Posted by Bill Sjostrom on April 25, 2006
SEC Chairman Christopher Cox will be testifying this morning before the Senate Committee on Banking, Housing, and Urban Affairs. The hearing is titled “A Review of Current Securities Issues” and starts at 10:00 a.m. EST. Click here for the live Webcast. I wonder if they’ll ask him about the SEC’s internal controls problems?
Update:Â CFO.com has some highlights from the testimony here.
Posted in politics, securities regulation | Comments Off
Posted by Thom Lambert on April 24, 2006
Today’s Heard on the Street column in the W$J reports that utilities are moving away from low-sulfur coal in favor of the dirtier, high-sulfur variety. This might seem odd, given that the Clean Air Act operates on sort of a “ratchet” principle — i.e., when air quality improves, degradation is generally forbidden. One might expect that, absent some change in relative prices, the trend would always be toward cleaner-burning fuels.
Ah, but that hypothesis disregards the fact that the Clean Air Act is a command-and-control statute drafted by legislators with lots of special interests to satisfy. One of those special interests was the eastern (dirty) coal lobby, which went to great lengths to ensure that the Act was drafted in a manner that would not encourage switching to cleaner burning, low-sulfur coal mined out west.
Bruce Ackerman and William Hassler documented eastern coal’s rent-seeking in their book Clean Coal, Dirty Air (wonderfully subtitled, How the Clean Air Act Became a Multibillion-Dollar Bail-Out for High-Sulfur Coal Producers and What Should Be Done About It). Jonathan Adler summarizes the story as follows:
Under the 1970 Clean Air Act, the EPA established a policy whereby all coal plants were required to meet an emission standard for sulfur dioxide. The original standard of 1.2 pounds of sulfur dioxide (SO2) per million BTUs (British Thermal Units) of coal could be met in a variety of ways.
Despite its apparent flexibility, the regulation had disparate regional effects. Most of the coal in the eastern United States is relatively “dirty” due to its high sulfur content. Western coal, on the other hand, is cleaner. By using western coal, utilities and other coal-burning facilities complied with the federal standard without installing costly scrubbers. Scrubbers were so expensive that many midwestern firms found that it was cheaper to haul low-sulfur coal from the West than to use closer, “dirtier” deposits.
When the Clean Air Act was revised in 1977, eastern coal producers got even. As Bruce Ackerman and William Hassler note in Clean Coal, Dirty Air, eastern producers of high-sulfur coal elected “to abandon their campaign to weaken pollution standards and take up the cudgels for the costliest possible clean-air solution—universal scrubbing.”
The amendments required coal plants to meet both an emission standard and a technology standard. In particular, the law contained “new-source performance standards” (NSPS) that forced facilities to attain a “percentage reduction in emissions.” In other words, no matter how clean the coal was, any new facility would still be required to install scrubbers. This destroyed low-sulfur coal’s comparative advantage. Since all new facilities had to invest in scrubbers, there was no longer a need to transport low-sulfur coal from the West to meet the SO2 emission standard—the cheaper, high-sulfur coal from the East would suffice.
Looks like the rent-seekers got what they were looking for. As Duke Energy Corp.’s vice-president of commercial fuels explained to the Journal, “We’re spending almost $4 billion as a company on various environmental plans, mostly for scrubbers, in the last few years, so we might as well go for” high-sulfur coal. This may be good for the high-sulfur coal industry, but it means we consumers are paying more for electricity than we would have paid had Congress permitted utilities to decide for themselves how to achieve air quality goals.
Posted in environment, regulation | 2 Comments »
Posted by Bill Sjostrom on April 24, 2006
Under SEC rules, a public company is required to start expensing options commencing with its quarter one 10-Q for its fiscal year beginning after June 15, 2005. This means the time has arrived for public companies with calendar year-ends, and as a result, this month many companies have reported or will be reporting for the first time numbers that reflect option expensing. In a January post on the subject (here, and discussed by Geoff here), Rich Booth noted as follows:
In the end, it might not matter whether a company treats the grant of options as an expense. Studies show that a company’s choice of accounting convention makes no difference as to stock price. As it is, analysts can translate earnings into cash flow, while CFOs can explain away the aberrant effects of accounting rules by calculating pro forma earnings.
Based on this article in today’s W$J, however, this may not be true with respect to option expensing, at least in the short term. According to the article: Read the rest of this entry »
Posted in disclosure regulation | 2 Comments »
Posted by Bill Sjostrom on April 23, 2006
Many of the papers for the upcoming Bloggership conference are available on SSRN here. I’ve skimmed a number of them. One paper in particular I want to talk about is Eric Goldman’s paper “Co-Blogging Law.� Here’s the abstract:
Bloggers frequently combine their efforts through joint blogging and guest blogging arrangements. These combinations may be informal from a social networks perspective, but they can have significant and unexpected legal consequences. This Essay looks at some of the ownership and liability consequences of co-blogging and guest blogging. To do so, the Essay will consider different possible legal characterizations of co-blogging, such as partnership, employment and joint ownership. The Essay concludes with some recommendations to minimize the implications of unexpected legal characterizations, including encouraging bloggers to make private agreements, educating bloggers about their choices, and exercising judicial restraint.
In light of the various liability and ownership issues, the article recommends that co-bloggers either form a limited liability entity or execute a co-blogger agreement. The article does not, however, say which is the best overall option, but I will. In my opinion (and this is not legal advice as the best option for you would depend on your specific facts and circumstances), if your group blog does not sell ads, have a tip jar or otherwise generate revenues, the way to go is a co-blogger agreement. The agreement can fully deal with all the IP ownership issues, allocate liability risk, and preserve an argument that the bloggers are not partners (being classified as partners has adverse potential liability consequences) (see here for some more thoughts). Additionally, as Eric mentions and Eugene Volkh points out in this post, a blogger’s homeowner’s insurance policy may provide protection for some blog related claims.
From a vicarious liability protection standpoint, a limited liability entity is superior but forming and maintaining one means filing fees, franchise taxes, agent for service of process fees, tax filings, etc. Hence, it comes down to whether the benefit of the liability shield afforded by a limited liability entity outweighs these costs (note also that another cost may be taking your homeowner’s policy out of the picture). In my mind the benefits do not outweigh the costs at least until your blog starts generating revenues. Once the blog starts generating revenues, especially if shared among the bloggers, it is advisable to go with a limited liability entity (probably an LLC) becauses otherwise the blog will likely be considered a partnership. Thus, Eric is correct in advising that “[b]loggers should think carefully before generating revenues from the blog.� But clearly there is a tipping point. At some level of expected revenue, it makes sense to form an LLC and go commercial.
As Eric points out, “[e]ven though there are disadvantages both to forming a limited liability entity or to structuring a co-blogger agreement, co-bloggers make a significant mistake by choosing to do neither.” I agree, so maybe I’ll get around to doing a co-blogger agreement for this blog some time soon.
Posted in blogging, legal scholarship | 1 Comment »
Posted by Josh Wright on April 22, 2006
My colleague David Bernstein at VC points out this article in Inside Higher Ed by Doug Lederman discussing the American Law Deans Association’s criticisms of the ABA’s imposition of requirements that go well beyond “assuring the quality of legal education.” Here’s David’s take:
I can certainly see the case for law schools choosing to give these faculty members tenure (assuming tenure is a good idea to begin with, which I’m not sure is true), but I don’t see any reason why the ABA should be requiring every law school in the country to do so. Indeed, the real reason is likely (a) heavy lobbying from groups representing librarians, writing instructors, and clinical faculty; and (b) the ABA’s general indifference to the costs it imposes on legal education. Actually, from the ABA’s perspective, the more legal education costs, the better, because that way the cost of law school serves as a greater barrier to entry. There’s no reason the Department of Education, which is deciding whether to continue using the ABA as the accrediting body for law schools for federal purposes, should endorse the ABA’s rules. For that matter, there is no reason the ABA should be mandating how many classes are taught by full-time faculty as opposed to adjuncts, nor restricting the number of hours faculty may be required to teach.
This sounds spot on. The problem is not an institution determining on its own to give librarians and other employees tenure, but the ABA using its accreditation power to mandate such contracts. David’s concerns are echoed by the comments offered by the ALDA (linked above):
Professional organizations can be expected to advocate job security for its members. And it is certainly within the discretion of a law school to decide whether to adopt such a policy. But it should not be within the realm of an accrediting organization, certainly not one bearing the imprimatur of the Secretary of Education, to translate advocacy for specific economic terms into prescribed conduct. This is an abuse of the power that the accrediting agency has secured by means of its governmental recognition.
We believe that in exercising its authority as an accrediting body recognized by the Secretary, the ABA has an obligation to focus its attention on those elements of institutional performance that relate to the quality of education provided its students. When it dictates terms and conditions of employment, the accrediting body inappropriately inserts itself into the internal affairs of the institutions it accredits and does so in a way that forces homogeneity, and conversely stifles innovation and diversity, among law schools.
It is worth pointing out, as Geoff did in his earlier post on the ALDA’s comments, that this debate is not really over tenure standards (though that debate may be one worth having). ALDA explicitly distinguishes between objecting to tenure and tenure-like standards per se and the imposition of such requirements by the ABA:
Many [law schools have] also chosen to establish “tenure-like� models that provide for assured employment for a term of years. However, these are domestic decisions made through the established processes of the institution, not models imposed upon them as a condition of acceptance among the brethren of ABA-accredited law schools.
So, why then all the fuss over ALDA’s comments? Geoff addressed this question in his prior post as well. His answer:
The fight isn’t over the practice of tenure; rather the fight is over the relative power of the ABA and its member schools. The ABA is reliably lefty and unashamedly so (only an institution with no shame could adopt this scheme). The named signatories to the ALDA comment are Saul Levmore, David Van Zandt, Katharine Bartlett and Jim Huffman. They are, as a group at least, far less reliably left wing. If memory serves, the ALDA was founded for the very purpose of opposing the ABA’s non-qualitative accreditation standards (stuff like tenure for clinical faculties, minimum salary requirements, faculties’ racial composition, etc.). The ALDA is here challenging the imposition of ideology masquerading as qualitative standard-setting.
Do check out David’s post and Lederman’s article (both linked above).
Posted in contracts, law school, universities | Comments Off
Posted by Bill Sjostrom on April 21, 2006
Following up on this post, a new paper entitled “The Dating Game: Do Managers Designate Option Grant Dates to Increase Their Compensation?� was recently posted on SSRN (click here). The paper was co-authored by two U. of Michigan Finance professors, M.P. Narayanan and Hasan Nejat Seyhan. Here’s the abstract:
We provide evidence of a dating game that entails picking a grant date ex-post, i.e., after the board’s compensation decision is made. We suggest two variants of the dating game. Back-dating (picking a date in the past with a lower stock price compared to board decision date) if the stock price has been rising prior to the board date, and forward-dating (waiting after the board decision date to observe the stock price behavior) if the stock price has been falling prior to the board date. Using a database of 638, 757, option grant filings by insiders between August 29, 2002, and December 31, 2004 we find evidence consistent with both types of dating games. Specifically, we find stock price behavior around the grant date to be positively related to reporting lag, consistent with back-dating. In the promptly reported sample, we find stock return behavior around the grant date and the pattern of reporting lags consistent with forward-dating. Our calculations show that managers can obtain economically significant benefits by playing the dating game.
Posted in option timing scandal, scholarship | Comments Off
Posted by Bobby Bartlett on April 21, 2006
The momentum seems to be building among legal academics that the SEC may lack the authority to exempt small companies from SOX 404 compliance. As many may recall, Bill previously analyzed this issue in the inagural post of this blog and concluded that the SEC most likely did not have the requisite statutory authority (he provided a follow-up analysis here).  Larry Ribstein shares this sentiment.  Apparently, they are not alone. Â
Yesterday, the SEC Advisory Committee on Smaller Public Companies concluded its deliberations and approved a draft Final Report to be submitted to the SEC next week. The Final Report continues to recommend exemptive relief from Section 404 for certain small-cap and micro-cap issuers. However, I found interesting a revision from the prior draft in the discussion concerning the SEC’s authority to promulgate an exemption.  Specifically, footnote 110 notes that “a different view as to the Commission’s authority under Section 36(a) was expressed in a letter from Professor James D. Cox and 19 other law professors, although the professors acknowledged that ‘[s]pecific disclosure requirements tailored to the unique risks and likely regulatory benefits of smaller public companies are entirely appropriate and consistent with the rulemaking authority the Commission enjoys under Section 3(a) of the Sarbanes-Oxley Act.’” Sadly, the letter doesn’t cite Bill’s analysis, but it is still worth a read. It can be found on the SEC website (see here).  Â
Posted in sarbanes-oxley | Comments Off
Posted by Josh Wright on April 21, 2006
The Federal Communications Commission has announced that it is stepping up efforts in its investigation of payola practices at four radio conglomerates: Clear Channel, CBS Radio, Entercom, and Citadel, and has issued former letters of inquiry. Bill pointed me to an article in the LA Times which reports that settlement talks with the four radio firms broke down recently:
“The four broadcasters have been negotiating with the FCC for weeks to forestall a federal inquiry by offering to discontinue certain practices and pay limited fines. But those talks stalled last month over the issue of how much the broadcasters should pay. Clear Channel proposed a fine of about $1 million, according to people with knowledge of the negotiations. Some commissioners were pushing for as much as $10 million, those sources said. ‘We were in the process of trying to reach settlements, but when talks were inconclusive, we decided we needed more information,’ said an FCC official who spoke on the condition of anonymity because the investigation was continuing. ‘We will continue to speak with the parties and to hold those who have violated commission rules accountable.’”
The FCC could issue sanctions ranging anywhere from fines to a revocation of licenses. This is in addition to the penalties imposed by settlements with Eliot Spitzer and the NY Attorney General’s office pursuant to its own ongoing payola investigation which has already extracted significant penalties from Sony BMG and Warner. $10 million strikes me as a pretty hefty fine for violating a statute that has seen haphazard enforcement for the past several decades. The magnitude of the fine, along with those already paid in the Spitzer settlements ($10 and $5 million), leads me to wonder whether the magnitude of the sanction is appropriately proportional to the harm at issue?
I have opined elsewhere that I believe payola is likely to help rather than harm consumers (see e.g., here and here), so perhaps I have already tipped my hand. But my conclusion is consistent with evidence presented by Coase in his seminal payola analysis, as well as more recent history, that the industry has consistently failed to coordinate a “no payola” agreement, though not for lack of effort. In that sense, a fine of this magnitude seems unreasonably large relative to the alleged harm.
A useful benchmark might be fines for other forms of business conduct challenged on the grounds that the conduct harms consumers, i.e. price fixing conspiracies. Unlike payola, however, there exists strong theoretical and empirical support for the proposition that price fixing actually harms consumers. There have been only 51 Sherman Act fines greater than $10 million, most associated with international price fixing conspiracies (the largest is a whopping $500 million). The average fine imposed in the 324 price fixing cases brought by the DOJ from 1990-99 was just under $5 million. Does it make sense that sanctions for payola statute violations are greater than or equal to the penalties imposed on the average international cartel? I say no. Your thoughts?
Posted in business, contracts, regulation | 4 Comments »
Posted by Bill Sjostrom on April 20, 2006
Option backdating was on page one of the W$J again yesterday (here). The story was spurred by comments made by UnitedHealth’s CEO, William W. McGuire, during UnitedHealth’s First Quarter 2006 Results Teleconference on Tuesday. UnitedHealth’s option grants to Dr. McGuire were among those cited as suspicious by a March 18 page one W$J (article here; earlier blog post here).
The Journal’s analysis raises questions about one of the most lucrative stock-option grants ever. On Oct. 13, 1999, William W. McGuire, CEO of giant insurer UnitedHealth Group Inc., got an enormous grant in three parts that — after adjustment for later stock splits — came to 14.6 million options. So far, he has exercised about 5% of them, for a profit of about $39 million. As of late February he had 13.87 million unexercised options left from the October 1999 tranche. His profit on those, if he exercised them today, would be about $717 million more.
The 1999 grant was dated the very day UnitedHealth stock hit its low for the year. Grants to Dr. McGuire in 1997 and 2000 were also dated on the day with those years’ single lowest closing price. A grant in 2001 came near the bottom of a sharp stock dip. In all, the odds of such a favorable pattern occurring by chance would be one in 200 million or greater. Odds such as those are “astronomical,” said David Yermack, an associate professor of finance at New York University, who reviewed the Journal’s methodology and has studied options-timing issues.
Dr. McGuire addressed the issue during Tuesday’s teleconference (click here for the transcript). Among other things, he recommended that that UnitedHealth: Read the rest of this entry »
Posted in 10b-5, disclosure regulation, option timing scandal, securities litigation, securities regulation | 2 Comments »
Posted by Geoffrey Manne on April 19, 2006
My co-author, Marc Williamson, just alterted me to this section in the recently-published FTC/DOJ Merger Guidelines Commentary (.pdf):
Industry Usage of the Word “Market� Is Not Controlling
Relevant market definition is, in the antitrust context, a technical exercise involving analysis of customer substitution in response to price increases; the “markets� resulting from this definition process are specifically designed to analyze market power issues. References to a “market� in business documents may provide important insights into the identity of firms, products, or regions that key industry participants consider to be sources of rivalry, which in turn may be highly probative evidence upon which to define the “relevant market� for antitrust purposes. The Agencies are careful, however, not to assume that a “market� identified for business purposes is the same as a relevant market defined in the context of a merger analysis. When businesses and their customers use the word “market,� they generally are not referring to a product or geographic market in the precise sense used in the Guidelines, although what they term a “market� may be congruent with a Guidelines’ market.
* * *
It is unremarkable that “markets� in common business usage do not always coincide with “markets� in an antitrust context, inasmuch as the terms are used for different purposes. The description of an “antitrust market� sometimes requires several qualifying words and as such does not reflect common business usage of the word “market.� Antitrust markets are entirely appropriate to the extent that they realistically describe the range of products and geographic areas within which a hypothetical monopolist would raise price significantly and in which a merger’s likely competitive effects would be felt.
In our article, Hot Docs. vs. Cold Economics, 47 Ariz. L. Rev. 609, we take the agencies (and courts) to task for conflating the different uses of the term. Along the way we write:
To be sure, business documents can be appropriately useful to regulators in certain areas of inquiry. Business documents may be useful in providing data for economic analysis, and business documents also serve to provide a basic picture of the industry under scrutiny.
* * *
In part our criticism is simply that there is a semantic disconnect that is often elided over. The business actor, who happens to use terms identical to those used to describe a legally relevant concept, is, in fact, describing something different. As we previously noted, the word “market” is employed to mean many different things. Likewise, the term “profit” has different meanings in different contexts. It is no more appropriate to ascribe to a word a distinct meaning not intended in the context than it is to ascribe to a word another word’s meaning.
* * *
In the end, it’s both unremarkable and irrelevant that business people say these things.
Uncanny similarities, no? Of course we disagree that the enforcement agencies are, in fact, careful not to equate the two uses of the term, but as far as I know this is the first time they have seen fit to actually disclaim the practice. Coincidence? I think not.
Posted in antitrust, federal trade commission, legal scholarship | 1 Comment »
