Archives For sarbanes-oxley

Much significant regulation has been inflicted on the financial markets over the last decade with little regard for evidence of whether the regulation is likely to accomplish its intended purpose.  A couple of recent studies on SOX and Dodd-Frank suggest that at least some of this regulation has made things worse.

Kim and Lu, Unintended Consequences of the Independent Board Requirement on Executive Suites investigates the effect of SOX independent director requirements.  They find that the executives react to the regulation by filling executive suites with their friends, with worse results for their firms. According to the abstract:

Following enactment [of SOX], affected firms fill their executive suites with significantly higher abnormal fractions of top-executives appointed (AFTA) during the current CEO’s tenure, replacing predecessors’ appointees. * * * [T]he newly appointed executives are more connected to their CEOs through past employment. * * * Higher AFTA is associated with lower firm valuation and less profitable acquisition bids. Moreover, the regulation’s overall effect on shareholder value is negative and significant, implying that the benefits of more independent directors are overwhelmed by harmful effects of the unintended consequences.

The good news is that markets to some extent ride to the rescue:

Importantly, affected firms facing strong product market competition do not increase AFTA. Strong external pressure for good governance from the product market seems to preclude the unintended consequence, demonstrating the merits of market-based solutions for better governance.

This suggests that the market would have done a better job on governance if the regulators had simply left them alone, at least in terms of independent director regulation. 

The authors explain why, in theory, we should expect exactly what occurred:

Board independence is but one of many facets of a firm’s governance structure. When regulation imposes a quota on one area of governance, it may have spillover effects on other less regulated areas of governance. The purpose of this paper is to identify spillover effects of the independent board requirement and ask: What are the effects of the regulation on shareholder value and what circumstances allow the spillover effects to take place?* * *

We explain these results with the Hermalin and Weisbach (1998) model, which shows in the absence of regulation, board independence is endogenously determined by a bargaining process between CEOs and boards, leading to an outcome where CEOs with greater bargaining power (due to their perceived superior managerial talent) have less independent boards. The quota on the percentage of independent directors nullifies the bargaining outcome for firms without independent boards, reducing their CEO influence over the board below what they bargained for. To recoup the loss of influence, these CEOs may attempt to increase their influence in their executive suites by replacing top-executives appointed by their predecessors with more of their own men–“circling the wagons” against more independent directors by assembling a more closely aligned and loyal team of top-executives. CEOs affected by the regulation will be more effective in making these personnel decisions and meet less resistance from the board because of their relatively strong bargaining positions, which according to the Hermalin and Weisbach model, is witnessed by the greater proportion of dependent directors prior to the regulation.

Martin, Trends in Financial Reporting: Shareholder Rights as a Poor Solution to Financial Reporting Abuses, studies the effect of shareholder rights provisions of Dodd-Frank. According to the abstract, it finds  

a general positive relation between stronger shareholder rights and accruals-based earnings management. Even when coupled with other reforms such as the Sarbanes-Oxley Act of 2002, this general positive relation may persist. These results provide evidence consistent with the inability of stronger shareholder rights to reduce earnings manipulation and actually provide evidence to the contrary. For those who propose shareholder rights as a solution to reduce irregularities in financial reporting, this paper should at a minimum cause pause and hopefully redirect regulatory and legislative efforts to more effective tools.

Martin theorizes that where shareholders are stronger managers have stronger incentives to manipulate earnings to keep them happy.

From the conclusion:

At a minimum, this paper provides additional evidence that manager discretion in financial reporting is complex, with many confounding incentives simultaneously in operation, with some in competition with one another. Therefore it is important for researchers to continue to explore better ways to identify and empirically document the factors that affect financial reporting decisions.

The lesson from both these papers is that corporate governance is a more complex mechanisms than the regulators thought. 

Of course even more conscientious regulators than the ones who enacted SOX and Dodd-Frank in a regulatory panic (see Romano on SOX) can’t predict all the potential effects of their laws.  That’s why they need to be more modest and recognize the need for regulatory competition (like the state competition that used to prevail in corporate governance) or at least sunset and opt-out provisions for federal regulation.  See Butler and Ribstein and Ribstein.

The WSJ opines on the impending sale of the NYSE to Deutsche Börse of Frankfurt.  It describes the merger as “a story of inevitable capitalist change and how no country or institution can take its dominance for granted” and a “lesson in how easily capital, both financial and human, can relocate.” It describes the 171 IPOs in the US last year as “dwarfed” by the 1,295 IPOs overseas.

Why did this happen?  As I noted last month:  overregulation of public companies.  As the WSJ says:

The Securities and Exchange Commission’s own exhaustive 2009 survey of U.S. and foreign firms showed that the burden of complying with Sarbox remains a major deterrent to going public in the United States. Yet the agency still hasn’t made a serious effort to pare these burdens. * * *

The Dodd-Frank law requires mountains of new rules that will further burden U.S. financial players, not least in the new derivatives regime emerging from the Commodity Futures Trading Commission. We would not be surprised if the NYSE Euronext managers view the Deutsche Börse merger as a potential refuge for its derivatives business if CFTC Chairman Gary Gensler realizes all of his regulatory ambitions.

See also Butler & Ribstein for a detailed examination of the effect of the burdens under SOX, and my article on the effect of regulation on the cross-listing market.

The WSJ concludes:

If we want the U.S. to be home to the next great financial institution, or even to keep the ones we have, our politicians need to make America a more inviting place to trade and do business.

Yesterday I noted, anticipating the President’s call tonight for spending to encourage US growth and competitiveness, that “a better way to increase U.S. competitiveness is by changing the law rather than spending money.” 

One law to consider is Sarbanes-Oxley. 

In our book, The Sarbanes-Oxley Debacle, Butler and I discuss, among other things, SOX’s effect on innovation.  We noted how SOX internal reporting requirements tax change and innovation, as well as particularly burdening smaller, riskier firms which are important sources of innovation.

Now we have some evidence of this effect:  Waters, The Effect if the Sarbanes-Oxley Act on Innovation.  Here’s an excerpt from the abstract:

This paper adds to the literature on the Sarbanes-Oxley Act’s net effects by looking at whether its passage was associated with a change in innovation and patenting. Its effects are separated into temporary uncertainty and changes in long term investment incentives in a dynamic programming problem faced by innovators who learn over time about SOX’s effect. Innovation is found to fall under uncertainty for potential losses that are low relative to the potential profits. As companies learn, innovation rates readjust to SOX’s long term persistent effect. We examine US patenting in stem cell technologies from 2001 to 2009 for SOX related changes. * * * We find a large and statistically significant change at a date consistent with a SOX effect under both testing methods. * * * Four competing explanations are found to account incompletely for the observed data.

A simple fix Congress might consider:  Let the shareholders decide if SOX is worth the costs.  We’ve got “say on pay.”  How about “say on SOX”?

In a must-read op-ed in today’s Wall Street Journal, Yale Law’s Jonathan Macey weighs in on Goldman Sachs’s decision to allow only foreign gazillionaires — no Americans, regardless of their wealth or sophistication — to invest in new shares of Facebook. 

Numerous observers have portrayed Goldman’s move as a “victory for the SEC.”  The New York Times‘ Dealbook called it “a serious embarrassment for Goldman.”  In reality, Macey contends, “[i]t is the SEC that should be embarrassed” for fostering a system in which, as Larry put it,  “the US securities laws exclud[e] US investors from investing in a US company in the US.”  

Echoing a number of Larry’s observations, Macey explains:

Thanks to SEC regulation and the litigious atmosphere it fosters — not to mention Sarbanes-Oxley’s onerous burdens on corporate executives — the whole capital formation process is moving offshore. The U.S. share of total equity raised in the world’s capital markets is shrinking, while the number of U.S. companies listing their shares for trading exclusively in foreign markets has risen steadily for the past five years.

Macey then points a finger at the SEC’s overarching regulatory philosophy, which views investors — even rich, sophisticated ones — as needing governmental protection and displays scant regard for the unintended consequences of paternalistic limitations on the freedom of contract: 

The SEC’s fundamental approach to regulation involves depriving investors of opportunities in order to protect them. This was not much of a problem in the immediate post-World War II period. Before Japan and Europe rebuilt, and before China emerged as an economic giant, the U.S. had the only large pools of investment capital in the world and dominated the financial scene. During this happy period of U.S. primacy, the SEC, along with most academics, took the rather ludicrous view that it actually deserved the credit for the primacy of U.S. capital markets. That world is long gone.

Still, according to the SEC, all investors large and small must be protected against the danger that they will succumb to a feeding frenzy of enthusiasm when given the opportunity to invest in a new deal. For example, the SEC rules governing the Facebook offering until Goldman pulled the plug include the requirement that the stock being sold “cannot be the subject of advertising, general promotional seminars or public meetings in connection with the offering.” The concern here is that publicity about a deal might, heaven forbid, create interest among investors. …

The investors who supposedly are being protected by the SEC’s rules here are not unsophisticated small investors. Goldman had limited the marketing of Facebook’s shares to the billionaires and large institutions that constitute its wealthiest clients.

Finally, Macey suggests that the Obama Administration, which has recently committed itself to ferreting out cost-ineffective regulations that “make our economy less competitive,” take a long, hard look at the “investor-protective” securities rules that drive capital overseas and prevent American investors from having access to the wealth-enhancing opportunities available to their European and Asian friends:

Ironically, the Goldman decision to move the Facebook deal offshore was announced just as President Obama was acknowledging in these editorial pages that “regulations do have costs” and saying that he would order a government-wide review to eliminate rules that cripple economic growth. That review should include the rules promulgated by the SEC, lest we continue to see U.S. capital markets fade into irrelevance.

If we ever get another President who believes that markets, while imperfect, generally work well, that government intervention often fails to make things better, and that regulations should be narrowly tailored to fix legimitate market failures, he or she should look hard at Prof. Macey for a spot on the SEC.

Last week I noted that Facebook’s big private sale to Goldman was a symptom of how higher disclosure costs have helped make private firms reluctant to take the once-expected step of going public:  “[I]t seems the increased costs of being public have helped exclude ordinary people from the ability to own the stars of the future.”  Gordon Crovitz picked this up yesterday in his WSJ column.

Today comes some evidence that higher disclosure costs, and specifically SOX, in fact have something to do with this phenomenon — Bova, Minutti-Meza, Richardson and Vyas, The Sarbanes-Oxley Act and Exit Strategies of Private Firms.  Here’s an excerpt from the abstract:

[W]e establish three principal findings. First, SOX appears to have shifted the incentive for firms to exit the private market via IPO to exit via acquisition by a public acquirer. Second, * * * [f]or our median-sized private target, the estimated dollar value decrease in deal proceeds when one moves from a high level to a low level of pre-acquisition SOX compliance is $1.3 million. Finally, public target deal multiples are not affected by a public target’s level of pre-acquisition SOX compliance. These findings suggest that SOX-related costs have both restricted the action space of possible exit strategies for private firms and led to lower deal multiples for those private acquisition targets that are less likely to be SOX compliant prior to acquisition.

The study’s basic intuition is that SOX makes it cost less for a public firm to acquire a private target than for a private target to do an IPO because the public firm can apply its existing SOX infrastructure to the newly acquired firm. This is consistent with the basic idea that SOX’s big problem for private firms is that its infrastructure costs are not perfectly scalable.  The effects of variations in target firm SOX compliance support the inference that this is, indeed, a SOX effect and not attributable to some other cause.

This means that in order for an IPO to be preferable to being acquired, a firm has to meet a higher value threshold than it would without SOX.  Thus, the authors conclude, “as a result fewer private firms should choose the IPO option as an exit strategy, post-SOX.”

Moreover, because increased SOX compliance costs are impounded into the price of the acquired firm, SOX compliance affects the price of private, but not public firms. (To be sure, SOX compliance also affects the value of the firms because they are more transparent and hence less risky.)  This could make it harder for private firms to be acquired by public firms post-SOX, although the authors don’t directly measure that effect.

Thus, the authors conclude, “[t]he combined results suggest that the costs to SOX are not restricted solely to public firms, and that an indirect cost of SOX may be its impact on restricting the exit opportunities for owners of private firms.”

To return to the conclusion of my prior blog post, “rules designed to make the markets safe for ordinary investors have ended by excluding them.”

My Missouri colleague, Peter Klein, of Organizations and Markets fame (and, like Larry, a proud non-voter), has been asked to contribute a book chapter on the Austrian theory of the firm and the law. Peter, who has written extensively on the Austrian theory of the firm and maintains an online bibliography on the subject, is an expert on the economics. He asked me to give him some thoughts on the law — i.e., which business law doctrines cohere or conflict with Austrian insights on the nature of the firm.

I’m posting my initial thoughts on the matter in the hope that readers may enlighten us on additional business law doctrines that reflect or reject Austrian thinking. (And, of course, please let me know where I’m off base.) You can either respond to this post or email Peter or me directly.

Before I get into a discussion of specific business law doctrines, let me provide some (extremely cursory!) background on Austrian thought.


A hallmark of Austrian thinking, especially as articulated by F.A. Hayek, is the notion that the information required to allocate productive resources to their highest and best ends, and thereby to maximize wealth, is not readily available to any individual or central authority. Instead, it is widely dispersed among individuals throughout society. Accordingly, attempts to maximize value by allocating productive resources in a centralized fashion — i.e., according to the dictates of central planners — are destined to fail. Those planners lack access to important information (most notably, information about how individual consumers value competing uses of productive resources) and could not effectively process all that information, much of which is conflicting, even if it were accessible.

But, say the Austrians, there’s no need to despair. In a society with well-defined, freely transferable property rights, the impossibility of effective central planning presents little problem. As individuals engage in trades in an attempt to better themselves, prices for productive resources will emerge. Those prices incorporate all available information about the relative value of competing uses of a productive resource (i.e., the person willing to pay the highest price for something will create the most value from it and should possess it if the goal is to maximize wealth). They present that information in a simple, useful form (i.e., one need not worry about calculating the net effect of conflicting bits of information about a resource’s highest and best use; the price mechanism will do so). And they motivate economic actors to take precisely the steps that will maximize total wealth (i.e., relatively high prices for a resource induce producers to make more of it and consumers to substitute away from it; relatively low prices induce less production and more consumption of the resource). Thus, when property rights are well-defined and freely transferable, prices will create a spontaneous order that trumps anything achievable using central planning.

But wait a minute. Isn’t the business firm an instance of central planning?  Within a firm, productive resources are allocated according to the dictates of “central planners” — i.e., managers.  Indeed, Ronald Coase famously observed that the defining hallmark of the firm is “the supersession of the price mechanism.”  Does it even make sense, then, to talk about an Austrian theory of the firm? 

Well, yes, if one understands the business firm as an instance of spontaneous order.  In the so-called “socialist calculation debate,” in which the Austrians contended that economic welfare would be greater in a free economy than in a centrally planned one, the central planners were expected to have state power (legitimate power to coerce using force) and were not expected to face significant competition.  The “planners” within a firm, by contrast, cannot forcefully coerce their subjects (they must procure consent from resource providers), and they face significant competition from other business firms.  These two considerations constrain planning within a business firm so that it is used only when the benefits it generates — chiefly, a reduction in the costs of using the market (i.e., transaction costs) — exceed the losses it occasions in terms of allocative inefficiency (i.e., mistakes by planners attempting to allocate resources optimally) and agency costs (i.e., losses from planners’ opportunism and neglect).  Thus, in the sort of economic system advocated by the Austrians — one coupling well-defined, enforceable, and transferable property rights with broad freedom to contract — one would expect business firms to emerge spontaneously as entrepreneurs seek to minimize the sum of transaction costs, allocative inefficiencies, and agency costs.  One would also expect the boundaries of the firm to change (spontaneously) as technological and other developments alter the relative costs of bringing functions within the firm rather than procuring them on the market.  Such thinking coheres nicely with the Coasean understanding of the firm.

Before looking at specific business law doctrines that reflect or reject Austrian thinking, I should note one other Austrian (specifically, Hayekian) distinction, this one between types of legal rules.  Some legal rules are general in their application, are “purpose-independent” (meaning that the law-giver isn’t trying to achieve some specific social outcome but is instead trying to resolve a dispute in accordance with the parties’ settled expectations), and have the effect of setting clear expectations so that parties may confidently predict outcomes in structuring their affairs.  Hayek refers to these sorts of rules as nomos.  Other legal rules are more akin to specific orders from a central authority seeking to achieve some specific purpose.  Such “teleological” rules Hayek refers to as thesis

In light of their emphasis on the knowledge problem and the impossibility of effective central planning, the Austrians (most notably Hayek) contended that legitimate law is nomos.  Thesis is something other than genuine law.  The common law, for the most part, is nomos.  Most (but not all) legislation is thesis.  The characterization of any piece of legislation will depend on whether it amounts to specific orders aimed at achieving a set purpose (e.g., the new federal health care law), in which case it is thesis, or is instead simply seeking to codify purpose-independent rules that settle parties’ expectations and enable them to order their affairs in light of the information to which they alone are privy (e.g., the Uniform Commercial Code), in which case it is nomos.   

Below the fold, I discuss some business law doctrines that cohere with Austrian thinking and others that conflict.  Not surprisingly, the doctrines that are most consistent with the Austrian view of the firm are nomos-like; the inconsistent legal doctrines are thesis.
Continue Reading…

Today’s WSJ notes criticism of Dodd-Frank’s bounty provision for whistleblowers on the ground that it undermines the internal reporting provisions of the previous financial law, Sarbanes-Oxley.  The WSJ notes that

plaintiffs lawyers eager to handle complaints on behalf of whistleblowers are getting the word out, issuing press releases and publishing articles about the new law and in some instances, running ads soliciting work. “We’re gearing up, we’re going to be very devoted to this topic,” said Rebecca Katz, a lawyer at Bernstein Liebhard LLP, a plaintiffs firm based in New York.

The article says companies are trying to beef up internal reporting incentives.  Indeed, firms have every incentive to encourage employees to report fraud.  After all, fraud is an agency cost that hurts companies as it helps employees cover up bad deeds or poor performance.  

Indeed, companies arguably can take care of these problems without a strong federal law.  Even if you don’t want to go that far, it’s still puzzling why Congress should want to bypass internal procedures altogether.  

There is another way:  authorizing insider trading about fraud, as I argued last summer:

The beauty of the insider trading approach to uncovering fraud is that it reduces the need for a lot of the Dodd-Frank whistle-blowing apparatus. The market decides through its price movements how important or original the information is and computes the insider’s compensation for disclosing it. While the insider might still worry about protecting his job, rewards from selling the information could make the disclosure worth the risk.

Another advantage of the insider trading approach is that it does not necessarily bypass the corporation as a first line of defense against employee fraud. The selling-induced stock drop could motivate honest executives to look into the cause of the decline and take action. The Dodd-Frank procedure always bypasses the corporation by rewarding only whistleblowers who bring new information to the SEC.

Anyway, it’s amusing to watch these misguided federal laws — SOX and Dodd-Frank — getting in each other’s way, with Dodd-Frank disabling the incentives SOX put in place.  I suppose we’ll need yet another federal law to referee.

We know that Sarbanes-Oxley imposed significant costs on firms in the interests of more accurate disclosures.  Maybe this is a cost worth bearing.  But what if one of these costs is actually less accurate disclosures?

Scott N. Bronson, Chris Hogan and Marilyn Johnson of Michigan State have written The Unintended Consequences of PCAOB Auditing Standards Nos. 2 and 3 on the Reliability of Preliminary Earnings Releases.  Here’s an excerpt from their discussion of the paper on the Harvard Blog:

Historically, the vast majority of publicly-traded companies wait until after the audit report date (i.e., after the completion of audit fieldwork) to release preliminary earnings information. However, the implementation of Public Company Accounting Oversight Board Auditing Standards No. 2 (“AS2”) on internal control and No. 3 (“AS3”) on audit documentation resulted in delaying completion of the audit for a large number of public companies.

Using a large sample of annual earnings releases over the period 2000-2005, we find a dramatic increase in the length of time between the fiscal year-end and the audit report date (“audit report lag”) that is concurrent with the implementation of PCAOB AS2 and AS3. * * * However, due to market demand for timely disclosures, most firms maintain the same preliminary earnings release date even though the audit may not be complete as of that date. Consequently, the incidence of firms announcing earnings after the audit report date declined from close to 70% in the 2000-2001 period to around 20% in 2005. This change is due predominantly to accelerated filers that had to comply with both AS2 and AS3. * * *

Consistent with the increase in the proportion of firms whose preliminary releases contain pre-audit report date numbers, we show that the number of PEA revisions in our sample has increased over time from 12 in 2000 to 186 in 2005. After controlling for characteristics of firms with PEA revisions, we find that this unintended regulatory effect is economically significant in that PEA revisions would have been 35% lower during 2005 if the historical frequency of issuing earnings releases after the audit report date had not changed due to the new regulations.

* * * Consistent with prior evidence of a negative market reaction to announcements that previously-filed earnings numbers will be restated, we find a significantly negative market reaction to the announcement of a forthcoming PEA revision for 35% of PEA revision firms that announce the revision in a press release and/or 8-K. However, we find no significant market reaction when the initial disclosure of a PEA revision is the 10-K filing containing the revised numbers (which occurs in 46% of our sample revisions). This result is consistent with our finding that revisions disclosed in 10-K filings are generally smaller in absolute magnitude than revisions disclosed in press releases and/or 8-K filings. In addition, for firms that foreshadow impending PEA revisions in the earnings press release (19% of our sample), we find that the market reaction around the release of preliminary earnings reflects the market’s reliability concerns, as evidenced by the fact that the market reaction to unexpected earnings is less (more) pronounced for good (bad) news.

So SOX’s requirements do increase the reliability of audited earnings, but also result in increased release of less reliable pre-audit information.  Any assessment of the benefits of SOX must take both of these effects into account.

This is one of many papers on the unintended consequences of SOX.  We await the papers on the unintended consequences of Dodd-Frank.

We usually think about jurisdictional choice for corporate law as applying to state business association laws, not the federal securities laws.  But this distinction has never been clear given global securities markets, and it’s less true now than it used to be.

The WSJ discusses the securities bar’s and regulators’ lamentations over last summer’s Morrison v. National Australia Bank holding that that foreign plaintiffs who transacted in foreign shares on a foreign exchange (i.e., “f cubed”) could not bring a 10b-5 action.  The article notes that the ruling seems to be helping foreign-based companies like BP and Toyota that are facing investor suits over non-disclosure of risks that turned into big liabilities. It says  judges have been barring U.S. suits even by U.S. investors who bought shares on foreign exchanges (i.e., “f squared”).

Plaintiffs’ securities lawyers and some state officials are trying to get Congress to reverse the decision because, according to the article, “in a global marketplace in which U.S. capital increasingly flows into foreign stock exchanges, it is unfair to deprive U.S. investors of the protection of domestic law because they purchased stock overseas.”

But as I pointed out when the Morrison decision came down, the ruling “promotes globalized securities markets . . . by adopting a test that enables investors to choose the applicable regulation by deciding where to trade.”  In other words, investors may not want to be “protected” by U.S. law because it’s better for plaintiffs’ securities lawyers than for investors.   The exchange-based test gives investors clear notice of when they’re protected and when not.

At the same time, foreign firms can more easily choose, just by deciding which exchange to trade on, whether the extra credibility they get from the application of U.S. law is worth the extra costs.  As I’ve written, this may be less likely the case after federal laws like SOX (and now Dodd-Frank), which try to impose U.S. governance norms on foreign firms.

In other words, a true “global marketplace” depends at least in part on jurisdictional choice, and not necessarily on the application of the same law everywhere.

My previous post listing my favorite books in corporate governance turned out to be fairly popular.  A few readers suggested however that my list contained few books that a practitioner would find useful in day to day practice.  I don’t know whether that’s true, but I will accept that my list had an academic focus.  Here is a list of my ten favorite books with a practioner focus.  Most of them are treatises.  What’s missing is the “Guide to Dodd-Frank” although I am sure someone will publish that once the implementing regulations are completed.  Until then, of course, your best bet to understand the corporate governance implications of Dodd-Frank is to read Defending Against Shareholder Proxy Access: Delaware’s Future Reviewing Company Defenses in the Era of Dodd-Frank.

Wolfe & Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery: Procedures in Equity, LexisNexis Matthew Bender

Ribstein and Keatinge on Limited Liability Companies, West Second Edition

John Olson and Amy Goodman, A Practical Guide to SEC Proxy and Compensation Rules, Aspen Fourth Edition

Loss, Seligman, & Paredes, Fundamentals of Securities Regulation, Aspen, Fifth Edition,

Marc Steinberg, Securities Regulation: Liabilities and Remedies, Law Journal Press

Welch, Saunders, & Turezyn, Folk on the Delaware General Corporation Law, Fifth Edition

R. Franklin Balotti, Delaware Law of Corporations and Business Organizations Deskbook, Aspen

Stephen A. Radin, The Business Judgment Rule: Fiduciary Duties of Corporate Officers, Wolters Kluwer Sixth Edition

Drexler, Black, & Sparks, Delaware Corporate Law and Practice, Matthew Bender

Stephen Bainbridge, The Complete Guide to Sarbanes-Oxley: Understanding How Sarbanes-Oxley Affects Your Business, Adams Media

The LA Times expresses surprise that Goldman Sachs will come out quite well from financial reform.

Who did they think was calling the shots in Congress? Consumers? Investors? How badly were accountants, the culprits in the last financial meltdown, hurt by Sarbanes-Oxley?

Most notably, the LA Times is shocked Goldman is not actually going to lose a lot of money from the Volcker rule barring proprietary trading by banks:

Goldman has started to move some employees engaged in proprietary trading — the often lucrative buying and selling of securities on behalf of the bank itself — to other parts of the bank, where they will make trades on behalf of clients, according to people familiar with the situation.

I’m not as surprised. I observed on the eve of Dodd-Frank that

The vaunted Volcker rule aimed at restricting banks’ “proprietary trading” defines the term to give ample leeway to banks (which, of course, heavily influenced the final law) to take significant risks as long as they do so in what they designate as customer accounts. This not only ensures the risk problem will continue, but is also likely to increase potential conflicts between banks and their customers.

Goldman is also set to capitalize on Dodd-Frank’s restrictions on derivatives trading. Guess who can set up the required clearinghouse?

I assume we’ll be getting more stories over the years about who is really helped and hurt by financial reform.

Gambling? In Casablanca?

When I last discussed HP, I reflected on the spectacular failure of independent board governance associated with pretexting-gate. That, you might recall, was Patricia Dunn’s highly questionable covert-op that epitomized the general board dysfunction that can accompany independent director governance of modern corporations.

Now we have news (from the NYT) that HP’s most recent CEO, Mark Hurd, misreported payments to a woman who worked for HP that he had some sort of relationship with. The woman hired Gloria Allred, so the doodoo hit the fan and Hurd had to leave.

The narrative that seems to have emerged is that it’s sort of silly that this highly successful executive should have to leave the company just as it’s zooming to success. The WSJ quotes a Wharton professor as saying “[Hurd] was one of the great-performing CEOs of the era and could have easily had another five years or more.” The NYT story says Hurd “talked about the board being swayed by the potential public relations problems that would follow accusations of sexual harassment.” What a shame that mere public relations will cause super-CEO Hurd to miss a reported $100 million payday he was negotiating for. He’ll have to settle for a mere $12 million in severance plus stock compensation.

But I’ve been wondering – exactly how successful was Hurd? The reason I’m wondering is this snippet from the Times story:

The company also released preliminary results for its third quarter. H.P. said it earned 75 cents a share, compared with 67 cents in the period a year ago. Excluding one-time items, earnings were $1.08 a share, slightly more than the $1.07 expected by analysts. Revenue rose 11 percent, to $30.7 billion; analysts were expecting $30 billion. In its outlook for the fourth quarter, H.P. said it expected earnings of $1.03 to $1.05 a share, or $1.25 to $1.27 after excluding one-time items. Analysts had forecast adjusted earnings of $1.26 a share. It forecast revenue of $32.5 billion to $32.7 billion, in line with expectations

Jeff Matthews says (tip Tom Kirkendall)

Wall Street’s Finest remain easily distracted by the inflated earnings figures at HP that became a fixture under Mark Hurd. * * * [A]s we see it, a guy who can fool all of Wall Street’s Finest all of the time—by among other things, turning 75 cents worth of earnings into $1.08 worth of earnings through the magic of numbers prepared using accounting principles not generally accepted by accountants—could certainly convince himself that a great deal else can be accomplished through the magic of other principles not generally accepted elsewhere in life. In other words, one fiction may reasonably lead to others.
Whatever the true story behind the story, however, one thing we know remains true: the more things change on Wall Street, the more they stay the same.

Indeed, haven’t we seen this before? Like over-reliance on imperial CEOs? Bernie Ebbers and Scott Sullivan just hitting the numbers quarter after quarter?

Well, things aren’t quite the same. Fortunately we’re in the post-SOX era and Bernie Ebbers is in jail for the rest of his life. So there’s no reason to worry about fraud. Is there?