With the recent release of the Trump administration’s tax plan, discussions of tax “reform,” or at least tax cuts, are once again at the center of American law and politics. Although the president’s tax plan is short on details, it has plenty of potential benefits for high-income earners, including a reduction in top marginal income tax rates and a modest decrease in the tax rate on capital gains. More specifically, the White House tax plan seeks to repeal the 3.8 percent Obamacare tax on net investment income, thereby increasing the tax preference for realized gains from capital investments.
Unsurprisingly, the … Read more
In a new paper, we examine how tournament-based incentives affect corporate cash holdings and the value of those holdings for shareholders.
Before a firm selects a new CEO, it may run a tournament within the firm to rank its vice-presidents (VPs) as candidates. Because the actual ability of a VP is unobservable, the VP with the best performance relative to his peers will likely win the tournament. The payoff structure of tournament-based incentives is similar to that of stock options, in which the payoff is an increase in pay, perquisites, and prestige associated with being the CEO. This option-like feature … Read more
Professor John C. Coffee, Jr. of Columbia Law School is scheduled to speak on June 22 before the Securities and Exchange Commission’s Investor Advisory Committee, which asked him to address the CHOICE Act’s impact on the SEC’s enforcement powers. These are his remarks:
The Financial CHOICE Act of 2017 has now passed the House of Representatives on a strict party-line vote (winning not a single Democratic vote), but its prospects in the Senate seem dim. Nonetheless, a fair chance exists that individual provisions of this bill will make it through the Senate in one or more watered-down compromises. But which … Read more
Congress, the U.S. Department of the Treasury (“Treasury”), and countless legislators have criticized corporate inversions — mergers designed to help American companies lower their tax bills by moving overseas — since McDermott International completed the first one in 1982. Nearly 59 percent of registered voters across the country believe it is Congress’ duty to stop such deals, according to a 2015 study, but about 35 years after the first one, little progress has been made. Every law against these transactions is met with a creative way around it. In other words, when Congress and the Treasury close one loophole, another … Read more
In the week since the Supreme Court’s unanimous decision in Kokesh v. SEC, which rejected the Securities and Exchange Commission’s longstanding position that disgorgement was an equitable remedy not subject to the five-year statute of limitations in 28 U.S.C. § 2462, many have commented about the increased need for the SEC’s enforcement attorneys to complete their investigations quickly and the frustration that hidden ill-gotten gains would never be recovered due to the five-year limit. These are important and valid ramifications, and we include them in this article.
But the Kokesh decision raises other potential consequences that have not … Read more
With trillions of dollars in assets, sovereign wealth funds (SWFs) play a major role in financial markets around the world. With billions (and perhaps trillions) of dollars’ worth of equity investments around the world, the investment behavior of SWFs is of primary concern to regulators, portfolio firms, and other investors. Most work on SWF equity investments has focused on the challenges that SWFs present to regulators, portfolio companies, or their own domestic constituencies. In a forthcoming essay, I seek to provide a realistic appraisal of the benefits and potential costs of SWF investment for other investors.
As numerous scholars have … Read more
Fair lending compliance and community benefit plans are increasingly important factors in the merger and acquisition (M&A) approval process. In 2016 and the first quarter of 2017, the Board of Governors of the Federal Reserve System (Federal Reserve) approved 20 bank or bank holding company M&A applications. Fair lending compliance history was an essential element of the regulatory analysis in these cases. While the Federal Reserve focused on compliance issues beyond fair lending —such as the Bank Secrecy Act, overdraft policies, residential servicing, commercial real estate concentration, and enterprise risk management—fair lending was one of the hottest compliance issues that … Read more
Perhaps not since the early 20th century has there been so much outrage about the malfeasance of the large corporation, and particularly the relationship of senior managers to such conduct. The sentiment is understandable. In reckoning with the wrongs of the big business firm in one serious case after another, a responsibility gap has emerged. The financial crisis of 2008 crystallized the problem, which has only repeated across many scandals since.
Consider, for example, the huge banking firm Wells Fargo, which became an emblem of the seeming impossibility of controlling management of big financial services corporations. The bank fired over … Read more
Two decisions by the Delaware Court of Chancery in the past two weeks reached seemingly disparate outcomes on fair value for the companies involved, but together stand for the general trend of recent appraisal decisions that deal price is the best indicator of fair value if the price resulted from a fair and robust sale process. However, the court will rely on other methods to determine fair value if the record suggests that the process could not have resulted in a deal price that is a reliable indicator of fair value (for example, where there were board conflicts or other … Read more
Financial regulatory institutions are at the center of intense debates over how to supervise financial firms and markets. They are also the focus of an important and growing body of literature that is mainly concerned with the question, “Who should regulate the regulators.” Financial regulatory institutions are usually audited as part of the review of a particular country by international organizations such as the International Monetary Fund, the World Bank, or the OECD. In practice, this means that the structure of financial regulatory institutions and the conduct of financial regulators are not regularly and consistently monitored.
In our recent … Read more
The corporate governance literature has shown a strong link between good governance practices and firm value. The mechanisms, however, that determine the choice of effective corporate governance and board arrangements in a changing global market are not well studied. In our new working paper “Governance Transfer Through Directors’ Foreign Board Experiences,” we examine one such potential mechanism—whether firms learn about corporate governance and board practices from their directors’ foreign board experiences.
Directors with international board experiences have access to a much larger and more diverse set of governance practices than directors who only sit on domestic firms’ boards. For example, … Read more
Efficiencies, economies of scale, and the general desire to improve the customer experience are the lifeblood of all mergers. And one of the most common efficiencies in any deal comes from enhanced purchasing power, or the ability to lower costs through increased volume. Long before a deal is announced, merging parties will create clean teams focused on comparing costs, hoping to leverage the better rates that one firm or the other has negotiated with key vendors. This low hanging fruit – simply moving volume from high-cost vendors to lower cost ones – is among the most basic, least speculative efficiencies … Read more
The fluidity of labor markets depends on the ease with which one side of the market can fulfill the needs of the other: whether workers can find employment that suits their skills and firms can find adequate substitutes for workers who leave. Today much is known about the worker’s perspective. A large body of empirical literature documents that workers suffer persistent earnings losses after they have been displaced from their job – in line with Becker’s (1962) idea that human capital has firm-specific components (see, e.g., Topel 1991; Jacobson et al. 1993; and Dustmann and Meghir 2005).
The other side … Read more
On June 8, 2017, the House of Representatives passed, by a 233-186 vote (with all Democrats and one Republican voting against), the Financial CHOICE Act of 2017, a bill principally designed to reverse many features of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). The House Financial Services Committee majority has provided both an executive summary and a comprehensive summary of the current bill. It is unclear at this time what action the U.S. Senate will take with regard to the bill in its current form.
While the vast majority of the bill relates to the … Read more
The era of large corporate penalties certainly looks to be over, and it is an open question whether we will continue to see companies pleading guilty or settling cases with deferred prosecution agreements. The notion of not imposing costs on “innocent” shareholders has taken hold, so the large fines extracted from banks in the wake of the financial crisis and manipulation of benchmarks like LIBOR are likely a relic of a bygone era.
Whether that is good or bad is a different question, and there are reasonable arguments that corporate criminal liability is a poor way to regulate business behavior. … Read more
On May 24, 2017, the United States Attorney for the Southern District of New York announced the arrests and criminal indictment of four individuals for alleged insider trading on the basis of confidential information about upcoming federal government actions that was obtained from a government employee. A fifth defendant pleaded guilty and is cooperating with prosecutors. Four of the five individuals also were named in a civil complaint filed by the Securities and Exchange Commission for the same conduct.
Theodore Huber, Robert Olan and Jordan Fogel served as investment professionals at an investment adviser to funds focused primarily on the … Read more
To be a public company in the United States is to be subject to an array of federally-imposed disclosure requirements. In my forthcoming article, Reviving Reliance, I describe how the private causes of action available to enforce these requirements have failed to keep pace with the changing purposes of mandatory disclosure. I trace the problem to the functional elimination of the element of reliance from claims brought under Section 10(b) of the Securities Exchange Act via the adoption of the fraud-on-the-market doctrine. I ultimately conclude that courts can better effectuate federal policy by drawing distinctions between actual reliance … Read more
Although still a minority of M&A transactions, appraisal actions are on the rise. In 2012, 20 transactions involving Delaware-incorporated target companies were challenged, but in 2016, this number increased to 48, representing a 240% bump in four years. Further, these figures do not include transactions where appraisal demands were settled before the 120-day deadline for filing an appraisal petition.
With this recent uptick in appraisal litigation, private equity firms should understand the associated risks for, including some that may be unique to PE deals. Recent Delaware decisions and anecdotal perceptions (real or otherwise) have suggested that private equity-led buyouts may … Read more
Uncertainty about government economic policy reduces corporate investment and increases financing costs, as prior research has shown. In our new paper, we examine the relationship between policy uncertainty and M&A and the implications for shareholder value. We use the BBD policy uncertainty index developed by Baker, Bloom, and Davis (2016) as a proxy to examine how policy-related economic uncertainty affects firm acquisitiveness, the time it takes to complete a deal, the method of payment, and acquirer and target shareholder value. The BBD index is based on the weighted average of three components: the frequency of newspaper articles containing key terms … Read more
The Situation: The IRS had discontinued issuing private rulings on certain transactions related to spin-offs, leaving companies to wonder if favorable tax treatment was likely.
The Action: Recent IRS guidance announced the resumption of private rulings in transactions under consideration, and provided confirmation that certain “north-south” transactions will not adversely impact second-step spin-offs.
Looking Ahead: Further clarification on these matters is necessary, and additional guidance on spin-offs may be in the offing.
The IRS recently provided taxpayers with favorable guidance involving tax-free spin-offs. First, the IRS will resume issuing private rulings that allow a distributing corporation to satisfy … Read more
Are regulatory interventions in financial markets delayed reactions to market failures, or can regulators pre-empt corporate misbehavior? Given the high economic and social costs associated with corporate scandals, and the substantial resources countries dedicate to preventing such misconduct, the answer to this question is of utmost importance.
Anecdotal evidence suggests that regulatory activity has a strong reactive component. History offers several prominent examples: The British Joint Stock Companies Act of 1844 followed widespread business failures and bankruptcies, the U.S. Securities Act of 1933 and the Securities Exchange Act of 1934 are often seen as a reaction to the Great Depression … Read more
The SEC has continued to pursue a number of insider trading cases this year, both large-scale and small. Some of those matters involved trades that yielded relatively small amounts of profits: $40,000-$60,000. Why does the enforcement division spend resources on these smaller cases? First, they serve as a reminder that violations can be identified, even if trades are relatively small. And the cases are relatively easy to prove when a connection to an insider source can be readily identified. More importantly, these cases demonstrate that the SEC is uncovering new leads through data analysis.
It is worth noting that the … Read more
In this essay — prepared for a Washington & Lee symposium on corporate law, governance, and purpose — I propound a simple thesis: Corporate governance is best seen not as a subset of economics or even law, but instead as a subset of moral psychology.
Moral psychology: instant, instinctive decision-making
Recent research in the nascent field of moral psychology suggests that we humans are not rational beings, particularly when we act in social and political settings. Our decisions on right and wrong (moral judgments) arise instantly and instinctively in our subconscious, out of conscious view. We rationalize these decisions — … Read more
On May 23, Target Corp. reached a record $18.5 million settlement with 47 states and the District of Columbia to end investigations into Target’s data breach in 2013. The settlement highlights the growing list of specific measures that companies are expected to have in place to mitigate the risk of cyber breaches.
In 2015, Target reached a class action settlement with consumers that required the company to implement certain measures to protect customer information. In re Target Corporation Customer Data Security Breach Litigation No. 14-2522 (D. Minn. Mar. 18, 2015). Comparing the measures that were required in the 2015 settlement … Read more
There is a longstanding and growing public debate about the costs and benefits of automation. Earlier this year, Bill Gates argued that robots who take human jobs should pay taxes. Mark Zuckerberg recently warned the graduating class at Harvard University that, “Our generation will have to deal with tens of millions of jobs replaced by automation like self-driving cars and trucks.” Elon Musk has joined the ranks of industrialists in favor of guaranteed minimum income, which he says will be necessitated by automation.
It isn’t just industry leaders who are aware of the problems automation poses. This year the EU … Read more
Recently in In re Cyan, Inc. Stockholders Litigation, the Delaware Court of Chancery dismissed a fiduciary duty claim and a request for a quasi-appraisal remedy in connection with the acquisition of Cyan, Inc. by Ciena Corporation. Relying on principles of existing Delaware case law, the court held that the business judgment rule applied to the Cyan board’s decision to approve the mostly stock-for-stock merger, a holding further reinforced under the doctrine set forth in Corwin v. KKR Financial Holdings LLC because Cyan shareholders had voted to approve the deal. The shareholders alleged numerous board conflicts (including that certain directors were … Read more
The 2008 financial crisis was catastrophic for the U.S. banking industry. Between 2007 and 2014, 510 banks failed. Another 700-plus banks received some type of federal monetary assistance. Unsurprisingly, this led to calls to hold bank directors and officers legally accountable for harm they may have caused.
One federal regulator with the power to hold directors and officers of failed banks financially responsible is the Federal Deposit Insurance Corporation (FDIC). The FDIC acts as a receiver for failed banks. It has authority to sue directors and officers for losses they caused to failed banks and has been aggressive in doing … Read more
The Brexit vote and President Donald Trump’s election and proposed regulatory and other reforms have led to worldwide geopolitical uncertainty. We expect reporting companies will continue to disclose risk factors relating to these events in their quarterly and annual filings in the foreseeable future.
We previously examined the Form 10-Q quarterly reports of public reporting companies registered with the U.S. Securities and Exchange Commission (SEC) that were filed after the Brexit referendum on June 23, 2016, through August 31, 2016 (the Initial Analysis). (See our October 3, 2016, client alert “SEC Disclosure Brexit Trends.”) In that analysis, we … Read more
Bankruptcy law has evolved over the centuries as an orderly way to deal with dying firms. However, during the recent recession, many policy experts, officials, and legislators advocated sidestepping the bankruptcy process and resorting to so-called bailouts.
Bailouts have been praised for reducing systemic risk and transforming failed firms into going concerns. Alan Krueger and Austan Goolsbee expressed that view in their paper, “A Retrospective Look at Rescuing and Restructuring General Motors and Chrysler.” However, in our recent paper, “Bankruptcies, Bailouts, and Some Political Economy of Corporate Reorganization,” we argue that defending bailouts on the grounds that they transform dead … Read more
In a new research paper, we consider the impact of a group of new entrants into financial services and regulation. These new entrants include technology, e-commerce, social media, and telecommunications companies with often large pre-existing bases of non-financial services customers. These firms (loosely termed “TechFins”) may be characterized by their capacity to leverage data gathered in their primary businesses into financial services by the use of Big Data analytics, machine learning, and artificial intelligence. Initially they often act as conduits linking their customers to regulated financial firms.
China’s Alibaba with its subsidiary Ant Financial is the frontrunner, and its founder, … Read more
The U.S. Department of Labor’s (DOL) final rule significantly expanding when a person is considered to be a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (Code) as a result of providing investment advice is set to become applicable at 11:59 PM (local time) on June 9, 2017. The expanded final rule might cover certain marketing and other related activities common to the investment management industry (including the private investment fund industry).
The final rule was initially set to become applicable on April 10, 2017, but the DOL delayed the final rule’s … Read more
Much has been written about U.S. Supreme Court Justice Antonin Scalia’s interpretive philosophy and his overall impact on the law. But surprisingly little attention has been paid to his contributions to modern bankruptcy law.
In an article about Justice Scalia’s legacy, I argue that bankruptcy law is a prime area in which to develop and refine Scalia-centric debates about the proper interaction between the judicial and legislative branches. The complex and lengthy Bankruptcy Code reliably produces a dazzling array of interpretive questions for courts to resolve. Meanwhile, the absence of any intermediate force to channel interpretation (such as an administrative … Read more
I want to thank Neel Kashkari for launching the Opportunity and Inclusive Growth Institute and for inviting me to join the deliberations of this distinguished group today [May 22]. This new Institute is another great example of how individual Reserve Banks are taking the initiative in illuminating key dimensions of our work and shaping the agenda of the Federal Reserve System.1
While it has long been understood that opportunity is central to the strength of America’s social fabric, it is now increasingly clear that opportunity and inclusion are central to the strength of America’s economy. I will touch on … Read more
Law is full of vague standards, legally relevant facts are frequently unclear, sanctions and damages are often uncertain, and the likelihood of detection is rarely known precisely. In our forthcoming paper, we ask how these sources of uncertainty, common in any legal system, affect the utility of risk-neutral actors such as business firms. We conclude that the answer depends on the source of uncertainty and the specifics of the enforcement environment.
Our most consequential finding is that an increase in legal or factual uncertainty harms firms when enforcement is targeted, meaning that greater deviations from what the law demands lead … Read more
In 2001, hedge fund manager Cliff Asness co-wrote a famous paper, Do Hedge Funds Hedge?1 Sixteen years later, amid significant changes in the industry, it’s worth asking, Are hedge funds worth as much as they say they are? And what explains the expectation, as reported by Preqin,2 that outflows from hedge funds will continue in 2017 (I suspect either performance-related or cost-related issues, or both)?
Using the CSFB/Tremont Hedge Fund Index’s monthly returns from January 1994 to January 2014,3 I conducted a study similar to the one described in Asness’s paper. I tried to determine whether hedge … Read more
Previous research on shareholder voting has placed most of the emphasis on the role of institutional shareholders. In our recent study, however, we provide evidence that managers strategically rely on the support offered by retail shareholders to ensure that their agenda passes and to communicate strong overall shareholder support during times of poor performance.
Our study is designed around the introduction of electronic proxy delivery. In 2007, the Securities and Exchange Commission (SEC) implemented rules allowing for electronic delivery of proxy materials. The revised system allows firms to choose between the traditional, mailed “full-set delivery” of proxy materials and the … Read more
The news media are an important source of information for the U.S. capital markets, especially when drawing attention to questionable behavior of corporate executives. Coverage can, however, pressure companies into making dubious financial decisions like emphasizing short-term earnings over long-term value. In our recent article, we explore the effect of media coverage on earnings management to shed light on the media’s role in the U.S. capital markets.
Earnings management is the use of accounting techniques to produce financial reports that misstate a firm’s business performance and financial position. There are two main mechanisms through which managers manipulate earnings: accrual-based and … Read more
The U.S. Supreme Court will soon decide an unusual, yet important, case brought by investors in bonds issued by Lehman Brothers, the infamous investment bank that collapsed in September 2008. The case, CalPERS v. ANZ Securities, Inc., is not about whether those investors were defrauded: It is widely known that Lehman concealed its exposure to subprime mortgage loans and complex derivatives, just as it used accounting gimmicks to hide risks. The investigation after Lehman’s bankruptcy showed incontrovertibly that its investors had been wronged.
Nor is the case about whether those investors could properly recover in class action litigation alleging … Read more
In In re Massey Energy Company Derivative and Class Action Litigation, the Delaware Court of Chancery recently dismissed shareholders’ derivative and putative direct claims alleging that Massey’s former directors and officers caused the company to willfully disregard safety regulations. Despite finding that shareholders had stated a “viable” claim that the directors had breached their duty of oversight under In re Caremark International, Inc. Derivative Litigation – claims that are difficult to plead successfully – the court found that they nevertheless lacked standing because they no longer held shares of the corporation due to an intervening merger.
In April … Read more
Tax regulators and acquisition sponsors have long been embroiled in a cat and mouse game in the context of corporate inversions—cross-border transactions in which a U.S.-incorporated public corporation is “acquired” by a foreign entity, and the survivor’s locus of incorporation moved out of the United States. If done in compliance with applicable tax regulations, inversions typically allow American targets to avoid high U.S. corporate tax rates on worldwide income, and make use instead of far lower tax rates applied only to income generated within the survivor’s destination jurisdiction.
As tax inversions grew in popularity, federal authorities responded with a gauntlet … Read more
After a period of public consultation, the European Central Bank (the “ECB”) published its final Guidance on Leveraged Transactions (the “Guidance”) on May 16, 2017. Twenty-four organisations (comprising credit institutions and market associations) commented directly on the ECB’s draft guidance. Most comments focused on ensuring consistency between the ECB’s Guidance and the 2013 Interagency Guidance on Leveraged Lending in the US (the “US Guidance”) and ensuring market viability in Europe. We wrote about potential issues raised by the ECB’s draft guidance in our last briefing; here, we discuss the most relevant changes that made the final … Read more
Delaware has reigned as the preeminent corporate law jurisdiction in the United States for over a century, weathering the rivalry of eager state competitors (such as Maryland and Nevada) and the looming presence of – and occasional intervention by – the federal government. Various explanations have been provided as to why Delaware continues to dominate. And various assessments have been offered as to whether, overall, Delaware’s corporate law jurisprudence is beneficial or detrimental for investors. These explanations and assessments typically focus on what Delaware has done well over the years to retain its supremacy, not on what, deliberately or fortuitously, … Read more
Delaware law provides important tools for directors to maintain control of derivative lawsuits.1 One such tool is the “demand requirement” embodied in Court of Chancery Rule 23.1, which requires that before a stockholder acts on behalf of the corporation, the stockholder must either demand that the board take action or establish that demand would be futile. The seminal opinion of the Delaware Supreme Court in Aronson v. Lewis established the test used by Delaware courts in determining whether a plaintiff stockholder’s demand would have been futile: Has the plaintiff stockholder seeking to proceed with a claim on behalf of … Read more
Notwithstanding decidedly hostile testimony last month from this humble columnist, the U.S. House of Representatives will soon pass legislation (probably on a strict party-line basis) entitled, “The Financial CHOICE Act of 2017” (H.R. 10) (which acronym stands for “Creating Hope and Optimism for Investors, Corporations, and Entrepreneurs”). Despite this cutesy and innocuous title, the CHOICE Act proposes dangerous and radical surgery that would gut those provisions of the Dodd-Frank Act that seek to prevent the failure of a single major bank from setting off a chain reaction that could bring down all interconnected banks. Indeed, the Act reads as … Read more
Global M&A activity in April 2017 declined by most measures from its March 2017 level, while the U.S. showed more mixed results. Globally, total deal volume, as measured by dollar value, decreased by 16.6% to $253.91 billion, whereas in the U.S., a large increase in average deal size led to a 58.4% increase in total dollar volume to $108.11 billion. The increase in U.S. volume came despite a 27.1% decrease in number of deals to 669, similar to the global decrease of 25.3% to 2,708 (a new 12-month low for number of deals globally).
Strategic vs. Sponsor Activity
Strategic activity … Read more
Corporations have been making news recently with repeated violations of the law. In some cases, such as financial services, the violations have occurred across large segments of an industry. Enforcement officials have imposed billions of dollars in sanctions against all the major U.S. financial institutions and many foreign ones as well. The large sanctions are the result of findings of recurring violations of law as well as recidivism. Why have regulatory standards and enforcement policies led to repeated violations? Will the recent billion dollar sanctions deter future wrongdoing? In my recent article, Corporate Wrongdoing: Interactions of Legal Mandates and … Read more
Society imposes legal requirements on businesses (issuers) when they offer or sell their securities to investors. These rules governing capital formation are generated both at the federal and state levels. State securities rules are generally referred to as “state blue sky laws.”
Both the federal rules and state blue sky laws contain antifraud provisions, which prohibit issuers that offer or sell their securities to investors from engaging in manipulative or deceptive acts. Federal and state rules also contain registration rules, which typically require issuers to provide closely prescribed investment information to designated state and federal governmental agencies (the Securities … Read more
Republicans on the House Financial Services Committee, led by Chairman Jeb Hensarling (R-TX), approved their “Financial CHOICE Act” (FCA) legislation on a party-line 34-26 vote on May 4, clearing the way for consideration on the House floor in the coming weeks. The Committee held this vote following a marathon three-day markup session that saw Committee Republicans defeat numerous Democratic amendments and other delaying tactics. The markup session was a clearly partisan affair that is indicative of the bill’s uncertain future in the closely divided Senate.
The bill, numbered H.R. 10, would make major, comprehensive changes to the Dodd-Frank Wall Street … Read more
In my recent paper, Tax Avoidance, Income Diversion, and Shareholder Value: Evidence from a Quasi-Natural Experiment, I examine how the interaction between the corporate tax system and corporate governance affects firm value. To this end, I empirically investigate two main questions. First, do investors value corporate tax avoidance? I find that, on average, they do. Second, does the corporate tax system (which includes both taxes and tax enforcement) affect the level of income diversion? I find that market reactions suggest that higher tax rates can erode good corporate governance by increasing the return from income diversion, and that stricter … Read more