Securities Mosaic® Blogwatch
May 26, 2017
Bank Governance and Systemic Stability: The “Golden Share” Approach
by Saule Omarova
Editor's Note: Saule T. Omarova is a Professor at Cornell Law School. This post is based on her recent article, forthcoming in the Alabama Law Review.

The global financial crisis of 2008 has underscored the urgent need for deep rethinking of how financial firms ought to manage risk, and do so not only for the sake of generating good results for themselves and their clients but also for the sake of keeping the entire financial and economic system from collapse. Conceptually, this collective post-crisis “rethinking” effort seems to proceed along two basic lines. Some scholars and policy experts focus on enhanced public regulation and supervision of financial firms and markets—through higher capital standards, mandatory stress testing, greater and faster data collection, etc.—as the key method of minimizing systemic risk. Others, by contrast, see improved private ordering—through strengthening various mechanisms of corporate governance, incentivizing individual firms and their employees to behave ethically, etc.—as the ultimate solution to the same problem.

Both of these approaches, of course, run into familiar problems and criticisms. All too often, even well-meaning regulators and supervisors find themselves at least one step (if not many steps) behind financial institutions that excel at regulatory arbitrage games. At the same time, even well-meaning private firms and their insiders—directors, shareholders, managers, and employees—are inherently limited in their ability to internalize a systemic-risk perspective, both because they generally do not have a full view of the financial system and because their actions are ultimately driven by private profit-maximization motives. Thus, neither the top-down public regulation nor the bottom-up private governance seem to offer a workable solution to this structural capacity dilemma.

There is, however, a third possibility that remains largely outside of mainstream academic and policy debate: the possibility of strategically combining certain key elements of public and private ordering, to allow for a more effective and seamless incorporation of systemic stability concerns into financial firms’ internal decision-making. In a recently published paper, I explore this unorthodox but potentially promising alternative.

The paper focuses on the structure and role of the board of directors as the key decision-making body within commercial banks, the archetypal systemically important financial institutions (“SIFIs”). Instead of tweaking existing standards and procedures that determine bank board composition or guide specific board actions, however, the paper advocates a fundamental structural reconfiguration of bank governance. It proposes the creation of a special “golden share” (“SGS”) regime that would grant direct but strictly conditional corporate governance rights to a designated government representative on the board of each systemically important banking organization.

In the 1980s-1990s, golden shares were widely used by governments around the world—including the famously conservative UK government under Margaret Thatcher—to reserve exclusive rights to control key business decisions by certain private companies in strategically significant industries. The paper examines how this familiar instrument can be adapted to serve as a tool of preventing excessive generation, concentration, and externalization of risk by privately owned banks. In essence, the proposed golden share regime is envisioned as a form of conditional (as opposed to absolute), temporary (as opposed to permanent), and individually calibrated (as opposed to uniformly predetermined) government control over banks’ internal governance.

The SGS would function as a dynamic mechanism, a sliding scale of management—but not economic—rights triggered by specified events. Under normal circumstances, the SGS is meant to remain largely a passive instrument. In this “peacetime” period of dormancy, the government-appointed directors would generally refrain from active participation in the management of the bank and perform primarily representational and observational functions, essentially serving as the public’s “eyes and ears” on the bank’s board of directors. The government’s direct management rights would get “triggered” only upon the occurrence of specified events that indicate a potentially greater likelihood of increasing systemic risk or instability. Examples of triggering events include certain worrisome trends in firm-specific metrics (falling capital levels, a sudden rise or change in the tenor of the firm’s liabilities, significant shifts in the composition or riskiness of the firm’s assets, etc.), regulatory compliance record and culture (e.g., significant instances or patterns of misconduct), as well as external indicators of potentially troubling systemic imbalances or vulnerabilities (e.g., sudden acceleration of credit growth across the financial system). In response to these warning signals, the SGS mechanism would shift into an actively participatory mode. At this “emergency” stage, the government-appointed directors would take effective control of the board and cause it to take actions necessary to remedy the specific “triggering” problem(s). Once that goal is achieved and the systemic danger is dissipated, the golden share would revert to the pre-trigger, passive state.

This brief sketch of the golden share proposal leaves out many important institutional and operational details discussed at length in the paper. Naturally, a daringly experimental project of this kind is bound to raise difficult design questions and face numerous implementation challenges. Yet, these challenges are hardly insurmountable, if we are willing to move beyond the outdated stereotypes and misplaced fears. As the paper shows, the proposed golden share regime is neither a nationalization measure nor an institutionalized bank bailout. Its overarching purpose is not to put the federal government in charge of private firms but, on the contrary, to steer those firms toward self-correcting and preventative actions necessary to avoid that undesirable result.

Moreover, enabling a public instrumentality to affect directly a private firm’s substantive business decisions—without holding a controlling economic equity stake—renders the golden share a particularly promising mechanism for preventing systemic financial shocks. As a special shareholder with uniquely tailored rights, the government would acquire the new capacity to take speedy and effective action necessary to counteract socially harmful, and thus irrational, effects of pure market rationality. In that sense, the golden share regime would effectively operationalize a novel approach to bank—and, more broadly, SIFI—corporate governance as an inherently hybrid public-private process.

The complete paper is available for download here.

May 26, 2017
Financial Scholars Oppose Eliminating "Orderly Liquidation Authority"; As Crisis-Avoidance Restructuring Backstop
by Jeffrey Gordon, Mark Roe
Editor's Note: Mark Roe is a professor at Harvard Law School This post summarizes the text of a letter by Professor Roe and Professor Jeffrey N. Gordon of Columbia Law School to the chairs and ranking members of the Senate and House Banking and Judiciary committees and co-signed by more than 100 other academics whose work and teaching deal with bankruptcy and financial regulation. The letter explains why a bankruptcy structure should not be allowed to substitute for the Dodd-Frank Act’s regulator-driven "orderly liquidation authority. The complete letter is available here

Last week, Jeff Gordon and I wrote to the chairs and ranking members of the Senate and House Banking and Judiciary committees, analyzing reasons why a bankruptcy structure should not be allowed to substitute for the Dodd-Frank Act’s regulator-driven “orderly liquidation authority.” Our letter was joined by more than 100 other academics whose work and teaching deal with bankruptcy and financial regulation.

The Financial CHOICE Act of 2017, H.R. 10, would replace the “Orderly Liquidation Authority” (“OLA”), Title II of Dodd-Frank, with a new bankruptcy procedure, the Financial Institution Bankruptcy Act (“FIBA”), as the exclusive means for addressing the failure of systemically important financial institutions (“SIFIs”). The House Banking committee reported out the bill several weeks ago. A stand-alone version of FIBA has already passed the House.

Although a bankruptcy mechanism usefully expands the channels for resolution of a failing financial firm, bankruptcy institutions alone cannot manage a full-blown financial crisis. Crisis management will need regulatory authorities. The difference in function, and the baseline uncertainty of success, could fan financial panic rather than stabilize the financial system, if there is no regulatory backup and support. While FIBA, particularly if made more robust than the current version, would be a valuable addition to the panoply of crisis tools, the economy and the financial system will still need OLA to make FIBA work. Hence, substituting FIBA for OLA risks exacerbating a financial crisis like that which the country faced in 2008-2009.

The letter describes four general reasons why bankruptcy cannot substitute for OLA: planning and backup, international coordination, coordinated response and liquidity provision.

Planning and backup. For FIBA to function properly, it needs institutional supports that only OLA and its related rules now provide. H.R. 10 contemplates that a failed SIFI would land in a bankruptcy court and be resolved and stabilized within 48 hours; for FIBA to have the possibility of success, a “FIBA-friendly” capital structure must be in place. That would need to be done before a bankruptcy and normally it would be the regulators who verify the capital structure’s adequacy through the OLA-based “living will” process.

Bankruptcy can routinize restructuring, particularly for bank holding companies that may fail for firm-specific reasons not embedded in a broader crisis. But it may not succeed and OLA needs to remain in place as a backup.

International coordination. Lehman Brothers’ bankruptcy in 2009 triggered or exacerbated a world-wide financial panic in significant part because of the lack of international coordination. Under Dodd-Frank’s OLA, the FDIC will have prior understandings with foreign regulators and can seek to manage or avoid global financial contagion. A U.S. bankruptcy court will lack deep prior relationships or the authority to reach understandings with foreign regulators in advance of a bankruptcy filing. American regulators will need to help make foreign regulators comfortable with the bankruptcy process. But repealing OLA and its supports would undermine that objective because it would remove an essential American backstop in the event that a FIBA restructuring is unsuccessful.

Coordinated response. A financial crisis that threatens the economy will involve multiple institutions failing or tottering simultaneously. The American economy will need a coordinated response, if the entire financial system suffers a panic or lack of liquidity. Bankruptcy judges cannot provide that coordinated response. They cannot caucus and decide how to handle multiple bankruptcies in a way that best stabilizes the economy. Bankruptcy courts have neither a mandate, nor the proper experience, nor the staff needed to design a plan to protect the financial system as a whole. Only the regulators can do that, and OLA and its supporting provisions are necessary for the regulatory effort.

Liquidity. Similarly, liquidity can be crucial to stabilizing financial firms in a crisis. But the bankruptcy judge cannot provide liquidity to the system or to a tottering SIFI. And, if financial distress is widespread, private markets cannot provide that liquidity either. Under the Dodd-Frank Act, the only source of public liquidity support for a failing financial firm would be through an FDIC receivership.

* * *

OLA issues. Two of the primary objections voiced in Congress to OLA lie in (1) the view that government loans under OLA will amount to a “bailout,” even though the Act requires that the loans be backed by the assets of the firm, and that they be recovered in the resolution process or from the largest members of financial industry thereafter, and (2) the discretion that OLA gives the regulators to provide similarly situated creditors with different recoveries. We understand these concerns, but any reform effort here should preserve OLA’s advantages. For example, without endorsing the following, those concerned with payback could mandate above-market penalty rates in any government liquidity lending or could delete the authorization for differential recovery, rather than by a baby-with-the-bath-water jettisoning of OLA.

* * *

Local weaknesses in FIBA. FIBA is not as robust as one would hope a bankruptcy channel would be. At least three bases for its lack of robustness are in play.

First, FIBA gives the SIFI and its executives exclusive control over when to initiate a FIBA proceeding. But bank executives have reason to wait, in hope, however small, of the bank recovering. Yet while waiting, the SIFI may lose whatever liquidity buffer it had, making it harder for bankruptcy to succeed and raising the stark choice between a bailout and a chaotic failure. Thus the regulators need authority to choose the timing of a FIBA proceeding.

Second, FIBA is silent on how the SIFI would be restructured if the 48-hour period runs out without a successful resolution. FIBA is not a general vehicle for financial firm bankruptcies, but a mechanism to effectuate a particular kind of quick restructuring. If it fails, FIBA provides no alternative.

Third, American bankruptcy courts currently lack the full judicial power of the United States, which will add uncertainty to the bankruptcy process in a crisis.

* * *

Conclusion. Bankruptcy cannot substitute for resolution via the Orderly Liquidation Authority administered by the FDIC. It can, in contrast, provide an additional, useful resolution channel.

Repealing OLA and its supporting provisions and replacing it with FIBA would be a serious disservice to the stability of the American economy.

Jeff Gordon’s and Mark Roe’s letter to the Banking and Judiciary committees chairs and ranking members can be found here.

May 26, 2017
Snap and the Rise of No-Vote Common Shares
by Ken Bertsch, Council of Institutional Investors
Editor's Note: Ken Bertsch is Executive Director at the Council of Institutional Investors. This post is based on Mr. Bertsch’s recent remarks to the SEC Investor Advisory Committee. Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock by Lucian Bebchuk and Kobi Kastiel (discussed on the Forum here).

Snap Inc.’s IPO [on March 2, 2017], featuring public shares with no voting rights, appears to be the first no-vote listing at IPO on a U.S. exchange since the New York Stock Exchange (NYSE) in 1940 generally barred multi-class common stock structures with differential voting rights.

Members of the Council of Institutional Investors have watched with rising alarm for the last 30 years as global stock exchanges have engaged in a listing standards race to the bottom. With NYSE-listed Snap’s arrival with “zero” rights for public shareholders, perhaps the bottom has been reached.

The Snap IPO took place as the Singapore Exchange proposed to permit multi-vote common stock, and Hong Kong Exchange leaders suggested their exchange may revive consideration of the same. The Hong Kong Securities and Futures Commission, which has provided strong leadership on the matter, blocked such a move just two years ago.

It is clear that Singapore and Hong Kong are responding to competitive pressure from low standards at the NASDAQ and the NYSE, just as NYSE was pressured to relax its rules in 1986 by the lack of restrictions on dual-class listings at NASDAQ. The Council of Institutional Investors was founded in 1985, and this was the first issue we confronted. The Council at that time adopted a strong policy setting one-share, one-vote as a bedrock principle. That remains our policy today, with strong support from all of our constituent groups, including asset owners and asset managers with varying investment methodologies.

We believe multi-class common structures and their power to separate ownership from control pose substantial risks with respect to all three aspects of the commission’s tripartite mission: protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation. It is time for the SEC to revisit with U.S.-based stock exchanges the rules on new offerings of multi-class common structures with differential voting rights.

If the exchanges are not willing to bar future common share structures with differential voting rights, the SEC should work with U.S.-based stock exchanges to:

  • Bar future no-vote share classes;
  • Require true and reasonable sunset provisions for differential common stock voting rights(that cannot be overridden by the controlling shareholder, as often happens); and
  • Consider enhanced board requirements for dual-class companies to build greater confidence that boards do not simply rubber-stamp founder managers or the controlling family.

Some background: Soon after the NYSE matched NASDAQ on this in the 1980s, the SEC took action itself to sharply limit multi-class share structures with differential voting rights. But the SEC rule was struck down by a court in 1990. Subsequently, the SEC approved new rules from the U.S. stock exchanges themselves. While the rules created consistency between U.S. exchanges, they have proven weak and decreasingly successful in promoting equal voting rights.

The core concern here is corporate governance 101: Separation of ownership and control over time can lead to a lack of accountability, and accountability to owners is necessary for course corrections that are critical in our capitalist system. Private equity owned firms typically have owners who are engaged and able to force change where management is failing. Public company shareholders rely on the board members they elect to do the same. At Snap, public shareholders, who likely will come to be the dominant providers of capital, have no role in electing directors. And disclosures may be limited compared with true public companies, including no requirement to file a proxy statement or hold an annual meeting open to public shareholders.

Corporations are led by human beings, who are fallible and who do not always see clearly their own mistakes and limitations. Eventually, every company runs into problems, and there needs to be an effective mechanism of accountability to owners. The vitality of American capitalism stems in large measure from U.S. companies’ responsiveness to pressures for change from the providers of capital, even when egos are bruised, strategies are upended and executive careers derailed.

Proponents of shielding founders and managers from a company’s owners through multi-class structures say that the public markets too often are impatient, and visionary leaders must be protected from company owners to create value for the long-term. For example, Snap CEO Evan Spiegel says it will be five years before markets will see what he can do. [1] That seems to be the basis for Snap’s extreme disenfranchisement of public shareholders.

I believe the assertion is dubious. But even if true, why not sunset the share structure in five years, or at least provide an opportunity at the five-year mark for shareholders to vote on a one-share, one-vote basis on whether to extend this protection for another five years?

Snap has a type of sunset provision, but it is triggered only when both founders die (unless they sell off their shares). One founder is age 26, and the other is age 28. Sumner Redstone turns 94 in May, and problems in recent years at Viacom, which he controls by virtue of dual-class shares, are a good example of long-term pitfalls of multi-class stock companies. Assuming that Mr. Spiegel matches Mr. Redstone in longevity, Snap shareholders may be stuck with current control for the next 66 years.

The Council’s membership of asset owners, mostly pension funds, have 25- or 30-year investment horizons. They view the increasing prevalence of ever-worse multi-class share structures as seeding problems that will manifest decades from now, harming pension beneficiaries and others. And all on the basis of a theory for which there is little evidence—that founders and controlling holders can grow companies more successfully if they are insulated from accountability to shareholders.

Evidence is lacking that, on net, the management teams, founders and families protected by dual class shares outperform. An upcoming Council study comparing multi-class companies with other firms finds that a multi-class structure neither increases nor decreases return on invested capital (ROIC). The study, of 1,763 U.S. companies in the Russell 3000 index, looks at ROIC from 2007 through 2015. Similarly, two IRRC Institute studies in recent years, including a 2016 paper, have found no clear advantage at controlled companies with differential voting rights, and some evidence of underperformance.

We hear an argument that as long as disclosure rules are good, multi-class structures are acceptable, as purchasers of shares with inferior voting rights can factor that into pricing. To the extent there is validity to that argument at IPO, it breaks down over the longer term given the present operation of our security markets, with long-term investors acting as universal owners, and portfolios to one extent or another indexed to the entire market.

Indeed, the growing importance of indexed investment in the market has increased the need for strong definitions around categories of securities. The idea of an endless variety of securities offerings, with fuzzy, poorly defined boundaries between categories, is attractive to investment bankers and law firms that can make a lot of money off their creative ideas. Such creative ideas include innovative structures that provide comfort to founder/managers that they will not be challenged by company owners, even as they pull in significant capital from public markets. But at some point there is substantial risk of market confusion, and disenabling of simple passive approaches to investment. We learned in the financial crisis that greater complexity in financial structures can have real downsides.

The Snap offering lacks some components for the definition of “equity security” that our members regard as inherent in the definition of an equity, most importantly voting rights. We have heard suggestions that Snap’s public share class is less like common equity and more like a preferred share, or a derivative, or a master limited partnership unit. There is merit in these comparisons, although the Snap public share class is a poor cousin to all of them as well. Just to take the preferred shares comparison, the Snap security lacks a higher claim on company assets, and there is no mechanism for providing voting rights if the company fails to perform or falls into distress.

CII and a group of our members are approaching index providers to explore exclusion from core indexes, on a prospective basis, of share classes with no voting rights.

But this does not absolve stock exchanges of responsibility. When the SEC worked with U.S. stock exchanges in the 1990s to put the present rules in place, I do not believe many envisioned significant classes of shares with zero voting rights. With the Snap IPO, it is clearer than ever that current rules are ineffective and need to be revisited. With each further step in enabling multi-class stock structures, critical investor protections are eroded and the potential for strong rules recedes. To the extent that Singapore, Hong Kong and other exchanges that have maintained strong standards on multi-class common share listings decide they cannot compete, we will see further decline that will be very difficult to reverse.

We also hear an argument that investors should tolerate multi-class structures as they entice private companies to go public when they might not otherwise. We believe the primary driver of reduced IPO activity relative to other times in history is easy access to private capital, not a fear among founders that their performance as managers will become subject to oversight from the company’s owners. In our view, asking public company investors to accept multi-class structures for the sake of IPO growth is as unreasonable as asking private company investors to cease investing in private companies for the sake of IPO growth.

I recognize that the chair-designee of the SEC, Jay Clayton, was intimately involved as a securities lawyer in Alibaba, a Chinese company that succeeded in sharply limiting voting rights of public shareholders only by listing at the NYSE rather than in Hong Kong. Nonetheless, I hope that the Investor Advisory Committee will work with the Commission, including its new chair, assuming that he is confirmed, on reviewing the adequacy of U.S. stock exchange rules.


1“We built our business on creativity,” Spiegel said. “And we’re going to have to go through an education process for the next five years to explain to people how our users and that creativity creates value.” See Los Angeles Times, at back)

May 25, 2017
AALS BA Call for Papers
by Usha Rodrigues

Call for Papers

AALS Section on Business Associations

Institutional Investors and Corporate Governance

AALS Annual Meeting, January 5, 2018

The AALS Section on Business Associations is pleased to announce a Call for Papers for a program to be held on Friday, January 5, 2018 at the 2018 AALS Annual Meeting in San Diego, California. The topic of the program is "Institutional Investors and Corporate Governance."

In thinking through the difficulty of agency costs within the public corporation, corporate law academics have turned repeatedly to institutional investors as a potential solution. The agglomeration of shares within a large investing firm, together with ongoing cooperation amongst a large set of such investors, could overcome the rational apathy the average shareholder has towards participation in corporate governance. Alternatively, activist investors could exert specific pressure on isolated companies that have been singled out—like the weakest animals in the herd—for extended scrutiny and pressure. In these examples, the institutionalization of investing offers a counterbalance to the power of management and arguably provides a systematized way of reorienting corporate governance. These institutional-investor archetypes have, in fact, come to life since the 1970s and have disrupted the stereotype of the passive investor. But have we achieved a new and stable corporate governance equilibrium? Or have we instead ended up with an additional set of agency costs – the separation of ownership from ownership from control? This program seeks to explore these questions and assess the developments in the field since the beginning of the new century.

The program is cosponsored by the Section on Securities Regulation.

Form and length of submission

Eligible law faculty are invited to submit manuscripts or abstracts that address any of the foregoing topics. Abstracts should be comprehensive enough to allow the review committee to meaningfully evaluate the aims and likely content of final manuscripts. Any unpublished manuscripts (including unpublished manuscripts already accepted for publication) may be submitted for consideration. Untenured faculty members are particularly encouraged to submit manuscripts or abstracts.

The initial review of the papers will be blind. Accordingly, the author should submit a cover letter with the paper. However, the paper itself, including the title page and footnotes must not contain any references identifying the author or the author’s school. The submitting author is responsible for taking any steps necessary to redact self-identifying text or footnotes.

Deadline and submission method

To be considered, manuscripts or abstracts must be submitted electronically to Professor Matthew Bodie, Chair-Elect of the Section on Business Associations, at Please use the subject line: "Submission: AALS BA CFP." The deadline for submission is Thursday, August 24, 2017. Papers will be selected after review by members of the Executive Committee of the Section on Business Associations. The authors of the selected papers will be notified by Thursday, September 28, 2017.


Full-time faculty members of AALS member law schools are eligible to submit papers. The following are ineligible to submit: foreign, visiting (without a full-time position at an AALS member law school) and adjunct faculty members; graduate students; fellows; non-law school faculty; and faculty at fee-paid non-member schools. Papers co-authored with a person ineligible to submit on their own may be submitted by the eligible co-author.

The Call for Paper participants will be responsible for paying their annual meeting registration fee and travel expenses.

May 26, 2017
This Week In Securities Litigation (Week ending May 26, 2017)
by Tom Gorman

Heading into a long holiday weekend the Chairman continued to fill out the senior staff of the agency. Peter Uhlmann, a staff veteran who has held several senior management positions, was appointed as Managing Executive in the Chairman’s Office.

The Commission filed another political intelligence insider trading case this week. The action named four individuals as defendants who are alleged to have repeatedly transmitted inside information obtained from a government agency in violation of the STOCK Act regarding the re-pricing of certain medical benefits. A parallel criminal action was also filed. In addition, the agency filed an action centered on a fake tender offer used to manipulate the share price of a stock to obtain a little over $3,000 in profits. The manipulation, however, caused significant harm to the markets and investors. The SEC also filed two new offering fraud actions.


Program: The Commission and the MSRB will hold a webinar on the Series 50 Exam for Municipal Advisors on June 15, 2017.

Stay: The Commission entered an order dated May 22, 2017 staying all administrative proceedings in which a respondent has the option to seek an appeal to the Tenth Circuit Court of Appeals. The order follws the Court’s denial of the Commission’s petition for rehearing en banc in Bandimere v. SEC which held that SEC ALJs had not been appointed in accord with the Constitution. The stay will continue pending the expiration of the time in which the Commission has to file a writ of certiorari, the resolution of that petition and any resolution by the Supreme Court or further order of the Commission.

SEC Historical Society

Program: Rule Making Under the ’40 Act, a discussion with three former Directors of Investment Management, June 1, 2017, 12:00 p.m. at SEC’s Washington, D.C. offices. The program will also be webcast (here). There is not charge for the program.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 4 civil injunctive cases and no administrative proceedings, excluding 12j and tag-along proceedings.

Offering fraud: SEC v. Wells, Civil Action No. 17 Civ. 7738 (S.D.N.Y.) is a previously filed action against William Wells and his firm, Promitor Capital Management LLC. According to the Commission’s complaint Mr. Wells falsely told some investors he was a registered investment adviser and would place their funds in specific investments. Instead he invested in high-risk options and used portions of the money to repay others. Much of the $1.1 million raised from investors was lost. Defendants settled with the Commission, consenting to the entry of permanent injunctions based on Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). Defendants also agreed to pay disgorgement of $660,427.62 which is deemed satisfied by the over $1.5 million in forfeiture and restitution ordered in the parallel criminal case. Mr. Wells pleaded guilty in that action. In a separate proceeding Mr. Wells agreed to be barred from the securities business and from participating in any penny stock offering. See Lit. Rel. No. 23845 (May 25, 2017).

Insider trading: SEC v. Blaszczak, Civil Action No. 1:17-cv-03919 (S.D.N.Y. Filed May 24, 2017). The action named as defendants: David Blaszczak, formerly an employee of CMS who has worked for a series of consulting firms since 2005; Christopher Worrall, an employee of CMS since 1999 and longtime friend of Mr. Blaszczak; Theodore Huber, a health care analyst for Adviser A; and Jordan Fogel, also a health care analyst for Adviser A. The case centers on alleged tips of inside information by Mr. Worrall to Mr. Balaszczak about three significant rate changes at CMS between May 2012 and November 2013. CMS issues proposed and final rules that set the Medicare reimbursement rates for the following calendar year. The releases often impact the share price of firms that offer products and services covered by the impacted fee changes. Accordingly, the rate changes are announced after the close of the market. Mr. Worrall had access to material non-public CMS decisions concerning reimbursement amounts. He also had obligations under the STOCK Act, the CMS non-disclosure policy and government ethics provisions to maintain the confidentiality of that information. Despite his obligations, in three instances over a period of about one and one half years, Mr. Worrall gifted inside information on CMS rate changes that lowered reimbursement rates to his longtime friend and former co-worked, Defendant Blaszczak. The information on each occasion was transmitted in personal meetings, on the telephone, in emails and through text messages. In each instance the information was transmitted by Mr. Blaszczak to Mr. Huber and/or Mr. Forel who in turn caused Adviser A to enter into securities transactions on behalf of certain hedge funds. Mr. Worrall knew, or should have known, the information would be used for securities trading. Those transactions yielded over $3.9 million in trading profits. The complaint alleges violations of Securities Act Section 17(a)(1) and Exchange Act Section 10(b). The SEC’s case, and that of the Manhattan U.S. Attorney’s Office, is pending.

Offering fraud: SEC v. Illarramendi, Civil Action No. 3:11-cv-78 (D. Conn.) is a previously filed action against Francisco Illarramendi and others which alleged a multi-year Ponzi scheme in which investors were defrauded out of millions of dollars. Following his guilty plea in a parallel criminal case, and admissions made in connection with that plea, the Court granted summary judgment in favor of the Commission. Defendant was enjoined from future violations of Advisers Act Sections 206(1), (2) and (4) and ordered to pay disgorgement of $25,844,834 along with a $1million civil penalty. Previously, the Court barred the Defendant from the securities business. The Defendant is currently serving a 13 year prison sentence. The Court appointed receiver has recovered more than $352 million. See Lit. Rel. No. 232843 (May 24, 2017).

Offering fraud: SEC v. Guzman, Civil Action No. 3;17-cv-00276 (W.D.N.C. Filed May 24, 2017) names as a defendant Gustavo Guzman. The complaint alleges that over a five year period beginning in April 2010 Mr. Guzman raised over $2.1 million from investors who were told their funds would be placed in an equity options fund and real estate fund he managed. Instead much of the investor money was misappropriated, lost in risky trading and used to repay other investors. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), (2) and (4). The case is pending. See Lit. Rel. No. 235842 (May 24, 2017).

Fraudulent accounts: SEC v. Ponn, Civil Action No. 16-cv-10624 (D. Mass) is a previously filed action against Nathanial Ponn. The complaint alleged that Mr. Ponn repeatedly opened brokerage accounts with bogus bank transfers from 2007 to 2014 and then purchased stocks, defrauding the brokers. In a parallel criminal case he was sentenced to 15 months in prison and ordered to pay over $20,000 in restitution to three brokerage firms. In the Commission’s action the Court entered a final judgment permanently enjoining the Defendant from future violations of Exchange Act Section 10(b). A conduct based injunction was also entered, directing that in the future he furnish any broker when opening an account a copy of the Commission’s complaint in this case. See Lit. Rel. No. 23840 (May 24, 2017).

Unprofessional conduct: In the Matter of Lisa Hanmer, CPA, Adm. Proc. File No. 3-17997 (May 23, 2017); In the Matter of Daniel Millmann, CPA, Adm. Proc. File No. 3-17996 (May 23, 2017). Mr. Millmann and Ms. Hanmer are, respectively, the engagement partner and engagement manager on the audit of Madison Capital Energy Income Fund I LP conducted by PCAOB registered audit firm RSM US LLP for 2011. The Order as to Mr. Millmann alleges, essentially, an audit failure in which Respondent failed to plan, assess the risk and conduct the proper field work during the engagement. Indeed, Mr. Millmann had never worked on the audit of oil and gas properties. Ms. Hanmer knew that adequate procedures had not been performed in auditing the fair value of the investment of the Fund in the underlying royalty interests. She tried to conceal that fact, according to the Orders. The Order as to each Respondent alleges unprofessional conduct within the meaning of Rule 102(e). The proceeding will be set for hearing as to Ms. Hanmer. Mr. Millmann resolved the proceeding in which he is named as a Respondent. He is denied the privilege of appearing or practicing before the Commission as an accountant with a right to request reinstatement after two years.

Offering fraud: SEC v. Murakami, Civil Action No. 1:17-cv-10928 (D. Mass. Filed May 22, 2017) is an action which names as defendants Yasuna Murakami, Avi Chiat, MC2 Capital Management, LLC and MC2 Canada Capital Management, LLC. The individual defendants are portfolio managers for the entity defendants. Beginning in 2007, and continuing until 2016, about 50 investors entrusted $15 million to defendants based on misleading statements regarding the performance of the two funds and the risks of the investment programs. During the period about $8 million of the investor funds was diverted to personal use while another $1.3 million was used to repay investors. The Commission’s complaint alleges violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Advisers Act Sections 206(1), 206(2) and 206(4). The action is pending. A parallel criminal action brought by the U.S. Attorney’s Office for the District of Massachusetts changes Mr. Murakami with one count of wire fraud. See Lit. Rel. No. 23837 (May 22, 2017).

Manipulation: SEC v. Murray, Civil Action No. 1:17-cv-03788 (S.D.N.Y. Filed May 19, 2017). Mr. Murray is a Virginia based mechanical engineer. In November 2016 he took a series of steps to prepare for, implement and execute a fake tender-offer for Fitbit shares using fake news. Essentially he pulled the name of an executive from the internet, falsified an application for EDGAR credentials and then filed a false form which claimed a tender offer was being made for Fitbit. The share price spiked over 350%. Mr. Murray, who had purchased options on the stock, realized profits of $3,118. The company later issued a press release denying that there was any tender offer. The fake news caused real harm to the capital markets. Over 25 million shares of Fitbit were traded, up 77% over the prior day. Investors purchasing shares following the announcement paid an artificial price. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 14(e). The Commission’s case, as well as that of the U.S. Attorney’s Office, is pending. See Lit. Rel. No. 23836 (May 19, 2017).

Insider trading: SEC v. Cooperman, Civil Action No. 2:16-cv-05043(E.D. Pa. ). Hedge fund manager Leon Cooperman and his firm settled insider trading charges with the Commission. Under the terms of the settlement Mr. Cooperman consented, without admitting or denying, to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b), 13(d) and 16(a). His firm, Omega Advisors, Inc., consented on the same basis to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). The Defendants also agreed to pay, on a joint and several basis, disgorgement of $1,759,049 and prejudgment interest as well as a penalty equal to the amount of the disgorgement. Mr. Cooperman will pay an additional penalty of $1 million tied to the 16(a) charges. Under the terms of the settlement Omega will retain a Compliance Consultant for a term that will extend to May 1, 2022 or the point in time when firm is no longer a registered investment adviser. The Compliance Consultant, Omega and Mr. Cooperman will "implement a system that requires that Defendant, Omega and/or any of their agents . . . who make a decision to trade or otherwise commit capital to a security and/or direct a trade of any security . . .[to] certify in writing that, prior to execution of such trade, the Trader was not aware of any material nonpublic information . . ." Monthly certifications will also be submitted to the staff by the Defendants stating that they were not aware of any inside information. The Compliance Consultant will, in addition, review the training, policies and procedures and practices of the firm and Mr. Cooperman with respect to compliance and formulate recommendations for policies and procedures for Omega which will be adopted. A written report will be submitted to Omega, Mr. Cooperman and the Commission staff. The Compliance Consultant will also retain a nationally recognized law firm to conduct at least two trainings per year. The filing of Section 16(a) reports will be outsourced to a law firm not unacceptable to the Commission staff. The case centered on trading in the securities of Atlas Pipeline Partners, L.P. by defendant Omega Advisors, a registered investment adviser controlled by Mr. Cooperman, according to the Commission’s complaint. Mr. Cooperman, who held a substantial stake in the firm, was alleged to have traded prior to the deal announcement but after talking to insiders. Violations of Exchange Act Sections 10(b), 13(d) and 16(a) were alleged in the complaint.

Offering fraud: SEC v. Bryant, Civil Action No. 4:17-cv-00336 (E.D. TX. Filed under seal May 15, 2017). Defendant Thurman Bryant formed Bryant United Capital Funding, Inc., also a defendant, in June 2011. Mr. Bryant is the firm’s only employee. He began fund raising money in early 2011 before forming his firm, soliciting his father, family and friends. Marketing was by word of mouth. Investors were told orally about the investment, assured of its safety and the manner in which their funds were invested. Mr. Bryant told investors that their funds would be used to facilitate the funding of mortgage loans which would immediately be sold to third parties for a fix fee. Investor funds would be held safe in a secure escrow account and used solely to secure a line of credit from a hedge fund that Bryant United used to fund the mortgages. Investors would receive 30% distributions with no risk. To date about 100 investors have purchased interests, investing about $22.7 million with Mr. Bryant and his firm. Indeed, about $1.4 million has been raised since January 2017. Defendants’ representations, as well as the account statements investors received, were, however, false. There were no investments; all the money was diverted either to the defendants or others. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The court entered a temporary freeze order and appointed a receiver at the request of the Commission. See Lit. Rel. No. 23838 (May 22, 2017).

FCPA –Anti-Corruption

Remarks: Acting Principal Deputy Asst. A.G. Trevor N. McFadden addressed the ACI’s 7th Brazil Summit on Anti-Corruption, Sao Paulo, Brazil (May 24, 2017). In his remarks Mr. McFadden reiterated the Department’s emphasis on individual accountability; noted the increase in international cooperation as resulting in more international actions; discussed alternative charges when the FCPA may not be applicable; and stated that the Criminal Division has initiated a Kleptocracy Asset Recovery Initiative which is specifically designed to target and recover the proceeds of foreign official corruption that have been laundered through the U.S. (here).

Criminal Cases

Investment fund fraud: U.S. v. Lazar, Case No. 1:09-cr-175 (E.D. Va. Filed May 22, 2017) is an action in which Angelina Lazar pleaded guilty to her role in an investment fund fraud scheme centered on foreign exchange currency. Ms. Lazar, a Canadian citizen, engaged in a scheme using her firm, Charismatic Exchange, Inc., in which she solicited investors from May 2005 through February 2007 to invest in foreign exchange currency funds she managed. Ms. Lazar claimed to have special software which would yield monthly returns of 20% or more for investors. In fact there was no software and no trades. Investors lost at least $20,000. Following her plea Ms. Lazar was immediately deported.

Securities fraud: U.S. v. Jaclin, Case No. 3:17-cr-00281 (N.D. CA. Filed May 19, 2017). Attorney Gregg Jaclin was charged with conspiracy, securities fraud, making false filings with the SEC, concealing material facts from a government agency, making false statements and obstruction of justice. The charging papers alleged that since at least March 2008 Mr. Jaclin participated in creating shell companies that engaged in reverse mergers to go public. The firms were shams. The fraud was facilitated by filings made with the SEC. The filings contained false representations about the firms, their CEOs and shareholders. See also SEC v. Husain, Civil Action No. 2:16-cv-03250 (C.D. Cal.)(parallel action which is pending); Lit. Rel. No. 23839 (May 24, 2017).


Overcharges: The Australian Securities Investment Commission or ASIC provided an update on its October 2016 action under which certain banks and financial advisers agreed to make refunds to investors. Specifically, the regulator found that certain banks had charged about 27,000 customers about $23.7 million for advice which was never provided. That amount has been paid. Since the time of that report it has been determined that an additional $37 million was charged to 18,000 for advice not provided. That sum has been repaid. At this point it is estimated at an additional $204 million plus interest needs to be refunded. The ASIC has published a table of the institutions involved along with the amounts paid and to be paid (here)

May 26, 2017
The Monitoring Role of the Media: Evidence from Earnings Management
by Yangyang Chen, C.S. Agnes Cheng, Shuo Li and Jingran Zhao

The news media are an important source of information for the U.S. capital markets, especially when drawing attention to questionable behavior of corporate executives. Coverage can, however, pressure companies into making dubious financial decisions like emphasizing short-term earnings over long-term value. In our recent article, we explore the effect of media coverage on earnings management to shed light on the media’s role in the U.S. capital markets.

Earnings management is the use of accounting techniques to produce financial reports that misstate a firm’s business performance and financial position. There are two main mechanisms through which managers manipulate earnings: accrual-based and real earnings management. Accrual-based earnings management is conducted through changing the accounting methods or estimates used when presenting a given transaction in the financial statements. Because accrual-based earnings management makes firm financial reporting more opaque and less reliable, it increases the risk that the market will receive false information.

Real earnings management refers to managers’ use of business practices to manipulate earnings. It can include an opportunistic reduction of discretionary spending (e.g., research and development, advertising, and maintenance), delay in starting a new project, overproduction, and acceleration of sales. Because real earnings management changes firm operations, its negative effect on long-term firm value is even more severe than that of accrual-based earnings management.

Managers are agents of shareholders (they manage the firm for shareholders in exchange for compensation), so they have incentives to manipulate earnings for their own benefit. Managers may, for example, manipulate earnings higher to inflate stock prices and increase the value of their stock and option compensation. However, such manipulation usually comes at the expense of long-term firm value and thus hurts shareholders. For example, earnings management could reduce the quality of firm financial disclosure, which increases a firm’s cost of issuing external capital. Because earnings management is common and skews the information the markets receive, it is important to examine whether the media play a role in earnings management.

On the one hand, the media may serve as an external monitor of managerial opportunism, which would reduce earnings management. If managers manipulate earnings, they risk having their activities detected and disclosed by the media, resulting in negative consequences such as lower stock prices and increased litigation risk. Anticipating this, managers may engage in less opportunistic earnings management activities.

On the other hand, the media may impose short-term performance pressure on managers, leading them to manipulate earnings. A news release announcing bad earnings could send a company’s stock price plummeting. Considering this, managers may have extra incentives to manipulate earnings when media coverage is high. Therefore, whether media coverage curbs or amplifies firm earnings management is an empirical question.

To answer it, we count the number of news articles about a given firm each year. We then examine whether firms with high media coverage engage in more or less earnings management. Using a large sample of U.S. public firms for the period 2000-2014, we find strong evidence that media coverage reduces both accrual-based and real earnings management. The findings are consistent with the argument that the media serve as an external monitor to reduce managerial opportunism in earnings management.

Further, we find that earnings-related news coverage is more effective at curbing accrual-based earnings management, and product and service-related news coverage is more effective at curbing real earnings management. This suggests that news articles with different focuses have monitoring effects on different aspects of firm operation. We also find that the effect of media coverage on earnings management is more pronounced for firms with lower audit quality or weaker internal corporate governance. These findings suggest that the media’s role as an external monitor is strengthened when other monitoring mechanisms fail, implying that the media can to an extent substitute for weak corporate governance.

Our article adds new empirical evidence to the debate about the role of the media in the U.S. capital markets. We show that media coverage has real consequences for the market by curbing managers’ earnings management. Our article also suggests that the media in general serve as an external monitor on managers and make financial reporting more transparent.

This post comes to us from Yangyang Chen, C.S. Agnes Cheng, and Jingran Zhao, who are professors at Hong Kong Polytechnic University, and Shuo Li, who is a PhD candidate at the university. It is based on their recent paper, "The Monitoring Role of the Media: Evidence from Earnings Management," available here.

View today's posts

5/26/2017 posts

The Harvard Law School Forum on Corporate Governance and Financial Regulation: Bank Governance and Systemic Stability: The “Golden Share” Approach
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Financial Scholars Oppose Eliminating "Orderly Liquidation Authority"; As Crisis-Avoidance Restructuring Backstop
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Snap and the Rise of No-Vote Common Shares
Conglomerate: AALS BA Call for Papers
SEC Actions Blog: This Week In Securities Litigation (Week ending May 26, 2017)
CLS Blue Sky Blog: The Monitoring Role of the Media: Evidence from Earnings Management

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.