VOLUME 15 • ISSUE 1 • PRINT
CAN SECTION 11 BE SAVED?: “TRACING” A PATH TO ITS SURVIVAL
John C. Coffee, Jr. & Joshua Mitts
Last term, a unanimous Supreme Court held in Slack Techs. v Pirani that purchasers of securities must “trace” their shares to the registration statement that contains the alleged misstatement or omission in order to be able to assert a claim under Section 11 of the Securities Act of 1933. Lawyers and law firms on both sides of the case agreed (with differing emotions) that the decision eclipsed Section 11, which had been the federal securities laws’ strongest litigation remedy for investors. We disagree with this conclusion that Section 11 is doomed, but we recognize the danger. Both in an amicus brief we filed with the Court and now in this article, we show how tracing can be performed and thus Section 11 preserved.
VOLUME 15 • ISSUE 1 • PRINT
INSIDER TRADING BY OTHER MEANS
Sureyya Burcu Avci, Cindy A. Schipani, H. Nejat Seyhun, & Andrew Verstein1Sureyya Burcu Avci, Visiting Scholar, University of Michigan; Cindy A. Schipani, Merwin H. Waterman Collegiate Professor of Business Administration and Professor of Business Law, University of Michigan; H. Nejat Seyhun, Jerome B. & Eilene M. York Professor of Business Administration and Professor of Finance, University of Michigan; Andrew Verstein, Professor of Law, UCLA School of Law. We are grateful for the support of our tireless research assistants: Drew Downing, Amy Jiang, Jacob Ottone, Lance Tianna, and Steve Verhoff. Likewise, Kevin Gerson, Henry Kim, and Ben Nyblade were diligent and creative in supporting our research. For helpful comments, we thank Jesse Fried, Louis Kaplow, Fernan Restrepo, Holger Spamann, Kathy Spier, Steven Shavell, Roberto Tallarita, and the participants in the UCLA-USC Business Law Workshop, the Harvard Law School Law & Economics Workshop, the 2025 Stanford Law and Economics Seminar, the 2023 American Law and Economics Association Annual meeting, and the 7th International Conference on Multidisciplinary Scientific Studies, Turkey, 2024. We also wish to thank the Mitsui Life Financial Research Center at the Stephen M. Ross School of Business for financial support of this project.
For more than thirty years, perhaps the most prevalent strategy for insider trading has gone undetected and unaddressed. This Article uncovers the techniques by which executives and directors sell overvalued stock worth more than $100 billion per year, shifting losses to ordinary investors. The basic idea is that insiders conceal their suspicious trades by publicly reporting them (as they are required to do) in ways that confuse or discourage investigators. We develop a taxonomy of concealment strategies, complete with suggestive examples. We then empirically test our taxonomy using a database of essentially all stock trades since 1992. We find that insiders who trade using the subterfuges we describe outperform the market by up to 20% on average. Worse yet, we find evidence that this simple subterfuge works. Essentially no one has ever been prosecuted for undertaking one of these suspicious trades. Nor do journalists or scholars seem to appreciate them. Accordingly, we call for scholars and prosecutors to cast a wider net in their studies and market surveillance, then discuss implications for the design of insider-trading reporting requirements and related legal rules.
VOLUME 14 • ISSUE 1 • PRINT
ZOMBIE STOCKS
Young Jae Choi, Joseph Engelberg, Frank Partnoy, Adam V. Reed & Matthew C. Ringgenberg
This Article examines a previously unstudied aspect of short selling: the risk that the shares a short seller has borrowed will be delisted and deregistered. We label such shares “zombie stocks” or “zombies,” because they appear to be “dead,” but nevertheless create financial horror for short sellers, exposing them to signifi- cant risks and costs even when the short seller has speculated correctly against a company’s shares. The central problem occurs when short sellers are unable to purchase shares to satisfy their borrowing obligations and instead become stuck paying equity loan fees and posting collateral, potentially indefinitely.
VOLUME 14 • ISSUE 1 • PRINT
MANIPULATING CITADEL: PROFITING AT THE EXPENSE OF RETAIL STOCK TRADERS’ MARKET MAKERS
Merritt B. Fox, Lawrence R. Glosten & Sue S. Guan
This Article considers whether securities market strategies designed to profit at the expense of so-called “internalizers” should properly be considered illegal manipulation. An internalizer acquires from a brokerage firm the right to be the market maker for the broker’s full order flow from its retail customers, promising in return to execute each order at a price slightly better than the best price available on any exchange (“price improvement”) as well as to pay the broker a fee for each executed order (“payment for order flow”). Almost all retail trading—about 29% of the country’s total share volume—is executed in this fashion, amounting in 2021 to about $41 trillion in transactions, a figure almost twice the nation’s GDP that year.
VOLUME 14 • ISSUE 1 • PRINT
HIGH-END SECURITIES REGULATION: REFLECTIONS ON THE SEC’S 2022-23 PRIVATE FUNDS RULEMAKING
William W. Clayton
For most of its history, the SEC has taken a hands-off approach to private markets. Instead of direct regulation, the SEC has relied primarily on investor access restrictions to create high-end contracting environments where investors (in theory) have the resources needed to fend for themselves. But in early 2022, this hands-off philosophy was turned on its head. In response to booming growth and concerns about harms to public pension plans and other institutional inves- tors, the SEC proposed a sweeping set of regulatory interventions in the private fund industry, a vast and important part of the private market ecosystem with over $25 trillion in assets under management. At the conclusion of a long and con- tentious comment period, the agency released a set of final rules requiring fund managers to provide detailed, standardized quarterly disclosures to investors and regulating preferential treatment, among other things.
VOLUME 13 • ISSUE 2 • PRINT
SHADOW TRADING AND MACROECONOMIC RISK
Yoon-Ho Alex Lee and Alessandro Romano
This Article explains that “shadow trading” occurs when a corporate insider uses sensitive inside information pertaining to her own firm to buy or sell shares of other companies whose stock price movements can be predicted given the information. These transactions are highly profitable but not systematically regulated, and there is evidence that they are a widespread phenomenon among corporate insiders. Un- like classical insider trading, shadow trading by a corporation’s insiders does not result in a direct harm to the corporation’s own shareholders, and to some extent, shareholders may even benefit from such transactions. In this Article, we argue nevertheless that shadow trading poses three issues: (i) it can create a moral hazard problem for corporate insiders, which can lead them to engage in excessive corporate risk-taking and to even invest in negative-expected-value projects; (ii) it can increase the level of macroeconomic risk to which the economy is exposed; and (iii) it can exacerbate the severity of economic crises. Our analysis thus offers novel rationales for regulating shadow trades. This Article concludes by suggesting a menu of possible policy reforms that can address the problems created by shadow trading.
VOLUME 13 • ISSUE 1 • PRINT
UNICORNIPHOBIA
Alexander I. Platt
The largest companies in the United States are now subject to two alternative sets of rules. One set of companies makes extensive periodic disclosures about their business, finances, and corporate governance arrangements; faces market discipline from short-sellers, financial analysts, and hedge fund activists; and faces a realistic threat of Securities and Exchange Commission (SEC) investigation and private securities litigation. The others don’t.
VOLUME 12 • ISSUE 2 • PRINT
SOCIAL GOOD AND LITIGATION RISK
Adam B. Badawi and Frank Partnoy
Questions about corporations and social good have become central in busi- ness law and legal scholarship. Both academics and practitioners are focused on environmental, social, and governance (ESG) issues, and on the the very purpose of corporations. Meanwhile, some commentators and practitioners have begun to hint that these large questions about social good might be linked to litigation risk. We show, for the first time in the literature, that measures of social good and litigation risk are in fact linked, and we explore the important implications of this new finding.
VOLUME 12 • COLUMNS
WILL NASDAQ’S DIVERSITY RULES HARM INVESTORS?
Jesse M. Fried2Dane Professor of Law, Harvard Law School. Thanks to Michal Barzuza, Keith Bishop, Alex Edmans, Elisabeth de Fontenay, Joe Grundfest, Yaron Nili, and Steven Davidoff Solomon for helpful comments, and to Jake Laband for excellent research assistance. I serve on the Research Advisory Council of proxy advisor Glass Lewis, but my views here are not necessarily those of Glass Lewis. Comments are welcome and can be sent to me at jfried@law.harvard.edu.
In August 2021, the Securities and Exchange Commission approved Nasdaq’s proposed rules related to diversity. The rules’ aim is for most Nasdaq-listed firms to have at least one director self-identifying as female and another self-identifying as an underrepresented minority or LGBTQ+. While Nasdaq claims these rules will benefit investors, the empirical evidence provides little support for the claim that gender or ethnic diversity in the boardroom increases shareholder value. In fact, rigorous scholarship—much of it by leading female economists—suggests that increasing board diversity can actually lead to lower share prices. The implementation of Nasdaq’s proposed rules thus may well generate risks for investors.
VOLUME 11 • ISSUE 1 • PRINT
POWER AND STATISTICAL SIGNIFICANCE IN SECURITIES FRAUD LITIGATION
Jill E. Fisch & Jonah B. Gelbach
Event studies, a half-century-old approach to measuring the effect of events on stock prices, are now ubiquitous in securities fraud litigation. In determining whether the event study demonstrates a price effect, expert witnesses typically base their conclusion on whether the results are statistically significant at the 95% confidence level, a threshold that is drawn from the academic literature. As a positive matter, this represents a disconnect with legal standards of proof. As a normative matter, it may reduce enforcement of fraud claims because litigation event studies typically involve quite low statistical power even for large-scale frauds.
VOLUME 11 • ISSUE 1 • PRINT
REGULATING FINANCIAL GUARANTORS
Steven L. Schwarcz
To improve financial regulation, scholars have engaged in extensive research over the past decade to try to understand why systemically important financial firms engage in excessive risk-taking. None of that research fully explains, how- ever, the unusually excessive risk-taking by financial guarantors such as bond insurers, protection sellers under credit-default-swap (CDS) derivatives, credit enhancers in securitization transactions, and even issuers of standby letters of credit. With tens of trillions of dollars of financial guarantees outstanding, the potential for failure is massive. This Article argues that financial guarantor risk- taking is influenced by a previously unrecognized cognitive bias, which it calls “abstraction bias.” Unlike banks and other financial firms that pay out capital—for example, by making a loan—at the outset of a project, financial guarantors do not actually transfer their property at the time they make a guarantee. As a result, they may view their risk-taking more abstractly, causing them to underestimate the risk (even after discounting for the fact that payment on a guarantee is a contingent obligation). The Article provides empirical evidence showing that abstraction bias is real and can influence even sophisticated financial guarantors. The Article also examines how understanding abstraction bias can improve the regulation of financial guarantor risk-taking.
VOLUME 10 • ISSUE 1 • PRINT
DRIVELESS FINANCE
Hilary J. Allen
While safety concerns are at the forefront of the debate about driverless cars, such concerns seem to be less salient when it comes to the increasingly sophisticated algorithms driving the financial system. This Article argues, how- ever, that a precautionary approach to sophisticated financial algorithms is jus- tified by the potential enormity of the social costs of financial collapse. Using the algorithm-driven fintech business models of robo-investing, marketplace lending, high frequency trading and token offerings as case studies, this Article illustrates how increasingly sophisticated algorithms (particularly those capable of machine learning) can exponentially exacerbate complexity, speed and corre- lation within the financial system, making the system more fragile. This Article also explores how such algorithms may undermine some of the regulatory re- forms that were implemented in the wake of the 2008 financial crisis to make the financial system more robust. Through its analysis, this Article demonstrates that the algorithmic automation of finance (a phenomenon I refer to as “driver- less finance”) deserves close attention from a financial stability perspective. This Article argues that regulators should become involved with the processes by which the relevant algorithms are created, and that such efforts should begin immediately—while the technology is still in its infancy and remains somewhat susceptible to regulatory influence.
VOLUME 10 • COLUMNS
RULES FOR PRINCIPLES AND PRINCIPLES FOR RULES: TOOLS FOR CRAFTING SOUND FINANCIAL REGULATION
Heath P. Tarbert3Chairman and Chief Executive, Commodity Futures Trading Commission. The opinions, analyses, and conclusions expressed in this Article are mine and do not necessarily reflect the views of other Commissioners or the Commission itself.
The fundamental objective for any government agency overseeing financial markets and institutions should be sound regulation. And how we regulate is just as important as what we regulate. Every major financial regulator in the world employs, to varying degrees, two primary methods of regulation: principles-based and rules-based. In this article, I discuss the key advantages of each of these forms of regulation. I also offer some considerations for determining when a principles-based, a rules-based, or hybrid approach to regulation is the most appropriate. That is to say, I outline a number of “rules for principles” and “principles for rules” for achieving sound regulation. Finally, I consider some real-world applications of this framework as applied to our modern and increasingly digital markets.
VOLUME 9 • ISSUE 2 • PRINT
DE-DEMOCRATIZATION OF FIRMS: A CASE STUDY OF PUBLICLY-LISTED PRIVATE EQUITY FIRMS
Sung Eun (Summer) Kim
This paper develops a definitional and conceptual framework to assess the extent to which firms are democratically organized and applies the framework to thirty-nine publicly-listed private equity firms (“PPE”). The proposed definitional framework merges the criteria used by influential observers of political democracies together with the metaphor of “corporate democracy” that has been used by state legislators, federal regulators, the judiciary, and legal scholarship that have shaped U.S. corporate governance. Under the proposed definitional framework, democratic corporate governance refers to a regime that invites broad participation by shareholders, treats shareholders equally, protects shareholders from misconduct, and facilitates mutually binding consultation. By the same token, de-democratization of firms refers to a trend towards a regime that is less inclusive, less equal, less protective, and unilateral. This case study focuses on mechanisms that are chosen by PPEs to facilitate shareholders’ participation in governance and to hold managers accountable to shareholders. PPEs are an appropriate subject for this case study because they are firms that have adjusted their once highly private and sophisticated governance structures to accommodate public investors. The organizational and contractual features that are chosen by these firms reveal the balance between shareholder and managerial power within these newly public institutions. This review finds evidence of de-democratization across all four dimensions (inclusion, equality, protection, and mutuality) of the proposed definition of corporate democracy. This account of the de-democratization within one segment of firms yields new insights about the relationship between firms and government. This Article takes the first step toward categorizing these various relationships between democratic principles in the corporate and political contexts and suggests tailored policy responses to the trend of de-democratization among firms.
VOLUME 9 • ISSUE 1 • PRINT
INFORMED TRADING AND CYBERSECURITY BREACHES
Joshua Mitts and Eric Talley
Cybersecurity has become a significant concern in corporate and commercial settings, and for good reason: a threatened or realized cybersecurity breach can materially affect firm value for capital investors. This paper explores whether market arbitrageurs appear systematically to exploit advance knowledge of such vulnerabilities. We make use of a novel data set tracking cyber-security breach announcements among public companies to study trading patterns in the derivatives market preceding the announcement of a breach. Using a matched sample of unaffected control firms, we find significant trading abnormalities for hacked targets, measured in terms of both open interest and volume. Our results are robust to several alternative matching techniques, as well as to both cross-sectional and longitudinal identification strategies. All told, our findings appear strongly consistent with the proposition that arbitrageurs can and do obtain early notice of impending breach disclosures, and that they are able to profit from such information. Normatively, we argue that the efficiency implications of cybersecurity trading are distinct—and generally more concerning—than those posed by garden-variety information trading within securities markets. Notwithstanding these idiosyncratic concerns, however, both securities fraud and computer fraud in their current form appear poorly adapted to address such concerns, and both would require nontrivial reimagining to meet the challenge (even approximately).
VOLUME 9 • ISSUE 1 • PRINT
NONBANK CREDIT
Christina Parajon Skinner
Investment funds increasingly substitute for banks in supplying credit to the economy. Regulators have paid considerable attention to the potential financial stability risks of this migration to nonbank credit. This Article, however, argues that certain private investment funds (and the asset management institutions that house them) can enhance financial stability by promoting economic resilience. Specifically, it argues that certain private funds are incentivized and structured to supply the economy with a countercyclical source of credit—turning on their credit spigots precisely when banks are likely to turn theirs off. In doing so, these private funds have the potential to keep the economy buoyant in periods of economic downturn or distress.
VOLUME 8 • ISSUE 2 • PRINT
INVESTOR-DRIVEN FINANCIAL INNOVATION
Kathryn Judge
Financial regulations often encourage or require market participants to hold particular types of financial assets. One unintended consequence of this form of regulation is that it can spur innovation to increase the effective supply of favored assets. This Article examines when and how changes in the law prompt the spread of “investor-driven financial innovations.” Weaving together theory, recent empirical findings, and illustrations, this Article provides an overview of why investors prefer certain types of financial assets to others, how markets respond, and how the spread of investor-driven innovations can transform the structure of the financial system. This examination suggests that investor-driven innovations can enhance efficiency and provide other benefits, but they can also increase complexity, interconnectedness, and rigidity in ways that render the financial system as a whole more fragile.
VOLUME 8 • ISSUE 2 • PRINT
THE CASE FOR INVESTOR ORDERING
Scott Hirst
Whether corporate arrangements should be mandated by public law or “privately ordered” by corporations themselves has been a foundational question in corporate law scholarship. State corporation laws are generally privately ordered. But a significant and growing number of arrangements are governed by “corporate regulations” created by the U.S. Securities and Exchange Commission (SEC). SEC corporate regulations are invariably mandatory. Whether they should be is the focus of this Article.
VOLUME 8 • COLUMNS
BLURRING THE EDGES OF CORPORATE LAW: INSIDER TRADING AND THE MARTOMA DECISION
Azfer A. Khan
In its recent decision, the Second Circuit in United States v. Martoma overturned key aspects of its decision in United States v. Newman. Justifying this departure based on the Supreme Court’s ruling in Salman v. United States, the majority in Martoma held that there is no requirement to prove a meaningfully close personal relationship in order to find liability for insider trading under Rule 10b-5. While Martoma ostensibly changed the test for tippee liability, this Article argues that the substantive outcome for most insider trading cases is likely to remain unaffected. However, because Martoma expanded the scope of tippee liability, more claims can now get into court. This expansion should be resisted under the traditional Santa Fe doctrine because it threatens to blur the distinction between corporate law and securities law. This Article first provides a quick roadmap to insider trading law, then dives into an analysis of Martoma and the decisions immediately preceding it, and concludes by offering perspectives on what the likely impact of the decision will be.
VOLUME 8 • COLUMNS
SIDESTEPPING THE RAT HOLES: INVESTMENT RISK AND SECURITIES LAWS
Thomas M. Selman
This Article presents a novel understanding of the purpose of federal securities laws as the management of investment risk. Those laws should be treated as a whole. When two rules, even under different statutes, address the same risk, they should be applied concomitantly. For example, broker-dealer regulation under the Securities Exchange Act of 1934 might justify relaxation of prospectus delivery requirements in the Securities Act of 1933.
VOLUME 7 • ISSUE 2 • PRINT
SKIN IN THE GAME FOR CREDIT RATING AGENCIES AND PROXY ADVISORS: REALITY MEETS THEORY
Asaf Eckstein
Financial markets function most efficiently when all of the actors perform their functions scrupulously and through exerting optimal effort. However, human nature demonstrates that people will often underperform if they lack sufficient incentives. In the case of the individuals and entities acting as agents in the U.S. financial markets, if these players do not perform appropriately then everyone suffers. This fact was clearly demonstrated through the Enron and Worldcom scandals, as well as the recent financial crisis. One promising mechanism for motivating these entities is forcing them to have “skin in the game”—a direct financial interest in the companies affected by their actions. Skin in the game has become ubiquitous with regard to corporate “inside” agents—the managers and directors who act on the corporation’s behalf—by providing them with stock options, bonuses, and other methods of pay-for-performance. So, if giving inside agents skin in the game tends to motivate them to act in the corporation’s best interest, would such a mechanism be appropriate for the “outside” agents—entities that are not actually part of the corporation, but perform work on its behalf or on behalf of investors?
VOLUME 7 • ISSUE 2 • PRINT
PROCEEDING LEGALLY: CLARIFYING THE SEC/DODD-FRANK WHISTLEBLOWER INCENTIVES
Matt Reeder
The 2016 U.S. presidential election was won on—among other things— promises to deregulate and to repeal the Dodd-Frank Act. Rather than completely eliminating the SEC Whistleblower Program created by Section 922 of that Act, I propose a legislative solution to the split in the Federal Circuit Courts of Appeals regarding the scope of the program’s anti-retaliation protections. The legislative proposal promises to better align corporate interests and regulatory goals, save costly and time-consuming litigation, and remove employees’ disincentives to report securities law violations within their company.
VOLUME 7 • ISSUE 2 • PRINT
THE REMAKING OF WALL STREET
Andrew F. Tuch
This Article critically examines the transformation of the financial services industry during and since the financial crisis of 2007–2009. This transformation has been marked by the demise of the major investment banks and the related rise of a set of powerful players known as private equity firms. First, this Article argues that private equity firms now mirror investment banks in their mix of activities; ethos of entrepreneurialism, innovation, and risk-taking; role as “shadow banks”; and overall power and influence.
VOLUME 7 • ISSUE 2 • PRINT
WE HAVE A CONSENSUS ON FRAUD ON THE MARKET — AND IT’S WRONG
James Cameron Spindler
Recent scholarship contends that the fraud on the market securities class action has neither deterrent nor compensatory effect and should be cut back or even abandoned entirely. This scholarship largely focuses on two critiques: circularity, which holds that shareholder class action claimants are suing themselves, making compensation impossible; and diversification, which holds that fraud constitutes a diversifiable risk, such that diversified shareholders both gain and lose from fraud in equal measure and hence are not negatively impacted. These critiques are arguably the most important and widely-used theoretical development of the last two decades in securities law, and enjoy a broad consensus.
VOLUME 7 • COLUMNS
TRADING IN SUBSTITUTE SECURITIES: LIABILITY UNDER RULE 10B-5
Cody Donald
A trade in a substitute security occurs when a trader with inside information, typically an employee, trades—not in the securities of the company that is the subject and source of the information—but in the securities of another company whose stock would be affected if such inside information were to become public. The main academic literature on this topic is Ian Ayres and Joe Bankman’s article, Substitutes for Insider Trading. This Article builds on that work by providing a more in-depth analysis of liability for insider trading on substitute securities under Rule 10b-5 promulgated under the Securities Exchange Act of 1934. In contrast to Ayres and Bankman, this Article concludes that trading in substitute securities is presumptively illegal under the misappropriation theory pursuant to Rule 10b-5.
VOLUME 7 • COLUMNS
STUCK WITH STECKMAN: WHY ITEM 303 CANNOT BE A SURROGATE FOR SECTION 11
Aaron Jedidiah Benjamin
Item 303 of SEC Regulation S-K requires companies to disclose “known trends and uncertainties” in certain public filings. Item 303 provides no private right of action. However, Steckman v. Hart Brewing Co. held that an Item 303 violation automatically states a claim under section 11 of the 33 Act, short-circuiting any separate consideration under the statute. This Article examines the Steckman decision and contends that it was wrongly decided. Given that (i) an Item 303 violation cannot sufficiently establish Basic materiality, and (ii) Basic materiality is required under section 11, it follows that an Item 303 violation cannot be sufficient to state a claim under section 11.
VOLUME 7 • COLUMNS
AGE BEFORE EQUITY? FEDERAL REGULATORY AGENCY DISGORGEMENT ACTIONS AND THE STATUTE OF LIMITATIONS
Michael Columbo and Allison Davis
At what point may a person rest assured that the government will not confiscate her money due to a past alleged regulatory infraction? In Kokesh v. SEC, the Supreme Court is poised to resolve a three-way split among the federal circuit courts of appeals over whether the statute of limitations in 28 U.S.C. § 2462 applies to federal regulatory actions seeking disgorgement of a person’s funds for long-past alleged regulatory infractions. The Supreme Court should reverse the Tenth Circuit’s decision and hold that the statute of limitations categorically applies to actions seeking confiscation of funds for past regulatory infractions, regardless of whether the government seeks the funds through forfeiture or disgorgement.
VOLUME 6 • ISSUE 2 • PRINT
PUFFERY ON THE MARKET: A BEHAVIORAL ECONOMIC ANALYSIS OF THE PUFFERY DEFENSE IN THE SECURITIES ARENA
Adi Osovsky
Puffery statements in the securities arena are statements that are so optimistic, general, broad, or vague that they are considered immaterial as a matter of law and, thus, shielded from liability. The courts’ underlying assumption is that investors disregard puffery statements and do not rely on them when making investment decisions.
VOLUME 6 • COLUMNS
IT AIN’T BROKE: THE CASE FOR CONTINUED SEC REGULATION OF P2P LENDING
Benjamin Lo
In 2008, the Securities and Exchange Commission made waves by deciding to regulate the nascent peer-to-peer lending industry. Only two lending platforms survived the SEC’s entry into a previously lightly-regulated market. Under this regulatory setup, the SEC would regulate the lending-investing process, while other agencies like the Consumer Financial Protection Bureau and Federal Trade Commission would regulate the borrower side of the business. This Article argues that the existing bifurcated system works and is continually getting better as the SEC amends existing exemptions and introduces new regulations to smooth the path for financial innovation.
VOLUME 6 • COLUMNS
THE ROLE OF SECTION 20(B) IN SECURITIES LITIGATION
William D. Roth
In response to a 2011 Supreme Court ruling that restricted the use of Section 10(b) of the 1934 Act as a cause of action for fraud, SEC Chair Mary Jo White expressed in 2014 her agency’s intent to use Section 20(b) to litigate cases where Section 10(b) would no longer be viable. This Article assesses whether Section 20(b) can be an effective litigation tool for the SEC and private plaintiffs by dissecting the provision’s function and purpose, and by delving into its relevant legal doctrinal questions.
VOLUME 5 • ISSUE 1 • PRINT
ANTI-HERDING REGULATION
Ian Ayres and Joshua Mitts
In some contexts, an individual’s choice to mimic the behavior of others, to join the herd, can increase systemic risk and retard the production of information. Herding can thus produce negative externalities. And in such situations, individuals by definition have insufficient incentives to separate from the herd. But the traditional regulatory response to externality problems is to impose across-the-board mandates. Command-and-control regulation tends to displace one pooling equilibrium by moving behavior to a new, mandated pool. Mortgage regulators, for example, might respond to an unregulated equilibrium where most homeowners start with 2% down by imposing a requirement that causes most homeowners instead to place 10% down. But this Article shows that society can at times be better off if regulation induces separating behaviors by regulated entities. We evaluate a variety of mechanisms including licenses, subsidies, and regulatory variances as well as regulatory menus and heterogeneous altering rules that can incentivize a limited number of regulated entities to take the path less chosen. Anti-herding regulation provides a new means to attend to ways that mimicry can both suppress the production of information and exacerbate systemic risk.
VOLUME 5 • COLUMNS
THE SARBANES OXLEY PRIVILEGE FOR PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD MATERIALS: ITS IMPLICATIONS FOR SEC ENFORCEMENT PROCEEDINGS
Andrew J. Morris
In 2002, a wave of high-profile accounting scandals led Congress to pass the Sarbanes-Oxley Act—“SOX.” In SOX, Congress created the Public Company Accounting Oversight Board—the “PCAOB”—and charged it to oversee the auditors of public companies. Recent developments, however, threaten to undermine one of the critical foundations of the PCAOB oversight program: the “SOX privilege.” This statutory privilege ensures that the details of PCAOB inspections and investigations remain confidential. The problem is that some private litigants, some SEC staff, and at least one court do not read this simple mandate to mean what it says. They find it counterintuitive—and therefore hard to accept—that a statute would restrict the SEC’s use of information it obtains from the PCAOB. This resistance to the statutory language is apparent in Securities & Exchange Commission v. Goldstone, 301 F.R.D. 593 (D.N.M. 2014), the first judicial opinion on the issue. In Goldstone, the United States District Court for the District of New Mexico concluded that when the SEC brings enforcement actions, it can disclose privileged information received from the PCAOB. This article explains how Goldstone misreads SOX.
VOLUME 5 • COLUMNS
NEW MARGIN REQUIREMENTS FOR UNCLEARED SWAPS
Craig Stein
One of the fundamental changes that the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) made in the financial markets has been to force most over-the-counter swap transactions onto exchanges and impose regulations on transactions that remain uncleared by a central counterparty. At the same time, laws and regulations adopted by the European Commission and other nations have imposed similar, but by no means identical, requirements on swap markets outside the United States. This article reviews one aspect of these changes in the over-the-counter swap markets: the new margin requirements for uncleared swaps. Because margin for uncleared swaps has to date been set by each dealer in negotiations with individual customers, the transition to margin requirements imposed by regulators is likely to be difficult.
VOLUME 5 • COLUMNS
THE STATUS OF ENVIRONMENTAL COMMODITIES UNDER THE COMMODITY EXCHANGE ACT
Matthew F. Kluchenek
This article examines the role of the Commodity Futures Trading Commission (“CFTC”) in regulating transactions in environmental commodities, such as renewable energy certificates (“RECs”), emissions allowances, carbon offsets and carbon credits. The article examines the general role of the CFTC, the types of products subject to the CFTC’s jurisdiction, the basis for and scope of exclusions to the CFTC’s jurisdiction, and how commodity option transactions could be converted into swaps subject to the CFTC’s jurisdiction.
VOLUME 4 • ISSUE 1 • PRINT
REGULATING CAPITAL
Prasad Krishnamurthy
Most observers agree that the excessive debt or leverage of systemically important financial institutions (SIFIs) was a central reason why the housing crash of 2007–2009 led to a recession. The Dodd-Frank Act authorizes the Financial Stability Oversight Council and the Federal Reserve to adopt new prudential standards for regulating these institutions. A fundamental challenge for these standards is how to restrain the leverage of SIFIs by prescribing a minimum amount of capital or equity they must hold relative to their assets.
VOLUME 4 • ISSUE 1 • PRINT
STATUTES OF LIMITATIONS FOR EQUITABLE AND REMEDIAL RELIEF IN SEC ENFORCEMENT ACTIONS
Steven R. Glaser
The sanctions that can be imposed by the Securities and Exchange Commission (SEC) in civil enforcement actions can be severe. Where the SEC prevails, the agency can impose significant civil monetary penalties on an individual. The SEC may also seek the disgorgement of ill-gotten gains or enjoin an individual from future violations of securities laws. Perhaps most significantly, the SEC can bar someone from associating with a registered investment adviser or broker- dealer, or from serving as an officer or director of a public company, which could be tantamount to a complete prohibition from working in the securities industry. Given the severity of the available sanctions and the SEC’s increasingly aggressive enforcement posture, the SEC’s enforcement actions frequently resemble criminal prosecutions brought by the Department of Justice. Yet given the civil nature of these claims, defendants in SEC actions frequently lack certain procedural and other protections afforded to criminal defendants.
VOLUME 4 • ISSUE 1 • PRINT
A TWO-PART DISCLOSURE MANDATE AS A COMPROMISE SOLUTION TO THE DEBATE ON SECTION 13(D)’s DISCLOSURE WINDOW
David Daniels
For several decades, Section 13(d) of the Securities Exchange Act of 1934 has required that investors acquiring more than 5% of the outstanding equity securities in a publicly traded company disclose to the Securities and Exchange Commission (SEC) their stake in that company within ten days of exceeding the 5% threshold—thus acting as a de facto deterrence mechanism against potential surreptitious takeovers of such companies. With the passage of the Dodd-Frank Act in 2010, the SEC was able to shorten this disclosure window, which sparked an intense debate over the proper scope and strictness of Section 13(d). The protransparency faction urges the SEC to reduce the disclosure window to one day, while its opponents urge that the status quo remain and raise concerns about the deterrent effect a shortened window would have on beneficial activist investor scrutiny on corporate management. The decline of shareholder rights plans and the simultaneous rise of activist investing in the U.S. increases the urgency of finding the ideal resolution to this seemingly intractable issue.
VOLUME 4 • COLUMNS
AN EVALUATION OF THE U.S. REGULATORY RESPONSE TO SYSTEMIC RISK AND FAILURE POSED BY DERIVATIVES
Kimberly Summe
This Article will focus on Titles II and VII of the Dodd-Frank Act in order to examine how transacting in derivatives has changed in the aftermath of this legislation and to assess how the bankruptcy of a systemically important financial institution engaged in derivative transactions will be approached.
VOLUME 4 • COLUMNS
THE CFTC’S CROSS-BORDER GUIDANCE FOR SWAPS AND SUBSTITUTED COMPLIANCE REGIME
James Schwartz
The regulation of the swaps market, in which transactions between counterparties in wide-ranging jurisdictions have long been routine, requires international coordination and cooperation. If this were lacking, the consequences could include regulatory arbitrage, outsized compliance costs for, or incomplete compliance by, market participants, the fracturing of liquidity among different jurisdictions, and perhaps even political tensions.
VOLUME 4 • COLUMNS
THE EQUITY FAÇADE OF SEC DISGORGEMENT
Russell G. Ryan
The SEC commonly describes disgorgement as an equitable remedy, and courts similarly begin their disgorgement analyses by assuming as axiomatic the equitable nature of disgorgement. But what if that premise is wrong? What if disgorgement is an equitable remedy only some of the time? What if in many cases it is actually a remedy at law, or even a punitive remedy? And what if in some cases the very label of disgorgement is a misnomer?
VOLUME 3 • ISSUE 1 • PRINT
FAIR MARKETS AND FAIR DISCLOSURE: SOME THOUGHTS ON THE LAW AND ECONOMICS OF BLOCKHOLDER DISCLOSURE, AND THE USE AND ABUSE OF SHAREHOLDER POWER
Adam O. Emmerich, Theodore N. Mirvis, Eric S. Robinson, and William Savitt
VOLUME 3 • ISSUE 2 • PRINT
PRIVATE REGULATION OF INSIDER TRADING IN THE SHADOW OF LAX PUBLIC ENFORCEMENT: EVIDENCE FROM CANADIAN FIRMS
Laura Nyantung Beny and Anita Anand
Like firms in the United States, many Canadian firms voluntarily restrict trading by corporate insiders beyond the requirements of insider trading laws (i.e., super-compliance). Thus, we aim to understand the determinants of firms’ private insider trading policies (ITPs), which are quasi-contractual devices. Based on the assumption that firms that face greater costs from insider trading (or greater benefits from restricting insider trading) ought to be more inclined than other firms to adopt more stringent ITPs, we develop several testable hypotheses. We test our hypotheses using data from a sample of firms included in the Toronto Stock Exchange/Standard and Poor’s (TSX/S&P) Index. Our empirical results suggest that Canadian firms do not randomly restrict insider trading, but rather do so predictably and with a predictable level of intensity, suggesting that some firms wish to control insider trading to enhance corporate performance. Our most robust finding is that firms with a greater prevalence of controlling shareholders are more likely to have adopted a super-compliant ITP than firms with fewer such shareholders, implying that influential shareholders may oppose insider trading and challenging the claim that private restrictions of insider trading would not arise in the absence of insider trading laws.
VOLUME 3 • ISSUE 2 • PRINT
RECALCULATING “LOSS” IN SECURITIES FRAUD
Scotland M. Duncan
Quantifying the amount of actual loss within securities fraud cases is crucial to criminal sentencing. The United States Sentencing Guidelines recently adopted a “modified rescissory method,” whereby loss is measured by comparing average stock prices during and after the fraud. This paper argues that the Guidelines imprudently opt for ease of judicial application over precise culpability. The new law’s arithmetic suffers from a number of serious flaws, including upward bias with respect to the number of damaged shares and skewed sentencing disparity (both upward and downward) due to the inclusion of extrinsic factors wholly unrelated to a defendant’s conduct. This paper instead proposes conforming criminal sentencing for securities fraud with its civil counterpart, as promulgated by the Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo. A “market-adjusted method,” which focuses on normalized change in a damaged security’s value, is a more precise way to calculate actual loss. And such precision need not come at the expense of ease of application.
VOLUME 3 • ISSUE 2 • PRINT
MANAGERS VS. REGULATORS: POST-ENRON REGULATION AND THE GREAT RECESSION
Sharon Hannes
Combating managerial opportunism is a difficult task. Managers do not tend to sit idle when facing a regulatory attempt to restrict their activities. They often seek ways to circumvent the regulation or new, alternative avenues for enriching themselves. This Article uncovers one recent and pervasive form of this phenomenon. Specifically, I show how managers tend to take excessive risks in response to regulation that hinders stock price manipulation, stock option backdating or repricing and a variety of additional ill-conceived schemes. This novel theoretical argument is particularly pertinent in the wake of the recent financial crisis in the American market. Indeed, the lesson for regulators should be that any reform that improves disclosure and prevents managerial rent-seeking must also curb risk-taking tendencies.
VOLUME 3 • ISSUE 2 • PRINT
MATERIALITY: A BEDROOM PRINCIPAL PROTECTING LEGITIMATE SHAREHOLDER INTERESTS AGAINST DISGUISED POLITICAL AGENDAS
Paul Atkins
The Committee on the Disclosure of Political Spending recently submitted a petition (“the Petition”) to the U.S. Securities Exchange Commission (“SEC” or “the Commission”) urging the Commission to require SECregistered companies to disclose their contributions and expenditures for political activities.1 In support of the Petition, Professors Lucian Bebchuk and Robert Jackson (who are members of the committee that submitted the Petition) have recently published an article in the Georgetown Law Journal entitled “Shining Light on Corporate Political Spending,”2 in which they argue for not only the requirement that SEC-registered companies disclose election-related contributions and expenditures, but also for increased disclosure of activities related to government relations and public affairs.3 Bebchuk and Jackson present several arguments and respond to a range of objections to their Petition. Unfortunately, these arguments play into the hands of specialinterest activists who are pursing ends that are unrelated to the economic success of SEC-registered companies and the wellbeing of their shareholders.
VOLUME 3 • ISSUE 2 • PRINT
AGAINST AN SEC-MANDATED RULE ON POLITICAL SPENDING DISCLOSURE: A REPLY TO BEBCHUK AND JACKSON
James R. Copland
Professors Lucian Bebchuk and Robert Jackson argue that the Securities and Exchange Commission (SEC) should engage in rulemaking to consider rules mandating new corporate political-spending disclosures, but their rationale is inconsistent with the agency’s statutory purpose of protecting investors, improv- ing market efficiency, and facilitating capital formation. Corporations’ political expenditures are tiny in relation to corporate budgets and clearly immaterial, in and of themselves, to investors’ financial interests. Bebchuk and Jackson’s argument that corporate political spending is more related to agency costs than to corporate leaders’ legitimate desire to ameliorate the potential adverse impacts of government action on businesses’ earnings, and that such agency costs could helpfully be reduced by further disclosures, is highly speculative. Instead, evidence strongly suggests that special-interest groups with viewpoints adverse to corporate interests have attempted to leverage existing disclosures to chill corporate political participation. Finally, shareholder proposals involving corporate political spending and political-spending disclosure have been overwhelmingly sponsored by some of these same special-interest groups and universally rejected by shareholders at large, when opposed by boards of directors.
VOLUME 3 • ISSUE 2 • PRINT
A CASE FOR THE STATUS QUO: VOLUNTARY DISCLOSURE
Matthew Lepore
VOLUME 3 • ISSUE 2 • PRINT
THE SECURITIES EXCHANGE ACT IS A MATERIAL GIRL, LIVING IN A MATERIAL WORLD: A RESPONSE TO BEBCHUK AND JACKSON’S “SHINING LIGHT ON CORPORATE POLITICAL SPENDING”
J.W. Verret
This Article responds to a piece by Lucian Bebchuk and Robert Jackson, “Shining Light of Corporate Political Spending,” which argues in favor of a rulemaking petition submitted by the authors to initiate a mandatory rule pursuant to the Securities Exchange Act requiring companies to disclose political expenditures, including contributions to politically active non-profits. This Article explores the economic cost-benefit analysis requirements that constrain SEC rulemaking and argues that when making a mandatory disclosure rule the SEC must demonstrate that the subject of the disclosure is material to investors. It shows how Bebchuk and Jackson have not made a sufficient case that corporate political expenditures meet that materiality threshold, nor that a mandatory disclosure rule would meet the SEC’s cost-benefit analysis requirements. This is true particularly in light of how a mandatory disclosure rule risks inhibiting corporate freedom of speech.
VOLUME 3 • COLUMNS
THE FEDERAL RESERVE’S SUPPORTING ROLE BEHIND DODD-FRANK’S CLEARINGHOUSE REFORMS
Colleen Baker (April 20, 2013)
Although largely overlooked, failures in PCS systems both domestically and internationally exacerbated the financial crisis of 2008. The Federal Reserve’s critical and significant role in responding to some of these disruptions has similarly been largely overlooked.
VOLUME 3 • COLUMNS
CLEARINGHOUSE HOPE OR HYPE? WHY MANDATORY CLEARING MAY FAIL TO CONTAIN SYSTEMIC RISK
Sean J. Griffith
Clearinghouses may not be the last and best solution to the problem of systemic risk and that further regulatory experimentation may be desirable. Policy-makers should strive instead for a structure that fosters diversity and experimentation.
VOLUME 3 • COLUMNS
MARGIN COSTS OF OTC SWAP CLEARING RULES
Paul Watterson, Joseph Suh & Craig Stein
Clearing requirements affect margin requirements, a key mechanism used to mitigate counterparty risk. New clearing rules may substantially costs for users of cleared derivatives because of the higher margin delivery requirements applicable to such transactions.
VOLUME 3 • COLUMNS
REGULATION OF CROSS-BORDER SWAPS
David Felsenthal and Lily Chu
We do not believe that there is any simple, one size-fits-all remedy for regulation of cross-border swaps. We propose therefore that each transaction-level requirement be considered separately, and that specific rules be adopted for each type of transaction-level requirement.
VOLUME 3 • COLUMNS
CREDIT DEFAULT SWAPS: DUBIOUS INSTRUMENTS
Charles W. Murdock
Derivatives and other “innovative” financial instruments such as CDOs and synthetic CDOs were largely responsible for the collapse of the economy in 2008. There is little justification for the existence of CDSs and especially naked CDSs. The issue raised CDSs need to be examined in light of how they add or detract from our overall long-term prosperity.
VOLUME 3 • COLUMNS
DETERRING DISRUPTION IN THE DERIVATIVES MARKETS
Matthew Kluchenek and Jacob Kahn
Dodd-Frank Act amendeded section 4c(a) of the CEA to add three types of prohibited transactions deemed to be “disruptive of fair and equitable trading.” Market participants in the ever-growing commodities and swaps markets should not take comfort in the CFTC’s delay in filing suit.
VOLUME 3 • COLUMNS
FROM REACTION TO PREVENTION: PRODUCT APPROVAL AS A MODEL OF DERIVATIVES REGULATION
Saule T. Omarova
This article outlines the contours of a regulatory scheme based on mandatory pre-market government licensing of complex financial instruments, including derivatives. This model of product approval regulation explicitly aims to control the amount and types of risk being introduced into the financial system.
VOLUME 3 • COLUMNS
COMPLEXITY OF REGULATION
Chester S. Spatt
While our financial system is itself very complex, our financial regulators would benefit in many cases by designing simple and robust approaches that build off of basic principles and that emphasize the role and importance of economic incentives and markets. While I recognize that to some degree complexity in financial structure breeds complexity in regulation, often the causality is reversed. Complexity in regulation leads to complexity in financial structures and systems, particularly in light of the efforts of market participants to mitigate the costs and complications induced by regulation, including attempts to engage in regulatory arbitrage.
VOLUME 2 • ISSUE 2 • PRINT
COMPLEXITY, INNOVATION, AND THE REGULATION OF MODERN FINANCIAL MARKETS
The intellectual origins of the global financial crisis (GFC) can be traced back to blind spots emanating from within conventional financial theory. These blind spots are distorted reflections of the perfect market assumptions underpinning the canonical theories of financial economics: modern portfolio theory, the Modigliani and Miller capital structure irrelevancy principle, the capital asset pricing model and, perhaps most importantly, the efficient market hypothesis. In the decades leading up to the GFC, these assumptions were transformed from empirically (con)testable propositions into the central articles of faith of the ideology of modern finance: the foundations of a widely held belief in the self-correcting nature of markets and their consequent optimality as mechanisms for the allocation of society’s resources. This ideology, in turn, exerted a profound influence on how we regulate financial markets and institutions. The GFC has exposed the folly of this market fundamentalism as a driver of public policy. It has also exposed conventional financial theory as fundamentally incomplete. Perhaps most glaringly, conventional financial theory failed to adequately account for the complexity of modern financial markets and the nature and pace of financial innovation. Utilizing three case studies drawn from the world of over-the-counter (OTC) derivatives—securitization, synthetic exchange-traded funds and collateral swaps—the objective of this paper is thus to start us down the path toward a more robust understanding of complexity, financial innovation, and the regulatory challenges flowing from the interaction of these powerful market dynamics. This paper argues that while the embryonic post-crisis regulatory regimes governing OTC derivatives markets in the U.S. and Europe go some distance toward addressing the regulatory challenges stemming from complexity, they effectively disregard those generated by financial innovation.
VOLUME 2 • ISSUE 2 • PRINT
COMPLEXITY, COMPLICITY, AND LIABILITY UP THE SECURITIZATION FOOD CHAIN: INVESTOR AND ARRANGER EXPOSURE TO CONSUMER CLAIMS
The financial crisis has revealed the complexity of mortgage financing. In a matter of a few years, a multitude of actors have replaced loan officers at local banks. Now, brokers, lenders, and Wall Street arrangers mediate between borrowers and investors. Most home loans are owned by securitization trusts and investors receive a stream of income from loan payments. The law, which was designed for more deliberative and less complex transactions, did not change with the new structures. Old laws and complex, innovative finance do not make good partners, particularly in the area of consumer law. Today, tremendous uncertainty exists about the extent to which consumers might have claims against arrangers and investment trusts based on misdeeds at the origination of their loans. For financial services firms, the uncertainty impedes their ability to calculate potential legal liabilities, which in turn makes it difficult to accurately price credit and securities backed by loans. Regulators, who are charged with assuring the safety and soundness of banks and thrifts, likewise, cannot readily determine the dent consumer claims might make in banks’ balance sheets.
VOLUME 2 • ISSUE 1 • PRINT
THE LAW AND ECONOMICS OF BLOCKHOLDER DISCLOSURE
Lucian A. Bebchuk and Robert J. Jackson, Jr.
VOLUME 2 • COLUMNS
CAPTURING TIME IN FINANCIAL STATEMENTS
George M. Williams Jr.
The Dodd-Frank Wall Street Reform and Consumer Protection Act[1] applies a number of heightened standards to bank holding companies with consolidated assets of $50 billion or more and to nonbank financial companies that have been subjected to supervision by the Board of Governors because of their systemic importance. Among these standards are new liquidity and capital requirements (the “Liquidity Standard”)[2] and a new requirement (the “Resolution Plan Requirement”) to prepare and maintain a resolution plan that articulates how the relevant company could best be dismembered if it represented a threat to the financial stability of the United States.[3] One of the, perhaps unintended, effects of these new standards may be to provide an additional reason for rethinking the form and purpose of financial statements prepared by financial institutions.
VOLUME 2 • COLUMNS
PROPOSED SEC RULES COULD LIMIT CARRIED INTEREST AND INCENTIVE COMPENSATION PAID BY PRIVATE EQUITY FIRMS
Elizabeth Pagel Serebransky, Michael P. Harrell, Jonathan F. Lewis and Charity Brunson Wyatt
On April 14, 2011, the Securities and Exchange Commission (“SEC”) and several other federal agencies jointly published proposed rules aimed at governing incentive compensation practices at a broad range of banks and other financial institutions, including private equity firms. The proposed rules were intended in part to address situations where employees at financial firms were perceived to have exposed their institutions to long-term risks in exchange for near-term fees to the institutions (and large near-term bonuses to the employees), leading to excessive risk taking and even, possibly, the risk of adverse impacts on the financial system should those institutions find themselves in material distress.
VOLUME 2 • COLUMNS
DODD-FRANK AND THE FUTURE OF FINANCIAL REGULATION
Edward F. Greene
Dodd-Frank represents the most sweeping changes to the financial regulatory environment in the United States since the Great Depression. While its enactment was important, the Act is seriously flawed. It does not deal with regulatory fragmentation, sidesteps international coordination, and is overly optimistic in dealing with too-big-to-fail. Going first doesn’t mean you get it right.
VOLUME 2 • COLUMNS
THE CRYSTALLIZATION OF HEDGE-FUND REGULATION
Jeff Schwartz
Eleven months after Dodd-Frank was signed into law, the SEC issued final rules pertaining to Title IV of the Act, which calls for the registration of advisers to hedge funds and similar private investment vehicles. This brief essay looks at the legislation and the rulemaking that followed from a procedural perspective. Namely, I focus on how much discretion Congress delegated to the SEC in shaping the final rules and the SEC’s use of that discretion. I find that the legislation granted a great deal of rulemaking authority to the SEC—authority that extended to the central elements of the regulatory scheme—and that the Commission used this power to extend federal oversight to a wide swath of the private-fund marketplace.
VOLUME 2 • COLUMNS
A CONSULTANT’S VIEW OF DODD-FRANK
David Mader
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) is ambitious and complex legislation designed to significantly transform the way the financial system operates. Yet in a year’s time, the rule-making and regulatory process has not yet delivered the kind of detail or clarity anyone expected. A big reason: The sheer scale of the law—more than 2,300 pages, requiring more than 290 new regulations and 13 new agencies.
VOLUME 2 • COLUMNS
THE SEC’S NEW DODD-FRANK ADVISERS ACT RULEMAKING: AN ANALYSIS OF THE SEC’S IMPLEMENTATION OF TITLE IV OF THE DODD-FRANK ACT
Kenneth W. Muller, Jay G. Baris, and Seth Chertok
The Investment Advisers Act of 1940, as amended (the “Advisers Act”) requires “investment advisers” within the meaning of the Advisers Act with assets under management (“AUM”) in excess of the new statutory floor to register with the Securities and Exchange Commission (“Commission” or “SEC”), unless they qualify for an exemption from registration. Among other things, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) repealed Section 203(b)(3) of the Advisers Act, the “private adviser” exemption, which many investment advisers relied upon. Section 203(b)(3) exempted from registration certain investment advisers having fewer than 15 clients in any 12-month period if they met certain conditions. In applying the numerical limit in the old Section 203(b)(3), which the Dodd-Frank Act repealed, the SEC generally permitted investment advisers to count as a single “client” any fund they advise, but the SEC did not require such funds to count the individual investors as separate clients. Accordingly, private fund managers had been able to rely upon the private advisers exemption in Section 203(b)(3) and advise a substantial number of separate funds (not more than 14 in any 12-month period) without becoming subject to SEC registration.
VOLUME 2 • COLUMNS
DODD-FRANK AT ONE YEAR: GROWING PAINS
J.C. Boggs, Melissa Foxman, and Kathleen Nahill
Addressing a joint session of Congress for the first time in February 2009, President Obama asked Congress to “put in place tough, new common-sense rules of the road so that our financial market rewards drive and innovation, and punishes short-cuts and abuse.” Nine months later, on November 3rd, then-Financial Services Committee Chairman Barney Frank (D-MA) introduced the Financial Stability Improvement Act. The bill grew exponentially throughout the month of November, and by the time H.R. 4173 came before the full House of Representatives on December 10th, Rep. Frank’s 380-page bill had expanded to 1,279 pages. When the final conference bill was signed into law on July 21, 2010, not only was it the most significant regulatory overhaul since the New Deal, but at almost 2,400 pages, it was more than twice the length of the three previous regulatory bills – the Securities Act of 1933, the Securities Exchange Act of 1934 and Sarbanes-Oxley – combined.
VOLUME 2 • COLUMNS
THE SEC’S WHISTLEBLOWER PROGRAM: WHAT THE SEC HAS LEARNED FROM THE FALSE CLAIMS ACT ABOUT AVOIDING WHISTLEBLOWER ABUSES
Douglas W. Baruch and Nancy N. Barr
The Dodd-Frank Wall Street Reform and Consumer Protection Act’s (“Dodd-Frank Act”) sweeping overhaul of the financial system now requires the SEC to pay substantial monetary awards to whistleblowers who disclose wrongdoing by publicly traded companies, financial services institutions, and other covered entities, and it prohibits employers from retaliating against SEC whistleblowers. On May 25, 2011, the SEC adopted final rules implementing these new mandates. Although the rules become effective 60 days after publication in the Federal Register, they apply retroactively to tips provided on or after July 21, 2010, Dodd-Frank’s enactment date. The SEC’s new whistleblower program borrows heavily from the whistleblower provisions of the civil False Claims Act (“FCA”), albeit with important distinctions that reflect an attempt by the SEC to distance itself from some of the problems plaguing FCA enforcement.
VOLUME 2 • COLUMNS
STRAIGHT TALK FROM A PRACTITIONER: NOTES FROM UNDER THE WALL
Steven Lofchie and Theresa Perkins
As a financial regulatory lawyer, I am accustomed to being cautious in my pronouncements. Equivocal and timid. When clients ask me for hard advice, rather than answer them, I often just rub my hands together like Uriah Heep and mumble, “that is a very good question.” If you search me on the Internet, you will see that my writing resulted in one commenter describing me as “the world’s most boring man.”
VOLUME 2 • COLUMNS
DODD-FRANK ACT HAS ITS FIRST BIRTHDAY, BUT DERIVATIVES END USERS HAVE LITTLE CAUSE TO CELEBRATE
Michael Sackheim and Elizabeth M. Schubert
A year has passed since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Title VII of the Dodd-Frank Act, entitled the Wall Street Transparency and Accountability Act of 2010 (“Title VII”) created a new transparent exchange-type trading marketplace for over-the-counter swaps subject to regulation by the Commodity Futures Trading Commission (“CFTC”) and security-based swaps subject to regulation by the Securities and Exchange Commission (“SEC”) (collectively, “OTC derivatives” or “swaps”). This article will discuss the significant impact Title VII has, and will continue to have, on the end user, or “buy” side, of the derivatives markets.
VOLUME 1 • ISSUE 1 • PRINT
ON THE DODD-FRANK ACT
Edolphus “Ed” Towns
VOLUME 1 • ISSUE 1 • PRINT
ON THE DODD-FRANK ACT
Bobby L. Rush
VOLUME 1 • ISSUE 1 • PRINT
DERIVATIVES AND THE LEGAL ORIGIN OF THE 2008 CREDIT CRISIS
Lynn A. Stout
Experts still debate what caused the credit crisis of 2008. This Article argues that dubious honor belongs, first and foremost, to a little-known statute called the Commodities Futures Modernization Act of 2000 (CFMA). Put simply, the credit crisis was not primarily due to changes in the markets; it was due to changes in the law. In particular, the crisis was the direct and foreseeable (and in fact foreseen by the author and others) consequence of the CFMA’s sudden and wholesale removal of centuries-old legal constraints on speculative trading in over-the-counter (OTC) derivatives.
VOLUME 1 • ISSUE 1 • PRINT
THE VOLKER RULE AND EVOLVING FINANCIAL MARKETS
Charles K. Whitehead
The Volcker Rule prohibits proprietary trading by banking entities—in effect, reintroducing to the financial markets a substantial portion of the Glass-Steagall Act’s static divide between banks and securities firms. This Article argues that the Glass-Steagall model is a fixture of the past—a financial Maginot Line within an evolving financial system. To be effective, new financial regulation must reflect new relationships in the marketplace. For the Volcker Rule, those relationships include a growing reliance by banks on new market participants to conduct traditional banking functions. Proprietary trading has moved to less-regulated businesses, in many cases, to hedge funds. The result is likely to be an increase in overall risk-taking, absent market or regulatory restraint. Ring-fencing hedge funds from other parts of the financial system may be increasingly difficult as markets become more interconnected. For example, new capital markets instruments—such as credit default swaps—enable banks to outsource credit risk to hedge funds and other market participants. Doing so permits banks to extend greater amounts of credit at lower cost. A decline in the hedge fund industry, therefore, may prompt a contraction in available credit by banks that are no longer able to manage risk as effectively as before.In short, even if proprietary trading is no longer located in banks, it may now be conducted by less-regulated entities that affect banks and banking activities. Banks that rely on hedge funds to manage credit risk will continue to be exposed to proprietary trading—perhaps less directly, but now also with less regulatory oversight, than before. The Volcker Rule, consequently, fails to reflect an important shift in the financial markets, arguing, at least initially, for a narrow definition of proprietary trading and a more fluid approach to implementing the Rule.
VOLUME 1 • ISSUE 1 • PRINT
REGULATING MONEY CREATION AFTER THE CRISIS
P. Morgan Ricks
Like bank deposits, money market instruments function in important ways as “money.” Yet our financial regulatory regime does not take this proposition seriously. The (non-government) issuers of money market instruments—almost all of which are financial firms, not commercial or industrial ones—perform an invaluable economic function. Like depository banks, they channel economic agents’ transaction reserves into the capital markets. These firms thereby reduce borrowing costs and expand credit availability. However, this activity—“maturity transformation”—presents a problem. When these issuers default on their money market obligations, they generate adverse monetary consequences. This circumstance amounts to a market failure, creating a prima facie case for government intervention. This Article evaluates policy alternatives in this area. It finds reasons to favor establishing money creation as a sovereign responsibility by means of a public-private partnership system—in effect, recognizing money creation as a public good. (This is just what modern bank regulation has done for decades.) Logically, this approach would entail disallowing access to money market financing by firms not meeting the applicable regulatory criteria—just as firms not licensed as banks are legally prohibited from issuing deposit liabilities. Against this backdrop, the Article reviews the Dodd-Frank Act’s approach to regulating money creation. It finds reasons to doubt that the new law will be conducive to stable conditions in the money market.
VOLUME 1 • ISSUE 1 • PRINT
TRANSPARENCY AND CONFIDENTIALITY IN THE POST FINANCIAL CRISIS WORLD — WHERE TO STRIKE THE BALANCE?
Annette L. Nazareth and Margaret E. Tahyar
Existing supervisors, as well as the new institutions that the Dodd-Frank Act created, collect and aggregate an unprecedented amount of commercially sensitive financial information. Although financial institutions and their supervisors are increasingly transparent in the post financial crisis era, some information that financial institutions provide regulators should be protected from disclosure. Untimely public disclosure of sensitive and competitive information— through FOIA requests, third-party subpoenas, or Congress—could undermine the goals of the Dodd-Frank Act by creating upsetting markets and making financial institutions reluctant to disclose data to the government voluntarily. The Article argues that when it passed the Dodd-Frank Act, Congress, out of an understandable desire to promote transparency in the financial system, created an intolerable level of uncertainty as to whether information that regulators gather will be kept confidential. The Article argues that regulators and Congress should act to strike a proper balance between transparency and confidentiality rather than allowing courts to determine the legally required level of disclosure in an unpredictable and ad hoc fashion.
VOLUME 1 • ISSUE 1 • PRINT
THE DODD-FRANK EXTRATERRITORIAL JURISDICTION PROVISION: WAS IT EFFECTIVE, NEEDED OR SUFFICIENT?
Richard W. Painter
In Morrison v. National Australia Bank, the U.S. Supreme Court ruled in June 2010 that securities fraud suits could not be brought under Section 10(b) of the Exchange Act against foreign defendants by foreign plaintiffs who bought their securities outside the United States (so called “f-cubed” securities litigation). The Court held that Section 10(b) reaches only fraud in connection with the “purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” Congress responded to Morrison with Section 929P of the Dodd-Frank Act, which gives federal courts jurisdiction over some similar cases if they are brought by the SEC or the Department of Justice (DOJ). This Article discusses alternative explanations for why Congress used extraterritorial jurisdiction language in Section 929P instead of directly addressing the reach of Section 10(b) on the merits, and whether as a result Section 929P does nothing more than confer jurisdiction on federal courts that the Morrison opinion already recognized courts have over all Section 10(b) cases. This Article also discusses whether Section 929P reinstates for SEC and DOJ suits some of the case law in the courts of appeals that was overturned by Morrison, and if so, how that case law is to be applied. This Article discusses whether Section 929P is retroactive, and how Section 929P likely will be used by the SEC and DOJ in insider trading and other cases. Finally, this Article discusses whether Section 929P was necessary given the SEC’s already expansive enforcement authority under Section 10(b) and whether Congress should have taken the opportunity to address other more pressing post-Morrison issues in Dodd Frank. These issues include the status under Morrison of securities listed both in the United States and outside the United States, and the status of off-exchange traded security-based swap agreements, as well as other private transactions where identifying a transaction location is not as easy as it is for exchange traded securities.
VOLUME 1 • ISSUE 1 • PRINT
RATINGS REFORM: THE GOOD, THE BAD, AND THE UGLY
John C. Coffee, Jr.
Although dissatisfaction with the performance of the credit rating agencies is universal (particularly with regard to structured finance), reformers divide into two basic camps: (1) those who see the “issuer pays” model of the major credit ratings firms as the fundamental cause of inflated ratings, and (2) those who view the licensing power given to credit ratings agencies by regulatory rules requiring an investment grade rating from an NRSRO rating agency as creating a de facto monopoly that precludes competition. After reviewing the recent empirical literature on how ratings became inflated, this Article agrees with the former school and doubts that serious reform is possible unless the conflicts of interest inherent in the “issuer pays model” can be reduced. Although the licensing power hypothesis can explain the contemporary lack of competition in the ratings industry, increased competition is more likely to aggravate than alleviate the problem of inflated ratings. Still, purging conflicts is no easy matter, both because (1) investors, as well as issuers, have serious conflicts of interest (for example, investors dislike ratings downgrades) and (2) a shift to a “subscriber pays” business model is impeded by the public goods nature of credit ratings. This Article therefore reviews recent policy proposals and considers what steps could most feasibly tame the conflicts of interest problem.
VOLUME 1 • ISSUE 1 • PRINT
FDICIA V. DODD-FRANK: UNLEARNED LESSONS ABOUT REGULATORY FORBEARANCE
Jonathan M. Edwards
Regulatory forbearance was widely blamed for increasing losses to deposit insurance funds in the 1980s. As part of the legislative response, Congress created a system of Prompt Corrective Action and expanded the grounds for appointing the FDIC receiver of a bank—changes partially intended to limit regulators’ ability to forbear. The recent financial crisis similarly evidenced regulatory forbearance, but Congress did not have the same determination to limit regulatory forbearance. As an afterthought, Congress created a system of early intervention called Early Remediation for systemically important financial companies. Instead of developing a comprehensive system like it did for Prompt Corrective Action, Congress requires the Federal Reserve to create the Early Remediation system. The Federal Reserve is now empowered to create a system that is completely discretionary and relies on the same regulatory judgment that failed in the recent crisis. A system of subjective early intervention is no different from regulators’ safety and soundness authority and will not limit regulatory forbearance or prevent its catastrophic consequences. In a similar vein, Congress created a system of orderly liquidation for systemically important financial companies that uses a closure rule that is prone to regulatory forbearance. Without a congressional limit on regulatory forbearance, we are reliant on market discipline to check regulatory forbearance even though it can cause the same systemic consequences that the Dodd-Frank Act failed to address. We can only hope that, in order to prevent another financial crisis, the regulators who are implementing the Federal Reserve-created Early Remediation system are conscious of the consequences of their inaction.
VOLUME 1 • ISSUE 1 • PRINT
SECURITIZATION REFORM: A COSEAN COST ANALYSIS
Aron M. Zuckerman
This Note analyzes securitization reform proposals through an examination of the underlying economic justification for securitization. The Note focuses on the increase in private label asset-backed securitization of residential mortgage loans from 2002–2006 and the corresponding subprime bubble. The analysis is motivated by a recognition that securitization and financial innovation were lauded for twenty-five years and that recent reform proposals have not challenged the underlying economic justifications for securitization. Nevertheless, there is widespread recognition that securitization led to an over-supply of mortgage credit available in the United States. This Note utilizes Coase’s theory of the firm to explain the disintermediation of credit markets and the appeal of securitization to banks and lenders. It then analyzes securitization reform proposals with the same Coasean framework and notes that the costs of securitization are not strict principal-agent problems. Rather, the contracting costs of securitization inhibit the ability of parties to identify the residual risk-bearer. Residual risk-bearers are best qualified to monitor the risks of over-supply and weak originating standards in securitization markets. The Note concludes by identifying improved representations and warranties as the reform proposal most likely to account for the contracting costs imposed by securitization. Enhanced representations and warranties and explicit disclosure requirements would impose contracting costs and proper restraint on sponsors and would require them to properly identify the risk factors and risk-bearers in securitization.
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CONTINGENT CONVERTIBLE BONDS AND BANKER COMPENSATION: POTENTIAL CONFLICTS OF INTEREST?
Gaurav Toshniwal
Two issues related to financial regulation have received significant academic and regulatory attention since the financial crisis: Contingent Convertible Bonds (“CoCos”) and banker compensation. The discussion, however, has largely been silent on the interaction between the two. This brief note explores the potential conflicts that may exist in the design and implementation of CoCos because of the incentive structure created by managerial compensation. Regulators, academics and market participants will need to address these concerns in designing the regulatory framework for CoCo instruments and managerial compensation.
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DURBIN STICKS TO GUNS, CHOOSE SLURPEES OVER CONSUMESR: AN OVERVIEW OF THE DURBIN AMENDMENT AND ITS POTENTIAL ADVERSE IMPACT ON CONSUMERS
Brandon Gold
When the chairmen of the Federal Reserve Board and Federal Deposit Insurance Corporation and the Acting Comptroller of the Currency express doubts about a regulation designed to eliminate seventy percent of a market, and when the queen and spokeswoman of consumer financial protection, Elizabeth Warren, refuses to comment on a financial rule supposedly enacted to protect consumers, one would expect a rational legislator to, at a minimum, delay such a measure until they could properly understand its ramifications. Dick Durbin, the number two democrat in the Senate, refuses to fit that mold. Instead, Durbin, the author of the self-titled “Durbin Amendment” to the Dodd-Frank Act, refuses to reconsider the legislation directing the Federal Reserve to limit debit card interchange fees and threatens to filibuster any bill brought before the Senate that seeks to delay its implementation.
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HARMONY OR CACOPHONY? A PRELIMINARY ASSESSMENT OF THE RESPONSES TO THE FINANCIAL CRISIS AT HOME AND IN THE EU
J. Scott Colesanti
To be sure, the recent reforms to the U.S. regulatory system are far from final. Even if House Republicans do not succeed in turning back the clock, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) require so many studies, interpretations, and effectuating regulations that it will evade meaningful analysis for years. And while the nominally bipartisan Financial Crisis Inquiry Commission recently issued its report on causes for the financial crisis, that spirited document both spread the blame and disclosed infighting so as to cloud sufficiently any lasting impressions. Separately, the European Union—tasked with confronting the same economic foes while facing its own legislative obstacle of supranationalism—has issued robust rounds of Directives, Regulations, and Recommendations. Similar to efforts in the United States, the culmination of these reforms will trigger debate about business regulation on that continent for years to come.
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IN DODD-FRANK’S SHADOW: THE DECLINING COMPETITIVENESS OF U.S PUBLIC EQUITY MARKETS
David Daniels
As we enter into 2011, things are looking up. The Dow Jones has recently broken through 12,000 and is climbing to pre-recession heights. The economy has emerged from the greatest downturn since the Great Depression and continues to show modest growth. Unemployment is slowly decreasing. But all is not well. A potentially worrying trend that gained traction at the beginning of the millennia continues to unfold: the decline of the competitiveness of U.S. public equity markets. For example, consider the U.S. primary equity markets. In 2000, these markets attracted 54% of all global initial public offerings (IPOs)—IPOs by foreign companies issued on at least one public exchange outside the company’s domestic market. Similarly, foreign companies raised about 82% of the dollar value of all global IPOs on U.S. public exchanges.
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QUESTIONING THE 500 EQUITY HOLDERS TRIGGER
William K. Sjostrom, Jr.
An obscure provision of the Securities Exchange Act of 1934 (Exchange Act) has received unprecedented attention in recent months because of the prominent role it appears to be playing in Facebook’s decision on going public. Specifically, Exchange Act Section 12(g)(1) requires any company with “total assets exceeding [$10,000,000] and a class of equity security . . . held of record by five hundred or more . . . persons” to register such security under the Exchange Act. The measurement date for these thresholds is the last day of a company’s fiscal year. It then has 120 days from that date to register. Today, the practical effect of this rule is to force certain types of firms into the public markets earlier than is desirable. A shift from a shareholder-based trigger to one based on trading volume would preserve the Rule’s underlying policy concerns while mitigating this unintended effect.