Securities Law Commons^™

Regulating Secondary Markets In The High Frequency Age: A Principled And Coordinated Approach, Michael Morelli

Michigan Business & Entrepreneurial Law Review

Technological developments in securities markets, most notably high frequency trading, have fundamentally changed the structure and nature of trading over the past 50 years. Policymakers both domestically and abroad now face many new challenges impacting the secondary market’s effectiveness as a generator of economic growth and stability. Faced with these rapid structural changes, many are quick to denounce high frequency trading as opportunistic and parasitic. This article, however, instead argues that while high frequency trading presents certain general risks to secondary market efficiency, liquidity, stability, and integrity, the practice encompasses a wide variety of strategies, many of which can enhance, …

The Sec, Administrative Usurpation, And Insider Trading, Adam C. Pritchard

Articles

The history of insider trading law is a tale of administrative usurpation and legislative acquiescence. Congress has never enacted a prohibition against insider trading, much less defined it. Instead, the SEC has led in defining insider trading, albeit without the formality of rulemaking, and subject to varying degrees of oversight by the courts. The reason why lies in the deference that the Supreme Court gave to the SEC in its formative years. The roots of insider trading law are commonly traced to the SEC’s decision in Cady, Roberts & Co. Cady, Roberts was only made possible, however, by the …

Public Pensions And Fiduciary Law: A View From Equity, T. Leigh Anenson

University of Michigan Journal of Law Reform

Controversies involving fund management may be the next frontier of public pension litigation. Recent scandals involving fraud, bribery, and corruption of public pension officials and other third parties have drawn the public eye toward the management of retirement assets. Individual and entity custodians, including pension boards of trustees, are charged with making investment and other decisions relating to pension funds. Unlike private pensions, there is no federal oversight of asset managers or others in control of retirement funds. Yet these funds hold more than three trillion dollars in assets. Until now, the guardians of these monies have operated almost invisibly …

Carrot Or Stick? The Shift From Voluntary To Mandatory Disclosure Of Risk Factors, Karen K. Nelson, Adam C. Pritchard

Articles

This study investigates risk factor disclosures, examining both the voluntary, incentive-based disclosure regime provided by the safe harbor provision of the Private Securities Litigation Reform Act as well as the SEC's subsequent mandate of these disclosures. Firms subject to greater litigation risk disclose more risk factors, update the language more from year to year, and use more readable language than firms with lower litigation risk. These differences in the quality of disclosure are pronounced in the voluntary disclosure regime, but converge following the SEC mandate as low-risk firms improved the quality of their risk factor disclosures. Consistent with these findings, …

Economic Crisis And The Integration Of Law And Finance: The Impact Of Volatility Spikes, Edward G. Fox, Merritt B. Fox, Ronald J. Gilson

Articles

The 2008 financial crisis raised puzzles important for understanding how the capital market prices common stocks and in turn, for the intersection between law and finance. During the crisis, there was a dramatic five-fold spike, across all industries, in “idiosyncratic risk”—the volatility of individual-firm share prices after adjustment for movements in the market as a whole.

This phenomenon is not limited to the most recent financial crisis. This Article uses an empirical review to show that a dramatic spike in idiosyncratic risk has occurred with every major downturn from the 1920s through the recent financial crisis. It canvasses three possible …

Sec Investigations And Securities Class Actions: An Empirical Comparison, Stephen J. Choi, Adam C. Pritchard

Articles

Using actions with both an SEC investigation and a class action as our baseline, we compare the targeting of SEC-only investigations with class-action-only lawsuits. Looking at measures of information asymmetry, we find that investors in the market perceive greater information asymmetry following the public announcement of the underlying violation for class-action-only lawsuits compared with SEC-only investigations. Turning to sanctions, we find that the incidence of top officer resignation is greater for class-action-only lawsuits relative to SEC-only investigations. Our findings are consistent with the private enforcement targeting disclosure violations at least as precisely as (if not more so than) SEC enforcement.

Revisiting The Accredited Investor Standard, Syed Haq

Michigan Business & Entrepreneurial Law Review

The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) and the Jumpstart Our Business Startups (JOBS) Act provided the impetus for several changes in the financial regulatory regime. In the securities markets, Dodd-Frank included provisions that lifted a ban on general solicitation and mandated a review of the accredited investor standard. These changes, while intended to increase capital formation within our private markets, also brought to light serious investor protection issues. This note advocates for a new accredited investor standard that more accurately reflects the risks associated with investing in the private markets.

Rebutting The Fraud On The Market Presumption In Securities Fraud Class Actions: Halliburton Ii Opens The Door, Victor E. Schwartz, Christopher E. Appel

Michigan Business & Entrepreneurial Law Review

In Halliburton Co. v. Erica P. John Fund, Inc. (Halliburton II), the United States Supreme Court reaffirmed the validity of the “fraud on the market” presumption underlying securities fraud class action litigation. This presumption is vital to bringing suits as class actions because it excuses plaintiffs from proving individual reliance on an alleged corporate misstatement on the theory that any public statements made by the company are incorporated into its stock price and consequently relied upon by all investors. Thus, the Court’s decision to uphold the validity of the presumption has been hailed as a significant victory for those …

3(A)(10) Financing: New Predatory Financing Using The Securities Act, Thomas S. Glassman

Michigan Business & Entrepreneurial Law Review

The Section 3(a)(10) exemption of the Securities Act of 1933 is meant to exempt securities transactions where a fairness hearing by a judge or government agency’s ruling replaces the usual SEC registration requirements. Recently, there has been a rise in 3(a)(10) financing schemes, where a third party investor, what I call a “3(a)(10) financier,” will offer to purchase the outstanding debts of a company from its creditors in exchange for discounted, and unregistered, shares of stock. In many cases these exchanges are done with no notification to current shareholders whose value falls precipitously when the 3(a)(10) financier begins not only …

Dual-Class Capital Structures: A Legal, Theoretical & Empirical Buy-Side Analysis, Christopher C. Mckinnon

Michigan Business & Entrepreneurial Law Review

“The advantage of a dual-class share structure is that it protects entrepreneurial management from the demands of ordinary shareholders. The disadvantage of a dual-class share structure is that it protects entrepreneurial management from the demands of shareholders.” Issuing dual classes of stock has become hotly debated since two major events transpired in 2014: (1) Facebook acquired WhatsApp for $19 billion and (2) Alibaba chose to list its shares on the New York Stock Exchange (NYSE) instead of the Hong Kong Exchange. Because dual-class managers, like those at Facebook and Alibaba, retain a controlling voting block, their decisions are immune from …

No More Quid Pro Quo: Abandoning The Personal Benefit Requirement In Insider Trading Law, Shannon Seiferth

University of Michigan Journal of Law Reform

A circuit split between the Second Circuit’s 2014 decision, United States v. Newman, and the Ninth Circuit’s 2015 decision, United States v. Salman, illustrates problems in insider trading law dating back over thirty years to the Supreme Court’s decision in Dirks v. SEC. Dirks held that when a corporate insider provides information to an outside party who then trades on the information, it must be shown that the insider received some form of a personal benefit for providing the information in order to impute liability. The courts in Newman and Salman disagreed on the sort of evidence …

The Corporation’S Place In Society, Gabriel Rauterberg

Michigan Law Review

The vast majority of economic activity is now organized through corporations. The public corporation is usurping the state’s role as the most important institution of wealthy capitalist societies. Across the developed world, there is increasing convergence on the shareholder-owned corporation as the primary vehicle for creating wealth. Yet nothing like this degree of convergence has occurred in answering the fundamental questions of corporate capitalism: What role do corporations serve? What is the goal of corporate law? What should corporate managers do? Discussion of these questions is as old as the institutions involved.

Amending China's Insider Trading Prohibition - An Immodest Proposal, Nicholas C. Howson

Law & Economics Working Papers

Presented in China in conjunction with the proposed amendment of the People's Republic of China (PRC) Securities Law 2006, this paper critiques the form and application of the PRC's current insider trading prohibition and its misconceived fealty to Rule 10b-5-limiting U.S. Supreme Court-derived doctrines of fiduciary duty and misappropriation, and urges that China's amended statute and enforcement system look to the broader doctrinal formulations employed in the United Kingdom and the European Union, ironically already used by China's securities regulator pursuant to internal (and likely illegal) administrative "guidance" norms.

Regulating To Achieve Stability In The Domain Of High-Frequency Trading, Lindsey C. Crump

Michigan Telecommunications & Technology Law Review

High-frequency trading has become a darling of capital markets debate. This debate thrives because the true and long-lasting effects of high-frequency trading are still unknown. On one hand, high-frequency trading evidences recent and powerful advances in trading technology; on the other, it is said to harness speed at the expense of fairness, prudence, and stability. In part because of this duality, the regulation of high-frequency trading in the United States has been slow to develop. Other nations, however, have been quicker to react and to promulgate laws that directly, or indirectly, affect high-frequency trading. This Note explores the legal responses …

Dirks And The Genesis Of Personal Benefit, Adam C. Pritchard

Articles

In United States v. Newman, the Second Circuit overturned the insider trading convictions of two hedge fund managers who received material nonpublic information from public companies via an extended tipping chain. The Newman court interpreted the Supreme Court's decision in Dirks v. SEC as requiring that the government prove: (1) that the tippee knew that the tipper was disclosing the information in exchange for a personal benefit; and (2) that if the personal benefit does not involve a quid pro quo to the tipper, that the disclosure arise from a "meaningfully close personal relationship" with the recipient of the …

Fraud Is Already Illegal: Section 621 Of The Dodd-Frank Act In The Context Of The Securities Laws, Nathan R. Schuur

University of Michigan Journal of Law Reform

In the aftermath of the financial crisis, lawmakers and the public focused on abuses in the securitization industry. Abacus, a Synthetic CDO created by Goldman Sachs & Co., became a symbol of what many felt was a corrupt system when it became known that Goldman and Fabrice Tourre, a Vice President at its Correlation Trading Desk, had assisted a hedge fund in designing the security to fail. Perceived failings of the securities laws to prevent transactions like Abacus spurred Congress to enact Section 621 of the Dodd-Frank Act, which prohibits conflicts of interest in asset-backed securitizations. But the law is …

Admit Or Deny: A Call For Reform Of The Sec's "Neither-Admit-Nor-Deny" Policy, Priyah Kaul

University of Michigan Journal of Law Reform

For four decades, the SEC’s often-invoked policy of settling cases without requiring admissions of wrongdoing, referred to as the “neither-admit-nor-deny” policy, went unchallenged by the courts, the legislature, and the public. Then in 2011, a harshly critical opinion from Judge Jed Rakoff in SEC v. Citigroup incited demands for reform of this policy. In response to Judge Rakoff’s opinion, the SEC announced a modified approach to settlements. Under the modified approach, the Commission may require an admission of wrongdoing if a defendant’s misconduct was egregious or if the public markets would benefit from an admission. Many supporters of the neither-admit-nor-deny …

Halliburton Ii: A Loser's History, Adam C. Pritchard

Articles

The Supreme Court was presented with an opportunity to bring fundamental reform to securities class actions last term in Halliburton Co. v. Erica P John Fund, Inc.. The Court ducked that opportunity, passing the buck to Congress to undo the mess that the Court had created a quarter century prior in Basic Inc. v. Levinson. Congress's history in dealing with securities class actions suggests that reform is unlikely to come from the legislature anytime soon. The Securities and Exchange Commission appears to be satisfied with the status quo as well. With these institutional actors resisting reform, corporations and …

The Volcker Rule, Banking Entities, And Covered Funds Activities, Jeffrey Koh, Kyle Gaughan

Michigan Business & Entrepreneurial Law Review

With the passage of the 2010 Dodd-Frank Act, Congress instituted a host of new laws attempting to protect consumers from the types of risky trading that led to the 2008 economic crisis. However, many of the new rules and regulations, including the Volcker Rule, are yet to fully take effect. Among other restrictions, the Volcker Rule attempts to curtail risky trading by limiting banking entity investments in private equity and venture capital funds. As the Volcker Rule nears its implementation deadline, banking entities are concerned that they will face substantial losses in having to comply with the Volcker Rule by …

The Fragmented Regulation Of Investment Advice: A Call For Harmonization, Christine Lazaro, Benjamin P. Edwards

Michigan Business & Entrepreneurial Law Review

Decades of short-term thinking and regulatory fixes created the bewilderingly complex statutory and regulatory structures governing the giving of personalized investment advice to retail customers. Although deeply flawed, the current systems remain entrenched because of the difficulties inherent in making radical alterations. Importantly, the current patchwork systems do not seem to serve retail customers particularly well. Retail customers tend to make predictable and costly mistakes in allocating their assets. Some of this occurs because many investors lack basic financial literacy. A recent study released by the staff of the Securities and Exchange Commission (the “Commission”) on financial literacy among investors …

From Basic To Halliburton, M. Todd Henderson, Adam C. Pritchard

Articles

Securities fraud class actions are big business for lawyers. Since 1996, nearly 4,000 suits have been filed, with the majority resulting in companies paying substantial settlements. The top 10 settlements alone totaled about $35 billion; plaintiffs' lawyers took home billions in fees. Companies paid their own lawyers similar sums for defending them. If spending these gigantic sums on lawyers deterred corporate fraud (that is, if they helped sort cases of actual fraud from mere business reverses), then that might be money well spent. But if lawyers are paid billions without reducing the probability or magnitude of corporate fraud, then from …

Broker-Dealers And Investment Advisers: A Behaviorial-Economics Analysis Of Competing Suggestions For Reform, Polina Demina

Michigan Law Review

For the average investor trying to save for retirement or a child’s college fund, the world of investing has become increasingly complex. These retail investors must turn more frequently to financial intermediaries, such as broker-dealers and investment advisers, to get sound investment advice. Such intermediaries perform different duties for their clients, however. The investment adviser owes his client a fiduciary duty of care and therefore must provide financial advice that is in the client’s best interests, while the broker-dealer must merely provide advice that is suitable to the client’s interests—a lower standard than the fiduciary duty of care. And yet …

Reverse Cross-Listings -- The Coming Race To List In Emerging Markets And An Enhanced Understanding Of Classical Bonding, Nicholas C. Howson, Vikramaditya S. Khanna

Law & Economics Working Papers

This paper examines the implications for the traditional "legal bonding" hypothesis arising from future "reverse" cross-listings, meaning the cross-listing by issuers from jurisdictions with stronger investor protections into capital markets and on exchanges where investor protections are deemed less robust. We use as examples the first "Indian Depositary Receipt" or IDR IPO in May 2010, and IPOs we believe will complete on a future Shanghai Stock Exchange "international board". This analysis serves to dilute one of the long-standing negative implications of the traditional legal bonding account -- that reverse cross-listings by issuers from jurisdictions with stronger investor protections into weaker …

Market Efficiency And The Problem Of Retail Flight, Alicia J. Davis

Articles

In 1950, 91 % of common stock in the U.S. was owned directly by individual inves­ tors. Today, that percentage stands at only 23%. The mass exodus of retail investors and their investment dollars has negative implications not only for capital formation and investor protection, but also for market efficiency. Individual investors are often assumed to be noise traders who distort stock prices and harm market functioning. Therefore, some argue that their withdrawal from the market should be of little concern; indeed, it should be celebrated. Recent empirical evidence calls this assertion of retail noise trading into doubt, and this …

A Blended Approach To Reducing The Costs Of Shareholder Litigation, Valian A. Afshar

Michigan Law Review

Multiforum litigation and federal securities law class actions impose heavy costs on corporations and their shareholders without producing proportionate benefits. Both are largely the result of the agency problem between shareholders and their attorneys, driven more by the attorneys’ interests in generating fees than by the interests of their clients. In response to each of these problems, commentators have recommended a number of solutions. Chief among them are forum selection and mandatory arbitration provisions in a corporation’s charter or bylaws. This Note recommends that corporations unilaterally adopt both forum selection and mandatory arbitration bylaws to address shareholder lawsuits under state …

Protecting The State From Itself? Regulatory Interventions In Corporate Governance And The Financing Of China’S 'State Capitalism', Nicholas C. Howson

Law & Economics Working Papers

From the start of China’s "corporatization without privatization" process in the late 1980s, a Chinese corporate governance regime apparently shareholder-empowering and determined by enabling legal norms has been altered by mandatory governance mechanisms imposed by a state administrative agency, most often to protect minority shareholders against exploitation by the party state controlling shareholders which are the accepted powers of "state capitalism." This chapter reviews the path of that benign intervention and the structural reasons for it, and then speculates on why this novel identity of the Chinese party state’s “fragmented authoritarianism” continues to be tolerated by the same party state, …

Reverse Cross-Listings - The Coming Race To List In Emerging Markets And An Enhanced Understanding Of Classical Bonding, Nicholas C. Howson, Vikramaditya Khanna

Articles

Studies have found that when a U.S. issuer lists abroad on a foreign exchange, its shares exhibit negative abnormal returns. This negative movement may be because the market expects that the foreign listing will facilitate undetectable insider trading on the foreign exchange or other conduct impermissible in the United States.

The Influence Of Arbitrator Background And Representation On Arbitration Outcomes, Adam C. Pritchard, Stephen J. Choi, Jill E. Fisch

Articles

We study the role of arbitrator background in securities arbitration. We find that several aspects of arbitrator background are correlated with arbitration outcomes. Specifically, industry experience, prior experience as a regulator, and status as a professional or retired arbitrator are correlated with statistically significant differences in arbitration awards. The impact of these characteristics is affected by whether the arbitrator in question serves as the panel chair and by whether the parties to the arbitration are represented by counsel. Our findings offer some preliminary insights into the debate over possible arbitrator bias. On the one hand, they suggest that the party …

Reconciling Tax Law And Securities Regulation, Omri Marian

University of Michigan Journal of Law Reform

Issuers in registered securities offerings must disclose the expected tax consequences to investors investing in the offered securities (“nonfinancial tax disclosure”). This Article advances three arguments regarding nonfinancial tax disclosures. First, nonfinancial tax disclosure practice, as the Securities and Exchange Commission (the SEC) has sanctioned it, does not fulfill its intended regulatory purposes. Currently, nonfinancial tax disclosures provide irrelevant information, sometimes fail to provide material information, create unnecessary transaction costs, and divert valuable administrative resources to the enforcement of largely-meaningless requirements. Second, the practical reason for this failure is the SEC and tax practitioners’ unsuccessful attempt to address investors’ heterogeneous …

Carrot Or Stick? The Shift From Voluntary To Mandatory Disclosure Of Risk Factors, Karen K. Nelson, Adam C. Pritchard

Law & Economics Working Papers

This study investigates risk factor disclosures under the voluntary, incentive-based disclosure regime provided by the safe harbor provision of the Private Securities Litigation Reform Act and the SEC’s subsequent disclosure mandate. Firms subject to greater litigation risk disclose more risk factors, update the language more from year-to-year, and use more readable language than firms with lower litigation risk. These differences in the quality of disclosure are pronounced in the voluntary disclosure regime, but converge following the SEC mandate. Consistent with these findings, the risk factor disclosures of high litigation risk firms are significantly more informative about systematic and idiosyncratic firm …