Business Law Prof Blog

London Regulating?

The FT reports here that the Financial Services Authority, the U.K.'s financial markets regulator, announced last week that it is going to study toughening up the requirements for foreign listings on the London Stock Exchange.  Currently, foreign issuers cross-listing on the LSE are subject to "light touch" regulation which principally requires maintenance of their primary listing and the furnishing of certain documents to the FSA.  The FT reports increasing fear in the City community that this light regulation will tarnish the LSE's reputation through scandal or generally perceived diminished quality.

The move is surprising on two levels.  First, the LSE had a spectacular year last year with respect to foreign issuers; of the £28 billion raised in IPOs on the LSE fully £10 billion was from foreign listings, the majority from the CIS states and India.  Second, London has been furiously marketing itself as an alternative market for Sarbanes-Oxley "refugees".  Why the FSA would act now to tighten regulation when things are going so well is uncertain and perhaps harmful to its own markets at a time of rising competitiveness.  But, I suspect part of the reason lies with the AIM, the LSE's similarly lightly regulated junior market.  It had a mixed year last year; attracting a large number of foreign IPOs itself but being criticized repeatedly for a number of scandals.  Moreover, the AIM was slightly down in 2006 and half of its largest IPOs were trading below their offering price by the end of last year.  The LSE has announced that it is considering raising regulatory standards for the AIM, and the concerns over light regulation have likely spilled over to the LSE.  But, London knows it has a good thing going in distinguishing itself from the United States.  The FSA may increase regulation of foreign issuers on the LSE at a later date, but they will be careful to set it apart from claimed "over-burdensome" U.S. regulation.  The bottom line is that any additional regulation will be measured.  Until the United States effects radical change, London is likely to continue to differentiate itself from the U.S. markets and better cater to its foreign issuers/customers by offering regulation more tailored to their needs. 

Steven M. Davidoff

Attacks on Private Equity Funds

Unions, long suspicious of private equity fund buyouts (leverage buyouts or LBOs), have a sympathetic ear in Congress.  Barney Frank, chair of the House Financial Services Committee, is rustling about attempting to find ways of regulating LBOs.  His basic complaint is that the LBOs do not help and often hurt rank and file employees (in particular unionized employees).  He seems to want to limit buy-out funds access to debt to finance the deals.  He will have trouble.  Buyout funds are taking advantage of a broader market phenomenon -- debt is cheap because it is subsidized and control by the government.  The federal government favors debt in the tax code and the fed keeps debt at below free market rates.  Buyout funds are using subsidized debt (interest rates are too low).  Too many across the financial markets (both main street and wall street) are invested in low interest rates to change this. Disabling one actor, private equity funds, from using debt, will merely embolden and empower others (who are probably less efficient but just as willing).

Take-Two Proxy Fight

The success of the dissident shareholders in the annual meeting of Take-Two Interactive Software, Inc., is stunning (five new directors and the firing of the CEO) and may be a harbinger of a new day for corporate governance.  Institutional investors held large stakes in the company, got together when problems surfaced, and in a no-nonsense show of steady strength, put a turnaround artist in control of the company. The ousted CEO tried to sell the company and delay the annual meeting but in the end, he lost.  The meeting will have long run effects -- it will encourage institutional investors to be active and, most important perhaps, it will encourage outside directors (two of whom survived by aligning themselves with the dissidents) to switch sides when it is obvious that there are internal problems. 

Lawyers Accountable?

Several recent new items suggest that lawyers are being held accountable for their roles in the recent financial scandals.  Several of Enron's house counsel have been indicted and Jenkins & Gilchrist has dissolved, due to the involvement of attorneys in an acquired Chicago law firm in the marketing of tax evasion schemes.  Modern financial scams, due to filing requirements imposed by both state and federal authorities, necessarily involve the participation of lawyers and often involve lawyers in the planning.  High profile prosecution of lawyers who have misbehaved should help to sober up the practice and give some cover to lawyers who want to resist pressure from clients.   

The Summit: To Whom Should We Listen??

The March 13 "Summit" at Georgetown with some of the biggest names in the country in finance, organized by the current Secretary of the Treasury Paulson, is a continuation of his efforts to create a political consensus for reducing business regulation.  He primary targets are parts of Sarbanes Oxley (Section 404) and class action (and derivative) litigation.  We have had two non-partisan reports (Hal Scott's and Senator Schumers' committees) and a US Chamber of Commerce report and now the "Summit."  The problem for observes is who to believe; many in the game have vested interests in spinning the facts to their advantage and they are good at it (they are pros).  Rubin and Paulson are carrying the water for concerned CEOs.  Are the CEOs just seeking another business advantage or are they speaking for something in the national interest?? It's hard to say.  But there is one man who is candid to a fault and who know what he is talking about -- Warren Buffet -- he is a national treasure.  His opinion??? "If something's wrong with he system, it hasn't seeped through to the operating results of business."  Translated -- the CEOs have not made their case.  Business performance, operating profits, are healthy; business to make there case must show that profits could be even better with less regulation -- something they have failed to do.  An answer to Buffett cannot come in general caterwauling about how tough it is to do business in the United States, it must come in a careful analysis of the details of the rules themselves -- what are Section 404 costs versus Section 404's benefits.

Hedge Funds and Political Contributions

Senator Grassley has proposed a bill to register hedge funds [CR 2845-2846] and Representative Barney Frank is holding hearings on how to regulate hedge funds.  The press is linking hedge fund activity to both current stock market corrections, the Asian market drop and the troubles of those in the sub-prime lending market.  Then a revealing article in the Wall Street Journal -- hedge funds do not make significant contributions to political parties or candidates.  We have a system of informal extortion in place.  If a widely successfully company or new group of companies does not get involved (i.e. contribute) in the political process politicians threaten regulation.  The threat induces the new company or group of companies to get politically active and join the fray (ie. with contributions).  Recall the Microsoft problems of the 90s.  Microsoft was attacked by Netscape, using Utah Senators and later the Department of Justice as vehicles, and article detailed how Microsoft had no political cover from political contributions.  Microsoft learned.  We also saw articles about how Microsoft and its founder did not give enough to charity; they do now.  I suspect we will soon see articles about hedge fund managers and their lack of charitable activities.

Professors Hu and Black on Short Selling

Professor Hu and Black have published three pieces on short selling (University of Southern California Law Review, Journal of Financial Economics, and Business Law Journal) and recommended more regulation of the practice.  All three articles discount the ability of the market to self police. I have made the point in a recent piece in our Entrepreneurial Journal.  Those who loan shares to short sellers charge a fee and the fee will increase with the risk that those who borrow the shares will vote or otherwise use the shares to hurt the company.  Those loaning the shares will get them back and are interested in their value.  If so, those who short shares to hurt a company will suffer the economic consequences, just as a shareholder would, in the increased fees paid to the lender of the shares.  There is evidence that fee increase do occur around short contracts entered into on the eve of record dates for example.   

"The [Public] Corporation Will Disappear"

Holman W. Jenkins, Jr., of the Wall Street Journal quote Nobel laureate Myron Scholes in the Weekend edition that "the [public] corporation will disappear."  His point:  the move from public markets in favor of private equity markets is caused by risk management contracts (derivatives) competing with equity.  He also notes the impact of regulation has affecting the trend.  His point only makes sense if one does not "look through" investors.  A public corporation has over 500 shareholders (300 on the way out).  We are calling corporations private is they have less than 300 shareholders even if each of those shareholders is itself a pool of multiple investors.  If we "looked through" the funds and counted individual investors, the 300 shareholder limit would be shaky for many newly converted "private companies."  In other words, his argument does not rest on risk management as much as it rests on a legal rule that does not permit "look through" judgments.  [ Recall the ill fated hedge funds rules which do use "look throughs"]  It suggests to me that an old, old standard, the 300 shareholder rule should be reconsidered and SEC regulation (for IPOs and for periodic reporting requirements, including Section 404 of SOX ) should scaled with the total capitalization of the firm.  This is the primary request of the Small Business Advisory Committee that reported to the SEC last year.  The SEC rejected the request out of hand; it should look at the scaling regulation question again. 

The Sub-prime Lenders Mess

Sub-prime lenders who securitized the loans (bundling them and selling them as debt securities) are in a bind (there stock prices have tanked) and the SEC, Department of Justice and many plaintiff lawyers are circling.  This is not a market failure.  If these folks oversold these collateralized debt securities with misleading claims, they will be held accountable to investors who have suffered losses. 

Regulation NMS

I have opposed Regulation NMS since it was first proposed -- several times in posts here.  The Regulation restructures, in fundament ways, the interrelationships of the country's securities trading markets. The application of the final rule has been held up for several years. Now, in the teeth of a market correction, we are going to role out the new rules, rules that further tax the computer systems of markets by adding another layer or routing rules.  Markets must route orders to each other to prevent "trade throughs."  The NYSE sought the new rule to protect its market share and may find that it will backfire because its new "hybrid" computer system will not be as good as the computer systems of smaller and faster ECNs.  This could be good.