Hardcover book forthcoming. 
Here is a description from the Amazon product page:

Since the 1980s,
society’s wealthiest members have claimed an ever-expanding share of income and
property. It has been a true counterrevolution, says Pierre Rosanvallon–the
end of the age of growing equality launched by the American and French
revolutions. And just as significant as the social and economic factors driving
this contemporary inequality has been a loss of faith in the ideal of equality
itself. An ambitious transatlantic history of the struggles that, for two
centuries, put political and economic equality at their heart, The Society of
Equals calls for a new philosophy of social relations to reenergize egalitarian
politics. For eighteenth-century revolutionaries, equality meant understanding
human beings as fundamentally alike and then creating universal political and
economic rights. Rosanvallon sees the roots of today’s crisis in the period
1830-1900, when industrialized capitalism threatened to quash these
aspirations. By the early twentieth century, progressive forces had begun to
rectify some imbalances of the Gilded Age, and the modern welfare state
gradually emerged from Depression-era reforms. But new economic shocks in the
1970s began a slide toward inequality that has only gained momentum in the
decades since.

Jennifer S. Taub has updated “What We Don’t Talk About When
We Talk About Banking” on SSRN.  Here is
the abstract:

The run on the shadow banking system in 2008 is routinely
identified as the event that transformed the nonprime mortgage securities
meltdown into a full-blown Global Financial Crisis. Yet, the components of this
shadow sector have not been brought into the light let alone under adequate
regulatory supervision. The government-initiated reform measures enacted to
date lack consistency and cohesion. Too little attention has been paid to how
the varied pieces of this system interconnect with each other and with “real”
banking. For example, the multi-trillion dollar repurchase agreement (“repo”)
market was ground zero for the sudden, severe withdrawal of liquidity from the banking
system in the United States. Yet little has been done to address the dependence
upon this short-term, often overnight funding market. Conversely, some shadow
players like money market mutual funds, (MMFs) that were already subject to
heavy structural controls, have been further regulated. While these new rules
were designed to strengthen the funds, making them less prone to runs by their
own investors, these same changes may create even more instability and risk for
bank and shadow bank counterparties who depend upon them for short-term
financing. Additionally, with regard to some of the most risky “nonbank”
financial firms, such as hedge funds, the regulatory reform measures to date
have been flimsy at best. Accordingly, this chapter first will describe what is
meant by “shadow banking,” and the role it played in the financial crisis.
Next, it will highlight two key components of shadow banking system: MMFs and
the repo market, including the regulatory reforms accomplished to date and
proposals being studied. And, finally it will present alternative suggestions
for further reform.

On October 16th, the US Chamber of Commerce’s
Center for Capital Markets Competitiveness will host a half-day event to
examine trends from the 2013 proxy season and look ahead to 2014.  The day
will start with a presentation from the Manhattan Institute about the 2013 season
and then I will be on a panel with Tony Horan, the Corporate Secretary of
JP Morgan Chase, Vineeta Anand from the Office of Investment of the AFL-CIO,
and Darla Stuckey of the Society of Corporate Secretaries and Governance
Professionals. Our panel will look  back at the 2013 proxy season and discuss hot
topics in corporate governance in general.  Later in the day, Harvey Pitt
and other panelists will talk about future trends and reform proposals, and
depending on the state of the government shutdown, we expect a
member of Congress to be the keynote speaker. The event will be webcast for
those who cannot make it to DC.  Click here
to register.

 

Dodd-Frank requires the SEC to issue rules barring national exchanges
from listing any company that has not implemented a clawback policy that does
not include recoupment of incentive-based compensation for current and former
executives for a three-year period.  Unlike the Sarbanes-Oxley clawback rule,  Dodd-Frank requires companies to recover compensation,
including options, based on materially inaccurate financial information,
regardless of misconduct or fault.

Although the SEC has not yet issued rules on this provision,
a number of companies have already disclosed their clawback policies, likely
because proxy advisory firms Glass Lewis and Institutional Shareholder Services
have taken clawback policies into consideration when making Say on Pay voting
recommendations. Equilar has reviewed the proxy statements for Fortune 100
companies filed in calendar year 2013 for compensation events for fiscal year
2012. The organization released a report
summarizing its findings, which are instructive. 

Of the 94 publicly-traded companies analyzed by Equilar, 89.4%
publicly disclosed their policies; 71.8% included provisions that contained
both financial restatement and ethical misconduct triggers; 29.1% included
non-compete violations as triggers and 27.2% had other forms of triggers.  68% of the policies applied to key executives
and employees including named executive officers, while only 14.6% applied to
all employees. 7.8% of clawback policies applied only to CEOs and/or CFOs.  35.9% of policies covered a range of
compensation types including deferred compensation, sales commissions, flexible
perquisite accounts and/or supplemental retirement plans.  

The Equilar report provides language and links to the
filings for Wal-Mart, Ignite Restaurant Group, CVS Caremark, Johnson &
Johnson, AIG, Supervalu, Apple, IBM, Johnson Controls and ConocoPhilips.  The report also notes that despite the early
disclosures, they tend to fall short of the Dodd-Frank standard in that only
37.9% mention outstanding options.  This
will surely change once the SEC finalizes the rule.

 

 

I am emerging from a rabbit hole of research that began approximately 3.5 hours ago.  The question was inspired by teaching the 2002 Delaware Supreme Court case,
Download Gotham 817_A.2d_160, in my unincorporated business associations class and students’ drafting of fiduciary duty waivers in a limited partnership agreement.  Many of you are already aware that Delaware allows for the complete elimination of general partners’ fiduciary duties. I knew that Delware was an outlier in this area, but I wasn’t certain by how much.  So 3.5 hours and a 50 state (plus D.C.) survey later, I have a concrete answer.  Only Delaware (
Download Delaware GP Fiduciary duty statute) and Alabama (
Download Alabama Statute) statutes allow for the complete elimination of fiduciary duties for general partners.  The remaining 49 jurisdictions surveyed only allow for the expansion or restriction of fiduciary duties, but not the elimination.  Of those 49 jurisdictions, 20 have a stand alone provisions that outline the fiduciary duties of general partners, and 29 statutes establish the minimum fiduciary duties for general partners by linkage to the traditional partnership statutes.  Of the 29 jurisdictions that rely on linkage to traditional partnership statutes, 13 use a Uniform Partnership Act (1914) “accounting” style fiduciary duty provision and 16 use a revised Uniform Partnership Act (1997) enumerated fiduciary duties style provision.  

My initial research table is available here: Download LP Fiduciary Duty waiver Chart.

My findings raise several questions.  The first is a curiosity as to where else are Delaware statutes outliers and what does this say about the reach of Delaware law?  The ubiquity of Delaware law is limited by the incentives for foreign entities to avail themselves of Delaware state laws, the challenge to Delaware’s dominance is seen most clearly with closely-held firms.

-Anne Tucker

I gave a talk
today about sustainable development, where I talked about the challenges of
trying to balance resource development with the need to preserve the
environment and deal with the social issues that come from increased
activity. 

One thing
came to mind: People matter.  Whether you work for EQT or the EPA, you’re a
person who has a job to do, which can have beneficial outcomes.   When we
discuss sustainable development, we also need to recognize the need for sustainable
conversation. Development doesn’t happen without conversation, which can lead to
compromise, which can lead to progress.  

Governments
and corporations are both made up of people.  Isolating either governments
or corporations as inherently evil entities is missing the point.  We can
disagree about the goals of either, but we need to be more careful about who we
vilify.  Negotiations don’t happen against governments or corporations,
they happen with people in governments or in corporations.  And we need to
remember that.

In the last 30 years, it has become incredibly important whether or not investors in securities offerings are accredited investors. An issuer can sell securities to accredited investors without registration (and without alternative disclosure requirements) under both Rule 506 and new Rule 506(c) of Regulation D.Accredited investor status also matters in determining whether an issuer is a reporting company under the Exchange Act. A company must register under the Exchange Act only if it has 2,000 record holders of a class of equity security or “500 persons who are not accredited investors.” Exchange Act sec. 12(g)(1)(A).

But the SEC may have taken a wrong turn when it defined the term to make individuals “accredited investors” based solely on the absolute level of their net worth or annual income.

The Section 4(a)(2) Exemption

Section 4(a)(2) [formerly, section 4(2)] of the Securities Act of 1933 exempts from registration “transactions by an issuer not involving any public offering.”

The leading case interpreting that statutory exemption is SEC v. Ralston Purina Co., 346 U.S. 119 (1953). In that case, the Supreme Court indicated that the availability of the exemption turns on “the need of the offerees for the protections afforded by registration.” According to the Court, what is now section 4(a)(2) exempts offerings “to those who are . . . able to fend for themselves.”

Since Ralston Purina, the cases analyzing section 4(a)(2) have focused primarily on the sophistication of the offerees and their access to information about the issuer.

The Rule 506 Safe Harbor

Sophistication and ability to fend for one’s self are inherently uncertain concepts. In the early 1980s, the SEC adopted a safe harbor, Rule 506 of Regulation D, intended to make the issuer’s task a little easier. Offerings that comply with the terms of the Rule 506 safe harbor are “deemed to be transactions not involving a public offering within the meaning of section 4(a)(2) of the Act.” Rule 506(a).

Under Rule 506, securities may be sold to investors falling into two categories:

1. Accredited investors (or investors the issuer reasonably believes are accredited investors); or

2. Sophisticated investors. Investors who, either alone or with a representative, have “such knowledge and experience in financial and business matters that . . . [they are] . . . capable of evaluating the merits and risks of the prospective investment.” (There is also a “reasonable belief” clause protecting the issuer with respect to this category.)

The second category is true to Ralston Purina and cases applying Ralston Purina: the investor or someone representing the investor must be sophisticated. And, under Rule 502(b), those non-accredited investors must be furnished with information about the issuer.

Accredited investors do not have to be sophisticated and the issuer is not required to furnish them with the information required by Rule 502(b). Because of this, most Rule 506 offerings are limited to accredited investors.

Rule 506(c)

Rule 506(c), recently added by the SEC pursuant to the JOBS Act, also limits sales to accredited investors. Unlike Rule 506, Rule 506(c) does not allow an issuer to sell to sophisticated, non-accredited investors. And Rule 506(c) imposes no information requirements.

Wealthy Individuals as “Accredited Investors”

The SEC’s definition of “accredited investor” strays from the
original Ralston Purina idea of investors who do not need the protection
provided by registration, particularly with respect to its inclusion of wealthy individual investors.

An individual investor is accredited if, among other possibilities:

(1) her individual net worth, or joint net worth with her spouse, in both case excluding the person’s primary residence, exceeds $1 million (Rule 501(a)(5)); or

(2)  the individual’s annual income over a period of years exceeds $200,000 or the joint net income with her spouse exceeds $300,000 (Rule 501(a)(6)).

The Possible Policy Rationales for Including Wealthy Investors

There are a couple of possible arguments for concluding that registration is unnecessary when securities are sold to these wealthy individuals. First, investors in these categories might be sophisticated enough to fend for themselves.

Obviously, not every person with an annual income greater than $200,000 or a net worth greater than $1 million has investment sophistication. For example, if someone just won $5 million in the lottery, there’s no good reason to suppose that person is a sophisticated investor. (In fact, if the person is spending money on lottery tickets, the opposite assumption makes more sense.)

It would still make sense to use wealth as a proxy for sophistication if most wealthy investors were sophisticated. The gains in certainty might be worth the overinclusiveness. It’s an empirical question, but there’s no reason to suppose that most wealthy people are sophisticated investors. Federal securities case law is filled with doctors, dentists, and other wealthy investors making stupid investment decisions.

There’s another reason we might conclude wealthy investors don’t need the protection of registration: they can afford to lose the money. This alternative argument has at least two problems. First, neither income nor net worth are very good measures of liquidity. If the net worth of a wealthy investor consists primarily of illiquid investments, any loss from an investment in securities could be devastating.

The second problem with this alternative argument is that neither Rule 506 nor new Rule 506(c) limit the proportion of the investor’s net worth or income that may be invested in the offering. Because of that, even if an investor’s assets are liquid, the investor still may not be able to afford the loss.

Assume, for example, that an investor has a net worth of $1 million, consisting of $1 million cash and no liabilities. If the investor invests the entire $1 million in the Rule 506 offering, a loss could bankrupt the investor. The investor clearly cannot afford to lose the money invested in the offering.

A Better Approach?

The recent approach Congress took in the JOBS Act’s crowdfunding exemption is more consistent with the question of whether the investor can afford to lose the amount invested. That exemption places no limit on who may invest; both wealthy and non-wealthy investors may participate in crowdfunded securities offerings (once the SEC adopts the implementing regulations). But the amount an investor may invest is limited to a percentage of the investor’s net worth or annual income.

One may disagree with the percentages Congress chose; I have argued elsewhere those percentages are too high. But the basic idea is sound. If you limit the investor to some percentage of his net worth or annual income, the investor can afford a loss and is therefore less in need of the protection of registration.

The SEC simply took a wrong turn. Its focus on the absolute level of net worth or income doesn’t fit either a sophistication or an affordability rationale.

Fernan Restrepo has posted “Do Different Standards of
Judicial Review Affect the Gains of Minority Shareholders in Freeze-Out
Transactions? A Re-Examination of Siliconix” on SSRN.  Here is the abstract:

Freeze-out transactions have been subject to different
standards of judicial review in Delaware since 2001, when the chancery court,
in In re Siliconix Inc. Shareholders Litigation, held that, unlike merger
freeze-outs, tender offer freeze-outs were not subject to “entire fairness
review”. This dichotomy, in turn, gave rise to a tension in the literature
regarding the potential impact of Siliconix, as well as the treatment that
freeze-outs should receive. While some defended the regime established by
Siliconix, others argued for doctrinal convergence through a universal
application of entire fairness, and still others proposed alternative
variations of convergence based on how the negotiation process is conducted.
The Delaware Chancery Court itself, in fact, subsequently made a partial step
toward convergence by narrowing the scope of its precedent, as reflected in In
re CNX Gas Corporation Shareholders Litigation. The empirical evidence on the
effect of Siliconix (and, therefore, on the practical relevance of different
standards of judicial review), however, is limited. In particular, in
“Post-Siliconix freeze-outs: Theory and Evidence,” Guhan Subramanian found that
minority shareholders obtain lower cumulative abnormal returns (CARs) in tender
offer freeze-outs relative to merger freeze-outs, and, based on this finding,
Subramanian advocates for doctrinal convergence. That article, however, does
not formally examine whether Siliconix generated a structural change in
relative CARs in both transactional forms and, therefore, whether the
differences in outcomes are actually attributable to the disparity in standards
of judicial review. The purpose of this work is, therefore, to fill this gap in
the literature. To this end, this work uses a difference-in-differences
approach, which compares changes over time (before and after Siliconix) between
CARs in tender offers (the treatment group) and CARs in statutory mergers (the
control group). As further discussed in the text, the results seem to suggest,
in line with Subramanian’s intuition, that Siliconix actually had at least some
negative effect on CARs in tender offers, since the estimator of
difference-in-differences is consistently negative and generally significant.
Based on the results, this work discusses specific policy implications,
particularly in terms of regulatory convergence.

Michael B. Dorff has posted “The Siren Call of Equity
Crowdfunding” on SSRN.  Here is the
abstract:

The JOBS Act opened a new frontier in start-up financing,
for the first time allowing small companies to sell stock the way Kickstarter
and RocketHub have raised donations: on the web, without registration.
President Obama promised this novel form of crowdfunding would generate jobs
from small businesses while simultaneously opening up exciting new investment
opportunities to the middle class. While the new exemption has its critics,
their concern has largely been confined to the limited amount of disclosure
issuers must provide. They worry that investors will lack the information they
need to separate out the Facebooks from the frauds. This is the wrong concern.
The problem with equity crowdfunding is not the extent of disclosure. The
problem is that the companies that participate will be terrible prospects. As a
result, crowdfunding investors are virtually certain to lose their money. This
essay examines the data on angel investing – the closest analogue to equity
crowdfunding – and concludes that the majority of the issuers that sell stock
to the middle class over the internet will lose money for investors, with many
failing entirely. The strategies that help the best angels profit will not be
available to crowdfunders. Plus, the losses most issuers inflict will not be
offset by a few huge winners. Investors will not find tomorrow’s Googles on
crowdfunding portals because they will not be there; instead, start-ups with
real potential will continue to use other programs, such as the newly expanded
Rule 506 exemption. This outcome is the inevitable result of the nature of
start-up investing and crowdfunding. No amendments to the Act or rule-making by
the SEC can prevent it. The only solution that will protect investors is to
abolish equity crowdfunding for the unaccredited.

Too bad I
didn’t have this information from today’s
Wall Street Journal to add to my arsenal of reasons of why I think the Dodd-Frank conflict minerals
SEC disclosure is a well-intentioned but bad law to address rape, forced labor,
plundering of villages, murder, and exploitation of children in the Democratic
Republic of Congo. I won’t reiterate the reasons I outlined in my two-part blog
post a couple of weeks ago.  According
to press reports, while acknowledging her responsibility to uphold the law, SEC Chair Mary Jo White mirrored some of the arguments about
discretion that business groups and our amicus brief raised on appeal to the DC
Circuit, and further explained, “seeking
to improve safety in mines for workers or to end horrible human rights
atrocities in the Democratic Republic of the Congo are compelling objectives,
which, as a citizen, I wholeheartedly share … [b]ut, as the Chair of the SEC, I
must question, as a policy matter, using the federal securities laws and the
SEC’s powers of mandatory disclosure to accomplish these goals.”  I couldn’t agree more. While I have no problems with appropriate and relevant disclosure, corporate responsibility, and due diligence related to human rights, Congress should let the SEC focus on its mission of protecting investors, maintaining efficient markets, and facilitating capital formation. 

The text of her speech at
Fordham Law School where she made these remarks and others about the need for
agency independence and discretion is available here.