There’s been a lot of controversy recently over the SEC’s use – or perhaps I should say, non-use – of the automatic “bad actor” disqualifications for firms that commit securities violations.  The disqualification provisions place certain limits on the activities of firms that are found to have committed securities violations.  Dodd Frank added a big stick to the list of penalties:  It added an automatic disqualification from participating in private placements under Rule 506 of Regulation D.  It’s a severe penalty; private placements are extremely lucrative.

But the SEC can waive the automatic disqualification – and frequently does, even for “recidivist” firms that repeatedly rack up securities violations.  It imposes fines, perhaps outside monitoring, but it waives disqualifications – especially the Rule 506 disqualification.

The issue has recently hit the public eye because Democratic Commissioners Luis Aguilar and Kara Stein have been objecting to the grant of waivers to recidivist firms.  In their view, waivers are an important tool for deterring securities violations, and the SEC has improperly adopted a policy of granting them “reflexively.”

In light of all of this, the SEC has promised to issue guidelines as to how Rule 506 waiver decisions are made; Commissioner Daniel Gallagher thinks the matter may ultimately have to be resolved by Congress.

Until recently, hasn’t been clear just how often these waivers have been granted, and who has received them.  But Urska Velikonja just posted a new paper that gathered data on 201 waivers issued between 2003 and 2014.  These waivers involved Regulation D disqualification, Regulation A disqualification, and also disqualification from the use of automatic shelf registration statements to raise capital.  Velikonja finds that: (1) large financial firms received over 80% of the waivers; smaller firms and nonfinancial firms rarely receive them even though they are much more likely to be the target of an enforcement action; (2) the SEC typically does not offer any real justifications for its decision to grant or withhold a waiver, but the pattern appears to be that the Commission does not grant waivers for firms accused of offering fraud or issuer disclosure violations; usually, they’re granted for firms accused of unrelated misconduct, such as violations of the broker-dealer and investment adviser rules – presumably because the Commission views the latter firms as presenting a lower recidivism risk; and (3) the number of waivers has declined over time, and the SEC has recently begun utilizing partial waivers.

(More under the jump)

I finally got it together and opened an account on SSRN (I know, I know), and posted two of my forthcoming pieces there.

The first, Searching for Market Efficiency, is a very short comment that will be published in the Arizona Law Review, discussing Donald Langevoort’s Judgment Day for Fraud-on-the-Market and Geoffrey Miller’s The Problem of Reliance in Securities Fraud Class Actions, both of which will be published in the same issue.  The comment discusses the Supreme Court’s recent decision in Halliburton, and the reasons behind courts’ difficulties in defining market efficiency for the purpose of Section 10(b) class actions.

The second, Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws, is a longer article forthcoming in the Georgetown Law Journal, and it deals with the claim that, because corporate governance documents are “contractual,” clauses that require arbitration of shareholder disputes must be enforced according to their terms, as required by the Federal Arbitration Act.  I’ve discussed this topic before; the Article spins things out in more depth.  I will eventually put up a longer post here summarizing the piece, but if there’s anyone who just can’t wait for the cliffs notes…

This seems to have been a great week for business stories with a touch of the absurd.

First up, we have Footnoted.org’s fantastic catch in Goldman’s 10-K.  Apparently, Goldman now has a new risk factor:

[O]ur businesses ultimately rely on human beings as our greatest resource, and from time-to-time, they make mistakes that are not always caught immediately by our technological processes or by our other procedures which are intended to prevent and detect such errors. These can include calculation errors, mistakes in addressing emails, errors in software development or implementation, or simple errors in judgment. We strive to eliminate such human errors through training, supervision, technology and by redundant processes and controls. Human errors, even if promptly discovered and remediated, can result in material losses and liabilities for the firm.

We can only speculate as to what specific, as-yet-undisclosed, human error prompted this disclosure, but if I had to make a bet, my money would be on an email address auto-fill mistake that is now the subject of some behind-the-scenes settlement discussions, the details of which will only come to light if negotiations fail and a public lawsuit is filed.

Next up, we have a Hunger-Games inspired video created…

One of the enduring debates in corporate law concerns whether shareholder empowerment promotes short-termism – i.e., temporary boosts in stock prices that can only be achieved at the expense of longer-term value-building projects, like research and development.  Related to this debate is the argument – championed by, among others, Margaret Blair and Lynn Stout – that directors cannot/should not be solely concerned with shareholder wealth maximization; instead, their role is to mediate among various firm stakeholders.  This is because a firm cannot thrive unless it offers a credible commitment to its employees and other corporate constituents  that they will not be ousted the moment it appears profitable to do so.  In other words, in order to induce employees and other stakeholders to invest valuable human capital in the firm, these actors must believe that the firm is committed to them – that shareholders are barred from, for example, insisting on downsizings or outsourcings or what-have-you the moment it appears that doing so will create a share price bump. 

Martijn Cremers and Simone Sepe weigh in on this debate in a new paper, Whither Delaware? Limited Commitment and the Financial Value of Corporate Law(summarized here), where they conclude that…

The news this week in shareholder rights is that GE joined the list of companies that have voluntarily enacted their own bylaws permitting large shareholders to nominate directors to be included on the company proxy.  

GE’s action comes in the midst of a publicly-announced campaign by the New York City Comptroller to gather support for shareholder-enacted bylaws that would do roughly the same thing.  (And a very ugly battle over such bylaws at Whole Foods, as Marcia previously posted.)

In that context, GE’s move seems like something of a Trojan horse.  By enacting its own bylaw, GE preempts any attempts by shareholders to do so.  Meanwhile, because the bylaw is director-enacted, GE can yank it at any time – like, if it feels there’s a coherent movement that threatens the current board’s dominance.  In fact, this strategy was recently on display when Rupert Murdoch announced an unsolicited takeover of Time Warner.  The first thing Time Warner’s board did was to repeal a director-enacted bylaw that permitted shareholders to call special meetings.

As a result, I’m not quite yet ready to call this a great win for shareholder democracy.

In their new paper, Rating Agencies and Information Efficiency: Do Multiple Credit Ratings Pay Off?, Stefan Morkoetter, Roman Stebler, and Simone Westerfeld  study whether it benefits investors to have more than one rating agency rate a particular security.

They find that when multiple rating agencies rate a particular tranche of a mortgage-backed security, not only is the initial rating more accurate, but the agencies devote more efforts to ongoing surveillance, increasing the accuracy of the rating over the life of the tranche.  They conclude that the increased efforts are traceable to a healthy competition among agencies; as the authors put it, “Since their activities are directly bench-marked to their peers’, rating agencies are induced to show more effort with regard to their monitoring obligations than observed for single-rated tranches.”

One of the reasons the paper is interesting is because Dodd Frank and the SEC implementing regulations impose new restrictions on conflicts of interest within credit ratings agencies, basically forbidding anyone from the business side from having any involvement with the ratings themselves.  In light of Morkoetter et al’s conclusions, I do have to wonder whether at least some business-side involvement with the ratings process creates a healthy sort…

Jonas Heese has posted an interesting paper to SSRN, Government Preferences and SEC Enforcement, where he argues that the SEC goes easy on firms that contribute significantly to employment in a particular area.  He finds that the effect is magnified in presidential election years in swing states, and for firms that are headquartered in districts senior congresspersons who have SEC oversight responsibilities.  This effect cannot be explained by the hypothesis that labor-intensive firms simply have better accounting; according to Hesse, they actually have worse accounting than other comparable businesses (which may in fact reflect their knowledge that the SEC is less likely to target them).  He concludes, essentially, that the SEC is responding to political/voter pressures to take a hands-off approach to firms that are responsible for providing jobs.

One of the interesting points he makes is that this kind of pressure is independent of “special interest” lobbying; rather, this kind of pressure is a result of government actors responding to voter preferences.

The paper is available for download here.