Thank you for permitting me to testify before you today on cost-benefit analysis conducted by the Securities Exchange Commission (SEC). I am speaking today on behalf of the Committee on Capital Markets Regulation (Committee), of which I am the Executive Director for Research. The Committee has, since its 2006 Interim Report, [1] strongly supported improved cost-benefit analysis by both the SEC and other agencies. Today, the need for improved cost-benefit analysis is particularly evident in the agencies’ respective rulemakings under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). We are deeply concerned that the inadequate cost-benefit analysis in the vast majority of rulemakings under Dodd-Frank could expose these rules to judicial challenge, prevent important rules from taking effect, and contribute to uncertainty in our markets over their fate.

The broad scope of new regulation under Dodd-Frank, issued by agencies including the SEC, Commodity Futures Trading Commission (CFTC) and others, will result in fundamental changes across the financial industry. Sound cost-benefit analysis must be a part of this process, to ensure that in each case, the proposed rule is optimal among all reasonable alternatives. In light of the ruling last July by the U.S. Court of Appeals for the D.C. Circuit in Business Roundtable v. Securities and Exchange Commission, [2] and a current lawsuit seeking to strike down the CFTC’s recently promulgated position limits rule, [3] we believe many of the rules under Dodd-Frank could be subject to successful challenge in court. It would be an unfortunate outcome if, after the Dodd-Frank rulemaking process has run its course for several years, important rules are invalidated because of inadequate analysis. Even if such rules are not eventually invalidated, prolonged uncertainty around their fate threatens to hamper economic activity.

…continue reading: The Need for Improved Cost-Benefit Analysis of Dodd-Frank Rulemaking

On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (“JOBS Act” or the “Act”) into law. While the Act and recent commentary have focused primarily on common equity issuances by “Emerging Growth Companies” (or “EGCs”), the JOBS Act also impacts companies that have issued only debt securities in registered transactions, typically pursuant to an “A/B” exchange for privately offered high-yield debt securities. Many of these companies subsequently become “voluntary filers” of SEC Exchange Act reports to comply with on-going debt covenants.

The attached chart summarizes how certain JOBS Act provisions apply to these debt-only issuers. As indicated in the chart, they may benefit from a number of JOBS Act provisions with regard to their Securities Act registration statements and Exchange Act reports, including:

• potentially indefinite EGC status, assuming the $1 billion revenue, $1 billion debt issuance every three years, and certain other thresholds are never crossed;
• the option to submit to the SEC confidential drafts of Securities Act registration statements for any offering prior to the issuer’s first sale of its common equity securities pursuant to an effective Securities Act registration statement;
• the option to comply with new accounting standards applicable to public companies on the schedule that is applicable to private issuers; and
• the option to provide scaled back executive compensation disclosure.

In addition, after the SEC adopts implementing rules, companies that issue debt securities privately will be permitted to engage in general solicitation and general advertising in connection with offerings made in reliance on Rule 506 of Regulation D and Rule 144A under the Securities Act, just as they will be able to do with respect to equity offerings.

…continue reading: JOBS Act Applies to Debt-Only Issuers

There is strong evidence that high levels of short selling are associated with lower future returns and this return predictability suggests that short sellers, on average, have an information advantage over other traders (e.g., Senchack and Starks, 1993; Asquith, Pathak, and Ritter, 2005; Boehmer, Jones, and Zhang, 2008). However, while return predictability suggests that short sellers have an information advantage, it says little about the source of this advantage. In our forthcoming Journal of Financial Economics paper, How Are Shorts Informed? Short Sellers, News, and Information Processing, we ask how short sellers obtain an information advantage.

During the financial crisis in 2008, some regulators and journalists accused short sellers of illegitimate trading practices. In fact, the Securities and Exchange Commission (SEC) suggested that short sellers spread “false rumors” in an effort to manipulate firms “uniquely vulnerable to panic.” However, in contrast to this manipulation hypothesis, we find that a substantial portion of short sellers’ trading advantage comes from their ability to analyze publicly available information. These findings suggest that, on average, short sellers do not manipulate prices, but rather, they help prices incorporate pertinent information.

…continue reading: Short Sellers, News, and Information Processing

In the past few years, hedge funds have moved into the mainstream of the U.S. economy. Once restricted to a small number of super-wealthy “sophisticated investors,” they now receive hundreds of billions of dollars from public and private pension plans acting as fiduciaries for school teachers, truck drivers, construction workers, first responders and others whom we have lately come to call “the 99 percent,” who share little in common with fund managers stocking the Forbes 400 list. Surfing upon this incoming tide of money, some individual funds now manage enough assets to exert significant influence in the markets.

But the widespread acceptance of hedge funds among institutional investors has not been matched by commensurate improvements in their level of transparency, accountability and corporate governance. In recent months, we’ve witnessed the dismal result: a parade of inside-trading scandals evoking the fraud-riddled implosions of Worldcom, Tyco, Enron and Global Crossing that rocked corporate America a decade ago. It’s time for hedge funds to be brought into the 21st century and reflect their new broader role and fiduciary responsibilities. This means the legal regime that sets the rules for hedge funds must change.

Without question, the profile of the average hedge fund investor has changed in the past few years. Battered by the financial crisis that erased billions of dollars in stock market value just a few years before the first baby boomers were scheduled to retire, many pension funds started investing with hedge funds in the hope of making up lost ground by taking advantage of their customized, often quant-driven investing strategies and promises of “absolute returns” regardless of the markets’ direction.

…continue reading: Hedge Funds Need More Accountability

The Commission has authorized that a Study be sent to Congress expressing the views of the Staff on the cross-border scope of the private right of action under Section 10(b) of the Securities Exchange Act of 1934. However, my conscience compels me to write separately to record my views on the Study. I write to convey my strong disappointment that the Study fails to satisfactorily answer the Congressional request, contains no specific recommendations, and does not portray a complete picture of the immense and irreparable investor harm that has resulted, and will continue to result, due to Morrison v. National Australia Bank, Ltd.

In the United States we have a strong belief that, whether rich or poor, we are all entitled to our day in court. Sadly, for many American investors this is no longer true.

If American investors are defrauded by a company that they have invested in – and that company is listed on a foreign exchange – investors may be unable to have their day in court and seek redress against this company for its lies and misrepresentations. Thus, investors have been stripped of a traditional American right.

This was not always the case. For decades, federal courts applied the same standard to determine whether U.S. federal securities law applied to frauds that took place, in whole or in part, outside of the United States. Under that standard, Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and other antifraud provisions applied “when there was ‘significant U.S. fraudulent conduct that directly caused the plaintiffs losses’ (the conduct test) or when there were ‘significant effects’ on the U.S. securities markets (the effects test).”

…continue reading: Defrauded Investors Deserve Their Day in Court

On March 26, 2012, in Credit Suisse Securities (USA) LLC v. Simmonds, the U.S. Supreme Court held 8-0 that the two-year statute of limitations for suits under the short-swing liability rules of Section 16(b) of the Securities Exchange Act of 1934 is not tolled (i.e., suspended) until an insider files a Section 16(a) disclosure statement; the limitations period can begin running even if the disclosure statement is filed at a later date or never filed at all. The Court’s decision provides insiders of U.S. public companies with better protection and more certainty against time-barred claims.

The Supreme Court reversed the Ninth Circuit, which had held, citing to its precedent, that the limitations period is tolled until an insider files the Section 16(a) disclosure statement “regardless of whether the plaintiff knew or should have known of the conduct at issue”. In dicta, the Supreme Court also rejected the Second Circuit’s rule that the limitations period is tolled until the plaintiff “gets actual notice that a person subject to Section 16(a) has realized specific short-swing profits that are worth pursuing”.

The Supreme Court did indicate some willingness to permit equitable tolling of the Section 16(b) limitations period, but under circumstances more limited than the “disclosure” rule of the Ninth Circuit or the “actual notice” rule of the Second Circuit.

…continue reading: Court Rules on Short-swing Liability Rules

On April 5, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), which as we’ve previously noted represents a very significant loosening of restrictions around the IPO process and post-IPO reporting obligations. While most of the commentary on this legislation has thus far focused on its impact on capital markets matters, there are implications for private company mergers and acquisitions as well.

Late-stage private companies contemplating an M&A or IPO exit often undertake so-called “dual-track” processes in which they simultaneously file an IPO registration statement with the SEC and hold discussions with prospective acquirors.  The IPO side of the process effectively becomes a stalking horse for M&A discussions and tends to force the hand of prospective acquirors that might otherwise not move as quickly as the target would like.  The publicly filed registration statement both attracts attention and provides prospective acquirors with a sort of first-stage diligence that theoretically helps encourage bids.

Under the JOBS Act, emerging growth companies or “EGCs” will now have the ability to file their registration statements confidentially, so long as the confidential filings are ultimately released at least 21 days before the road show.  Whether confidential filings will become the norm remains to be seen; there are a number of reasons why an IPO candidate might want to continue to use the traditional public filing process, including the publicity, customer and employee-related benefits of having a highly visible registration statement.  For many companies, however, these benefits will be outweighed by the competitive advantages of keeping early filings confidential.  The optionality that confidential filings create may be hard to resist: A confidential filer can now pull its deal without the stigma associated with withdrawing a publicly filed registration statement.

…continue reading: The JOBS Act: Implications for Private Company Acquisitions and M&A Professionals

In our paper, Equity-Holding Institutional Lenders: Do They Receive Better Terms?, which was recently made publicly available on SSRN, we evaluate the way in which institutional equity holders are involved in the lending process. Participation by equity-holding institutions has become a major part of the syndicated loan market. In our sample of 11,137 institutional “leveraged” loan tranches between 1997 and 2007 from the DealScan database, 2,008 (18%) have participation by a “dual holder” institution that owns at least 0.1% of the borrowing firm’s equity. Lending to firms in which one has an equity position goes against the principle of diversification, since it exposes the investor to firm-specific shocks through both its equity and debt ownership. To justify dual holding, the investor must receive compensation of some sort, either through the improvements in the value of its equity holdings, or by above market rates of return on the loan.

We estimate the abnormal return a dual holder receives by comparing spreads on dual holder tranches to those on observationally equivalent tranches that do not have a dual holder. Our estimates indicate, holding all else equal, that loan tranches with dual holder participation receive a 13 basis-point higher spread than otherwise similar tranches without an equity holder’s participation in the lending syndicate. The positive spread is statistically and economically significant for revolvers as well as term loans and for loans to borrowers of different ratings and to unrated borrowers as well.

…continue reading: Equity-Holding Institutional Lenders

Recently, in Global Reinsurance Corp.–U.S. Branch v. Equitas Ltd., the New York Court of Appeals, New York’s highest court, refused to apply the state’s antitrust statute, the Donnelly Act, to allegedly anticompetitive conduct in Great Britain that had only incidental effects in New York.  Reversing a divided decision of the intermediate appellate court, the Court of Appeals reasoned that state antitrust law could not have a broader extraterritorial reach than federal antitrust law; otherwise, statutory and judicial limitations on the federal Sherman Act “would be undone if states remained free to authorize ‘little Sherman Act’ claims that went beyond it.”

This rationale may have significant implications beyond the antitrust arena, as the Court of Appeals more broadly reaffirmed that “[t]he established presumption is, of course, against the extra-territorial operation of New York law.”  For example, the potential impact on securities claims under state common law is particularly notable.  In the wake of the United States Supreme Court’s decision in Morrison v. National Australia Bank, which held that Section 10(b) of the Securities Exchange Act applies only to domestic securities transactions (see our memo here), a number of plaintiffs have attempted to invoke state common law to recover losses on extraterritorial transactions.  One potential obstacle to such state-law suits appeared to have been removed late last year, when the Court of Appeals, in Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management, rejected a line of lower-court and federal precedents that had held common-law securities actions preempted by New York’s securities statute, the Martin Act (see our memo here).

…continue reading: Limits on Extraterritorial Reach of State Law

Although a branch of a bank is not a separate juridical entity from the bank of which it is a component, U.S. law treats branches as separate from the head office and other branches of a bank when such differentiation is appropriate for various purposes. Branches are a hybrid structure, at the same time both an integral part of the banks of which they are merely offices and separate legal entities for a number of U.S. regulatory and commercial law purposes. This feature of bank branches is a central tenet of federal banking statutes, and the law governing U.S. branches of foreign banks in particular.

At times the status of a U.S. branch of a foreign bank under a particular statutory scheme is explicit. Such is the case with the U.S. law treatment of U.S. branches of foreign banks in insolvency. As discussed below, U.S. law treats those branches virtually as separate entities in insolvency.

In other circumstances, a particular statute does not explicitly address the status of U.S. branches of foreign banks, and the treatment has to be arrived at through an analysis of the purpose of the statutory scheme. For example, as discussed below, after a long series of no-action letters, the Securities and Exchange Commission (“SEC”) issued interpretive guidance providing that securities issued or guaranteed by U.S. branches of a foreign bank (but not its non-U.S. branches) could rely on the exemption from registration afforded to securities issued or guaranteed by a bank under Section 3(a)(2) of the Securities Act of 1933 (“Securities Act”). Thus, U.S. branches can rely on the Section 3(a)(2) exemption while the bank itself is required to register to distribute its securities in the United States.

This paper will review the treatment of U.S. branches of foreign banks under a variety of statutory schemes and explore the rationale for that treatment.

…continue reading: Separate Entity Doctrine for U.S. Branches of Foreign Banks