As is well known, a key feature of the Dodd-Frank Act is the effort to treat swaps more like commodities. In particular, large categories of swaps are to be centrally cleared, replacing the pre-Lehman OTC model with a commodities model that has worked reasonably well for decades.
But the result is to massively increase the importance of the clearinghouses in the global financial system. Clearinghouses are regulated, but given the vital place of clearinghouses in Dodd-Frank, it is surprising that Dodd-Frank makes no clear provision for the failure of a clearinghouse.
Given the key role that clearinghouses will play in … Read more
Group bankruptcies tend to be large (e.g., Global Crossing, Maxwell, MG Rover, Parmalat) and affect a significant number of stakeholders. Business groups constitute a common way for ultimate owners to exercise control over a large number of companies while containing their risk exposure to different parts of the business through limited liability. In countries with underdeveloped financial infrastructures, business groups overcome difficulties in accessing external finance by reshuffling funds within the corporate structure. The bankruptcy of business groups can be extremely complex, especially if the group’s assets are spread over multiple jurisdictions. The nature of business group structure and operations … Read more
The U.S. Court of Appeals for the District of Columbia Circuit held that federal District Courts do not have subject-matter jurisdiction to entertain challenges to ongoing SEC administrative enforcement proceedings. A party to a pending administrative proceeding must defend against that proceeding and then seek review from the SEC Commissioners and, eventually, the federal appellate courts.
The D.C. Circuit’s decision in Jarkesy v. SEC follows the Seventh Circuit’s August 2015 decision in Bebo v. SEC in rejecting preemptive constitutional attacks on pending SEC administrative proceedings. In a potentially significant sentence, however, the D.C. Circuit observed that “[t]he result might be … Read more
Accredited investors are eligible to participate in unregistered securities offerings such as private equity, venture capital and hedge fund private placements under the SEC’s Regulation D. Based on current SEC Rule 501, an individual investor is qualified as an accredited investor if he has an annual income over $200,000 ($300,000 for a married couple) or a net worth over $1 million excluding primary residence.
The purpose of SEC Regulation D is to preserve a balance between investor protection and capital formation. Exempting some securities issuers from registration and disclosure requirements provides easier access to outside capital by reducing transaction costs … Read more
In an important ruling last week, the Delaware Supreme Court reaffirmed that control of Delaware companies lies in the boardroom and held that the deferential business judgment rule is the “appropriate standard of review for a post-closing damages action” when a third-party merger “has been approved by a fully informed, uncoerced majority of the disinterested stockholders.” Corwin v. KKR Fin. Holdings LLC, No. 629, 2014 (Del. Oct. 2, 2015) (en banc).
The ruling affirms the Court of Chancery’s dismissal of a case challenging KKR’s $2.6 billion acquisition of KKR Financial Holdings LLC (“KFN”), about which we previously wrote. … Read more
Thank you to the organizers and BIS for the opportunity to address this research conference on “Global Financial Interconnectedness.” The OFR was established to identify, monitor, and assess threats to financial stability, so improving our collective understanding of the interconnectedness of the global financial system is essential for achieving the OFR mission.
The financial crisis exposed critical gaps in our analysis and understanding of the financial system, in the data used to measure and monitor financial activities, and in the policy tools available to mitigate potential threats to financial stability. These gaps in analysis, data, and policy tools contributed to … Read more
The enforcement program at the Securities and Exchange Commission has been the subject of severe criticism in recent years, and occasional changes to the system have not begun to root out the deeper, structural defects in the investigation and charging process at the SEC. Reforms going to the essence of the way the Division of Enforcement operates are needed.
The three fundamental problems with SEC enforcement are that the Commission and the Division of Enforcement (1) advance legal theories that are outside settled boundaries, (2) misunderstand or mischaracterize the factual record, and (3) fail to accord fair and impartial treatment … Read more
On September 24, 2015, the U.S. District Court for the Northern District of Ohio denied the Federal Trade Commission’s (“FTC”) motion for a preliminary injunction to prevent the merger of Steris Corporation (“Steris”) and Synergy Health plc (“Synergy”), two providers of sterilization services for manufacturers predominantly in the healthcare industry. Merger cases are rarely litigated, and the decision marks the first trial defeat in recent years for either of the U.S. antitrust agencies (the FTC and the Antitrust Division of the U.S. Department of Justice (collectively, the “Agencies”)), each of which has been successful in its active approach towards … Read more
Levying record-breaking fines and other punishments, government regulators have maintained a sharp enforcement focus over the past decade on banks and other financial institutions as potential enablers of money laundering activity. The complex web of existing AML laws and accompanying regulations require these institutions to monitor their operations for potential money laundering activity and report suspicious transactions and other customer behavior to government agencies. Consequences for violating AML laws could be disastrous for many institutions, as they may face crippling criminal and civil penalties for facilitating money laundering or for failing to monitor their operations properly for possible money laundering … Read more
Last week, a federal district court judge in New York overseeing several multidistrict litigation (“MDL”) proceedings dismissed all claims against Barclays PLC, Barclays Capital Inc., and several major U.S. stock exchanges (the “Exchanges”), including NASDAQ, the New York Stock Exchange, BATS Global Markets, and the Chicago Stock Exchange, brought by pension funds and other investors accusing the Exchanges of manipulation and other market abuse in connection with high frequency trading (“HFT”). This alert briefly analyses the court’s decision in In re: Barclays Liquidity Cross and High Frequency Trading Litigation and other recent legal developments relating to HFT in the U.S. … Read more
It is confounding that futures customers currently receive a lower level of protection than cleared swaps customers under US law. This legal phenomenon has occurred because the law in the US derivatives markets developed in a piecemeal fashion over several decades.
The Commodity Exchange Act (“CEA”) was designed to include protections for the collateral (known as margin) that futures customers post with their Futures Commission Merchants (“FCM”). Section 4d (a) contains a ‘segregation requirement’, which places the margin of a futures customer into a trust account. This prohibits an FCM from “using” a customer’s margin for its own purposes … Read more
The tradeoffs between facilitating private contracting or imposing a one-size-fits-all solution by regulatory mandate are often unclear. In the field of corporate governance, predicting which approach would be more efficient is particularly complicated. Because the optimal level of shareholder rights may vary across firms, a universal public mandate may be a blunt solution when compared to private contracting. On the other hand, agency problems may impede private market forces, as when entrenched boards resist changes desired by shareholders.
In our new working paper, “Public versus Private Provision of Governance: The Case of Proxy Access,” we study a unique … Read more
Incomplete contracting theories build on the idea that it is either not feasible or too costly for contracting parties such as borrowers and lenders to write contracts that perfectly anticipate all future scenarios. As a result, transacting parties are left exposed to the risk that they might face a costly future renegotiation. This expectation can in turn lead to inefficiencies in terms of investment or other value-enhancing corporate decisions. Despite the widespread use of incomplete contracting theories, few if any empirical studies have directly examined the extent to which future renegotiation considerations affect debt contract structures. My paper contributes to … Read more
On September 22, 2015, the US Securities and Exchange Commission (“SEC”) brought and settled charges against a registered investment adviser (the “RIA”) for violations of the Gramm-Leach-Bliley Act’s “safeguards rule” adopted under Regulation S-P.1 These violations occurred immediately prior to a cybersecurity breach of the RIA’s systems, in which the hackers may have obtained personally identifiable information (“PII”) of 100,000 individuals.
In 2000, the SEC adopted the safeguards rule as part of Reg. S-P, which requires that every investment adviser registered with the Commission adopt policies and procedures reasonably designed to: (i) ensure the security and confidentiality of customer … Read more
Our paper titled “Staggered Boards and Private Benefits of Control” adds a new perspective to the ongoing debate about whether staggered (or classified) boards of directors lead to entrenchment. The novelty of the paper is focusing directly on private benefits of control by taking advantage of a new market-based measure of the value of voting rights, which is interpreted as a lower bound for private benefits.
In a firm with a staggered board, only a fraction (usually one-third) of the board members are up for election at an annual shareholder meeting. Thus staggered boards provide a potent anti-takeover … Read more
On September 9, 2015, the Department of Justice (“DOJ”) issued a new policy memorandum, signed by Deputy Attorney General Sally Yates, regarding the prosecution of individuals in corporate fraud cases—“Individual Accountability for Corporate Wrongdoing” (“the Yates Memorandum”).
The Yates Memorandum has been heralded as a sign of a new resolve at DOJ, and follows a series of public statements made by DOJ officials indicating that they intend to adopt a more severe posture towards “flesh-and-blood” corporate criminals, not just corporate entities. Furthermore, the Yates Memorandum formalizes six guidelines that are intended “to strengthen [DOJ’s] pursuit of corporate wrongdoing.”
Though much … Read more
Takeover disputes can be fiercely contested. Given this, there is an important question about the forum for these disputes. Traditionally, takeover disputes were resolved by the courts. However, in recent years, there has been a trend to have these disputes resolved by Takeovers Panels. The countries with these Panels include Australia, the United Kingdom, Hong Kong, Singapore, India, Ireland, New Zealand, Switzerland and South Africa.
Takeover dispute resolution in the United States is undertaken by the courts. According to Cornerstone Research, in 2014, 93% of all mergers and acquisitions deals in the United States valued at over US$100 million were … Read more
On August 25, 2015, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) proposed a rule that would subject investment advisers that are registered with the U.S. Securities and Exchange Commission (SEC) to certain formal anti-money laundering (AML) compliance program and reporting requirements. The proposed rule seeks to expand the Bank Secrecy Act’s (BSA) definition of financial institutions to cover investment advisers. Currently, the AML compliance rules apply to entities such as banks and broker-dealers, but not to investment advisers and private funds. As a result, the adoption of the proposed rule would have three primary effects, requiring investment advisers to: … Read more
The September 9 Department of Justice release of guidelines on corporate prosecution is a significant development that should be taken seriously by governing boards across industry sectors. The new guidelines, with their substantially increased focus on individual accountability, will likely affect the board’s approach to legal compliance, internal investigations and interaction with management on matters of regulatory concern. An attentive, yet measured response would be consistent with the board’s fiduciary duty of care.
The guidance, presented in the form of a memo to federal prosecutors from Deputy Attorney General Sally Quillan Yates, concentrates on seeking individual accountability for corporate wrongdoing. … Read more
The European insurance sector has approximately 6.8 trillion euros of assets under management. It is the largest European institutional investor, a fundamental element of financial stability and provides support for the global economy. Additionally, the European insurance sector is a significant source of jobs, providing employment for more than one million people. The chart below illustrates the share of GDP represented by insurance premiums, generally defined as penetration ratios.
What is Solvency II?
The Solvency II Directive is a set of regulatory requirements for the European insurance industry. Adopted in 2009, the Directive was slated to take effect … Read more
Both parties to a complex financial instrument are likely to be sophisticated – this has led many to wonder why complex financial products need to be regulated at all. However, when the stability of the financial system is at stake, the parties to the transaction shouldn’t be the primary focus. Policymakers should instead be concerned with the externalities that complex financial products can generate for third parties.
Financial innovation – the process by which financial institutions develop new and complex financial products – increases the complexity of the financial system. Complexity is a destabilizing force: not only does complexity make … Read more
On September 10, 2015, a divided panel of the Second Circuit issued an opinion in Berman v. Neo@Ogilvy LLC, No. 14-4626 (2nd Cir. Sept. 10, 2015), creating a split with the Fifth Circuit on an issue that has also divided lower federal courts: whether the anti-retaliation provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act apply to tipsters who claim retaliation after reporting internally, or only to those retaliated against after reporting information to the SEC. The Second Circuit, granting Chevron deference to SEC interpretive guidance, held that Dodd-Frank protections apply to internal whistleblowers. This … Read more
Four years ago, the SEC set out to improve its cost-benefit approach in rulemaking. After enduring a series of judicial setbacks (e.g., Business Roundtable v. SEC) and criticisms from the Members of the Senate Banking Committee, the SEC conducted an introspective review to identify weaknesses and inconsistencies in its economic analysis process. This assessment resulted in the March 2012 publication of a memorandum (hereafter, the ‘New Guidance’) that formulates how the SEC would conduct cost-benefit analysis moving forward.
The New Guidance mandates that every SEC economic analysis must include: (i) a stated need for rulemaking; (ii) a well-defined … Read more
Local governments in the United States have long relied on special assessments to fund the provision of goods and services. The assessment is a halfway house between the ad-valorem property tax that pays for public goods, such as schools or highways, and an individual charge or fee for service that pays for individual goods, such as for sewerage or electricity; they are parcel taxes levied on neighborhoods for club goods, such as park construction or street lighting. In many locales, parcel taxes depend not on the value of a property but instead are proportional to the expected benefit that … Read more
Fair Value Accounting is arguably the most controversial financial reporting topic debated over the past decade. Conceptually, the idea behind fair value accounting is appealing: if a Balance Sheet is dated as of December 31, 2015, then all of the items reported on that report should be valued as of that same day. After all, the objective of the Balance Sheet is to provide a “snapshot” of the makeup of the firm – its assets and whether these are financed by debt or equity – at a point in time. With this objective, why not value these components at their … Read more
From the 2013 Target Corporation breach to this year’s attacks on Primera Blue Cross and American Airlines Group Inc., the issue of cybersecurity has emerged at the forefront of risks to be confronted by corporations across a spectrum of industries.1 Given the catastrophic risks and consequences that have emerged from recent cyberattacks and the litigation, regulatory, and enforcement trends that are driving the evolution of relevant legal standards, both senior executives and directors should be proactive in their oversight and monitoring of the implementation and continued refinement of their company’s cybersecurity controls and processes.
I. Government Enforcement and Regulatory … Read more
Washington is a strange town! The more you succeed, the more you attract enemies. If you outperform all prior occupants of your office, behave like a model gentleman, and achieve what no one thought possible, that will make you a political target, and, worse yet, attract the neurotic envy of all those you have outshone. If one individual among all U.S. financial regulators has earned world-wide respect in recent years—both for his brains and diplomacy—, it has been James R. Doty, Chair of the Public Company Accounting Oversight Board (“PCAOB”). Guess what that means?
Yes, no good deed goes … Read more
The SEC recently fined Bank of New York Mellon (“BNY Mellon”) nearly $15 million for allegedly violating provisions of the Foreign Corrupt Practices Act (“FCPA”) by providing student internships to family members of foreign government officials in the Middle East.
Importantly, several other banks have publicly disclosed investigations into similar conduct.[i] It is unclear whether those banks will be subject to public enforcement action by the SEC, but there are certainly lessons to be learned from these investigations that apply far beyond the banking industry.
Important Facts Noted by the SEC in the BNY Mellon Order
- The bank, without admitting
… Read more
Over the past 15 years expectations for board risk oversight have skyrocketed. In 2002 the Sarbanes-Oxley Act put the spotlight on board oversight of financial reporting. The 2008 global financial crisis focused regulatory attention on the need to improve board oversight of what is increasingly being referred to as management’s “risk appetite and tolerance.” In the wake of a number of high-profile personal data breaches, questions are being asked about board oversight of cyber-security, the newest risk threatening long term success of companies. Most recently, boards, particularly boards in the financial services sector, are being called on to actively … Read more
What does it mean to win a case in the Supreme Court? A perfectly good explanation is looking at the party that prevails on the merits. But winning on the merits encapsulates only a small portion of the fruits of a Supreme Court litigator’s labor. In a recent article I wrote entitled, Who Wins In the Supreme Court? An Examination of Attorney and Law Firm Influence, I argue that the most significant gains are made in shaping the language of the law. How does this work? A clear example I provide in the paper comes from Steiner v. … Read more
The Supreme Court’s protection of corporate political expenditures in Citizens United v. FEC and corporate religious exercise in Burwell v. Hobby Lobby has rekindled perennial fears about the influence of corporations in U.S. politics and policy. One popular response has been to argue for stripping corporations of constitutional rights. For example, the proposed “People’s Rights Amendment” would exclude corporations from the categories of “people, person, or citizen as used in this Constitution,” thus denying corporations the constitutional rights of human individuals.
Unfortunately, denying corporate constitutional rights is unlikely to have much effect. Insofar as the Supreme Court has protected … Read more
The Federal Trade Commission’s longstanding effort to establish itself as the primary federal regulator of cybersecurity survived its first appellate test on Monday when the Third Circuit allowed the FTC to continue pursuing its case against Wyndham Worldwide Corp. The FTC sued Wyndham after the hotelier suffered three data breaches that allegedly compromised the payment card information of more than 600,000 customers. The FTC alleged, among other things, that Wyndham’s failure to use encryption, firewalls, and non-obvious passwords constituted an “unfair” practice under Section 5 of the FTC Act. The district court denied Wyndham’s motion to dismiss the FTC’s case, … Read more
The Treasury Department and the Internal Revenue Service have announced (in Notice 2015-59) that they are studying issues related to the qualification of certain corporate distributions as tax-free under Section 355 of the Internal Revenue Code in situations involving substantial investment assets, reliance on relatively small active businesses, and REIT conversions. The IRS concurrently issued related guidance (Rev. Proc. 2015-43), adding such transactions to its ever-expanding list of areas on which it will not issue private letter rulings. While this expansion of the IRS’s “no-rule” areas is not a statement of substantive law, these announcements may have … Read more
The question of whether corporate law affects firm value has been a long-standing debate. Some believe corporate laws are trivial and have no effect on firm value, but the dominant view argues that corporate laws do affect firm value. Scholars assume that states are competing for incorporations, and market forces lead states to devote different resources to resolving corporate disputes. Theory predicts that when corporate law increases investor protection and reduces agency costs, it will increase firm value. Alternatively, when corporate law caters to management and relaxes rules on investor protection, it should increase agency costs and reduce firm value.… Read more
In a networked and digital age, we need to rethink the structure of the modern corporation. In order to survive and grow, corporations must operate with a new set of assumptions and principles in order to remain relevant, competitive, and successful. Consider the growing number of technology startup companies that are doing something that once seemed unthinkable: challenging and disrupting traditional corporate giants. Even the behemoths that operate in industries that traditionally were not viewed as technology-related industries have not been spared from the impact of new arrivals and the resulting transformation in the business environment. With the rise of … Read more
Recent provocative evidence suggests that a board’s decision to remove a CEO from office is influenced by components of firm performance that have little to do with the CEO’s efforts or abilities. In particular, several authors have suggested that boards do not appropriately filter out industry performance measures when making CEO dismissal decisions. This evidence raises the alarming possibility that a substantial number of highly talented CEOs are removed from office for bad luck, while others are inefficiently retained because of good luck. The value loss from these types of inefficient removal decisions could be quite substantial if CEO talent … Read more
Since the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”) expanded the authority of the Securities and Exchange Commission (“SEC”) to seek civil penalties through administrative proceedings,1 the SEC has brought, as one court observed, “an ever increasing number of enforcement actions within its own administrative scheme, rather than in federal court.”2 In 2014, for instance, the SEC initiated 43% of its litigated actions as administrative proceedings.3 This shift may be due, at least in part, to the reported advantage the SEC enjoys before its own Administrative Law Judges (“ALJs”). From October 2010 through … Read more
Companies tell us they buy back stock because it is undervalued. The data, however, tells a different story.
Buybacks peaked in 2007 at $589 billion—the best time to sell. And then fell to $138 billion in 2009—the best time to buy.
More than 460 of the 500 companies that make up the S&P index bought back stock over the past decade. It is hard to believe that public companies are systemically undervalued. Much less 92% of the S&P 500.
If companies aren’t undervalued, why do they buy back stock? Taxes.
Buybacks and dividends accomplish the same goal. Both distribute cash … Read more
The US Department of Justice (DOJ) is creating a new compliance counsel position in the Criminal Division to assess the effectiveness of an entity’s compliance program and help prosecutors decide whether or how to charge an entity under investigation. Public statements from Chief of the Criminal Division’s Fraud Section Andrew Weissmann suggest that the new compliance counsel position’s purpose is to help prosecutors distinguish between effective compliance programs and “paper” programs. The compliance counsel will also provide companies with greater clarity and guidance about the DOJ’s expectations for compliance programs. The DOJ is reportedly vetting a former prosecutor with private … Read more
Crown jewel lock-up options, a deal protection device common during the 1980s mergers and acquisitions boom, are back. My forthcoming paper, Fleecing the Family Jewels, is the first scholarly paper to examine the reemergence of crown jewel lock-ups in M&A transactions and to compare recent lock-ups to those used in the 1980s.
Crown jewel lock-ups became popular in the 1980s, a period which saw a significant number of hostile transactions. Lock-ups were defense du jour – employed to deter hostile bidders. These lock-ups took the form of agreements between a target company and a buyer pursuant to which … Read more
As the struggle for corporate control between advocates for long-term, sustainable economic growth and promoters of short-term financial performance rages on, we thought it made sense to highlight the point at which this battle manifests itself most frequently in discussions of executive pay: the selection of performance goals in incentive compensation programs. Specifically, we wanted to call attention to the brewing debate over the use of earnings per share and similar goals (EPS) in performance-based pay programs.
For many good reasons, EPS is among the most common financial performance metrics used by public companies in their incentive compensation programs. First, … Read more
In an administrative enforcement case called Flannery, a bare majority of SEC Commissioners adopted broad positions on primary liability under parts of the two main anti-fraud provisions in the securities laws, Rule 10b-5(a) and (c) and Section 17(a)(1), (2), and (3). The Commission not only advanced expansive legal conclusions, but it also insisted that the courts accept the agency’s legal interpretations as controlling.
The SEC’s decision in Flannery raises thought-provoking issues about the role of administrative agencies in the development, enforcement, and adjudication of federal law. In my comment on the decision, which is publicly available on SSRN, … Read more
The high-risk business model of large financial conglomerates (frequently called “universal banks”) was an important cause of the financial crisis. Universal banks rely on cheap funding from deposits and shadow banking liabilities to finance their speculative activities in the capital markets. By combining deposit-taking and short-term borrowing with underwriting, market making, and trading in securities and derivatives, the universal banking model creates a strong likelihood that serious problems occurring in one sector of the financial industry will spread to other sectors. To prevent such contagion, federal regulators have powerful incentives to bail out universal banks and protect all of their … Read more
What unites Atlantic City, the Chicago Public School System, and Puerto Rico’s electric company? They are financially distressed government entities facing various legal and political barriers to using the United States bankruptcy system. Negotiations over those barriers are, in part, a referendum on the historic Detroit chapter 9 case – not just the substantive outcome, but the procedural pathway constructed by the court from the case’s inception to the finish line.
Detroit was a game changer in understanding the federal court’s influence through management decisions rather than landmark rulings after trials. According to the conventional wisdom, judges perform primarily gatekeeping … Read more
Not surprisingly, cognitive abilities predict many economic and social outcomes such as salary, job complexity, or success in investment decisions. What is surprising, however, is that almost all auditing research analyzing archival data on audit outcomes has assumed that all auditors are equally good at their work. This assumption is especially surprising because auditing involves a great deal of subjective judgments and decisions. Auditors assess various economic estimates that are subject to uncertainty arising from difficulty to predict the outcome of future events. Auditors moreover design and implement tests to evaluate the likelihood of errors in financial reporting.
In our … Read more
Does the Dodd-Frank Act lower the earnings of the private fund industry? For much of its history, the private fund industry has viewed private fund adviser registration and the disclosure of proprietary information as a threat to its profitability. Title IV of the Dodd-Frank Act introduced the most significant regulatory change in the history of the private fund industry in the United States – requiring mandatory registration for private fund managers with over $150 million in assets under management and increasing the disclosure requirements pertaining to confidential and proprietary information. Implemented under Title IV, the controversial disclosure obligations in Form … Read more
On July 1, 2015, the Securities and Exchange Commission issued a concept release seeking public comment on possible revisions to audit committee disclosure requirements, focused primarily on audit committee oversight of independent auditors. The concept release is available here. Comments are due no later than September 8, 2015.
At the July 1 open meeting, SEC Chair Mary Jo White noted that “effective audit committee oversight is essential to investor protection and the functioning of our capital markets.” The concept release follows this statement and requests public comment on four primary topics: (i) audit committee oversight of independent auditors, (ii) … Read more