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Securities Regulation

The Problematic Role of Computer Code in Initial Coin Offerings

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The Initial Coin Offering (ICO) is one of the stranger financial innovations in recent memory. Imagine if Coca-Cola had funded its initial deployment of vending machines through the sale of tokens its machines might one day require. Now replace soda and physical tokens with software-based services and digital (“crypto”) assets. This scenario roughly captures the ICO. If you believe what you read on social media, you might get the impression the ICO form is revolutionary—a “1000x improvement over the status quo,” as one observer put it. But if you trust the Wall Street Journal, you might think the ICO … Read more

Gibson Dunn Offers 2018 Mid-Year Update on Securities Litigation

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The continued explosion in the number of securities class action filings is once again the big headline in our half yearly update.  The now-sustained increase in both the number of filings and average and median settlement amounts—including a five-fold increase in average settlement amounts in the first half of 2018 to $124 million from $25 million in 2017—is causing significant alarm in the securities defense bar, prompting insurance carriers and others to seek regulatory reform and explore other alternatives to reverse these trends.  The trends and critical case law updates are explored in detail below.

I. Filing and Settlement Trends

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The Power of Words: How SEC Comment Letters to Foreign Issuers Affect the Capital Markets

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In our recent paper, we find that the tone of language in Securities and Exchange Commission (SEC) comment letters after enforcement reviews has capital market implications, which are amplified or abbreviated based on the strength of a given country’s enforcement.

In the financial reporting realm, foreign firms listed on U.S. stock exchanges account for a significant percentage of market capitalization. They often attract particular scrutiny, however, because their accounting quality is weak compared with that of U.S. firms[1]. In an effort to enhance informational transparency and promote the overall compliance with U.S. reporting regulations, the SEC conducts periodic … Read more

SEC Chair Issues Statement on Proxy Process Roundtable

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Shareholder engagement is a hallmark of our public capital markets, and the proxy process is a fundamental component of that engagement. In 2010, the Commission issued a concept release seeking public comment on whether the U.S. proxy system as a whole operates with the accuracy, reliability, transparency, accountability, and integrity that shareholders and companies should expect.[1] In light of the many changes in our markets, technology, and how companies operate since then, SEC staff will host a roundtable this fall to hear from investors, issuers, and other market participants about whether the SEC’s proxy rules should be refined.

The … Read more

Is Silence Golden? Negative Effects of Mandatory Disclosure

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“When you talk, you are only repeating what you already know. But if you listen, you may learn something new.”                                                                                     – Dalai Lama XIV

Disclosure regulation is a cornerstone of modern securities markets. Its economic consequences have been extensively studied and heavily debated. A widely recognized benefit of mandatory disclosure is that it levels the playing field by publicly disclosing to everyone what is known only to sophisticated investors. This leveling reduces trading costs and consequently reduces the firm’s cost of capital.

In our recent paper, available here, we show that this reduced informational advantage of sophisticated investors is … Read more

Davis Polk Discusses Ninth Circuit Approval of Securities Suit Over Unsponsored ADRs

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On July 17, 2018, the Ninth Circuit issued an opinion in Automotive Industries Pension Trust Fund v. Toshiba Corp., No. 16-56058 (9th Cir. July 17, 2018), holding that the Supreme Court’s Morrison decision does not preclude purchasers of Toshiba’s unsponsored American Depository Shares or Receipts (“ADRs”) in the over-the-counter (“OTC”) market from maintaining securities claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 against Toshiba.  The Ninth Circuit’s decision reverses the district court’s dismissal of the securities claims under Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010).  The Ninth Circuit … Read more

Tippees and Tippers:­­ The Impact of Martoma II

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This is a column for insider trading junkies—a special breed who love all the nuances in this very nuanced subject. Late last month, a Second Circuit panel did something fairly unusual: It withdrew a 2017 decision and substituted a new opinion with a new rationale (but still with the same 2-1 division on the panel). The new decision in United States v. Martoma[1] has a less sweeping and more defensible rationale but still deviates from the law in other circuits. In addition, it has some nuances that future cases are certain to explore. Chief among these is the status … Read more

Taking Investor Preferences Seriously

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Over the last half century, finance has made remarkable progress explaining the pricing of financial assets.  In relying on portfolio theory, however, mainstream pricing models tend to ignore investor preferences for certain asset types.  This is a mistake.  In a new paper forthcoming in Harvard Business Law Review and available here, I weave recent empirical findings on the demand for “safe assets” with an institutional account of how financial intermediaries increase the effective supply of such assets to demonstrate how investor preferences can drive financial innovation and radically alter the structure of the financial system.  By moving beyond abstract … Read more

The Role of Disclosure in the Unregulated Crypto Market

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Our new research paper studies the issuers of unregulated crypto-tokens such as EOS and Tether. We examine two dimensions: the success of the Initial Coin Offering (ICO) process, and the capital market patterns following the listing of the tokens on exchanges. Specifically, we study how these issuers signal their quality to investors, and how their disclosure practices affect market quality.

Crypto-tokens are different from crypto-currencies such as Bitcoin, which serve as a medium of exchange like fiat currencies. Instead, crypto-tokens are sold by “virtual organizations” that want to raise capital for their projects through initial coin offerings (ICOs), which are … Read more

How External Whistleblower Rewards Affect Internal Reporting

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Does paying employees for blowing the whistle on corporate crime to regulators discourage internal reporting and undermine corporate governance? The answer is not as simple as it might seem. My research shows that, as the amount of reward increases, the probability of internal reporting rises at first but then falls.

The question has been discussed in countries that have introduced or contemplated the introduction of legislation to reward whistleblowers but has not yet been fully analyzed. One of the overlooked obstacles is that the standard of proof for external whistleblowing cases is higher than for cases of internal reporting, and … Read more

Latham & Watkins Discusses SEC Official’s Analysis of Digital Assets as Securities

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William Hinman, Director of the US Securities and Exchange Commission (SEC) Division of Corporation Finance, provided substantial color on the SEC’s evolving view of digital asset classification recently when he shared his thoughts on how to characterize purchases and sales of digital assets under US securities laws (the securities laws), as part of the Yahoo Finance All Markets Summit: Crypto.[1] While the headline moment occurred when he stated his belief that current transactions in Bitcoin and Ether are not securities transactions, he also laid out a framework for his reasoning that has greater implications for digital asset market … Read more

SEC Proposes Changes to Whistleblower Rule

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The Securities and Exchange Commission voted on June 28, 2018, to propose amendments to the rules governing its whistleblower program. The whistleblower program was established in 2010 to incentivize individuals to report high-quality tips to the Commission and help the agency detect wrongdoing and better protect investors and the marketplace.

The Commission’s whistleblower program has made significant contributions to the effectiveness of the agency’s enforcement of the federal securities laws.  Original information provided by whistleblowers has led to enforcement actions in which the Commission has ordered over $1.4 billion in financial remedies, including more than $740 million in disgorgement of

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SEC Adopts New Requirements on Using XBRL Reporting Language for Financial Statements

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The Securities and Exchange Commission voted on June 28, 2018, to adopt amendments to eXtensible Business Reporting Language (XBRL) requirements for operating companies and funds.  The amendments are intended to improve the quality and accessibility of XBRL data.

The amendments, which will go into effect in phases, require the use of Inline XBRL for financial statement information and risk/return summaries.  Inline XBRL has the potential to benefit investors and other market participants while decreasing, over time, the cost of preparing information for submission to the Commission.  The amendments also eliminate the requirements for operating companies and funds to post XBRL

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SEC Updates Definition of “Smaller Reporting Companies”

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The Securities and Exchange Commission voted on June 28, 2018, to adopt amendments to the “smaller reporting company” (SRC) definition to expand the number of companies that qualify for certain existing scaled disclosure accommodations.

“I want our public capital markets to be a place where smaller companies can thrive and thereby provide our Main Street investors with more access to investing options where our public company disclosure rules and protections apply,” said SEC Chairman Jay Clayton.  “Expanding the smaller reporting company definition recognizes that a one size regulatory structure for public companies does not fit all.  These amendments to the

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SEC Proposes New Approval Process for Exchange Traded Funds

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The Securities and Exchange Commission voted on June 28, 2018, to propose a new rule and form amendments intended to modernize the regulatory framework for exchange-traded funds (ETFs), by establishing a clear and consistent framework for the vast majority of ETFs operating today.  ETFs that satisfy certain conditions would be able to operate within the scope of the Investment Company Act of 1940 and to come to market without applying for individual exemptive orders.  The proposal would therefore facilitate greater competition and innovation in the ETF marketplace, leading to more choice for investors.

ETFs are hybrid investment products not originally

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SEC Adopts Changes to Disclosure of Funds’ Liquidity Risk

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The Securities and Exchange Commission on June 28, 2018, adopted amendments to public liquidity-related disclosure requirements for certain open-end funds.  Under the amendments, funds would discuss in their annual or semi-annual shareholder report the operation and effectiveness of their liquidity risk management programs.  This requirement replaces a pending requirement that funds publicly provide a quantitative end-of-period snapshot of historic aggregate liquidity classification data for their portfolios on Form N-PORT.

The Commission adopted the open-end fund liquidity rule in October 2016 in an effort to promote effective liquidity risk management programs in the fund industry.  Management of liquidity risk is important

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Bitcoin’s Price Chaos Demonstrates the Importance of Sophisticated Financial Products

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Between January 1 and December 17, 2017, the value of a single Bitcoin skyrocketed from under $1,000 to nearly $20,000. To match Bitcoin’s 1183 percent return during this period, an investor would have needed the equivalent of 38 years’ average equity market returns.[1] Investors and news outlets alike were entranced by Bitcoin’s stratospheric rise, and direct investment in the crypto-asset surged. But Bitcoin’s climb was followed by an equally stomach-turning fall, as its price declined 70 percent in less than two months between December 17 and February 6.[2]

Discussion of Bitcoin’s swing occurred primarily in one of two … Read more

Will Swing Pricing Save Sedentary Shareholders?

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Starting in November 2018, U.S. public, open-ended mutual funds will have the option to adjust the daily pricing of the fund—the net asset value or NAV—to account for and recoup large transaction costs.  Currently, the fund, and therefore its remaining shareholders, absorb those costs generated by existing shareholders. This quiet, technical change in the regulation—swing pricing—is a part of the SEC’s sweeping mutual fund Liquidity Management Rules, adopted in 2016.

Swing pricing is an anti-dilution tool protecting shareholders staying in a fund—the sedentary shareholders—by guarding their investment from transaction cost erosion, which by 2014 estimates total $10-17 billion annually.  This … Read more

Wachtell Lipton Discusses Supreme Court Ruling on SEC Judges

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On June 21, in a much anticipated decision, the Supreme Court held that SEC Administrative Law Judges (“ALJs”), who have historically been appointed by SEC staff, are “Officers of the United States” and, hence, under the Appointments Clause, can be appointed only by the President or by the SEC itself.  Lucia v. SEC.  The Court further ruled that any litigant who has made a “timely challenge” to the validity of an ALJ’s appointment is entitled to a new hearing before a different, properly appointed ALJ or the SEC itself.

In addition to possibly reopening past cases, the Court’s opinion … Read more

Cleary Gottlieb Discusses SEC’s Latest Take on Digital Assets as Securities

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On Thursday, June 14, the SEC Director of Corporation Finance, William Hinman, stated his view that current secondary market trades of Ether are not now securities transactions as part of a speech on the treatment of digital assets under the securities laws.  While he expressly set aside the question of whether the capital-raising that initially accompanied the sale of Ether in 2014 was a securities offering, he confirmed previous suggestions that Ether is a prime example of a digital asset that may once have been offered as a security, but is now “something else” that is not  regulated by the … Read more