichester kidnapped his daughter from his ex-wife did the police discover his true identity and connection to unsolved murders.
Perhaps such celebrity bias had some role in the SEC’s bungling of the Bernie Madoff fiasco. On Thursday, the S.E.C.’s Inspector General’s Report explored why the agency missed so many “red flags” about Madoff since 1992. The report discussed missed leads, bureaucratic snafus, and investigators’ inexperience. Investigators were far too believing because they were simply awed by him. One investigator described Madoff as “a wonderful storyteller” and a “captivating speaker.” As with the faux Rockefeller and Rothschild incidents, Madoff’s ruse worked for so long despite the clues of foul play perhaps because investigators and investors could not shake their sense of Madoff as a rich, powerful, and trusted financial guru. Madoff’s celebrity reputation anchored their thinking, permitting Madoff to get away with his scheme for far longer than it should have. As Madoff’s victims’ stories attest, celebrity bias had profoundly destructive consequences.
StockXchange Image; Wikimedia Commons Image
September 5, 2009 at 3:39 am
Posted in: Behavioral Law and Economics, Corporate Law, Culture, Current Events, Psychology and Behavior, Securities Regulation, Uncategorized
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“A great vampire squid wrapped around the face of humanity”
posted by Kaimipono D. Wenger
That’s how Matt Taibbi describes Goldman Sachs in the opening paragraph of his 12-page Rolling Stone article (which, as far as I can tell, is available online only here, in moderately annoying scanned form). From there, Taibbi picks up steam. For instance, we learn that:
The bank’s unprecedented reach and power have enabled it to turn all of America into one giant pump-and-dump scam, manipulating whole economic sectors for years at a time, moving the dice game as this or that market collapses, and all the time gorging itself on the unseen costs that are breaking families everywhere — high gas prices, rising consumer credit rates, half-eaten pension funds, mass layoffs, future taxes to pay off bailouts. All that money that you’re losing, it’s going somewhere, and in both a literal and a figurative sense, Goldman Sachs is where its going.
Yikes!
Is this just another crackpot conspiracy theory? (Paging Mr. Stein, Mr. Ben Stein.) Nay — Taibbi has give us proof of Goldman’s nefari-iety. It goes more or less along these lines: 1. Goldman survived the Great Depression. 2. Goldman made some savvy bets in the past ten years. 3. Goldman pays really big bonuses. Read the rest of this post »
June 26, 2009 at 11:51 am
Tags: financial crisis, goldman sachs, market, money, securities law
Posted in: Corporate Finance, Corporate Law, Current Events, Securities, Securities Regulation
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Washington Backwards on Fin Reg
posted by Lawrence Cunningham
If Treasury Secretary Timothy Geithher has his way, two big mistakes appear to be forthcoming from the Obama Administration on financial regulation, born of an atmosphere in which any kind of reform seems possible. A quick quiz illuminates:
1. Suppose someone you put in charge of overseeing banks did a terrible job supervising them while someone you put in charge of mutual funds did a reasonably good job supervising them. If banks failed while mutual funds prospered, would you (a) increase the power of the bank supervisor and decrease that of the fund supervisor or (b) correct the failings of the bank supervisor and reward and maintain the fund supervisor? The correct answer is (b) but the Administration is about to propose (a), by stripping the Securities and Exchange Commission of power and expanding the Federal Reserve’s power.
2. Suppose a system-wide financial crisis spread across the land that gave you an opportunity to revise the prevailing oversight system of relevant financial institutions. Would you (a) authorize a formal investigation of the source of problems to identify tailored solutions and follow up with legislative corrections or (b) begin with legislative overhauls followed by a formal investigation? The correct answers is (a) but the government is choosing (b). The House and Senate have approved legislation now heading to the President’s desk for signature to start the investigation, while simultaneously writing legislation to be enacted long before investigation is complete.
The case to expand the Fed’s powers will be made under the fashionable heading of the need to have a single super-senior risk regulator able to oversee all institutions posing systemic risk. Participants should not be misled. In effect, what appears to be happening is the banking industry exercising its considerable influence to regain market share it has lost to the mutual fund industry in recent decades. Read the rest of this post »
May 20, 2009 at 6:44 am
Posted in: Current Events, Securities Regulation, Uncategorized
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Hello Ms. Schapiro
posted by Lawrence Cunningham
The Senate on Thursday confirmed President Barack Obama’s nomination of Mary Schapiro as Chair of the Securities and Exchange Commission. In Ms. Schapiro’s written answers to questions posed by Senator Carl Levin, she indicates a refreshingly sharp break with many policies of her predecessor, Chris Cox.
Differences appear on numerous particular subjects. These reflect a general orientation to re-dedicate the agency to its primary mission of investor protection. Examples from Ms. Schapiro’s letter follow (with full text available here from Investment News):
1. Corporate Governance. Ms. Schapiro favors (a) rules letting shareholders (at least significant, long-time holders) nominate candidates for corporate boards of directors; and (b) rules allowing shareholders to express advisory opinions and votes on executive compensation .
2. International Accounting. Ms. Schapiro, unlike Mr. Cox: (a) does not believe that the International Accounting Standards Board meets US legal criteria and is not prepared to delegate authority to it; and (b) believes that US authorities must oversee foreign auditing firms auditing financial statements of companies with securities listed in the US.
3. Internal Controls. Ms. Schapiro, unlike Mr. Cox, would enforce laws requiring internal controls as to small and large public companies alike.
4. Accounting. Ms. Schapiro also believes in: (a) maintaining the independence of the US accounting standard setter, the Financial Accounting Standards Board; (b) cracking down against abuses of off-balance sheet accounting; and (c) continuing the requirement that stock options be accounted for as compensation expense.
5. Regulatory Scope. Ms. Schapiro favors: (a) regulating hedge funds; (b) strengthening capital requirements for securities brokers; and (c) strengthening regulation of rating agencies.
So far so great.
January 24, 2009 at 3:20 pm
Posted in: Accounting, Securities Regulation
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Good Bye Mr. Cox
posted by Lawrence Cunningham
Yesterday was Christopher Cox’s last day of a 3.5 year term as Chair of the Securities and Exchange Commission, the United States federal agency charged with investor protection. Investors may be tempted to feel some relief. He leaves the agency weakened and its staff demoralized. But he also leaves its continued existence in doubt, given its manifest failures and contributions to the global financial crisis. It may be undiplomatic to say, but it is possible that his tenure was among the worst in the agency’s history.
Despite the agency’s primary mission of investor protection, Mr. Cox mostly ignored or subordinated that mission in preference to elevating other goals, such as promoting capital formation and engagement with technology and globalization. Headline dramas illustrating these problems include how, during Mr. Cox’s tenure, the SEC:
• failed to interdict Bernard Madoff’s Ponzi scheme despite warnings, costing investors billions, with Mr. Cox later saying he was “deeply troubled” that he didn’t catch it;
• failed in its oversight of the investment banking industry, which led to its extinction, costing investors hundreds of billions more (with multiplied costs for the rest of the economy and probably permanently impairing the economy of New York City, the country’s center of investment capital), with Mr. Cox later describing the SEC’s oversight program as a total failure;
• reduced enforcement intensity for securities law violations (measured by year-to-year reductions in fines and restitution of about 2/3), with uncertain but probably significant future costs for investors from reduced deterrence; and
• reversed major parts of the 2002 Sarbanes-Oxley Act’s implementation concerning corporate internal controls, the costs and fallout from which will not be known for months or years when accounting scandals emerge as a result of the increased opportunities for fraud, although the costs may again run to billions of dollars.
In addition, as Chair of the SEC, Mr. Cox concentrated considerable personal and institutional resources on two subjects that subordinated investor interests to pursue projects that Mr. Cox believed in for some other reasons. In particular, Mr. Cox and the SEC Staff at his direction:
• spent thousands of hours and enormous other resources pushing an ill-advised campaign to eliminate US accounting standards in favor of global ones, although this was fortunately delayed in the final months of his term in response to investor and academic criticism; and
• spent considerable resources promoting policies to let non-US enterprises access US capital markets, without any US regulatory oversight or legal enforcement, so long as they are overseen at home by authorities deemed comparable, also an idea that luckily has gained little traction and may die on the vine.
January 21, 2009 at 11:10 pm
Posted in: Securities Regulation
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Congrats to Mary Schapiro, SEC Chair Nominee
posted by Lawrence Cunningham
US President-elect Barack Obama announced his intention to nominate Mary Schapiro as Chair of the Securities and Exchange Commission. We at GW Law School, from which Ms. Schaprio graduated in 1980, are delighted. We wish her well in what promises to be a very difficult period for the SEC. Already, questions arise about the orientation Ms. Schapiro will bring, raised sharply in Susan Antilla’s Bloomberg column today. From the Obama transition team web site is the following biography of Ms. Schapiro.
December 19, 2008 at 12:40 am
Posted in: Securities Regulation
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Times Softens SEC Bashing
posted by Lawrence Cunningham
On Monday, I posted my opinion that people should be cautious in rushing to rebuke the Securities and Exchange Commission for any failures leading to the Madoff Ponzi scheme. Also on Monday, the New York Times engaged in such a rush. In today’s paper, the Times softens that stance. These views may have some bearing on whether the SEC survives, is dismantled or reconstituted in coming financial regulation reform.
My post said charges against the SEC for failure in the Madoff case should be looked into but that it was equally likely that the charges would prove incorrect. Above all, I opined that talk of SEC blame for the Ponzi scheme risks distracting from manifestly pressing matters of systemic significance arising in the general financial crisis.
In Monday’s Times Stephen Labaton painted a very unflattering piece on the SEC, emphasizing its alleged failures to interdict the Madoff scam, and quoting Chris Cox, current SEC Chair, as acknowleding some fault. The story, which ran on page B6 and spanned 876 words, called the Madoff episode the “latest black eye” for the SEC. It also mentioned the SEC’s failure to anticipate the problems at Bear Stearns, and cited SEC inspector general reports on “several major botched investigations” (although without noting that those reports have been contested by other SEC officials).
The Monday story also reported on other rumor-based and word of mouth complaints about morale among SEC staff, even assertions of a “hollowing out” of the agency under Bush administration directives.
In today’s paper, Mr. Labaton offers a different view.
December 18, 2008 at 11:37 am
Posted in: Securities Regulation
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Required versus Probable Reform and the Madoff Distraction
posted by Lawrence Cunningham
The press, politicians and reformers are devoting extraordinary attention to a Ponzi scheme whose only peculiarities are scale and duration. Compared to ongoing global financial devastation, this is trivial. Yet this attention may lead politicians to distract focus from their role in the deeper problems that matter far more.
Recriminations against the Securities and Exchange Commission arise from allegations it has made (complaint here) that Mr. Madoff operated a large-scale Ponzi scheme involving tens of billions of dollars over perhaps decades and bilking scores of sophisticated parties. SEC critics include prominent securities law professors Jim Cox (Duke) (SEC may “have a hell of a lot to answer for”) and Joel Seligman (Rochester) (“a debacle for the SEC”).
Critics express concern that the SEC may have failed to investigate investor tips (see Wall Street Journal story here); failed to regulate sufficiently Madoff’s investment advisory services or fund vehicles; or failed to enforce existing regulations. Calls are for both investigation and greater regulation, many pinning hope on the incoming Obama administration to institute such searching and effect requisite change.
December 15, 2008 at 2:37 pm
Posted in: Securities Regulation
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Countrywide Sub Prime Suit May Proceed
posted by Lawrence Cunningham
Many securities lawsuits arising out of the sub-prime mortgage lending debacle are not showing much promise of success. But an important exception may be that concerning Countrywide. Kevin LaCroix provides analysis of the 112-opinion issued last week denying most defendants’ motions to dismiss the Countrywide securities class action complaint.
The opinion contains several points of special interest because they may seem to go against the weight of authority. This may simply reflect the procedural stage of the case. But they may also suggest that the scale and unusual nature of the sub-prime market may invite judicial reconsideration of some traditional securities law doctrines.
December 8, 2008 at 11:22 am
Posted in: Securities Regulation
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SEC Schizophrenic on Global Accounting
posted by Lawrence Cunningham
With surprising absence of fanfare, the Securities and Exchange Commission released over the weekend a 165-page document outlining its delayed and long-awaited proposals for how the US might switch from using its own generally accepted accounting principles to new international financial reporting standards. The release bears a schizophrenic quality. It offers one unsurprising and one surprising proposal.
The unsurprising portion reflects what the Commission reluctantly came to accept last summer: the US is not ready for such a switch and is not likely to be until 2014 at the earliest. Accordingly, the release principally outlines the many obstacles to such a switch and lays out milestones that would have to be met before considering such a radical move.
The surprising portion contemplates allowing selected US issuers voluntarily to make the switch as early as the year after next—2010. This radical proposal would be limited to US issuers whose industry uses IFRS as the basis of financial reporting more than any other set of standards. The release struggles to explain why this special approach for such issuers overcomes the many obstacles facing other US issuers.
November 17, 2008 at 11:05 pm
Posted in: Accounting, Securities Regulation
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Crisis Yields Turnabout by SEC Chair
posted by Lawrence Cunningham
In a
at the Practising Law Institute’s program on securities regulation, the historically arch-conservative, deregulatory Chair of the Securities and Exchange Commission, Christopher Cox, offered very surprising recommendations for financial regulation reform based on lessons taught by the current economic meltdown. Highlights include:
1. Establishing a Congressional Select Committee on Financial Services Regulatory Reform.
2. Merging the SEC and the Commodity Futures Trading Commission “with a clear mandate to protect investors by regulating the markets in all financial investments, including securities, futures, and derivatives.” Many such calls have been made, dating to the 1987 market crash to the Treasury Department’s March 2008 blueprint for financial regulation reform. Most propose diluting the resulting agency by having the merged agency adopt the lax approach to regulation used by the CFTC rather than the relatively tight approach of the SEC. Mr. Cox’s statement emphatically prescribes sticking with traditional SEC approaches in the resulting merged agency. He says the crises “highlight the need for a strong SEC.”
3. Merging all existing bank regulators, of which there are six at the federal level and scores at state levels. Again, this proposal has been often made, including by Treasury, although Mr. Cox again signals an urgency and muscularity that differs from the looser supervisory approach Treasury contemplated. Mr. Cox says: “the lessons of the credit crisis all point to the need for strong and effective regulation.” He contrasts the traditionally “strong SEC” with the comparatively lax banking regulatory structure: the SEC is independent of those it regulates. In contrast: “banks regulated by the Federal Reserve Bank of New York elect six of the nine seats on the board of the New York Fed. Both the CEOs of J.P. Morgan Chase and Lehman Brothers served on the New York Fed board at the beginning of the credit crisis.”
4. Mr. Cox also takes the lessons from the crisis to reject proposals, made as recently as a year ago, to weaken US regulations on the grounds such regulation results in the US losing financial business to less-regulated markets. The “mortgage meltdown” and “credit crisis” show that what is needed is strong regulation backed by statute, not mere supervision, voluntary compliance, weaker regulation or limited enforcement, Mr. Cox said.
The speech overall is an impassioned defense of a strong SEC, and strong regulation. Numerous SEC observers over Mr. Cox’s tenure may recognize this as a bit of a turnabout for him.
November 14, 2008 at 5:16 pm
Posted in: Securities Regulation
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Capitalism and Regulation
posted by Lawrence Cunningham
This weekend’s talk among world leaders will be accompanied by opposing diagnoses of economic failure and prescriptions for correction and prevention. The outgoing President of the United States sought to frame discussion in a speech yesterday extolling the virtues of unbridled free-market capitalism, warning that government regulation is a danger not a solution. In contrast, the continuing President of France and Prime Minister of Great Britain signal interest in devising an elaborate international, government-sponsored regulatory structure at global levels, to modulate capitalism’s most acute downsides.
Neither of these extremes is likely to hold. All modern capitalistic economies involve considerable government regulation and no advanced modern government is likely to cede sufficient national sovereignty to international regulatory authorities to forge a single global financial regulator. Reality suggests a combination of continued or enhanced national regulatory oversight with perhaps greater international coordination among senior national regulators.
Deeper policy talk may turn to the form regulations should assume within nations to enhance oversight and facilitate coordination. This may refashion discussion about whether rules or standards are superior. No slogan has been more popular in financial regulatory circles in the past few years than “principles-based systems” as contrasted to “rules-based systems.” Conservative reformers in the US, including current Treasury Department leadership, had been condemning the US system as “rules-based” and celebrating the “principles-based systems” they assert exist in the UK and Europe.
Regulation in general, and rules in particular, are a problem not a solution, in this view. If any regulation is politically necessary or economically justified, it would assume the form of broad general expressions of expected conduct, as standards or principles, not rules. This approach enables reposing maximal discretion in targeted actors, letting them exploit opportunities and take risks sans regulatory shackles. Opponents, skeptical of such discretion, contend that, at least for some purposes, strict rules are required to restrain excesses to which such actions can lead. When taking stances on the form of national and international financial regulation in coming discussions, participants may need to confront several fundamental questions.
November 14, 2008 at 12:14 pm
Posted in: Securities Regulation
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Rating Agencies: Disease and Cure
posted by Lawrence Cunningham
Today Congress put credit rating agencies on the hot seat during intense hearings. Rating agencies, including Moody’s and Standard & Poor’s, gave top grades to debt the credit crisis is now showing everyone was junky. Scholars have long berated the rating agencies, especially Frank Partnoy. The fundamental problem is that securities issuers pay the rating agencies their fees. The proverbial result: whose bread I eat, his song I sing. Also, law requires very little of rating agencies and essentially insulates them from liability to investors harmed by irresponsible ratings.
As Congress turns hearings into policymaking, Members should consider new scholarship from Jeffrey Manns forthcoming in North Carolina Law Review. He proposes that investors, not issuers, pay rating agencies. The so-called user fee system is coordinated mainly by investors, those owning rated bonds, with a government agency coordinating the system in the pre-issuance stages of a rated debt offering. In addition, rating agencies would have to certify their ratings much as auditors certify their audits. Also like auditors, agencies would be required by law to disclose discovered fraud or illegal acts at issuers whose securities they rate.
The proposal is timely and sensible. Inevitably, it contains elements worthy of debate as well. In particular, the proposal contemplates applying a standard of gross negligence for investor recovery for rating agency violations. The standard for auditors generally is the tougher one of recklessness. In addition, the proposal caps rating agency damages measured in relation to earnings from the botched rating. Despite decades of campaigning by auditor lobbyists for such a cap on their damages, they have not been able to win this victory. Also, alas, auditors continue to be paid by the clients whose financial statements they audit (which I’ve proposed addressing by using financial statement insurance or capital market funding to prevent destroying the auditing industry).
Those interested in preliminary diagnosis of causes and cures for the current crisis should read Manns’ new article. My guess is that everyone who has written or thought about the rating agency’s role in our corporate finance system will consider the piece must reading.
October 22, 2008 at 10:38 pm
Posted in: Securities Regulation
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“Interim Final Temporary Rule”?
posted by Lawrence Cunningham
What should regulated persons make of a federal agency describing a binding regulation as an “interim final temporary rule”? That’s the self-titling the Securities and Exchange Commission gives to two (here and here) of its latest in a series of controversial regulations concerning short selling of securities (selling securities one doesn’t own at a current price to be delivered in the future after buying them at an expected lower price).
The strange nomenclature may be due to difficulties the SEC has faced trying to create a sensible policy on short selling as it struggles with a role to play in addressing the credit crisis. It settled on restricting short selling in the name of trying to prop up prices of equity securities. It adopted emergency measures, and amended and expanded these then allowed them to lapse and is now reviving its effort to play a role. Everything it has done has been subject to criticism and second-guessing, with some evidence indicating that its efforts have exacerbated equity market performance rather than helped.
The SEC now adopts these two “interim final temporary rules,” trying to micro-regulate short selling with greater precision. Separately, it also adopted more traditional forms of regulation more in keeping with its longstanding regulatory philosophy, establishing anti-fraud principles.
October 17, 2008 at 2:33 pm
Posted in: Securities Regulation
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The SEC’s Failed Cover Up
posted by Lawrence Cunningham
SEC officials redacted extensive portions of the agency’s internal watchdog’s report exposing its internally documented failures overseeing failed investment bank, Bear Stearns. But an unredacted version is published by Senator Charles Grassley, Senate Banking Committee Member who requested the study.
The failed cover up is ironic for an agency charged with promoting transparency in corporate America. It makes a mockery of todays’s SEC roundtable on how the SEC can help investors by promoting corporate transparency.
Many of the failed deletions refer to internal SEC documents showing that the SEC knew of problems that it left unaddressed. Also deleted are judgments the inspector makes about SEC performance, including one concerning the existence of ignored red flags.
It is not obvious why it is appropriate for SEC officials to delete these materials. Indeed, Senator Grassley obviously believes there is no basis for doing so. Below I highlight differences between the SEC’s redacted version (available in full here) and Senator Grassley’s published version of the original (available in full here).
October 8, 2008 at 8:09 pm
Posted in: Securities Regulation
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