On December 21, 2009, the Securities and Exchange Commission issued a proposed amendment to paragraph (c) of Rule 163 under the Securities Act of 1933, as amended. Rule 163 was initially adopted in 2005 as part of the SEC’s Securities Offering Reform, which, among other things, eased many of the “gun jumping” restrictions on communications by issuers and others in connection with registered securities offerings. The proposed amendments to Rule 163 would further ease some of these restrictions and may thereby facilitate so called “wall-crossed” offerings by well-known seasoned issuers, or WKSIs. [1]

As currently in effect, Rule 163 permits a WKSI to offer securities before filing a related registration statement. Such offers may be deemed made, for example, when discussions with potential investors take place to gauge market interest prior to broad public disclosure of a transaction. However, as currently drafted, Rule 163 applies only to communications made “by or on behalf of the issuer itself.” Other offering participants, such as underwriters or dealers, may not rely on this exception from the gun jumping restrictions. This limitation can create a significant impediment to a WKSI seeking to communicate with potential investors in advance of a securities offering, but has not filed an automatic shelf registration statement, or ASR, [2] covering the security to be offered.

…continue reading: Proposed Changes May Facilitate “Wall-Crossed” Offerings

In our recently updated working paper Stockholder and Bondholder Reactions to Revelations of Large CEO Inside Debt Holdings: An Empirical Analysis, we investigate investor reactions to the first disclosures of the values of CEOs’ pensions and deferred compensation. These two items together comprise managers’ “inside debt” claims against their firms, since each represents a fixed liability owed by the companies to their executives at a future date.

We identify 231 companies whose CEOs have positive inside debt holdings and whose proxy statements with 2006 compensation data are filed in early 2007 during the first wave of disclosures under the SEC’s new executive compensation disclosure regulations. About 45% of these CEOs have excessive inside debt, as their personal inside debt-equity ratios exceed the external debt-equity ratios of their firms. As expected, we find evidence of transfers of value away from equity and toward debt upon revelations that top managers hold large pension and deferred compensation claims. Our results show that bond prices rise, equity prices fall, and the volatility of both securities drops at the time of disclosures by firms whose CEOs have large inside debt.

…continue reading: Market Reactions to CEO Inside Debt Holdings

In our forthcoming Journal of Finance paper entitled Security Issue Timing: What Do Managers Know, and When Do They Know It?, we complete a large-scale empirical analysis of companies who sell put options on their own stock. A unique feature of our setting is the ability to investigate option exercises and expirations directly. Also, since put sales can be viewed as a levered bet that the stock price will not drop, they offer a unique setting to study market timing by corporations.

We identify firms that sold put options on their own stock by searching annual and quarterly reports available on the Lexis-Nexis, Factiva, and Edgar databases. We eliminate put issues which were sold in conjunction with other equity or debt securities by the same firm, and retain only stand-alone put sales. We match put sellers with data on firm characteristics from Compustat and data on stock returns from CRSP. The final sample contains 137 firms and 802 distinct put issues.

…continue reading: Security Issue Timing

The Global Financial Crisis, recently published by Foundation Press, describes the basic causes of the financial crisis; analyzes the regulatory, political and market responses to it; and discusses the merits of various recent reform proposals. Written by Hal S. Scott, the Nomura Professor and Director of the Program on International Financial Systems at Harvard Law School, the book represents perhaps the most learned and succinct account of the financial crisis to date. Its careful focus on the terms of regulation – existing and proposed, U.S. and international – and its clear explanation and analysis of scholarly studies set it apart from many other recent offerings on this topic. The author offers rich, forthright insights and skillfully situates events in their historical and regulatory context. The book will likely hold strong appeal for scholars and policy makers and for others with an interest in rigorous, concise analysis of perplexing policy questions.

The book is structured as follows:

• Chapter 1 – causes and severity of the financial crisis
• Chapter 2 – measures taken throughout the crisis to stabilize the financial system
• Chapter 3 – problems afflicting the housing market and proposed solutions
• Chapter 4 – proposals for reforming regulatory rules
• Chapter 5 – proposals for reforming U.S. regulatory structure
• Chapter 6 – international responses to the crisis

Each chapter is further divided and sub-divided into topics, each of which is just a page or two in length. This structured approach aids understanding without compromising the book’s readability. In this brief post I touch on some of the material covered in the book. I cannot convey the depth of the author’s analysis or reproduce his succinct and engaging literary style.

…continue reading: The Global Financial Crisis

At an open meeting held on December 16, 2009, the Securities and Exchange Commission (”SEC”) approved a set of proposed rules to enhance the information provided to shareholders in company proxy statements regarding a number of risk oversight, compensation, board leadership and composition and other corporate governance matters.  The SEC approved the final rules by a 4-to-1 vote, with Commissioner Kathleen Casey dissenting.  The SEC released the text of the final rules on the same date they were adopted, with the 129 page adopting release available here.

The new rules have an effective date of February 28, 2010, except that a rule change on how equity awards are reported in the Summary Compensation Table applies to all companies with fiscal years ending after December 20, 2009.  Because all of the rule changes other than the equity reporting rule call for enhanced disclosures, companies presumably could, but would not be required to, voluntarily comply with all of the new rules even if they file their definitive proxy statements before February 28, 2010.

…continue reading: SEC Adopts Final Rules on Enhanced Proxy Statement Disclosures

The current multi-pronged effort for U.S. federal preemption of state corporate law, particularly in the area of corporate governance, is largely predicated on the view that it is necessary to forestall excessive risk-taking in the private sector. However, the federal preemption “cure” is a carrier of its own systemic disease. Before imposing this “cure,” it is essential to make a responsible assessment of its need and consequences.

State Regulation of Public Business Corporations: A Cornerstone of Capitalism

The modern U.S economic system — variously called capitalism, free enterprise or private enterprise — is centered around the publicly traded business corporation organized under state law. It is the principal vehicle for gathering non-government capital, investing it and managing the businesses in which it is invested. Historically, the governance of these companies has been regulated by their states of incorporation, with limited exceptions. And, in general, the state law-based corporate governance model has been very respectful — indeed protective — of the core concepts of the U.S. private enterprise system: freedom, capital raising, risk-taking, experimentation, innovation and value maximization. The model recognizes that publicly traded business corporations, as key enablers of the U.S. capitalist system, should be regulated in a manner which permits these core private enterprise concepts to operate with minimal interference.

…continue reading: The Risks to Private Enterprise from Federal Preemption of State Corporate Law

In recent years, securities fraud lawsuits in the United States have increasingly been brought against non-U.S. companies. In October 2008, the United States Court of Appeals for the Second Circuit issued an important decision concerning the extraterritorial application of the U.S. securities laws, Morrison v. National Australia Bank, 547 F.3d 167 (2d Cir. 2008). On November 30, 2009, the U.S. Supreme Court decided to hear an appeal from the Second Circuit’s decision. Non-U.S. issuers with businesses in the U.S. should follow the Morrison case closely, along with legislation that is currently making its way through Congress concerning the extraterritorial application of the U.S. securities laws. These developments may determine the circumstances under which non-U.S. companies can be exposed to private securities fraud suits or regulatory enforcement actions in the U.S.

…continue reading: Supreme Court to Consider Extraterritorial Application of Securities Laws

A number of recent studies debate the impact of investor protection law on corporate policy and performance. On one hand, many papers identify cross-country differences in firm characteristics and attribute these differences to variation in legal protection of investors from insider expropriation (which in turn is attributed to heterogeneity in countries’ legal origins). On the other hand, a number of studies find within-country evidence that changes in investor protection laws have little impact on corporate decisions.

I address this debate in a new working paper entitled The Impact of Investor Protection Law on Corporate Policy: Evidence from the Blue Sky Laws which I recently presented at the CELS 2009 4th Annual Conference on Empirical Legal Studies. More specifically, I exploit the staggered passage of state investor protection statutes (”blue sky laws”) in the U.S. in the early 20th century to estimate the effects of investor protection law on firm financing decisions and investment activity.

Regression estimates indicate that the introduction of investor protection law, keeping legal origin fixed, causes firms to pay out greater dividends, issue more equity, grow in size, and experience improvements in operating performance and market valuations. Additional analysis suggests that alternative hypotheses for the measured changes in corporate policy and performance – such as political economy considerations, changes in unobservable investment opportunities, and firm location decisions – have limited explanatory power.

Overall, the evidence is strongly supportive of theoretical models which predict that investor protection laws have a significant impact on firm financing and investment policy. The findings further suggest that proper design of legal institutions can have important implications for the functioning of capital markets.

The full paper is available here.

The Harvard Law School Program on Corporate Governance recently issued our paper, Private Ordering and the Proxy Access Debate. The paper can be downloaded here.

The paper addresses key objections raised against the SEC’s proposal to provide shareholders with rights to include shareholder nominees for election as directors on the company’s proxy statement. Opponents have argued that a preference for private ordering and a recognition that “one size does not fit all” support retention of the current default rule that prevents shareholder nominees from being included on the company’s proxy. We show that this is not the case.

First, opponents argue that, even assuming proxy access is desirable in many circumstances, the existing no-access default should be retained and the adoption of proxy access arrangements should be left to opting-out of this default on a company-by-company basis. Our article identifies strong reasons against retaining no-access as the default. There is substantial empirical evidence indicating that insulating directors from removal is associated with lower firm value and inferior performance. Furthermore, when opting-out from a default arrangement serves shareholder interests, a switch is more likely to occur when it is favored by the board than when disfavored by the board. We analyze the impediments to shareholders’ obtaining opt-outs that are favored by shareholders but not the board, and we present empirical evidence indicating that such impediments are substantial. The asymmetry in the reversibility of defaults highlighted in this article should play an important role in default selection.

…continue reading: Private Ordering and the Proxy Access Debate

(Editor’s Note: This post comes to us from Sanford J. Lewis, Counsel to the Investor Environmental Health Network.)

A clash is emerging between the needs and duties of directors and investors to manage risks, and attorneys who advise “don’t ask; don’t tell” to minimize corporate liability in any possible future litigation. The task of mitigating this clash falls on the shoulders of regulators at the Securities and Exchange Commission and the Financial Accounting Standards Board.

When the Financial Accounting Standards Board (FASB) took up the issue of contingent liability disclosures on behalf of investors in 2008, it appeared progress would be made. However, under pressure from the corporate legal community, which sought to block any requirements to require disclosure of potentially prejudicial information, the FASB may now be about to take a step backward unless the directors and investors can be mobilized.  The Securities and Exchange Commission is also in a position to act to make vital improvements in disclosure of information relevant to potential liabilities.

Will we have to wait for a flood of lawsuits, or will regulators act to establish clearer reporting rules that encourage better management of risks?

…continue reading: Don’t Ask, Don’t Tell: A Poor Framework for Risk Analysis by Both Investors and Directors