Securities Mosaic® Blogwatch
May 13, 2012
Crowdfunding: Who Will (and Who Won't) Be Doing It
by Kevin LaCroix

Among the features of the recently enacted JOBS Act that has attracted the most attention are the legislation's provisions for "crowdfunding." Under these provisions, a company is permitted to raise up to $1 million during any 12-month period through an SEC-registered crowdfunding portal. While these provisions have attracted a great deal of discussion and even controversy, a more basic question is - who will actually be taking advantage of this new fundraising procedure?

A common assumption about the new crowdfunding procedure is that it will be most beneficial to start-up companies. But at least according to a May 9, 2012 article (here), due to the procedural burdens and costs associated with the JOBS Act's crowdfunding provisions, crowdfunding is unlikely to be an attractive alternative for start-up companies.

According to the article, the crowdfunding provisions in the JOBS Act may be "too complex and onerous" and "not very cost-effective" for an early-stage company. Among other things, entrepreneurs launching a new venture "may lack the financial acumen and robust business plans they'll need to comply with the JOBS Act" and they also "may not have the cash to hire the accountants and lawyers they will need to navigate the law."

Instead, the companies likeliest to be using crowdfunding will be "more mature firms" that "have the experience of searching for sources of capital" and that are "able to show, based on financial information, performance metrics and forecasts, that they are heading in the right direction." Among other things, the crowdfunding process will require a certain amount of rigor, if for no other reason than the company using the process will have to provide financial statements.

The financial statement requirements will impose a cost-benefit analysis on companies considering a crowdfunding financing, due to the Act's sliding scale requirements. Companies raising up to $100,000 need provide only a financial statement signed by the company's directors. But companies raising between $100,000 and $500,000 must provide financials reviewed by a CPA. And for companies raising between $500,000 and $1 million, audited financials must be provided. Companies will have to decide whether their financing requirements justify the expense of having their financials reviewed or audited. In addition, the Internet platforms through the crowdfunding offerings will be conducted will also be charging fees, which will add to the cost.

As I have previously noted (refer here), the JOBS Act's crowdfunding features also expressly include liability provisions. The potential liability exposures mean that issuers trying to raise money through a crowdfunding offering "will probably need to get a lawyer involved," which, as a commentator quote in the article notes, is "not ever cheap."

There is also the possibility that the SEC will add even greater burdens and expense when it releases its crowdfunding rules in January 2013. Among other things, the SEC could add additional burdens in the way that it regulates the funding portals. The SEC has also no secret of its concerns about the possibility of scam artists using crowdfunding to try to con investors, as a result of which, as a commentator quote in the article notes, the SEC might "layer on more regulation." For example, the SEC might require disclosure after the crowdfunding offering, which "could make crowdfunding potentially cost prohibitive."

The Venue That Suits You Best: Where is the best place in the world to file a lawsuit? Well that depends on the kind of lawsuit you want to file. Want to sue for libel? Then you want to file in the U.K. Thinking of suing for patent infringement? Then you should file in Germany. All of this is according to the "best and worst places to sue" atlas published on May 10, 2012 in BusinessWeek, and which can be found here.

More Thoughts on Asia: As I discussed in a blog post summing up my observations of my recent Asia trip, there is an incredible amount going on now in Asia. The present and future business opportunities in Asia are enormous - so much so that I really regretted during my trip that my children were not there to see what I was seeing.

It is in this context that I note an article that appeared on May 11, 2012 Wall Street Journal. The article, entitled "P&G Unit Bids Goodbye to Cincinnati, Hello to Asia" (here), describes how Proctor & Gamble is moving its cosmetics and personal-care unit from Cincinnati to Singapore. The company is making the move based on its "decision to base the business in the fast-growing Asia beauty market," as part of a larger plan to move employees and manufacturing facilities closer to its key customer bases. The article goes on to note that the Asia-Pacific region already accounts for half of the world's market for skin care, and is also by far the fastest growing region.

The article includes a sidebar identifying a number of similar moves developed-world companies have made recently. For example, GE has moved its X-ray unit from Wisconsin to Beijing; Halliburton has set up a separate headquarters in Dubai; DSM Engineering Plastics has moved its headquarters from the Netherlands to Singapore: and Rolls-Royce has moved its global marine headquarters to Singapore from London. (As I understand it, AON's recent decision to move its headquarters from Chicago to London is in part explainable as part of this same phenomenon, because so much of its business and growth is outside the U.S.)

Maybe I am giving too much significance to these developments I am overly focused on Asia so soon after my return home from Asia. Even allowing for that possibility, these companies' moves still seem significant. These companies are re-orienting themselves because the world is re-orienting. It seems pretty clear to me that the path to future business success is going to run through Asia. Those of us doing business in the U.S. and in Europe now need to prepare for the fact that our clients, or at least those who are likeliest to succeed, are going to be positioning themselves to participate in Asian opportunities. Provides of services will need to be prepared to adjust as the companies reposition.

China in Ten Words: Another observation from my Asia trip is how vast, complex and enigmatic China is. Since returning home, I have read several books about China and its history, trying to get a better sense of the country and the changes it has been through in recent years. The country is so large and the changes it has been through have been so momentous that it seems nearly impossible to briefly summarize it all. For that reason, the slim, readable book China in Ten Words by Yu Hua, a Chinese author who lives in Beijing, is so interesting and impressive.

Yu's book is divided into ten short chapters, each of which has a single word as a theme. The ten chapters are: people; leaders; reading; writing; Lu Xun (a pre-revolutionary Chinese author); revolution; disparity; grassroots; copycat; and bamboozle. Yu took this thematic approach because, as he says, if he tried to capture everything about China, the result would be a book so long that no one could ever read it. By limiting himself to just ten words, he gives us "ten pairs of eyes" to scan the contemporary Chinese scene.

Yu's method has a very specific purpose, which he explains in his introduction:

"The arrow hits the target, leaving the string," Dante wrote, and by inverting cause and effect he impresses on us how quickly change can happen. In China's breathtaking changes during the past thirty years we likewise find a pattern of development where the relationship between cause and effect is turned in its head. Practically every day we find ourselves surrounded by consequences, but seldom do we trace those outcomes back to their roots. The result is that conflicts and problems - which have sprouted everywhere like weeds during these past decades - are concealed amid the complacency generated by our rapid economic advances. My task here is to reverse normal procedure; to start from the effects that seem so glorious and search for their causes, whatever discomfort that may entail.

In tracing the current outcomes back to their roots, Yu tells the story of contemporary China from the perspective of his own personal experiences. What quickly becomes apparent is not only how much Yu has seen and experienced in his life, but how much everyone in China older than, say, forty or so, has seen and experienced. The dramatic and appalling details of the scenes he witnessed during the Great Leap Forward and the Cultural Revolution, which took place during his childhood and adolescence, provide an almost incredible backdrop to China's current prosperity and economic growth. As Yu says, "in this quest to follow things back to their source, we cannot help but stumble on one misfortune after another."

The unexpected and interesting message that emerges from Yu's account is the directness of the connection between the events during the Great Leap Forward and the Cultural Revolution and contemporary circumstances. Yu finds parallels between the excesses of those earlier eras and many of the excesses of modern China. In his chapter titled "Revolution," he shows how the propaganda deceptions of the Great Leap Forward era and the revolutionary violence of the Cultural Revolution era continue to shape behavior and events.

The consequences for China emerge Yu's book progresses; his final four chapters - disparity, grassroots, copycat and bamboozle - portray a country beset with "moral bankruptcy and confusion of right and wrong." For example, in discussing the "copycat" phenomenon - whereby, as a result of an engrained revolutionary era ethos, counterfeiting and infringement are accepted as part of the "anarchist spirit" - Yu characterizes the trend as "a sign of something awry in China's social tissue."

In the same vein, in the book's final chapter, Yu explains how the word "bamboozle" has come to gain such broad acceptance in modern China, as its particular usage "throws a cloak of respectability over deception and manufactured rumor." Yu describes a society where the people routinely bamboozle the government and the government routinely bamboozles the people. Yu recounts several different tales illustrating this process in action, and then comments that "there is really no end to these stories of fraud and chicanery, for 'bamboozle' has already insinuated itself into every aspect of our lives."

Yu concludes that "the rapid rise in popularity of the word 'bamboozle,' like that of 'copycat,' demonstrates to me a breakdown of social morality and a confusion in the value system in China today," which he says is "an aftereffect of our uneven development these past thirty years." Yu ends his book with a personal anecdote showing how the attempt to bamboozle can backfire. (Yu recounts how as a child he faked a stomachache to get out of doing chores and wound up getting his appendix removed.) Yu doesn't expressly connect the link between his personal experiences and China, but the implicit message seems to be that China could wind up as the victim of its own bamboozlement.

Yu writes simply and clearly, and his many anecdotes humorously illustrate his themes. Using ten words, Yu manages to provide an interesting and though-provoking picture of contemporary China. In the portrait he paints, China is a troubled giant still struggling to recover from the painful events of the country's early history.

May 13, 2012
Social Enterprise Symposium: Regent Law
by Haskell Murray

There is still so much about benefit corporations (and social enterprise in general) that could be written about. I was only able to scratch the surface during my short guest blogging stint, but I will continue to explore the issues in an article I am currently writing for American University's Business Law Review. I will provide the Glom with an SSRN-link when I post the article.

Also, on Saturday, October 6, 2012, our main law review here at Regent University School of Law is hosting a symposium on social enterprise. The symposium will be held on our beautiful campus in Virginia Beach, VA (pictured below). We already have an impressive group confirmed (listed below) and plan to add one or two additional speakers.

Each of our guests brings a unique perspective and an incredible amount of knowledge to the symposium. I linked to their profiles because I would have to do 7 separate posts to even touch on all of their many accomplishments. Two or three Regent law professors (including me) will moderate and contribute.

We at Regent University School of Law are incredibly excited about the upcoming symposium (even if it is still months away) and hope some of the readers will join us. I will provide more information about the symposium to the permanent Glom bloggers when we get closer to the date.

Feel free to e-mail our excellent symposium editor Rachel Bauer at symposium[at] if you would like more information.

May 14, 2012
Another Aggressive Insider Trading Case For The SEC
by Tom Gorman

The Commission has brought a series of aggressive insider trading actions which are pushing the edges of, and may redefine, insider trading theory. In one case has been based in part on the observation of matters such as tours of a company facility by individuals in business suits which lead to speculation by employees who later traded that investment bankers were sizing up the company for sale. SEC v. Steffes, Case No. 1:10-cv-06266 (N.D. Ill. Filed Sept. 30, 2010)(in litigation). In another a brother decided to trade based on fragments of a telephone conversation he overheard while in the office of his sister, a company executive. SEC v. Ni, Case No. CV 11 0708 (N.D. Cal. Filed Feb. 16, 2010)(settled). Another was based on inferences that employee family members were tipped by other insiders who were not named in the action. SEC v. Carroll, Case No. 3:11-cv-00165 (W.D. Ky. Filed March 17, 2010)(in litigation).

The case against Frank L. Bystone, former CEO of Tri-Vallley Corporation or TIV, is another in this series of cases. SEC v. Blystone, Case No. 1;12-cv-00774 (E.D. Cal. Filed May 10, 2012). Mr. Bystone retired from his position as CEO of the company on March 5, 2010. The Bakersfield, California headquartered company engaged in petroleum and mineral exploration and development. Its shares are listed on the NYSE and the AMEX.

In December 2009 TIV retained an investment banking firm to serve as a financial advisor in connection with a contemplated $10 to $15 million underwritten of securities. In early February the firm altered its plan, deciding to proceed with a registered direct offering of common stock. By the end of the month the company again altered the plan, concluding that it would break the offering into three $5 million tranches. This change was based on the advise of the investment banking firm which had concluded the market for thinly traded small cap stock had dwindled significantly and pricing was more difficult. This is reflected by the fact that the firm only had commitments for $3.5 million from two of six prospective institutional investors who were contacted. The investment bankers were looking for another partner to complete the first tranche.

Mr. Blystone was informed about these events through internal e-mails. Based on this information he concluded that the terms of the offering would be "onerous." He also thought that the securities would either be priced at a discount or additional stock would have to be sold which could dilute the outstanding shares. During this period he continued to hold shares of the company.

In March the retired former CEO received additional information about the proposed offering. A friend informed him that TIV hoped to close the first tranche of the offering soon. Mr. Blystone responded to this e-mail by noting that in his view the company needed more than $5 million. He also "speculated," according to the complaint, that the company would sell assets as a "fire sale" price. There is no indication in the complaint that Mr. Blystone was able to confirm his speculation about the possible offering or when it might proceed.

Based on his conclusions from all of the information available to him Mr. Blystone sold shares of his former company on two occasions. First, on March 23, 2010 he sold 5,000 from a trust account. Second, on April 5, 2010 he sold the remaining 45,100 shares of company stock held in that account. The sales were made at prices ranging from $2.00 to $2.099 per share. These were Mr. Blystone's first sales of company stock. The complaint does not indicate if he continued to hold shares of company stock.

The next month, on April 6, 2010, TIV announced that it had entered into an agreement to sell shares to six institutional investors in a registered direct offering. The company raised $5 million, selling 3,846,154 shares at $1.30. The deal included warrants to purchase an additional 2,307,692 shares at prices ranging from $1.50 to $1.95. Following the announcement the share price dropped 38.6%, closing at $1.32. By selling prior to the announcement Mr. Blystone avoided losses of $36,267, according to the complaint which alleges violations of Securities Act Sections 17(a)(1) and 17(a)(3) and Exchange Act Section 10(b).

According to the Commission, Mr. Blystone agreed to settle the case, paying $75,000 without admitting or denying the allegations. Lit. Rel. No. 22367 (May 11, 2012).

May 14, 2012
JPMorgan's Big Loss: Explain it to Me
by Mark Astarita

JPMorgan announced last week that it lost 2 billion dollars over the past six weeks. The local newspapers and talking heads made a huge deal about it. After all, it is 2 BILLION dollars, and the implied worries that the bank will go under, the economy will collapse and there were will be general mayhem abound.
However, that loss will not crash the bank, or anything else. According to the real money media, JPMorgan has more assets than any other bank in the country. Its net loss for the quarter is estimated to be $800 million and the bank made $5.4 billion in the first three months of the year alone.

But 2 billion dollars is a lot of money, and one has to wonder how in the world any one, or any financial institution, could lose that much money in a month. According to CNN Money and the Wall Street Journal, it is all caused by huge hedging transactions in credit default swaps. You remember them, they played a large part in the collapse in 2008 and 2009. According to the press, the credit default positions were so large that they caused unusual market movements, prompting hedge funds to take the opposite position.

So far, no one is saying that anyone did anything wrong, but we will have to wait and see on that one. But the back story is interesting, and starts at CNN Money- JPMorgan's big loss: Explain it to me

May 14, 2012
Facebook IPO Opportunity for Fraudsters?
by Mark Astarita

From the Sun-Sentinel, as the Facebook IPO arrives, not only are investors lining up for what they hope will be a golden opportunity, but so are scammers. The combination of heavy hype, potentially lucrative returns and starry-eyed novice players in the equities market have created ripe conditions for con artists to operate, according to financial regulators and securities attorneys. People are being warned to be especially careful about offers to purchase private shares of Facebook before the initial public offering (IPO) of stock expected later this week.

'It's the hottest IPO in years and anything that is hot will be exploited by scammers," said Jim Sallah, a Boca Raton securities attorney. "If you want to raise a quick $5 million, the quickest thing to do is start marketing Facebook pre-IPO shares."

Facebook's looming IPO a juicy opportunity for South Florida fraudsters, authorities say- South Florida

May 14, 2012
The JPMorgan $2 Billion Trading Loss: Three Talking Points
by David Zaring

What traders do is regulated, and will only get more regulated upon the implementation of Dodd-Frank. But what they do isn't the heart of financial regulation, which doesn't so much scrutinize individual trades (a generalization, to be sure), as attempt to put into place institutional arrangments that ensure that the financial system will survive one or a few trades going south. For lawyers, in other words, the talking points in the wake of JPMorgan's $2 billion trading loss aren't obvious. Here is an attempt at three:

  • When traders blow up a bank, the bosses get fired. The Chief Investment Officer just got canned from JPMorgan- she was the fourth highest paid person at the firm last year. But the London Whale wasn't. Regardles of who was precisely responsible for the bank's loss, you get a sense that banks internally sanction risk managers, rather than profitable traders, when the traders make a mistake. That could be because the paper losses could yet come good. Or it could be a reason to regulate- if it is the risk managers who will get it in the neck, maybe outsiders need to sanction the traders.
  • The conventional- and pretty attractive- response to these sorts of messes is to try to make regulation simple. Smaller banks, Volcker and Glass-Steagal-like rules ... the idea is that you couldn't possibly regulate whether JPMorgan's hedge was a safe one or a risky one, so you need to make it so the trade just couldn't threaten the financial system. I'm quite persuaded, but I actually wonder whether big, diversified banks or small interconnected ones get bailed out more often by the government. If you know, or have some other talking points, by all means offer them in the comments.
  • Dodd-Frank is on the job, but unruffled: "The Financial Stability Oversight Council, the committee set up in the wake of the crisis to identify and respond to threats to the banking sector, is not planning a special meeting to discuss JPMorgan," the Times tells us. But the implication is that they could do exactly that, which in turn suggests that the emergency committee is the exception to the rules on reporting, netting, clearing, margin, &c. It is the part of financial regulation that can respond to individual trades.
May 14, 2012
JOBS Act: EGC Status As a Risk Factor
by Broc Romanek

JOBS Act: EGC Status As a Risk Factor

As noted in this article, LegalZoom is one of the first companies to announce its upcoming IPO after first submitting its registration statement under Corp Fin's confidential submission policy. Here's the company's Form S-1 that it filed on Thursday, presumably after responding to comments from the Staff.

The company's prospectus has several disclosures related to its status as an "emerging growth company." For example, notice this risk factor on page 20 (there are several other risk factors that also touch upon EGC status- or risks of losing that status):

We are an "emerging growth company," and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an "emerging growth company," as defined in the Jumpstart Our Business Startups Act, or the JOBS Act. For as long as we continue to be an emerging growth company, we may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We could be an emerging growth company for up to five years, although circumstances could cause us to lose that status earlier, including if the market value of our common stock held by non-affiliates exceeds $700 million as of any June 30 before that time, in which case we would no longer be an emerging growth company as of the following December 31. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

Under the JOBS Act, emerging growth companies can also delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourself of this exemption from new or revised accounting standards and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

That matches the theme of this statement on the prospectus cover page:

We are an "emerging growth company" under the federal securities laws and will be subject to reduced public company reporting requirements. Investing in our common stock involves risks. See "Risk Factors" beginning on page 11.

In addition, there is this MD&A statement on page 50 under "Recent Accounting Pronouncements":

As an emerging growth company under the JOBS Act, we have elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the Act. This election is irrevocable.

Don't forget that our just-published May-June issue of The Corporate Counsel contains in-depth and practical guidance on the JOBS Act. If you're not yet a subscriber, try a no-risk trial now to get the issue rushed to you.

JOBS Act: Corp Fin Updates Its Confidential Submission Process

When Corp Fin initially announced its procedures for making confidential submissions under the JOBS Act last month, it stated that it would be implementing a system for electronic transmission. On Friday, Corp Fin provided an updated announcement that launches an electronic transmission process that replaces the procedures announced back in April- this is available for emerging growth companies and certain foreign private issuers. Someday, these submissions will be made via Edgar- but Edgar still needs to be reconfigured to allow for that.

Here's an excerpt from the updated announcement:

All issuers submitting draft registration statements confidentially pursuant to the JOBS Act or for non-public review under the Division policy must follow these instructions on how to use the secure e-mail system. All draft submissions must be in text searchable PDF format and should include a transmittal letter identifying the issuer and the type of submission. Emerging Growth Companies should confirm their status as an EGC in their transmittal letters. We will confirm receipt of submissions via secure e-mail.

More on our "Proxy Season Blog"

We continue to post new items regularly on our "Proxy Season Blog" for members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

- Even More on " Adjournment and Circulation of Proxy Cards"
- SEC Staff Comments: Questioning Qualifications of Financial Reporting Staff
- Reminder: SEC Interpretation on Reconciliation for Use of Non-GAAP Measures in CD&As - OPERS: Auditor Ratification Dependent on % of Non-Audit Fees Paid
- A Final Look at E&S Proposal Results
- Shareholder Proposals: Questions of Proof of Ownership Continue

- Broc Romanek

May 14, 2012
The Board and "Reliable" Directors
by J Robert Brown Jr.

Boards are sometimes described as institutions designed to provide the CEO with advice. To the extent filled with knowledgeable people from different backgrounds, boards stand ready to counsel and assist CEOs in what can often be very challenging environments.

There may be some boards that play this role. But boards that give advice can also fire the CEO. CEOs wanting to retain their post have a rational incentive to "neutralize" the board. This entails a preference not for directors who provide the best advice but for those who will be the least likely to intervene in corporate affairs. In short, directors are often picked not for their diverse perspective but for their "reliability." This is discussed at some length in Essay: Neutralizing the Board of Directors and the Impact on Diversity.

Picking reliable directors, however, is not without limits. Most boards of public companies consist of independent directors. Thus, to the extent the CEO prefers reliable directors, these individuals must be both reliable and independent.

What are some categories that meet both tests? Friends of the CEO. As we have noted, the definitions of director independence used by the stock exchanges do not require boards to screen for friendship. To the extent boards contains directors who are friends of the CEO, they will presumably be less likely to intervene in the affairs of the company (something that can include firing the CEO).

Another category, however, are executive officers of other companies, particularly other CEOs. A CEO of another company is likely to be less interested in intervention. For one thing, he (and rarely she) does not want his/her own board to intervene. The CEO as director probably takes that same philosophy to other boards where he/she sits as a director.

These directors may be common but pressure is growing to make them a little less common. According to an article in the WSJ, 118 "top officers of Fortune 1000 companies sit on at least three boards," including their own. The actual analysis is here. Some institutional investors think that this is too much and are pressuring some of them to reduce their commitments. As the article noted:

  • Some investors are actively objecting to executives' multiple directorships. Calpers and the UAW Retiree Medical Benefits Trust, which manages about $53 billion in assets for retired auto workers, say they likely will oppose board re-elections at 2012 annual shareholder meetings of several dozen CEOs with more than one outside board seat.

Top executives may take these positions "to broaden their business perspective." But they are also well paid. "Among companies in the Standard & Poor's 500-stock index, average annual compensation for directors exceeded $232,000 in 2010, up 8% from $215,000 the year before, according to a 2011 study by recruiting firm Spencer Stuart."

The pressure is to prevent executive officers from taking too much time away from the primary company that they manage. At the same time, however, the approach also makes it a little bit harder to ensure the reliability of the board.

May 14, 2012
The Role of Institutional Investors in Voting
by R. Christopher Small

Editor's Note: The following post comes to us from Reena Aggarwal, Professor of Finance at Georgetown University; Pedro Saffi of the Cambridge Judge Business School at the University of Cambridge; and Jason Sturgess of the Department of Finance at Georgetown University.

In the paper, The Role of Institutional Investors in Voting: Evidence from the Securities Lending Market, which was recently made publicly available on SSRN, we use a unique setting to examine if institutional investors influence firm-level corporate governance through proxy voting. Understanding institutional investor preferences regarding corporate governance is important for firms trying to attract new investors as well as policy makers considering the regulation of different governance mechanisms. The activities of institutional investors in the securities lending market provide one of the few opportunities to directly examine the behavior of institutional investors in influencing firm-level governance.

To study the securities lending market for U.S. firms during the period 2007-2009, we use a proprietary data set comprising shares available to lend (supply), shares borrowed (demand), and loan fees. The data covers more than 85% of the securities lending activity for these firms and allows for a comprehensive analysis during a period of tremendous growth in that market. In the past, understanding the securities lending market has been limited partly due to the lack of transparency in this fragmented market. We find that on average, 22.48% of a firm's market capitalization is available for lending, 3.44% is actually borrowed, and the annualized loan fee is 35 basis points. The supply of lendable shares shows great variation, with minimum and maximum values of 0.01% and 74.38% of market capitalization. We find that more lending supply is available for firms with larger institutional ownership and strong corporate governance. There is considerable interest in some stocks and almost 100% of the available supply of such stocks is actually borrowed and on loan. The annual fee can be quite high, with the maximum at 745 bps. During 2007-2009, 10% of the stocks were very expensive to borrow and had a fee greater than 100 basis points. 2007 was the peak year for the securities lending market, with activity dropping off after the financial crisis.

We analyze the supply of lendable shares around the time of a proxy vote to examine the role of institutional investors in the voting process. Just prior to the proxy record date there is a significant reduction in the supply of lendable shares, because institutions restrict or call back their loaned shares prior to a vote. The reduction in securities lending by institutions around the time of a vote is direct evidence that to bring about changes at companies, institutions play a role in the voting process. The reduction in the supply of lendable shares is most pronounced when there are contentious proposals on the ballot, for example, proxy contests, when management supports the proposals but ISS recommends voting against the proposal, and for firms with weak corporate governance. We find that the recommendations of proxy advisors have a strong influence on the securities lending market around proxy voting.

We find that the recall in equity lending supply is positively associated with the subsequent vote outcome. Votes cast against management's recommendation and votes cast against a proposal are positively related to a recall in lending supply. If proposals are sponsored by shareholders or proposals that are opposed by ISS, then we find they are likely to get fewer FOR votes. The outcome of the result is more likely to be close when lending supply is recalled and ISS opposes the proposal. The results show that beneficial owners of securities recall lending supply ahead of the proxy record date in order to exercise their vote. In doing so, institutional investors reveal both that corporate governance is important and that the proxy process is an important channel for corporate governance.

In contrast to the activity around a proxy vote's record date, we find that the large increase in loan fees around the time of the ex-dividend record date is driven by an increase in borrowing demand for cash flow reasons. During the financial crisis of 2008, activity in the securities lending market decreased as demand for borrowing decreased and institutions cut back on their lending programs. Lending fees also experienced large reductions during the financial crisis. Our results suggest policy makers should address several issues related to proxy voting, including the need for investors to learn about proxy items before the record date so that they can decide whether to lend their shares or not.

The full paper is available for download here.

May 14, 2012
Federal Reserve Clarifies Deadline for Volcker Rule Compliance
by Bradley K. Sabel

Editor's Note: Bradley Sabel is partner and co-head of Financial Institutions Advisory & Financial Regulatory practice group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication from Mr. Sabel and Donald N. Lamson, available here.

The Federal Reserve issued a statement last week clarifying that it will interpret the Volcker Rule to afford banking entities the full two-year period provided by the statute to conform their activities and investments to the Rule's prohibitions and restrictions. The financial services industry should welcome this alternative to curtailing trading and investment activities earlier than the statute on its face would have required, but inevitably some questions remain. The Federal Reserve still has not given any indication whether it may extend this period. As compliance activities progress and we gain greater insight into the effect of the Rule on the economy, the public may seek even clearer guidance on this aspect of the Federal Reserve's discretion.


The Volcker Rule added a new section 13 ("Section 13") to the Bank Holding Company Act of 1956 imposing prohibitions and requirements on a banking entity that engages in proprietary trading and has investments in or certain relationships with a hedge fund or private equity fund. [1] The Rule also provides that a non-bank financial company supervised by the Federal Reserve that engages in proprietary trading or makes hedge fund investments must comply with certain other requirements, including supplemental capital requirements or quantitative limitations. [2] The Rule takes effect on the earlier of two years after the date of its enactment, July 21, 2012, or 12 months after the date of issuance of rules implementing that section. Because the Agencies did not issue implementing rules by July 21, 2011, the effective date will be July 21, 2012.

Conformance Period Rule

The Federal Reserve must adopt rules governing the period for banking entities to conform their activities and investments to the Rule's requirements. Unless the Federal Reserve extends the conformance period, a banking entity must conform its activities and investments to the Rule's requirements and any final implementing rules no later than two years after the effective date. The Federal Reserve may extend the conformance period three times with separate one-year extensions, as well as the period for retaining an ownership interest in an illiquid fund. The Federal Reserve issued its final conformance rule on February 9, 2011. [3]

Need for Clarification

The Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation and SEC (together with the CFTC, the "Agencies") in October 2011 proposed interagency rules implementing the Volcker Rule. [4] A number of commenters on that proposal sought clarification that a banking entity had the full period permitted by statute to conform its investments and activities and that the requirements would not apply to activities conducted and investments made during the conformance period. In response, and in apparent coordination with the other Agencies, the Federal Reserve has now clarified how the conformance period will operate and how the Rule's prohibitions will be enforced by confirming the statute's plain language that banking entities have two years, until July 21, 2014, to conform their activities and investments to the Volcker Rule, unless that period is extended.

No Free Ride

The Federal Reserve's clarification is not intended to be a license for banking entities to continue business as before, for it comes with strings. During the two year conformance period, the Federal Reserve expects banking entities to engage in good-faith planning efforts to conform their activities and investments to the requirements of the Rule, which may include complying with new reporting or recordkeeping requirements. The Federal Reserve signaled that the Agencies may likely adopt such requirements for the conformance period in final rules implementing the Rule.

A banking entity also should undertake good-faith efforts actually to conform its activities and investments to the requirements of the Rule. The entity should evaluate the extent to which it is engaged in activities and investments that are covered by the Rule and develop and implement a specific plan about how it will conform its activities and investments by the deadline.


In a further sign of interagency coordination, the Federal Reserve announced that the Agencies will administer their oversight of banking entities under their respective jurisdictions in accordance with the conformance rule and this new clarification. However, the Federal Reserve could not help but repeat the familiar dictum that this new guidance does not restrict in any way the authority of the Agencies to limit - even during the conformance period - any activity determined to be unsafe or unsound or otherwise in violation of law.

Unanswered Questions

While the statement is welcome, there remain several important questions that it does not purport to address:

  • 1. How strictly will the agencies construe the requirement to be in "good faith"? It is understood that the agencies differ in their views on the importance of the Volcker Rule generally. Will some agencies be lenient while others are strict? If so, would this matter? Would the strictest agency as a practical matter set the bar that an organization will have to enforce throughout the organization?
  • 2. Can organizations continue to organize and invest in private equity funds during the conformance period? Proprietary trading on its face seems likely to be amenable to a phase-down within the two-year period, though the nature of the final regulations will define whether this is so. However, investments in private equity funds are usually commitments for a long period, much longer than two years. Can an organization make an investment during the two-year period in good faith? Must it have a strong legal right to transfer its interest to third parties or be redeemed out? Can an organization organize a new fund during that period? If the organization does not know the final requirements for the fiduciary-sponsorship exception for organizing new funds, how can it be sure that its design will be in good faith?
  • 3. When will decisions on good faith be made? Will the agencies review the required conformance plans in a coordinated manner among themselves, or will different agencies come to conclusions on their own and at their own pace?
  • 4. What are non-US banks to do during the conformance period? The US agencies are not global supervisors of those organizations. While they supervise regulated US operations, one of the very difficult questions under the proposed rules was the extent to which activities may be conducted that are 'solely outside of the United States". Will non-US banks be expected to take actions at their non-US operations in order to be ready for the final rules?
  • 5. On a more technical level, what exactly is the status of the "statement"? Pronouncements by a Federal agency have more or less weight in court depending on their nature. A "statement" is generally not treated with great deference. In light of likely legal challenges to anything the agencies do, this might be an important point. The fact that the Statement refers to itself as an "interpretation" will likely allow it to be treated as such, which should cause a court to give it great deference.


The Federal Reserve provided assurance to the industry that there would be a full two years in which to conform trading and investment activities to the Volcker Rule's requirements, but any gratitude it earned may soon turn to impatience. The Federal Reserve still shows no sign whether it will provide additional extensions of time within which banking entities may conform their activities. It will be only a matter of time until we hear calls for additional clarity on this point as well. As we continue to observe the effect of the Rule on the financial services industry, these calls may well become louder.


[1] Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Volcker Rule" or "Rule"). A "banking entity" includes any insured depository institution (other than certain limited purpose trust institutions), any company that controls an insured depository institution, any company that is treated as a bank holding company under section 8 of the International Banking Act of 1978 and any affiliate or subsidiary of any of those entities. A "hedge fund" and a "private equity fund" are defined identically as an issuer that would be an investment company, as defined under the Investment Company Act of 1940 (but for two exceptions of that Act), or any similar fund as the appropriate Federal banking agencies, the Securities and Exchange Commission ("SEC") and the Commodity Futures Trading Commission ("CFTC") may determine.

[2] The Financial Stability Oversight Council ("FSOC") may determine that a non-bank financial company (i.e., a company predominantly engaged in financial activities) shall be subject to supervision by the Federal Reserve. The FSOC has not yet made any determinations, nor has the Federal Reserve yet proposed to impose prudential supervisory requirements on a nonbank financial company.

[3] "Conformance Period for Entities Engaged in Prohibited Proprietary Trading or Private Equity Fund or Hedge Fund Activities," 76 FR 8265 (Feb. 14, 2011). The conformance rule provides that extensions beyond the general conformance date (other than for newly chartered banks) would only be available with prior Federal Reserve approval on a bank-by-bank basis where certain conditions have been met. The Federal Reserve did not use its broader authority to automatically extend the Volcker Rule conformance date beyond the default July 21, 2014 date.

[4] Those proposed rules may be found at 76 FR 68846 (Nov. 7, 2011). The CFTC later requested comment on a substantially similar proposal. This proposed rule may be found at 77 FR 8332 (Feb. 14, 2012).

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