The SEC’s Proposed Cyber 8-K Disclosure

On March 9, 2022, the SEC proposed rules mandating cybersecurity disclosure, including a new Item 1.05 for Form 8-K, which requires current reporting of cybersecurity incidents deemed by the registrant to be material.

In a 2018 article published in the Harvard Business Law Review, Columbia Law Professor Eric Talley and I identify trading patterns suggestive of informed trading prior to the disclosure of cybersecurity breaches.  We argue that trading of this type raises complex and, in context, unique concerns over price discovery, liquidity, and efficient allocation of resources.  Profits from such trading may increase hackers’ incentives to exploit security vulnerabilities, … Read more

The SEC Acts on Short-and-Distort Petition

On February 25, 2022, the Securities and Exchange Commission proposed rules to enhance the transparency of short positions in equity securities.  One proposal would require confidential, monthly reporting of short sellers’ individual positions, which would then be aggregated by security and disclosed to the public.  A second proposal would establish a new buy-to-cover order-marking requirement for broker-dealers.

In its proposing release, the SEC explained that the purpose of these rules is to deter manipulative short selling campaigns:

In determining  the  proposed  reporting  requirements  under  Proposed Rule  13f-2  and  Proposed Form  SHO, the  Commission  is  mindful  of  concerns  that  certain  … Read more

An Academic Critique of the SEC’s GameStop Report

On October 18, 2021, SEC staff released a long-awaited report on equity and options trading in connection with the meteoritic rise of GameStop’s share price in January 2021.  The staff report addressed several issues surrounding the GameStop episode, but one of the most widely reported was the conclusion that neither a short squeeze nor a gamma squeeze caused the increase in GameStop’s share price.  Rather, staff concluded, “it was the positive sentiment, not the buying-to-cover, that sustained the weeks-long price appreciation of GameStop stock.”[1]

As members of the Ad Hoc Academic Committee on Equity and Options Market Structure Conditions … Read more

The Price of Your Vote: Proxy Choice and Securities Lending

On October 7, 2021, BlackRock announced that, beginning in 2022, institutional clients would have the opportunity to direct the voting of shares held by index funds.  Some commentators heralded this change as “a catalyst for others in [the investment management] industry” and a move that would “expand the voting choice options for investors,”[1] though others were noncommittal or downright skeptical.[2]

Did BlackRock bury the lede?  Consider the following fine print: “BlackRock will determine eligibility criteria under this program based upon . . . financial considerations, including the decision to lend securities.”[3]  In an era of rock-bottom … Read more

Democrats’ Gift-Wrapped Cloak of Secrecy for Wall Street

On July 29, 2021, the House Financial Services Committee voted to advance H.R. 4618, The Short Sale Transparency and Market Fairness Act, a well-intentioned bill with a misguided provision that was likely the product of hurried drafting.  The legislation would require investors managing over $100 million in assets to provide ongoing portfolio disclosure on Form 13-F on a monthly rather than quarterly interval and extend disclosure to short positions and derivatives.

There is much to praise in H.R. 4618.  Current periodic disclosure rules require the reporting of long positions alone, which is partial at best and outright misleading at … Read more

A Reddit Rebellion in the Robinhood Era

For over a decade, hedge funds and other sophisticated traders have taken advantage of ordinary Americans who sought to share in the rewards of entrepreneurship and economic growth by investing in public companies.  My research has identified tens of billions of dollars of transitory price crashes from short attacks aimed at retail investors on social media.  Until last week, it appeared that GameStop was on its way to becoming yet another target of the activist short-selling machine.  This was the week that investors decided to fight back.

“Negative activist” hedge funds mastered the art of driving down share prices via … Read more

The Index-Fund Dilemma: An Empirical Study of the Lending-Voting Tradeoff

The future of corporate stewardship – and therefore corporate governance – rests in the hands of a few large institutional investors.[1] Questions of whether these funds have the necessary incentives to pursue stewardship have set off an explosion of research by both legal scholars and economists alike. Some say that funds lack even the basic incentives to vote on value-enhancing corporate governance matters because, while even large benefits diffuse among investors, funds bear the totality of the upfront costs.[2] Others argue that funds – through their common ownership of nearly all public companies – have perverse incentives to … Read more

Passive Exit

Economist Albert O. Hirschman (1970) classically set out the two alternatives facing dissatisfied members of an organization: They can voice displeasure or exit for greener pastures. Hirschman’s model has long explained the tradeoff facing shareholders of a poorly governed firm: Agitate for change or take the “Wall Street Walk” by selling shares.[1] Professor John C. Coffee (1991) showed that large institutional investors have little incentive to voice their concerns to monitor portfolio firms,[2] a trend exacerbated by low-fee “passive”[3] portfolio management (Bebchuk et al., 2017).[4]

While voice is often too costly for passive investors, exit is … Read more

Insider Trading and Strategic Disclosure

With COVID-19 cases rising rapidly around the world, Pfizer’s announcement on November 9, 2020, that its coronavirus vaccine was highly effective in early trials offered a rare bright spot for the coming winter.[1] But the news was soon dampened by word that the company’s CEO, Albert Bourla, sold some 60 percent of his Pfizer shares on the day of the announcement.[2]  According to Pfizer, Bourla’s sales occurred under a preset arrangement known as a 10b5-1 plan – so named for an obscure SEC rule designed to shield executives from spurious insider-trading accusations. The rule gives an affirmative defense … Read more

Short Sellers and Plaintiffs’ Firms: A Symbiotic Ecosystem

On October 8, 2020, in In re BofI Securities Litigation, the United States Court of Appeals for the Ninth Circuit reversed the district court’s finding that the plaintiffs had not adequately alleged loss causation when claiming that BofI Holding portrayed its banking company as a safer investment than it actually was.[1]  These claims originated in two places: a whistleblower lawsuit and blog posts published by a pseudonymous short seller.  The court reversed the district court on the first, holding that a whistleblower lawsuit could serve as a corrective disclosure even though it merely alleged that fraud had occurred.

More … Read more

Fir Tree v. Jarden and M&A Appraisal

The Delaware Supreme Court’s recent decision in Fir Tree v. Jarden[1] marks an important milestone in the law of appraisal, making clear that unaffected market price can and should be decisive in some appraisal actions. Because the court’s opinion relied on the proposed methodology we advocated in our recent article, Asking the Right Question: The Statutory Right of Appraisal and Efficient Markets, published in the 2019 edition of the Business Lawyer, [2] we here offer some observations about the Jarden opinion and the future of the law of M&A appraisal.

Jarden involved the not-so-uncommon situation where an acquirer … Read more

Petition for Rulemaking on Short and Distort

Short selling serves a critical function in the capital markets by encouraging price discovery and preventing the formation of asset bubbles.  But recent years have seen a rise in “negative activism,” a novel phenomenon that has flourished in the era of social media and algorithmic trading.[1]  The typical negative activist opens a large short position; disseminates sometimes aggressive negative opinion about a public company (often stopping just short of factual falsehoods) on Twitter and elsewhere, which induces a panic and run on the stock price; and rapidly closes that position for a profit, prior to the stock price partially … Read more

Long-Run Short Selling

On December 3, 2019, Japan’s Government Pension Fund (GPIF) announced that it would suspend share lending to short sellers.  This is the latest development in a growing global regulatory skepticism of shorting, with Reuters recently reporting that short selling bans are under consideration in South Korea, Germany, France, Italy, and Turkey.  Prominent short activists have characterized these regulatory efforts as a “war on truth,” calling themselves modern-day Davids fighting corporate Goliaths, powerful companies who commandeer protectionist instincts to shield local industry from legitimate criticism.

To be sure, a large academic literature has found that short selling improves price Read more

Short Selling and the New Market Manipulation

Stock market manipulation has been around since shortly after stock markets were invented. Everyone is familiar with the methodology in the standard “pump and dump” scheme: False rumors are circulated, the stock is bid up by the manipulators, supply might be constrained, and, once the public’s appetite is aroused, the stock is dumped by the manipulators.

But the internet has changed all that. No need exists today for the boiler shop or its battery of phones or even carefully assembled lists of suckers. All that one needs today is to put one’s message (written under a pseudonym) on a blog … Read more

Why Investors Pay So Much for Dual Class Firms

Professor Coffee makes the insightful point that if founders receive a lower price for their stock when they retain voting control, it does not seem fair to allow other shareholders to take away that control without compensation.  But, Professor Coffee argues, if shareholders can take away founders’ control without compensation, then founders should not receive less when they retain voting control, because such control is largely “illusory” in his words.  Of course, this argument may bring back memories of the economist’s admonition not to pick up the (obviously fake) $100 bill on the floor.  Clearly, markets can get out of … Read more

What Can We Learn from Stock Prices?

Prices convey information.  Hayek (1945) put it this way: Prices “coordinate the separate actions of different people in the same way as subjective values help the individual to coordinate the parts of his plan.”  Stock prices, in particular, matter a great deal in corporate and securities law.  Event studies, which measure statistically significant changes in stock prices, are widely used by investors and courts to infer the effect of an event on the value of a firm (Bhaghat & Romano, 2002b).

In my recent article, I ask a basic question: What can we learn from stock prices?  It is a … Read more

Short and Distort

Anonymous political speech has a celebrated history (Publius, 1787) and has long enjoyed strong protections under the U.S. Constitution.[1] But there is a dark side to pseudonymity: Fictitious identities can wreak havoc in financial markets. A large literature in economics examines why markets are vulnerable to rumors and information-based manipulation (Benabou & Laroque, 1992; Van Bommel, 2003; Vila, 1989). In a review of this body of work, Putnins (2012) emphasizes the importance of reputation: “if market participants are able to deduce that false information originated from a manipulator, the manipulator will quickly be discredited and the manipulation strategy will … Read more

The SEC’s Holiday Gift to High-Speed Traders

Last month, we released a new study, How the SEC Helps Speedy Traders, covered here by the Wall Street Journal, revealing that the Securities and Exchange Commission’s systems have been giving certain investors market-moving corporate filings before those same filings are made available to the investing public. In the days after the Journal published its article, the Senate Banking Committee issued a bipartisan letter to the SEC, “urg[ing] the SEC to quickly investigate this timing disparity for company filings and take the necessary steps to eliminate it.” Based on our subsequent research, the Journal later reported that the … Read more

Why the CFPB’s Qualified Mortgage Rule Misses the Mark

This post grows out of two working papers (downloadable here and here) that Professor Ayres wrote with Joshua Mitts, a former student who is now working at Sullivan & Cromwell.

On Friday, January 10th, the Consumer Financial Protection Bureau’s “qualified mortgage” rule went into effect.  This rule is designed to put an end to the risky lending practices that led to the financial crisis.  But a simpler rule could better assure borrowers’ ability to repay and simultaneously create greater repayment flexibility.

The purpose of the QM rule is to help assure that borrowers have sufficient monthly income to make … Read more

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An Incentive-Compatible Alternative to “Don’t Ask Don’t Waive” Standstills

In a recent essay forthcoming in the Delaware Journal of Corporate Law (available on SSRN), we argue that the current controversy over “Don’t Ask, Don’t Waive” standstills in M&A practice highlights the need to apply mechanism design to change-of-control transactions.[1]  Mechanism design is a Nobel Prize-winning theory based on incentive compatibility, whereby algorithmic procedures render it in the parties’ interests to be forthcoming, or truthful about their “bottom lines,” rather than relying exclusively on ex-post enforcement.

A.  The Tension Between Deal Certainty and Value Maximization in M&A Transactions

In M&A auctions, the board’s duty to maximize … Read more

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Editor's Tweet: NYU's Professor Steven J. Brams discusses An Incentive-Compatible Alternative to “Don’t Ask Don’t Waive” Standstills