Securities Mosaic® Blogwatch
May 28, 2015
What worries directors and GCs most today?

As we have discussedbefore, several issues keep up boards of directors and general counsels at night.

The recent Law in the Boardroom Study, performed by Corporate Board Member and FTI Consulting and discussed here, confirms that several of these issues continue to worry directors and GCs.

Cybersecurity tops the list for both directors and GCs, and each group also cites Operational Risk, Corporate Reputation and Crisis Preparedness as top 5 issues. In addition, directors are concerned about Succession Planning and GCs about Regulatory issues.

The study highlighted the following areas of concern:

  • Cybersecurity and IT: risks and breaches are increasing, costs are rising, investors want accountability, companies need crisis management plans  and directors need more information
  • Shareholder engagement: investor scrutiny of board refreshment, diversity, independence and compensation is increasing and companies need to be prepared
  • Heightened M&A risk: increased deal activity brings transaction risk and the need for extensive due diligence
  • Governance and compliance: regulatory compliance has shifted from the implementation of procedural-based rules to an emphasis on investor transparency and disclosure
  • Social media risks: increased risk requires oversight and a digital strategy that incorporates social media

This study was released in Corporate Board Member's annual issue featuring "America's Best Corporate Law Firms." Akin Gump is proud to be recognized a "top ten" corporate firm in a survey of more than 500 participating U.S. corporate directors of publicly traded companies.

May 29, 2015
A Reputational Theory of Corporate Law
by Roy Shapira

How does corporate law matter? My recent paper suggests that the main impact of corporate law is not in imposing sanctions, but rather in producing information. The process of litigation or regulatory investigations produces information on the behavior of defendant companies and businessmen. This information reaches third parties, and affects the way that outside observers treat the parties to the dispute. In other words, corporate and securities litigation affects behavior indirectly, through shaping the reputations of companies and businessmen.

The paper explores how exactly information from the courtroom translates into the court of public opinion. By analyzing the content of media coverage of iconic corporate law cases we gain two sets of insights. First, we learn that judicial scolding does not necessarily hurt the misbehaving company's reputation. The reputational impact of litigation depends on factors such as who the judge is scolding, what she is scolding them for, and how her scolding compares to the preexisting information environment. Second, we flesh out the ways in which information flows from the courtroom get distorted. Information intermediaries selectively disseminate certain pieces of information and ignore others. And the defendant companies produce smokescreens in an attempt to divert the public's attention.

Recognizing that reputation matters and that the legal system affects reputations carries important policy implications. For one, the reputational perspective calls for reevaluating key doctrines in corporate law according to how they contribute to information production. Consider for example how Delaware uses stringent standards when determining whether to impose legal sanctions, but more lax standards in the pleading stage. In other words, Delaware courts let big cases proceed to discovery and trial even when the odds that these complaints will ultimately win are slim.[1] Such liberal pleading standards generate a previously-overlooked informational benefit: when cases proceed to discovery market players may gain access to reputation-relevant information that they were not previously privy to. Other doctrines that shape the quantity and quality of information production include the use of open-ended standards (such as good faith), and the question whether to assess director liability individually or collectively.

The reputational theory also offers a fresh perspective on the effectiveness of SEC enforcement. The SEC's longstanding practice of settling the majority of enforcement actions with a "neither-admit-nor-deny" pact has faced mounting criticism following the Bank of America and Citigroup cases.[2] I argue that the real problem with SEC settlements is not that the SEC leaves money on the table, but rather that the SEC leaves information on the table. Both the SEC and big firm defendants have incentives to settle quickly and for high amounts, in exchange for limiting the public release of damning information. Such information-underproduction dynamics are good for both parties to the settlement, but bad for society overall.

As is often the case with timely topics, SEC settlement practices have been undergoing changes since my paper was originally written. When evaluating current changes we need to heed the distinction between the quantity and quality of information. SEC settlements do produce more information than other settlements, but the information that the SEC typically releases is not reputation-relevant. It does not help market players distinguish between good and bad actors. From this perspective, the internal changes to SEC practices (led by Chairwoman White[3]) seem promising, as they lead to more admissions in a certain type of cases (think about the recent JPMorgan settlement). On the other hand, the external changes to SEC practices (led by the recent Court of Appeals' Citigroup decision[4]) seem problematic, as they limit the ability to question whether a given settlement is informative or not.

Lastly and more generally, the reputational perspective can enrich our understanding of regulators' behavior. After all, regulators care about their reputations too. The literature on regulatory competition has recognized that both Delaware and the SEC try to strike a balance. They cater to the general public (and political overseers) by being tough on corporate America, but not so tough as to alienate the regulated entities.[5] My reputational perspective offers an explanation to how exactly regulators engage in such a balancing act. Regulators face tradeoffs when choosing between enforcing directly (imposing sanctions) and enforcing indirectly (producing damning information). Both Delaware and the SEC seem to pick the method of enforcement that makes them look tough in the eyes of outsiders but is actually less hurtful to the regulated entities.

To use the famous Disney case[6] as an example: several corporate legal scholars view Disney as a show trial meant to convince the public that Delaware got the then-burning issue of inflated executive pay under control. My contribution is in adding that "no incumbent managers were harmed during the filming of this show." Delaware got the presumed mitigating-backlash benefit without really hurting Disney. The judicial scolding was directed at individuals who were no longer part of the company, and as a result the company and its incumbent managers did not suffer reputational harms (and did not pay legal fines). Delaware courts can therefore use judicial scolding as a low-visibility favoritism tool: allowing Delaware to appear tougher on corporate America than it actually is. Similar "make it look like a struggle" dynamics apply to the SEC, albeit with interesting twists. Delaware tends to refrain from imposing legal sanctions, but does not shy away from offering strong criticism; while the SEC tends to maximize the direct legal outcomes (amount of fines collected), but refrains from offering strong criticism.

One overarching theme throughout my inquiries is the focus on diffusion of information. The corporate and securities law literature is dominated by classic economic analysis and agency theory. As a result, little attention is given to informational issues: market players are assumed either to have information or not to have it.[7] I shift our focus to questions such as how information is diffused (contrary to popular belief, information does not fall on individuals like manna from the sky), what is the role of information intermediaries such as mass media,[8]and what types of messages are perceived as being more credible than others.


[1] This is the essence of famous doctrines such as Zapata (Zapata Corp. v. Maldanado, 430 A.2d 799 (Del. 1981)), which applies an enhanced standard of review to the special litigation committee conduct; or Kaplan (Kaplan v. Wyatt, 499 A.2d 1184 (Del. 1988)), which makes the question of how much discovery to accord to plaintiffs a matter of court discretion.

[2]. SEC v. Citigroup Global Mkts. Inc., 827 F. Supp. 2d 328 (S.D.N.Y. 2011); SEC v. Bank of Am., 653 F. Supp. 2d 507 (S.D.N.Y. 2009).

[3] James B. Stewart, S.E.C. Has a Message for Firms Not Used to Admitting Guilt, N.Y. Times (Jun. 21, 2013).

[4] SEC v. Citigroup Global Mkts. Inc., 752 F. 3d 285(2014).

[5] See generally Mark J. Roe, Delaware's Competition, 117 Harv. L. Rev. 588 (2003).

[6] In re The Walt Disney Co. Derivative Litig., 907 A.2d 693 (Del. Ch. 2005).

[7]. On the gap in the literature regarding the corporate governance role of the media, see Alexander Dyck & Luigi Zingales, The Corporate Governance Role of the Media, in The Right to Tell (2002).

[8] Because most people do not read judicial opinions, the role of the media and other information intermediaries in selectively diffusing information from the courtroom becomes especially important.

This post comes to us from Roy Shapira, a John M. Olin Corporate Governance Fellow at Harvard Law School. The post is based on his recent paper, which is entitled "A Reputational Theory of Corporate Law". The paper was recently published in 26 Stanford Law and Policy Review 1 (2015), and is available to download here

May 29, 2015
Shareholders Defeat Mandatory Deferral Proposal
by See Editor's Note
Editor's Note:

John R. Ellerman is a founding Partner of Pay Governance LCC. The following post is based on a Pay Governance memorandum by Mr. Ellerman, Lane T. Ringlee, and Maggie Choi.

Many large U.S. based multinational banking and financial services corporations have implemented executive compensation clawback policies that require the cancellation and forfeiture of unvested deferred cash awards or performance share unit awards. These policies typically condition the cancellation of deferred compensation if it is determined that an executive engaged in misconduct, including failure to supervise or monitor individuals engaging in inappropriate behaviors that caused harm to the organization's operations. Policies also apply to unvested deferred awards that could be vested and paid based on inaccurate financial statements. Most of the clawback policies have been implemented in response to the Dodd-Frank financial legislation of 2010 that requires public companies to adopt clawback policies to protect shareholder interests. The Securities and Exchange Commission is expected to release final guidance with respect to clawbacks later this year.

Key Takeaways
  • Shareholders of a large financial services institution were subject to an advisory vote on an unusual mandatory deferral proposal from a financial policy advocate during the most recent proxy season.
  • The terms of the proposal include a requirement that executives be required to defer a percentage of earned incentive compensation for a period of 10 years, and that the executives would forfeit such deferred funds if the organization incurred a financial penalty for any violation of applicable law during the deferral period.
  • An unusual provision of the proposal was the required forfeiture of deferred funds even if such executives were not individually responsible for the misconduct during the deferral period.
  • Many institutions have previously established clawback policies that require the cancellation and forfeiture of any unvested deferred cash awards or performance share unit awards.
  • Research of the 50 largest financial institutions and 100 largest public companies shows that very few organizations require a mandatory deferral of incentive compensation awards subject to harsh forfeiture provisions.

In one situation that has received media attention, a proposal was placed before shareholders in the proxy leading up to the company's annual meeting regarding a stringent policy of mandatory deferral of executive compensation and potential forfeiture in the event of financial misstatement or material wrongdoing. The proposal was submitted by a nonprofit, nonpartisan public advocacy organization to request the Board of Directors to revise the design of the current executive compensation program "to provide that a substantial portion of annual total compensation of Executive Officers, identified by the board, shall be deferred and be forfeited in part or in whole, at the discretion of Board, to help satisfy any monetary penalty associated with any violation of law regardless of any determined responsibility by any individual officer; and that this annual deferred compensation be paid to the officers no sooner than 10 years after the absence of any monetary penalty; and that any forfeiture and relevant circumstances be reported to shareholders." In support of the proposal, the shareholder cited prior settlements regarding the bank's conduct in the issuance of residential mortgage-backed securities prior to January 2009.

Two aspects with respect to this particular proposal that depart from normal practice are the time frame associated with the deferral pool and the conditions for potential forfeiture of deferred compensation (clawbacks). The proposal requires that executives keep their deferred compensation in the pool for a minimum of 10 years, and that their deferred funds could be forfeited and returned to shareholders even if such executives were not guilty of misconduct while such compensation was deferred.

Current Program Design and Competitive Practice

With respect to current market practice, such mandatory deferrals of annual incentive payments are currently a minority practice, even among the largest and most prominent organizations. Of the 50 largest financial services institutions in the U.S., only seven (14%) require mandatory deferrals. This practice is even less prevalent in general industry-for example, only four companies (all of which are either banking or insurance organizations) out of the Fortune 100 (4%) reported such a practice. Most of the aforementioned companies require only a portion of earned annual incentives to be deferred. This portion is often expressed as a fixed percentage of earned amounts, or a fixed percentage of the incremental payouts above a certain dollar amount. Deferral periods also range from one to four years, with three years being the most common. Further, it is atypical for the deferred amounts to be subject to additional performance hurdles during the deferral period-only one company reported such requirements.

Rather than instituting mandatory deferrals, we are finding selected institutions implementing several practices that strengthen the alignment of pay and performance that result in performance periods for equity awards that are longer than typical practice, and performance scorecards that are broader. Annual incentive compensation may be split between cash and deferred stock that vests over a three- to four-year period, and may be coupled with a backward-looking reduction in shares vesting if pre-tax losses are incurred.

Our Perspective and Conclusion

It is our view that this shareholder proposal was extreme because of its 10-year deferral period and failed to recognize the prevalence of policies most companies have in place to return unearned compensation to shareholders as well as protect long-term shareholder interests. Most large public companies have already implemented clawback policies. As soon as the SEC releases its final guidance on clawbacks, all public companies will be required to implement such policies. Other shareholder protection mechanisms such as stock ownership guidelines are in place at the majority of companies. Competitive practice data show that mandatory deferrals of annual incentives are not a popular element of current compensation program design and not meaningful. Our judgment is that this proposal should be considered redundant and not necessary in the current governance arena.

The proposal is an advisory vote and nonbinding to this institution, and 95 percent of shareholders voted to defeat the proposal.

May 29, 2015
Chancery Addresses Advancement Claim for Offensive v. Defensive Litigation
by Francis Pileggi

Mooney v. Echo Therapeutics, Inc., C. A. No. 10054-VCP (Del. Ch. May 28, 2015). This is one of two Chancery decisions in separate matters handed down today on the issue of advancement. This opinion is notable for addressing the limits of the types of litigation subject to advancement when the litigation is offensive in nature as opposed to the typical circumstance where a director seeks advancement for fees incurred to defend a suit filed against her. Although well-established case law allows for advancement of fees incurred for certain counterclaims that are compulsory in nature, this case addresses a suit that was allegedly filed in response to claims asserted in a separate suit.

Also noteworthy is a procedure the court imposed, in an order that accompanied this opinion, for addressing disputes on fee claims for advancement going forward in this matter, based in part on the Fitracks decision.

May 29, 2015
Defenses to Advancement Based on Conditions in Agreement Rejected
by Francis Pileggi

Blankenship v. Alpha Appalachia Holdings, Inc., C.A. No. 10610-CB (Del. Ch., May 28, 2015). This is the latest Chancery decision in a long series of recent Delaware decisions (and one of two opinions handed down today), rejecting defenses to advancement claims by former directors and officers. At least one member of the Court of Chancery regards advancement claims as the bane of his docket. This 66-page opinion might reveal hints about why. One might paraphrase the introduction to this opinion with the following colloquial expression of exasperation: Here we go again-another company trying to evade its advancement obligations.

The facts of the case involve the former CEO of a coal mining company defending a criminal indictment related to the death of 29 minors in a coal mining accident in West Virginia. The court granted advancement in the amount of nearly $6 million (for the last few months of legal fees) as well as fees on fees for the current proceeding. The company stopped making advancement payments a few months ago based in part on the argument that the former CEO did not fulfill a condition of truthfulness in an agreement providing the terms of advancement.

Executive summary of takeaway from this and other recent Chancery opinions: If a company hopes to defend an advancement claim based on a condition precedent in an agreement, or a "carve-out" from coverage, the terms of that condition must be beyond unambiguous, because all doubts will be resolved in favor of the claimant. Although prerequisites to advancement are not per se prohibited, see, e.g., older case highlighted here, some restrictions on advancement are considered void as being contrary to the mandatory nature of DGCL Section 145. See, e.g., recent decision highlighted here on these pages.

Aside: Another indication of the judicial frustration that might be gleaned from this Chancery decision (and others) regarding a company's challenge to a claim for advancement, is the court's choice of words to describe the company's arguments made by one of the most respected and most able Chancery practitioners: nonsensical, absurd, unreasonable, not logical. One message that might deduced: Proceed with caution when challenging an advancement demand if you would prefer not to have those words (or worse) associated with your arguments.

May 29, 2015
The Impact of Newman on SEC Enforcement: Part I
by Tom Gorman

The Impact of Newman on SEC Enforcement: Part I

This is the first segment of a five part series discussing the impact of the Second Circuit's ruling in Newman on SEC insider trading cases


In seeking rehearing and an en banc hearing before the Second Circuit Court of Appeals the Manhattan U.S. Attorney's Office told the Court that the panel decision in U.S. v. Newman, Case Nos. 13-1837, 13-1917 (2nd Cir. December 10, 2014), would undermine the ability of law enforcement to effectively police the securities markets for insider trading. Petition of the United States of America for Rehearing and Rehearing En Banc, filed January 23, 2015 ("Petition for Rehearing") at 22. The SEC, in an amicus brief, concurred. Brief for the Securities and Exchange Commission as Amicus Curiae Supporting the Petition of the United States for Rehearing or Rehearing En Banc, filed January 29, 2015 ("SEC Brief") at 11. The Court denied the request for rehearing. Newman is the law, at least in the Second Circuit.

Unless Newman is overturned by the Supreme Court, the decision will remain the law in the Second Circuit and perhaps others in view of the Court's influence in securities law. The impact of Newman thus becomes a critical issue for SEC enforcement. To assess the potential impact of Newman on SEC enforcement four key points should be considered: 1) the decision; 2) its impact on existing criminal and civil cases; 3) its impact on SEC cases; and 4) analysis.

The Decision in Newman

Todd Newman and Anthony Chiassons, remote tippees, three to four steps removed from the source of the inside information about pending earnings announcements for Dell, Inc. and NVIDIA, were convicted of insider trading. In reviewing their convictions the Second Circuit stated: " We note that the Government has not cited, nor have we found, a single case in which tippees as remote as Newman and Chiasson have been held criminally liable for insider trading." U.S. v. Newman, Nos. 13-1837-cr, 13-1917 (2nd Cir. Decided December 10, 2014). The Second Circuit drew a clear line regarding the requirements for tipper liability using the "personal benefit" test crafted for the protection of analysts by the Supreme Court in Dirks v. S.E.C., 463 U.S. 646 (1983). The convictions were reversed.

Todd Newman and Anthony Chaisson were portfolio managers at, respectively, Diamondback Capital Management, LLC and Level Global Investors, L.P. Both were convicted of insider trading in the shares of Dell and NVIDIA following a six week trial. Both were remote tippees. With regard to the trading in Dell, the inside information went down a chain: Company employee Rob Ray transmitted the earnings information to analyst Sandy Goyal, who in turn tipped Diamondback analyst Jesse Tortora who then told Mr. Newman and Global Level analyst Sam Adondukis who told Mr. Chaissom. Each portfolio manager traded.

The inside information regarding NVIDIA traveled a similar, lengthy path to the two portfolio managers. It began with company insider Hyung Lim who passed the information to Danny Kuno who furnished it to Messrs. Tortora and Adondukis who transmitted it to, respectively, Mr. Newman and Mr. Chaisson. Each portfolio manager traded in NVIDA shares.

At the close of the evidence each defendant made Rule 29 motions for acquittal, arguing that tippee liability derives from that of the tipper. Since here there was no evidence that the corporate insiders obtained a personal benefit the charges should be dismissed. The District Court reserved judgment and sent the case to the jury for consideration based on its instructions. The defendants argued that the jury charge on tippee liability should include the element of knowledge of a personal benefit received by the insider. The Court gave the jury an alternate instruction which stated in part that the Government had to prove that the insider "intentionally breached that duty of trust and confidence by disclosing material nonpublic information for their own benefit." The instructions also stated that the defendant had to "know that it [the inside information] was originally disclosed by the insider in violation of a duty of confidentiality." The jury found both defendants guilty of insider trading.

The Second Circuit disagreed. The Court held that the jury instructions were inadequate and that the evidence on tippee liability was insufficient. Accordingly, the convictions were reversed and the charges dismissed with prejudice.

The Court began its analysis by reviewing the basic tenants of the classical and misappropriation theories of insider trading. The elements of tipping liability are the same regardless of the theory utilized, according to the Court. Under Dirks the test for determining if there has been a breach of fiduciary duty is "’whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty ...'" the Court stated, quoting Dirks. The tippee's liability stems directly from that of the insider. Since the disclosure of inside information alone is not a breach, "without establishing that the tippee knows of the personal benefit received by the insider in exchange for the disclosure, the Government cannot meet its burden of showing that the tippee knew of a breach."

In reaching its conclusion the Court held that "nothing in the law requires a symmetry of information in the nation's securities markets." That notion was repudiated years ago in Chiarella v. U.S., 445 U.S. 222 (1980). While efficient capital markets depend on the protection of property rights in information, they also "require that persons who acquire and act on information about companies be able to profit from the information they generate." It is for this reason that both Chiarella and Dirks held that insider trading liability is based on breaches of fiduciary duty, not on "informational asymmetries."

Based on these principles, the elements of tippee liability are: (1) the corporate insider had a fiduciary like duty; "(2) the corporate insider breached his duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper's breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade..." Since the jury instructions did not incorporate these elements they were incorrect.

Finally, in reviewing the sufficiency of the evidence, the Court gave definition to the personal benefit test. That test is broadly defined to include pecuniary gain and also reputational benefit that will translate into future earnings and the benefit one would obtain from making a gift of confidential information to a relative or friend. While the test is broad it does not include, as the Government argued, "the mere fact of a friendship, particularly of a casual or social nature." A personal benefit can be inferred from a personal relationship but "such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature. In other words ... this requires evidence of a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the latter." (internal quotes omitted). Here the evidence is not sufficient to meet this test. The Second Circuit subsequently denied a motion for rehearing by the U.S. Attorney.

May 29, 2015
Expanded Audit Reports: Rolls Royce is the "Rolls Royce"
by Broc Romanek

As the PCAOB continues to toy with the long-floated idea of "expanded" audit reports - which means that auditors would be required to include some narrative in their boilerplate - I thought it would be helpful to provide an example of what that might look like. Since 2012, companies in the UK have been required to provide this type of expanded audit report. And last year’s audit report (see page 130) for Rolls Royce has been held up as one of the best since the company & its auditor – KPMG – go further than what the UK's Financial Reporting Council's rules require. Here's an excerpt from this CFA Institute Blog:

In short, the auditor reports the greatest risk of material misstatement and how it responded to those risks. KPMG could have stopped there to be in compliance with the new standard, but that wasn't good enough for Rolls Royce. With the investor user in mind, KPMG in cooperation with management took it a step further and included the findings. Aside from the communicative value of this information to investors, extending the auditor's report to include the findings demonstrates a willingness on the part of the auditor and management to work together toward meaningful communication to investors - a major departure from past practice.

In addition, check out this explanation from KPMG about what they did - and this article about the UK requirements...

PCAOB Seeks Comment on Specialists Use

Yesterday, the PCAOB issued this Staff Consultation Paper - "The Auditor's Use of Specialists" - that seeks input on potential changes to standards for the auditor's use of the work of specialists, specifically the objectivity and oversight of specialists and the use of their work in audits.

BE-10 Reports: Deadline Flexibility & How to File?

Here's a question posted yesterday on our "Q&A Forum" (#8437): "Tomorrow, May 29, 2015 is the due date. Does anyone know if the BE-10 reports must be in the hands of the BEA by tomorrow or is it sufficient if it is postmarked with tomorrow's date? Also, any reason we can't Fed Ex the survey? The instructions however state to send the reports filed by mail "through the U.S. Postal Service."

Here's an answer that I received from Gibson Dunn's David Wolber: "I haven't heard officially from BEA on the due date aspect - and haven't seen much explicit guidance – but I note the BE-10 Instructions say: 'A fully completed and certified BE-10 report comprising Form BE-10A, and Form(s) BE-10B, BE-10C, or BE-10D is due to BEA no later than May 29, 2015 for U.S. Reporters required to file fewer than 50 forms, and June 30, 2015 for U.S. Reporters required to file 50 or more forms.' This would tend to imply the report must be in there hands by sometime on Friday.

However, note that the BEA recently extended the deadline for all 'new filers' to June 30th. A new filer is 'a U.S. company or person that is required to file on the BE-10 survey but has never filed any BEA survey of U.S. direct investment abroad, including the BE-10, BE-11 and BE-577 surveys.' This is probably good news for quite a number of folks. Also, it appears that 30- and 60-day extensions are being readily granted.

Regarding method of delivery, BEA guidance in the BE-10 Instructions and in FAQs on the website contemplates a range of acceptable methods including mail, hand delivery and fax. Although I haven't seen anything official from BEA on this, overnight would seem to be a safe choice, and I suspect that, as long BEA gets the report at the end of the day, they shouldn't care too much if it arrived via USPS or some other carrier such as FedEx."

– Broc Romanek

May 29, 2015
Megabanks and the Need for Glass Steagall
by J Robert Brown Jr.

Politico has a piece on why the big banks should not be dismantled.  See Don't Break Up the Megabanks  The article asserts that doing so is radical, costly, and will not necessarily enhance stability.  The article also asserts that reform is working and community banks have more influence than the megabanks.  

Much of the discussion addresses straw arguments.  For example, in describing a breakup as "radical," the article asserted that the "United States government does not normally cap the size of private firms, even gigantic firms like Apple or Wal-Mart. Who would invest in a company that's legally prohibited from growing?"   It would be unusual and logistically difficult to impose an arbitrary limit on size.  This is, therefore, a highly unlikely method of downsizing megabanks.

A more likely method would be to limit the types of activities that can be conducted by the megabanks.  Thus, they could grow but not in all segments.  The Volcker Rule was a half hearted step in this direction.    

More directly, however, the article missed the single most important reason altering the size and activities of the megabanks.  Back in 1996, I wrote a piece predicting that, with the repeal of Glass Steagall, investment banks as a separate class of intermediaries would disappear and that the market niche would become dominated by commercial banks.  See The "Great Fall": The Consequences of Repealing the Glass-Steagall Act 

This wasn't a guess; the process had been underway when Congress halted it by adopting Glass-Steagall in the 1930s.  Moreover, over the long term, commercial banks have inherent advantages, including access to deposits and the discount window.  Without artificial barriers, commercial banks will eventually squeeze out the investment banks.  

This prediction made in 1996 came to pass a bit over a decade later.  When the 2008 crisis began, there were five world class investment banking firms in the US.  That quickly changed.  There was the sale of Bear Sterns to JP Morgan, the purchase of Merrill by BofA, and the collapse of Lehman.  Goldman and Morgan Stanley converted to commercial banks.  

Does this matter?  When investment banks existed, they essentially made their profits through risk taking in the the securities markets.  This benefited the markets and made them more dynamic.  Commercial banks are by definition more conservative both because of the oversight by bank regulators (who are permanently on site) and the need to protect deposits.  As a result, the elimination of investment banks as a separate class of intermediaries has likely resulted in reduced risk taking in the securities markets.  This has the potential to cause long term harm to the securities markets. 

Policies with respect to the megabanks should be designed with an eye towards strengthening the securities markets.  Reducing the megabank footprint in the investment banking space would make them smaller and less risky.  It would also allow for the reeemergence of a class of intermediaries designed to ensure the vibrancy of the US securities markets.   

5/29/2015 posts

AG Deal Diary: What worries directors and GCs most today?
CLS Blue Sky Blog: A Reputational Theory of Corporate Law
HLS Forum on Corporate Governance and Financial Regulation: Shareholders Defeat Mandatory Deferral Proposal
Delaware Corporate and Commercial Litigation Blog: Chancery Addresses Advancement Claim for Offensive v. Defensive Litigation
Delaware Corporate and Commercial Litigation Blog: Defenses to Advancement Based on Conditions in Agreement Rejected
SEC Actions Blog: The Impact of Newman on SEC Enforcement: Part I Blog: Expanded Audit Reports: Rolls Royce is the "Rolls Royce"
Race to the Bottom: Megabanks and the Need for Glass Steagall

Blog posts are subject to copyrights held by the authors and are republished here with permission. Views expressed are those of the authors alone. Infringement Notification.