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Securities Regulation

Lemonade, Inc.: Harbinger of Future Public Benefit Corporation IPOs?

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The last six months have been marked by profound changes in how we live and interact with one another. The COVID-19 pandemic has cast a spotlight on societal inequities and racial injustice and reinvigorated dialogue around sustainability and environmental reform. While lawyers have long engaged with corporate governance and more specifically ESG-related issues,[1] the dialogue on those issues has recently focused sharply on the role of the corporation and the extent to which corporations should consider stakeholder interests other than stockholder pecuniary gain.

In this post, we take a closer look at online insurer Lemonade, Inc.’s successful July 2 … Read more

Marginal Benefits of the Core Securities Laws

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To many, the core securities laws on disclosure, fraud, and insider trading are desirable from an investor-protection perspective. But the dominant law and economics view is dubious of this thinking. Under this view, securities prices are discounted to reflect obstacles to the cash flows investors expect to receive, thereby preserving the returns those investors would expect even absent those obstacles. Information asymmetry in the stock market presents such an obstacle, and is therefore addressed by such a discount. Private ordering thus saves the day.

In Marginal Benefits of the Core Securities Laws, I aim to shed more light on … Read more

Executive Private Misconduct

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Over the last few years, misbehavior of corporate executives like Harvey Weinstein, Steve Wynn, Leslie Moonves, and Elon Musk has outraged many people around the world.  The misconduct has ranged from the inadvisable to the unethical to the criminal.  Almost all of it – when made public – has damaged the executives’ public reputations, diminished the value of their companies’ stock, and raised some serious legal and policy issues.

My recent article, Executive Private Misconduct, in The George Washington Law Review examines this convergence of private lives and public consequences of executive misbehavior.  The article puts the legal issues … Read more

SEC’s Division of Investment Management Director Takes Stock and Looks Ahead

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Good Morning. Thank you Barry [Barbash] and Paul [Roye] for the kind introduction and thank you and PLI for inviting me to speak again with you. I looked back at my remarks the last time I was with you. Two years ago, the focus of our discussion primarily centered on SEC rulemaking regarding Standards of Conduct for Financial Professionals and Liquidity Risk Management.[1] This year, we have many more items on the agenda, and COVID-19 has reshaped our lives, tested our markets and reordered – but not reduced – our priorities.

Clearly, there’s more to discuss than I can

… Read more

Lessons from Luckin Coffee: The Underappreciated Risks of Variable Interest Entities

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On April 2, China’s Luckin Coffee announced that some of its employees, including the chief operating officer, had fabricated over $300 million in reported revenues. On April 21, the Securities and Exchange Commission and the U.S. Public Company Accounting Oversight Board alerted investors that firms based in “emerging markets, including China,” often do not satisfy the auditing standards normally met by firms traded on U.S. exchanges.  In May 2020, the Nasdaq Stock Market ordered Luckin to delist and proposed stricter listing requirements for firms based in markets that restrict U.S. regulators’ access to information.  Concurrently, the U.S. Senate enacted, and … Read more

Why the SEC’s Proposal to Amend Rule 13f-1 Should Fail

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On July 10, the Securities and Exchange Commission (SEC) proposed a 35-fold increase – from $100 million to $3.5 billion – in the threshold for requiring institutional investment managers to publicly report their equity holdings on Form 13F.[1]  This is a remarkable development at a time when issuers and large sectors of the market are demanding more, not  less, transparency from investment managers, particularly activist hedge funds.

Section 13(f) of the Exchange Act was adopted by Congress in 1975 and requires an institutional investment manager to file a report with the SEC if it exercises investment discretion over accounts … Read more

SEC Chairman Speaks on Amendments to Proxy Solicitation Rules

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Good morning.  This is an open meeting of the U.S. Securities and Exchange Commission, under the Government in the Sunshine Act.  Today we have two items on the agenda, both continuations of our ongoing work to modernize and enhance the accuracy, transparency and effectiveness of our proxy voting system.[1]

I want to make two general observations.  First, today’s recommendations are the fruits of a rigorous and well-functioning rulemaking process where final rules reflect and benefit from the input of a wide array of market participants with a myriad of interests and perspectives.  The proposing release that the Commission issued

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EBITDAC, Civil Liability, and New Paradigms

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COVID-19 has led companies to patch-up financial reporting by adding estimates of pre-COVID-19 profits to their EBITDA. Recently, COVID-19 prompted measuring-equipment manufacturer Schenck Process, for example, to add back €5.4 million, resulting in an adjusted EBITDA of €18.3 million (termed, unsurprisingly, as ‘EBITDAC’ [1]). This may spark other U.S. corporations to use an EBITDAC metric in initial public offerings, which may result in litigation under Section 11 of the Securities Act of 1933 (Securities Act) over alleged omissions or material misstatements. This post seeks to analyze the use of EBITDAC against the civil liability provisions of Section 11 … Read more

Cleary Gottlieb Discusses SEC Proposal to Significantly Change Reporting by Institutional Investors

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On July 10, 2020, the Securities and Exchange Commission (the “SEC”) proposed changes that would substantially reduce the number of investors required to file quarterly reports showing their holdings of U.S.-listed equities on Form 13F.[1]  The SEC’s proposal would increase the 13F reporting threshold 35 fold — from $100 million to $3.5 billion — and eliminate the ability to exclude de minimis positions from reporting on Form 13F.[2]  According to the SEC, almost 90% of the investment managers who file a Form 13F today would no longer be required to do so.  However, the SEC’s data … Read more

Disgorgement After Liu v. SEC: The Game Is On!

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Experienced litigators know that an adverse appellate decision (even from the U.S. Supreme Court) rarely ends their case. The question is instead: What is the next move? What defenses do we fall back on? So it is likely to be with Liu v. SEC,[1] which, by an 8-1 margin, resolved that the SEC does have the authority to order disgorgement. Still, the Court subjected this authority to the important qualifications that: (1) the ill-gotten gains consist only of the net gains (with all “legitimate expenses” being deducted); (2) the recovery is returned to the injured investors (and thus not … Read more

SEC Chair Clayton Addresses the Financial Stability Oversight Council

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Market Functioning and Monitoring

We have continued our efforts to help facilitate the orderly and fair market function, including in coordination with our colleagues at the Federal Reserve and Treasury.[1]

Market activity has remained active in June and thus far in July, but has declined from the peaks in late February and March.  By way of just a few examples:

  • On the last day of February 2020, we observed the second most shares traded ever, 19.3 billion shares.  In June, the average remained quite high by historical standards at 13.3 billion shares per day.  By comparison, in June of

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Cooperation in Securities Market Regulation: Perspectives from Australia

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The global financial crisis highlighted the interconnectedness of international financial markets and the risk of contagion it posed. The crisis also emphasized the importance of supranational regulation and regulatory cooperation to help address and ameliorate that risk.

Yet, although capital flows are global, securities regulation is not. As a 2019 report by the International Organization of Securities Commissions (IOSCO) notes, the regulatory challenges, which were revealed so starkly during the global financial crisis, have by no means dissipated over the last decade. According to IOSCO, lack of international standards, or differences in the way jurisdictions implement such standards, can lead … Read more

SEC Commissioner Advocates ESG Disclosure for Asset Managers, Not Issuers

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Good afternoon, everyone. Thank you, Keir [Gumbs], for the kind introduction, and thank you to the Society for Corporate Governance for the invitation to speak today. I had been looking forward to seeing everyone in Colorado this week but, of course, life for all of us has changed since we made those plans. Given how hectic I presume the last few months have been for you, I want you to know how much I appreciate that you are taking the time to call in and listen to me speak.

I would like to begin by taking a moment to remember

… Read more

Activist Short Selling Today: The Two Sides of the Coin

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Two extraordinary accounting scandals — one at Luckin Coffee Inc. in China and the other at Wirecard AG, the German digital payments firm — have revealed brazen and bankrupting frauds, directed by the most senior executives at each firm. Together, they tend to support three conclusions:

  • Stealing candy from a baby appears to be harder than getting fraudulent financial statements past a Big 4 accounting firm;
  • If you want to detect fraud, forget the accountants and contact your local short sellers; they are the real detectives today; and
  • When the fraud is really egregious, we often find that the regulator

… Read more

Did Congress Trade Ahead on News of Covid-19?

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In a new paper,[1] we study the impact on U.S. stock prices of news stories about accusations that several members of Congress traded ahead of private material information about COVID-19. The lawmakers traded stocks during the early stages of the pandemic, in late January through February 2020, prompting concern that they did so in anticipation of COVID-19 having a major impact on the financial markets. Each has said the trades were based on other factors.

The specifics were as follows: Two U.S. senators, Richard Burr and Kelly Loeffler, sold large amounts of stock when U.S. markets were near their … Read more

The Role of Investor Attention in Seasoned Equity Offerings

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Many studies of seasoned equity offerings (SEOs) have attempted to explain the decline of a company’s stock price after it announces an SEO (see, e.g., Asquith and Mullins (1986) or Masulis and Korwar (1986)). The literature has focused on the asymmetric information about a firm in the equity market as the main explanation. Further, in models such as Myers and Majluf (1984), a crucial assumption is that all investors pay immediate attention to the equity issue announcement.

In a new paper, here, we assume instead that only some investors in the equity market pay attention to the SEO announcement, … Read more

Davis Polk Discusses NYSE’s New Proposal on Direct Listings

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On June 22, the New York Stock Exchange (NYSE) filed a proposed rule change with the Securities and Exchange Commission that would permit companies to raise capital in a direct listing. The NYSE had previously proposed a rule change, which it subsequently revised and resubmitted, that would have allowed companies to participate in direct listings (as discussed in our November 2019 memo and December 2019 memo). The latest iteration of the NYSE’s rule proposal is similar to the prior versions, but it provides more detail around the auction mechanics for a primary direct listing. In addition, it eliminates the … Read more

SEC Update on Regulatory Relief During the Pandemic

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The U.S. Securities and Exchange Commission’s efforts in response to the COVID-19 pandemic are centered, first and foremost, on the health and safety of our employees and all Americans.  The Commission’s recognition of the corresponding need of market participants to also prioritize health and safety while ensuring the continuity of operations essential to the orderly function of our capital markets, drove the prompt actions of the Commission and its staff in the early stages of the pandemic’s effects in the United States.  We have assessed these actions in light of developments over the past several months, current conditions and our

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SEC Chief Accountant on Importance of High-Quality Financial Reporting in Light of Covid-19

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On April 3, 2020, the Office of the Chief Accountant (OCA) issued a statement[1] regarding the importance of high-quality financial reporting in light of the significant impacts of COVID-19.[2]  At that time, in addition to facing a number of operational and other challenges, many public companies were in the midst of their first quarter financial reporting process, working through accounting and financial reporting issues related to the impact of, and uncertainties related to, COVID-19.  In this time of unprecedented uncertainty, because of the diligent efforts of so many, our financial reporting system has continued to serve its critical

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Explaining Dirks

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Dirks v. SEC established the fraud claim for tipping as part of the insider trading prohibition in the federal securities laws.  An essential element of the claim was proof that the insider personally benefited from disclosing confidential information to the tippee.

A paragraph in Dirks explained the personal benefit test.  The paragraph said that an insider needed to receive cash, reciprocal information, or other things of value but went on to say that certain fact patterns often created an inference that the insider expected to receive a personal benefit.  Those fact situations included the insider’s gift of information to a … Read more