Archives For disclosure

A Set-top Box Set-Back and an Opportunity for Good Government

Geoffrey Manne & Kristian Stout —  29 September 2016

There must have been a great gnashing of teeth in Chairman Wheeler’s office this morning as the FCC announced that it was pulling the Chairman’s latest modifications to the set-top box proposal from its voting agenda. This is surely but a bump in the road for the Chairman; he will undoubtedly press ever onward in his quest to “fix” a market that is flooded with competition and consumer choice. But, as we stop to take a breath for a moment while this latest FCC adventure is temporarily paused, there is a larger issue worth considering: the lack of transparency at the FCC.

Although the Commission has an unfortunate tradition of non-disclosure surrounding many of its regulatory proposals, the problem has seemingly been exacerbated by Chairman Wheeler’s aggressive agenda and his intransigence in the face of overwhelming and rigorous criticism.

Perhaps nowhere was this attitude more apparent than with his handling of the Open Internet Order, which was plagued with enough process problems to elicit a call for a delay of the Commission’s vote on the initial rules from Democratic Commissioner Rosenworcel, and a strong rebuke from the Chairman of the House Oversight Committee prior to the Commission’s vote on the final rules (which were not disclosed to the public until after the vote).

But the same cavalier dismissal of public and stakeholder input has plagued the Chairman’s beleaguered set-top box proposal, as well.

As Commissioner Pai noted before Congress in March:

The FCC continues to choose opacity over transparency. The decisions we make impact hundreds of millions of Americans and thousands of small businesses. And yet to the public, to Congress, and even to the Commissioners at the FCC, the agency’s work remains a black box.

Take this simple proposition: The public should be able to see what we’re voting on before we vote on it. That’s how Congress works, as you know. Anyone can look up any pending bill right now by going to congress.gov. And that’s how many state commissions work too. But not the FCC.

Exhibit A in Commissioner Pai’s lament was the set-top box proceeding:

Instead, the public gets to see only what the Chairman’s Office deigns to release, so controversial policy proposals can be (and typically are) hidden in a wave of media adulation. That happened just last month when the agency proposed changes to its set-top-box rules but tried to mislead content producers and the public about whether set-top box manufacturers would be permitted to insert their own advertisements into programming streams.

Now, although the Chairman’s initial proposal was eventually released, we have only a fact sheet and an op-ed by Chairman Wheeler on which to judge the purportedly substantial changes embodied in his latest version.

Even Democrats in Congress have recognized the process problems that have plagued this proceeding. As Senator Feinstein (D-CA) urged in a recent letter to Chairman Wheeler:

Given the significance of this proceeding, I ask that you make public the new proposal under consideration by the Commission, so that all interested stakeholders, members of Congress, copyright experts, and others can comment on the potential copyright implications of the new proposal before the Commission votes on it.

And as Senator Heller (R-NV) wrote in a letter to Chairman Wheeler this week:

I believe it is unacceptable that the FCC has not released the text of this proposal before Thursday’s vote. A three-page fact sheet does not provide enough details for Congress to conduct proper oversight of this rulemaking that will significantly impact both consumers and industry…. I encourage you to release the text immediately so that the American public has a full understanding of what is being considered by the Commission….

Of course, this isn’t a new problem at the FCC. In fact, before he supported Chairman Wheeler’s efforts to impose Open Internet rules without sufficient public disclosure, then-Senator Obama decried then-Chairman Martin’s efforts to enact new media ownership rules with insufficient process in 2007:

Repealing the cross ownership rules and retaining the rest of our existing regulations is not a proposal that has been put out for public comment; the proper process for vetting it is not in closed door meetings with lobbyists or in selective leaks to the New York Times.

Although such a proposal may pass the muster of a federal court, Congress and the public have the right to review any specific proposal and decide whether or not it constitutes sound policy. And the Commission has the responsibility to defend any new proposal in public discourse and debate.

And although you won’t find them complaining this time (because this time they want the excessive intervention that the NPRM seems to contemplate), regulatory advocates lamented just exactly this sort of secrecy at the Commission when Chairman Genachowski proposed his media ownership rules in 2012. At that time Free Press angrily wrote:

[T]he Commission still has not made public its actual media ownership order…. Furthermore, it’s disingenuous for the FCC to suggest that its process now is more transparent than the one former Chairman Martin used to adopt similar rules. Genachowski’s FCC has yet to publish any details of its final proposal, offering only vague snippets in press releases… despite the president’s instruction to rulemaking agencies to conduct any significant business in open meetings with opportunities for members of the public to have their voices heard.

As Free Press noted, President Obama did indeed instruct “agencies to conduct any significant business in open meetings with opportunities for members of the public to have their voices heard.” In his Memorandum on Transparency and Open Government, his first executive action, the president urged that:

Public engagement enhances the Government’s effectiveness and improves the quality of its decisions. Knowledge is widely dispersed in society, and public officials benefit from having access to that dispersed knowledge. Executive departments and agencies should offer Americans increased opportunities to participate in policymaking and to provide their Government with the benefits of their collective expertise and information.

The resulting Open Government Directive calls on executive agencies to

take prompt steps to expand access to information by making it available online in open formats. With respect to information, the presumption shall be in favor of openness….

The FCC is not an “executive agency,” and so is not directly subject to the Directive. But the Chairman’s willingness to stray so far from basic principles of transparency is woefully inconsistent with the basic principles of good government and the ideals of heightened transparency claimed by this administration.

In Administrative Law, Copyright, Federal Communications Commission, Intellectual Property, Regulation, Regulatory Reform, Telecommunications, Truth on the Market , , , ,
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Innovation Death Panels and Other Economic Shortcomings of the White House Proposed Privacy Bill

Geoffrey Manne & Ben Sperry —  18 March 2015

In short, all of this hand-wringing over privacy is largely a tempest in a teapot — especially when one considers the extent to which the White House and other government bodies have studiously ignored the real threat: government misuse of data à la the NSA. It’s almost as if the White House is deliberately shifting the public’s gaze from the reality of extensive government spying by directing it toward a fantasy world of nefarious corporations abusing private information….

The White House’s proposed bill is emblematic of many government “fixes” to largely non-existent privacy issues, and it exhibits the same core defects that undermine both its claims and its proposed solutions. As a result, the proposed bill vastly overemphasizes regulation to the dangerous detriment of the innovative benefits of Big Data for consumers and society at large.

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In Amazon, Apple, Data Privacy & Security, Facebook, Federal Trade Commission, Google, Net Neutrality, Platforms, Regulation, Section 5, Securities, Telecommunications , , , , , , , , , , , ,
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Simplifying Small Firm Disclosure

Michael Sykuta —  14 March 2014

An occasional reader brought to our attention a bill that is fast making its way through the U.S. House Committee on Financial Services. The Small Company Disclosure Simplification Act (H.R. 4167) would exempt emerging growth companies and companies with annual gross revenue less than $250 million from using the eXtensible Business Reporting Language (XBRL) structure data format currently required for SEC filings. This would effect roughly 60% of publicly listed companies in the U.S.

XBRL makes it possible to easily extract financial data from electronic SEC filings using automated computer programs. Opponents of the bill (most of whom seem to make their living using XBRL to sell information to investors or assisting filing companies comply with the XBRL requirement) argue the bill will create a caste system of filers, harm the small companies the bill is intended to help, and harm investors (for example, see here and here). On pretty much every count, the critics are wrong. Here’s a point-by-point explanation of why:

1) Small firms will be hurt because they will have reduced access to capital markets because their data will be less accessible. — FALSE
The bill doesn’t prohibit small firms from using XBRL, it merely gives them the option to use it or not. If in fact small companies believe they are (or would be) disadvantaged in the market, they can continue filing just as they have been for at least the last two years. For critics to turn around and argue that small companies may choose to not use XBRL simply points out the fallacy of their claim that companies would be disadvantaged. The bill would basically give business owners and management the freedom to decide whether it is in fact in the company’s best interest to use the XBRL format. Therefore, there’s no reason to believe small firms will be hurt as claimed.

Moreover, the information disclosed by firms is no different under the bill–only the format in which it exists. There is no less information available to investors, it just makes it little less convenient to extract–particularly for the information service companies whose computer systems rely on XBRL to gather they data they sell to investors. More on this momentarily.

2) The costs of the current requirement are not as large as the bill’s sponsors claims.–IRRELEVANT AT BEST
According to XBRL US, an XBRL industry trade group, the cost of compliance ranges from $2,000 for small firms up to $25,000–per filing (or $8K to $100K per year). XBRL US goes on to claim those costs are coming down. Regardless whether the actual costs are the “tens of thousands of dollars a year” that bill sponsor Rep. Robert Hurt (VA-5) claims, the point is there are costs that are not clearly justified by any benefits of the disclosure format.

Moreover, if costs are coming down as claimed, then small businesses will be more likely to voluntarily use XBRL. In fact, the ability of small companies to choose NOT to file using XBRL will put competitive pressure on filing compliance companies to reduce costs even further in order to attract business, rather than enjoying a captive market of companies that have no choice.

3) Investors will be harmed because they will lose access to small company data.–FALSE
As noted above,investors will have no less information under the bill–they simply won’t be able to use automated programs to extract the information from the filings. Moreover, even if there was less information available, information asymmetry has long been a part of financial markets and markets are quite capable of dealing with such information asymmetry effectively in how prices are determined by investors and market-makers.  Paul Healy and Krishna Palepu (2001) provide an overview of the literature that shows markets are not only capable, but have an established history, of dealing with differences in information disclosure among firms. If any investors stand to lose, it would be current investors in small companies whose stocks could conceivably decrease in value if the companies choose not to use XBRL. Could. Conceivably. But with no evidence to suggest they would, much less that the effects would be large. To the extent large block holders and institutional investors perceive a potential negative effect, those investors also have the ability to influence management’s decision on whether to take advantage of the proposed exemption or to keep filing with the XBRL format.

The other potential investor harm critics point to with alarm is the prospect that small companies would be more likely and better able to engage in fraudulent reporting because regulators will not be able to as easily monitor the reports. Just one problem: the bill specifically requires the SEC to assess “the benefits to the Commission in terms of improved ability to monitor securities markets” of having the XBRL requirement. That will require the SEC to actively engage in monitoring both XBRL and non-XBRL filings in order to make that determination. So the threat of rampant fraud seems a tad bit overblown…certainly not what one critic described as “a massive regulatory loophole that a fraudulent company could drive an Enron-sized truck through.”

In the end, the bill before Congress would do nothing to change the kind of information that is made available to investors. It would create a more competitive market for companies who do choose to file using the XBRL structured data format, likely reducing the costs of that information format not only for small companies, but also for the larger companies that would still be required to use XBRL. By allowing smaller companies the freedom to choose what technical format to use in disclosing their data, the cost of compliance for all companies can be reduced. And that’s good for investors, capital formation, and the global competitiveness of US-based stock exchanges.

In Financial Regulation, Securities, Truth on the Market ,
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Contemplating Disclosure-Based Insider Trading Regulation

Thom Lambert —  15 June 2012

TOTM friend Stephen Bainbridge is editing a new book on insider trading.  He kindly invited me to contribute a chapter, which I’ve now posted to SSRN (download here).  In the chapter, I consider whether a disclosure-based approach might be the best way to regulate insider trading.

As law and economics scholars have long recognized, informed stock trading may create both harms and benefits to society.  With respect to harms, defenders of insider trading restrictions have maintained that informed stock trading is “unfair” to uninformed traders and causes social welfare losses by (1) encouraging deliberate mismanagement or disclosure delays aimed at generating trading profits; (2) infringing corporations’ informational property rights, thereby discouraging the production of valuable information; and (3) reducing trading efficiency by increasing the “bid-ask” spread demanded by stock specialists, who systematically lose on trades with insiders.

Proponents of insider trading liberalization have downplayed these harms.  With respect to the fairness argument, they contend that insider trading cannot be “unfair” to investors who know in advance that it might occur and nonetheless choose to trade.  And the purported efficiency losses occasioned by insider trading, liberalization proponents say, are overblown.  There is little actual evidence that insider trading reduces liquidity by discouraging individuals from investing in the stock market, and it might actually increase such liquidity by providing benefits to investors in equities.  With respect to the claim that insider trading creates incentives for delayed disclosures and value-reducing management decisions, advocates of deregulation claim that such mismanagement is unlikely for several reasons.  First, managers face reputational constraints that will discourage such misbehavior.  In addition, managers, who generally work in teams, cannot engage in value-destroying mismanagement without persuading their colleagues to go along with the strategy, which implies that any particular employee’s ability to engage in mismanagement will be constrained by her colleagues’ attempts to maximize firm value or to gain personally by exposing proposed mismanagement.  With respect to the property rights concern, deregulation proponents contend that, even if material nonpublic information is worthy of property protection, the property right need not be a non-transferable interest granted to the corporation; efficiency considerations may call for the right to be transferable and/or initially allocated to a different party (e.g., to insiders).  Finally, legalization proponents observe that there is little empirical evidence to support the concern that insider trading increases bid-ask spreads.

Turning to their affirmative case, proponents of insider trading legalization (beginning with Geoff’s dad, Henry Manne) have primarily emphasized two potential benefits of the practice.  First, they observe that insider trading increases stock market efficiency (i.e., the degree to which stock prices reflect true value), which in turn facilitates efficient resource allocation among capital providers and enhances managerial decision-making by reducing agency costs resulting from overvalued equity.  In addition, the right to engage in insider trading may constitute an efficient form of managerial compensation.

Not surprisingly, proponents of insider trading restrictions have taken issue with both of these purported benefits. With respect to the argument that insider trading leads to more efficient securities prices, ban proponents retort that trading by insiders conveys information only to the extent it is revealed, and even then the message it conveys is “noisy” or ambiguous, given that insiders may trade for a variety of reasons, many of which are unrelated to their possession of inside information.  Defenders of restrictions further maintain that insider trading is an inefficient, clumsy, and possibly perverse compensation mechanism.

The one thing that is clear in all this is that insider trading is a “mixed bag”  Sometimes such trading threatens to harm social welfare, as in SEC v. Texas Gulf Sulphur, where informed trading threatened to prevent a corporation from usurping a valuable opportunity.  But sometimes such trading creates net social benefits, as in Dirks v. SEC, where the trading revealed massive corporate fraud.

As regular TOTM readers will know, optimal regulation of “mixed bag” business practices (which are all over the place in the antitrust world) requires consideration of the costs of underdeterring “bad” conduct and of overdeterring “good” conduct.  Collectively, these constitute a rule’s “error costs.”  Policy makers should also consider the cost of administering the rule at issue; as they increase the complexity of the rule to reduce error costs, they may unwittingly drive up “decision costs” for adjudicators and business planners.  The goal of the policy maker addressing a mixed bag practice, then, should be to craft a rule that minimizes the sum of error and decision costs.

Adjudged under that criterion, the currently prevailing “fraud-based” rules on insider trading fail.  They are difficult to administer, and they occasion significant error cost by deterring many instances of socially desirable insider trading.  The more restrictive “equality of information-based” approach apparently favored by regulators fares even worse.  A contractarian, laissez-faire approach favored by many law and economics scholars would represent an improvement over the status quo, but that approach, too, may be suboptimal, for it does nothing to bolster the benefits or reduce the harms associated with insider trading.

My new book chapter proposes a disclosure-based approach that would help reduce the sum of error and decision costs resulting from insider trading and its regulation.  Under the proposed approach, authorized informed trading would be permitted as long as the trader first disclosed to a centralized, searchable database her insider status, the fact that she was trading on the basis of material, nonpublic in­formation, and the nature of her trade.  Such an approach would (1) enhance the market efficiency benefits of insider trading by facilitating “trade decod­ing,” while (2) reducing potential costs stemming from deliberate misman­agement, disclosure delays, and infringement of informational property rights.  By “accentuating the positive” and “eliminating the negative” conse­quences of informed trading, the proposed approach would perform better than the legal status quo and the leading proposed regulatory alternatives at minimizing the sum of error and decision costs resulting from insider trading restrictions.

Please download the paper and send me any thoughts.

In Amazon, Antitrust & Competition, Corporate & Securities Law, Error Costs, Financial Regulation, Platforms, Regulation, Securities , , , , ,
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Bainbridge on the SEC’s Conflict Minerals Disclosure Getting Business Roundtabled…

Josh Wright —  5 January 2012

As in, “If the SEC doesn’t pull up its socks and do a serious cost-benefit analysis, it may discover that Business Roundtable has become a verb. As in, the court Business Roundtabled yet another SEC rule.”

Here.

In Securities ,
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Crowdfunding

Larry Ribstein —  17 November 2011

Should you have to do a costly SEC registration and work through a registered broker-dealer just to raise a little money for your start-up? 

Today’s WSJ covers so-called “crowd-funding.” It tells of a guy who raised $41,000 from 17 investors.  The business has done well, but the website it used was ordered to stop doing this because it wasn’t a licensed broker-dealer.  

Supporters of a crowd-funding exemption are rallying near the SEC in Washington today (Occupy the SEC!).

The House has voted an exemption that would allow sales of up to $2 million in equity online to investors whose crowdfunding investments are up to $10,000 year or 10% of their annual income.  A Senate bill would limit these amounts to $1 million and $1,000.

Opponents of crowdfunding exemptions cite the potential for fraud.  But surely there’s a balance between fear of fraud and permitting what could be a significant jobs-generator.

For some academic coverage of crowd-funding see Heminway and Hoffman (arguing that “the offer and sale of crowdfunding interests under certain conditions should not require registration” and suggesting “principles, process, and substantive parameters of a possible solution in the form of a new registration exemption adopted by the SEC under Section 3(b) of the Securities Act”); Steve Bradford (proposing to exempt certain crowdfunding sites from federal regulatory requirements but not antifraud rules); and Hazen (reviewing proposed crowdfunding exemptions and arguing that “the proposals to date do not adequately justify an exemption”).

In Antitrust & Competition, Exemptions, Securities
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Illinois Corporate Colloquium: Choi on SEC backdating investigations

Larry Ribstein —  5 October 2011

Yesterday at the Illinois Corporate Colloquium Steve Choi presented his paper (with Pritchard and Weichman), Scandal Enforcement at the SEC: Salience and the Arc of the Option Backdating Investigations.  Here’s the abstract:

We study the impact of scandal-driven media scrutiny on the SEC’s allocation of enforcement resources. We focus on the SEC’s investigations of option backdating in the wake of numerous media articles on the practice of backdating. We find that as the level of media scrutiny of option backdating increased, the SEC shifted its mix of investigations significantly toward backdating investigations and away from investigations involving other accounting issues. We test the hypothesis that SEC pursued more marginal investigations into backdating as the media frenzy surrounding the practice persisted at the expense of pursuing more egregious accounting issues that did not involve backdating. Our event study of stock market reactions to the initial disclosure of backdating investigations shows that those reactions declined over our sample period. We also find that later backdating investigations are less likely to target individuals and less likely to accompanied by a parallel criminal investigation. Looking at the consequences of the SEC’s backdating investigations, later investigations were more likely to be terminated or produce no monetary penalties. We find that the magnitude of the option backdating accounting errors diminished over time relative to other accounting errors that attracted SEC investigations.

As readers of this blog, and Ideoblog before it, will appreciate, this paper particularly resonated with me.  As I wrote in a large number of posts (e.g.) backdating was a molehill the media blew up into a mountain.  Now come Choi et al with evidence that while the SEC was spending its scarce resources on this overblown molehill it was ignoring real mountains (e.g., Madoff).

I found the paper overall quite persuasive.  I wasn’t entirely convinced by the evidence that the backdating cases were getting weaker.  In particular, stock price reactions may just indicate the market was learning about the which companies were involved before the investigations were brought, and was gradually figuring out that backdating was not such a big deal.  But I was convinced of the evidence of the opportunity costs of the SEC’s backdating obsession — the otherwise inexplicable decline in investigations of serious non-backdating accounting problems.

As we discussed in the Colloquium, the paper reveals that there are agency costs not just in the backdating companies that were investigated but also in the agency that was doing the investigating.  Although it’s not clear exactly what moved the SEC to follow the media, there is at least some doubt about whether the SEC’s resource allocation decisions were in the public interest.

This calls attention to another set of agents — the ones in the media.  Why did the media love backdating so much?  As discussed in my Public Face of Scholarship, there are “demand” and “supply” explanations:  the public demands stories about cheating executives and/or journalists like to supply these stories.  David Baron, Persistent Media Bias, presents a supply theory emphasizing journalists’ anti-market bias.

Whatever the cause of media bias, when the media is influential its bias can result in bad public policy. SEC enforcement isn’t the only example. As I discuss in my article (at 1210-11, footnotes omitted):

Where interest groups are closely divided, the outcome of political battles may depend on how much voter support each side can enlist. This may depend on how journalists have portrayed the issue to the public. For example, the press is an important influence on corporate governance. One factor in the rapid passage of the Sarbanes-Oxley Act, the strongest federal financial regulation in seventy years, may have been the overwhelmingly negative coverage of business in the first half of 2002: seventy-seven percent of the 613 major network evening news stories on business concerned corporate scandals.

It’s not clear what can be done to better align SEC enforcement policy with the public interest.  Incentive compensation for SEC investigators?  Perhaps the only thing we can do (as with corporate crime) is to try to keep in mind when creating regulation that even if corporate agents may sometimes do the wrong thing, people don’t stop being people when they go to work for the government.

In Corporate & Securities Law, Securities , , , ,
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Can insider trading combat accounting fraud?

Larry Ribstein —  23 August 2011

Last year I suggested that regulators would better fight corporate fraud by letting those in the know trade on the information than through the complex whistleblowing rules like those in Dodd-Frank.

Robert Wagner has similar thoughts.  The article is  Gordon Gekko to the Rescue?: Insider Trading as a Tool to Combat Accounting Fraud.  Here’s the abstract:

This Article puts forward that, counter-intuitively, one way to help avoid future accounting scandals such as WorldCom would be the legalization of “fraud-inhibiting insider trading.” Fraud-inhibiting insider trading is the subcategory of insider trading where: (1) information is present that would have a price-decreasing effect on stock if made public; (2) the traded stock belongs to an individual who will likely suffer financial injury from a subsequent stock price reduction if the trading does not take place; (3) the individual on whose behalf the trading occurs would have the ability to prevent the release of the information or to release distorted information to the public; and (4) the individual in question did not commit any fraudulent activities prior to availing himself of the safe harbor. Arguing that prohibiting all insider trading incentivizes corporate fraud, this Article begins by giving examples from recent cases in which insider trading could have been used to avoid significant harm. Next, the Article briefly discusses both the history of insider trading and the philosophical and policy arguments against it. This Article particularly focuses on the two most prominent arguments raised against insider trading: (1) that it erodes confidence in the market; and (2) that it is similar to theft and should be prosecuted accordingly. Previously unexamined empirical evidence suggests that the confidence argument may be incorrect and does not suffice to justify a prohibition on fraud-inhibiting insider trading. This Article also shows that while the property rights rationale is the strongest position against general insider trading, it is an insufficient basis to outlaw fraud-inhibiting insider trading. The Article concludes with a proposal that the courts, the Securities and Exchange Commission, or Congress enact a safe harbor to legalize fraud-inhibiting insider trading and thus enable the insider trading laws to more effectively achieve their purported goal of protecting the securities market and investors.

In Securities ,
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Should the SEC regulate corporate political speech?

Larry Ribstein —  4 August 2011

Ten leading corporate and securities law professors have petitioned the SEC to develop rules to require companies to disclose their political spending.

This is the latest iteration of efforts to end-run Citizens United’s restrictions on regulating corporate campaign activities by calling it corporate governance regulation.  See my recent post on the Shareholder Protection Act.  I’ve written on these issues in my recently published The First Amendment and Corporate Governance.

The proposed regulation has a good chance of passing muster under the First Amendment because it would focus on disclosure rather than imposing substantive restrictions on corporate speech. Nevertheless, the First Amendment is still relevant.  I have already noted my view that the SEC’s proxy access rule (which is also basically a disclosure rule) avoided a confrontation with the First Amendment only because the DC Circuit could invalidate it on other grounds. At some point mandatory disclosure can sufficiently burden corporate speech to be unconstitutional.  To give just one example, requiring firms to pre-disclose all of their spending for the coming year, thereby preventing them to respond flexibly to changes in the political environment, could push the line.

Even if the SEC rules are constitutional, they would still not necessarily be good policy.  Notably, the law professors’ rulemaking petition, while spending some time discussing the supposed importance to investors of corporate political spending, said nothing about whether an SEC rule was necessary.  The petition highlighted the fact that many corporations already were voluntarily disclosing political spending, sometimes even without shareholder request. Why not continue the experimentation and evolution rather than locking down a one-size-fits-all rule?  Do the benefits of standardization outweigh the costs of experimentation?

The petition cites precedents such as executive compensation disclosure as evidence of the “evolving nature of disclosure requirements.”  But there’s nothing about this evolution that suggests it needs to proceed toward more disclosure about every political hot-button issue.

No doubt the SEC will proceed as the petition requests.  After all, it needs a juicy political issue to deflect attention from the recent questions about the SEC’s soundness and competence as a financial cop. But let’s at least hope that the Commission has learned something from its most recent run-in with the DC Circuit and tries to get some data on exactly who would be helped and hurt by regulation of political disclosures and how much. As with proxy access, would this be all about empowering certain activists at the expense of others, or passive diversified shareholders?  My article discusses some of these tradeoffs. The SEC’s analysis  might benefit from data on exactly what was accomplished by the Commission’s past disclosure enhancements the petitioners highlight.

The danger that the SEC will fall prey to the arbitrariness the DC Circuit criticized is especially intense given the petitioners’ argument that the “symbolic significance of corporate spending on politics suggests setting an appropriately low threshold” on when disclosure is required. I don’t even want to think about the consequences of inviting the SEC to weigh the benefit of “symbolism” against the direct and indirect costs of disclosure.

Anyway, get ready for a contentious debate which, while providing an enjoyable distraction, does nothing to protect investors from the fraud and market dangers that are supposed to be the SEC’s top priority.

In Constitutional Law, Corporate & Securities Law, First Amendment, Securities , , , ,
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Groupon’s tmi

Larry Ribstein —  28 July 2011

The WSJ reports that the SEC is on Groupon’s case for reporting “adjusted consolidated segment operating income” of $81.6 million while noting that subtracting marketing costs would produce a loss of $98 million.  Groupon recently added that adjusted CSOI “should not be considered as a measure of discretionary cash available to us to invest in the growth of our business or as a valuation metric” and that, according to the WSJ’s paraphrase, “investors should look at standard financial metrics such as cash flow, net loss and others when evaluating its performance.”

Apparently the SEC thinks Groupon shouldn’t disclose CSOI at all because it’s gross revenues rather than “profits.”  But does the SEC really know what investors should rely on?  Might not CSOI be a more realistic measure of future earnings than focusing on the investment the company made to produce that income?  Maybe not, but as long as it’s accurate, why not just give investors all the information with the appropriate qualifiers?

Then, too, Groupon co-founder Eric Lefkofsky committed the sin of “gun-jumping” by saying that “Groupon is going to be wildly profitable.” Sort of reminds me of Google’s famous Playboy interview.  As I asked back then:

[S]houldn’t the First Amendment have something to say about this broad regulation of truthful speech? See my article (with Butler), Corporate Governance Speech and the First Amendment, 43 U. Kans. L. Rev. 163 (1994), a chapter in our Corporation and the Constitution.

I recognize that there’s a point to this regulation:  to protect investors from rushing into horrendous investments like Google in 2004.

In Amazon, Constitutional Law, First Amendment, Google, Platforms, Securities ,
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Opening the US securities markets

Michael Sykuta —  8 April 2011

Larry makes a strong argument below for why the proposed SEC rules changes reported today in the WSJ should not be heralded as some great opening up of US securities markets, but that the changes are little more than political posturing to prevent addressing the real problem of the costs imposed by securities regulation more generally. I don’t disagree that the proposed rules changes Larry targets are, at best, window dressing to release some (well-justified) pressure created by innovative market-based solutions to circumvent the rules that lie more at the root of the securities market problem.  So long as the costs associated with “public” placements are so high, investors and issuers will continue to look for ways to expand their access to capital within the “private” placement market, which by definition excludes many (especially smaller) investors.

That said, I will point out that one of the quotes in the article bemoaning this proposal comes from an institutional investor–one of the groups that is more likely to benefit from the current 500 entity cap. If raising the cap would not open up the market meaningfully to new potential investors, I wouldn’t expect to see such negative comments from one of the groups who will face this greater competition in the supply of private equity. So while the proposed changes certainly don’t address the real problem, it seems they may make the market a bit more open (and less subject to contrived and costly work-arounds like special purpose vehicles) than it currently is.

However, among the rules changes being proposed is one that should open up the market to greater access even to smaller investors (up to whatever new cap might replace the current 500 entity rule). And it’s a rule  change that appears a direct response to something Larry blogged about here just earlier this year.

According to the WSJ report, the SEC “is considering relaxing a strict ban on private companies publicizing share issues, known as the ‘general solicitation’ ban.” The current regulations are currently under Constitutional scrutiny as a potential violation of 1st Amendment speech rights, as a result of a case by Bulldog Investors that Larry discussed in his earlier post.  Again, how far will the ‘relaxing’ go and will it be a substantive change in the underlying problem, or just another hanging of curtains? But there should be no doubt that more open communication about private equity investment opportunities should further open the market to smaller investors.

All this to say, I believe Larry is on point for the big picture, but the proposed regulation changes don’t seem to be all bad. Of course, the devil is in the details–so we’ll have to reserve judgment until the specifics are revealed before having more confidence in that conclusion.

In Securities ,
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Closing the US securities markets

Larry Ribstein —  8 April 2011

The WSJ reports that the SEC is considering raising the 500-shareholder limit on the number of holders of a class of securities a company can have before having to register that security with the Commission under Section 12(g) of the 1934 Act. The SEC reportedly is also considering relaxing the “general solicitation” restriction on private offerings.

At first blush this seems like a pro-market liberalization.  The story notes that “the agency has a responsibility to encourage companies to raise capital as well as to protect investors.”

But look again.  The SEC move clearly results from market arbitrage moves by hot firms like Facebook, Twitter and Zynga to open an end-run around the 500 shareholder rule.  I noted last January that Facebook got around the limit by selling all the stock to one person, a special purpose vehicle, which only wealthy investors can trade privately under an exemption to the 1933 Act.  (And maybe only non-US rich people.  Shortly after the story reported above, I noted that Goldman had moved its Facebook market exclusively offshore.) The SEC was also worried about insider trading in this new private market.

In other words, the market created this exemption, not the SEC.  Faced with inexorable market demand and arbitrage the SEC is considering making the escape route official. This resembles the “check the box” tax rule a decade ago which opened the door for LLCs after numerous unincorporated vehicles had challenged the government’s ability to put a lid on exempting unincorporated firms from the partnership tax. 

The SEC’s other option was reducing the various regulatory taxes on IPOs and public companies under the 1933 Act, SOX and Dodd-Frank which created the pressure on the 500 share limit.   In my earlier post I noted that VC partner Ben Horowitz had told the WSJ that

the incentive for going public has lowered and the penalty for going public has increased. . . [T]he regulatory environment and the rise of hedge funds has made it “dangerous” for start-ups go to public without a large cushion of cash. In general, we recommend that our companies be very careful about going public.

By expanding the private market for new firms, the SEC would release some of the political and market pressure building against over-regulation of going public.  Rather than liberalizing regulation, it would help protect existing regulation. 

The costs of this choice are significant.  Consider that in 2004, Google went public when it ran up against the 500 shareholder requirement.  Now, instead of IPOs, we have a market reserved for rich people. As I said last January:

[T]he increased costs of being public have helped exclude ordinary people from the ability to own the stars of the future.  Back in the 1980s, you could just call your broker and get rich off of the Microsoft IPO.  Now you have to be a wealthy Goldman client to do it.  Of course you also got to get poor off of a company that turned out to be a dog.  Now both options are reserved for wealthy people in the name of increasingly onerous disclosure regulation and federal governance requirements such as board structure, proxy access, and whistleblowing rules.

Each of these rules was thought to have some benefit at the time they were enacted.  Nobody really considered how private markets would react (e.g., by establishing alternatives to public markets) or the long-run effects of substituting quasi-private for public markets.  So rules designed to make the markets safe for ordinary investors have ended by excluding them.

Maybe it’s time to start considering whether we got what we wanted

The emerging market for rich people is especially ironic in view of the SEC’s increased push against insider trading. While the SEC is going all out in its Quixotic task to “level the playing field,” it is emptying that playing field of the people for whom it’s supposedly unlevel.

This move from public to private has broad ramifications.  The US traditionally has the broadest and deepest public securities markets in the world.  Indeed, the securities laws were enacted in the 30s to encourage participation by ordinary investors, and the securities laws have been interpreted consistent with that goal.  The problem is that Congress and the SEC have taken this goal too far, overburdening the US markets with regulation.  Coupling the shrinkage of the public market with an expanded option for rich people hastens this evolution away from strong US capital markets. 

At the same time, the US faces increased global competition.  As I discussed last week, evidence on IPOs suggests that public markets elsewhere in the world are catching up with the US.

The privatization of US markets could have important indirect effects.  Broad public participation helps democratize capitalism.  A move in the opposite direction could deepen Americans’ suspicion of capitalism as the playground of the wealthy.  Also, the securities markets are the primary source of data about large companies.  Closing these markets reduces transparency for everybody and not just investors.

The better move is to reverse the regulation that prompted this trend toward closing the public markets. The SEC is opting instead for short-term political expediency.

In Antitrust & Competition, Facebook, Financial Regulation, Google, Platforms, Securities, Taxes, Twitter, Tying , , ,
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