Results matching “sarb”

My Final Response - PointOfLaw Featured Discussion

Let me be clear on my policy prescriptions: �dump & sue� is a violation of 10b-5, but if not or if there is a fear of that interpretation being too expansive, in the alternative, the SEC could enact regulations to capture �suing and dumping�.  In my claim that short-selling and suing violates 10b-5, I am not relying on the insider trading jurisprudence as Larry seems to keep assuming (hence his emphasizing on the abuse of property rights principle).  What I am relying are the general market manipulation jurisprudence that has flowed from 10b-5.  Section 10 of the Securities and Exchange Act (titled �Manipulative and Deceptive Devices�) states that

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange:

(a)(1) To effect a short sale, or to use or employ any stop-loss order in connection with the purchase or sale, of any security registered on a national securities exchange, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.


(b) To use or employ, in connection with the purchase or sale of any security � any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. (emphasis added)

This is a broad license to the SEC to promulgate rules to protect investors with respect to short-sales specifically and any transactions generally.  The SEC has then seen fit to promulgate Rule 10b-5, which states:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a)To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security. (bold added)

Under 10b-5, the SEC has generally pursued two lines of cases: insider trading (which requires the property rights element as Larry points out) and the market manipulation cases (such as the �pump and dump� and �cyber-smear� schemes).

It is the second line of cases that I have argued the short-selling plaintiffs are analogous to.  When a short-seller spreads bad news to negatively affect the stock price, this is market manipulation as this falls under the first part of Rule 10b-5(b) (�make an untrue statement�).  The short-selling plaintiff is omitting to state a material fact, and therefore, this practice falls under the second part of 10b-5(b).  The material fact that I am referring to is the fact that the plaintiff is about to sue the company, i.e. the short-selling plaintiff is about to become the source of the demise of the stock price�s value.  This is not a case of an outsider who properly happened upon some non-public information; rather this is a person whose non-public information is that he is about to act in a way contrary to the company�s interest.

The �pump and dump� and �cyber-smear� prosecutions have never required any property rights theory �just market manipulation.  In the short-selling scenario, the fraud is by silence.  While there may be no Supreme Court jurisprudence saying the plaintiffs need to disclose, that is, because this seems to be a recent phenomena (and hence our discussion); there nothing preventing a court in the future from viewing this practice as falling under Rule 10b-5.  It boils down to whether a court will agree with me that failure to mention the news of an imminent lawsuit is an omission to state a material fact.  If it is, then it falls squarely under the plain reading of 10b-5.  In the alternative, the SEC has a broad license under Section 10(b) to promulgate a rule that captures this practice; as such a rule is needed to protect investors.  Larry�s claims that this is beyond the SEC�s jurisdiction is wrong as a plain reading of Section 10(b) (and Rule 10b-5) will reveal. 

The reason that it is fraud is because the announcement of a suit has an adverse impact on the stock price�s value.  I have pointed out how, even in an efficient market, a lot of noise can exist initially.  The market, even a perfectly efficient one, will discount the stock price by the expected cost of the suit.  Even if the suit is a low probability suit, as long as the potential payoff is high, there will be an adverse effect on the stock price.  This means that upon the initial announcement of the suit (especially if unexpected, which is the most likely scenario for these dump and sue cases), there will be a drop in price.  This will allow the plaintiff to profitably short-sell, no matter how frivolous the suit is.  I have not ignored financial economics, as Larry claims. I even cited a study (which he did not respond to) that shows that the market initially has a hard time figuring out the merits of the suits.  This is a function of our litigation system being so complex.  Perhaps the solution is to fix our litigation system, but until that happens, investors will be at the mercy of short-selling plaintiffs.  It is a question of what we believe the best way to combat the harm to America�s investors and corporations.  Were I convinced that meaningful litigation reform was around the corner, perhaps I would not be so upset by this practice. 

As to the argument that allowing this practice will create an incentive for better quality suits, this argument only works if high-quality plaintiffs can credibly distinguish themselves from low-quality plaintiffs in the extreme short-run.  Short-selling plaintiffs profit in the extreme short-term, however, because there is much noise in the market upon the announcement of the suit, which will allow even low quality suits to be brought.  It may eventually emerge which quality suit is being brought, but it is the initial announcement that will trigger the drop in price.  Were the markets able to initially discern the quality of any news released, there would be no need to prosecute those �pump and dump� and �cyber-smear� culprits, for when they announced their false news, the market should have never reacted.  The reality is that the market did initially react in all of those cases, thereby allowing the fraudsters to profit.  If our focus were on the long-run, then I would agree with Larry that there would be no issue.  The truth is that in the short-term, the markets are not as efficient as Larry seems to believe.  Even the most fervent defender of efficient markets Burton Malkiel states:[1]

As long as stock markets exist, the collective judgment of investors will sometimes make mistakes. Undoubtedly, some market participants are demonstrably less than rational. As a result, pricing irregularities and even predictable patterns in stock returns can appear over time and even persist for short periods. Moreover, the market cannot be perfectly efficient, or there would be no incentive for professionals to uncover the information that gets so quickly reflected in market prices �. ...

� Moreover, whatever patterns or irrationalities in the pricing of individual stocks that have been discovered in a search of historical experience are unlikely to persist and will not provide investors with a method to obtain extraordinary returns.

I am not quibbling with the notion of efficient markets, which Larry misunderstands to mean perfect ascertaining of the quality of the information as opposed to the idea that no investor can consistently profit from exploiting historical information.  What I am saying is that given that short-run anomalies can exist in an efficient market where there is no noise (such as the January effect, holiday effect, or even the sunshine effect), why it so hard to accept that in a noisy environment (litigation), even an efficient market will have a hard time initially getting it right? 

Because of the potential for short-term profiting, investors are always at risk when the short-selling plaintiff dumps the stock and then sues.  Furthermore, this gives the extra incentive to bring any quality lawsuit, since it is a profitable strategy in the short-term.  The double recovery concern follows from these conclusions.


Short-selling plaintiffs manipulate the market by failing to mention their impending suit.  This is actionable under Rule 10b-5, just as the spreaders of false news are liable for market manipulation.  If Larry is concerned about an expansive interpretation of my view of this practice, the answer is twofold.  Those who possess outside information are not at risk from my view, since they are not acting to the detriment of the target firm and hence not manipulating the market, whereas short-selling plaintiffs are taking an active step aimed at destroying value (otherwise why would they short-sell).  Secondly, if this response does not assuage Larry, the SEC is well within its statutory mandate to enact a narrowly tailored rule that can just capture the short-selling plaintiffs.

Let me say at the end, that my arguments have all been in the shadow of our existing securities regulations framework.  The reason this practice causes me concern is, because I see no difference between an insider going long on his firm�s shares when there is good news to be announced (I understand he is an insider � but they are functionally equivalent).  Given that the laws have hamstrung those who produce the wealth, I fail to see why we are being squeamish at taking on those who destroy it. 

If we are to give free reign to the plaintiff�s bar, then let us do right thing and repeal all insider trading and market manipulation laws (i.e. the SEA, Sarbanes Oxley and all regulations).  Let the market truly decide and let caveat emptor rule the day for all.  For that matter, let us abolish all federal regulations that do not affect national security, immigration, and navigable waters.  Let the Supreme Court overturn United States v. Northern Securities, Wickard v. Filburn, NLRB v. Jones, Erie R.R. v. Tompkins, Roe v. Wade.  My list goes on.  Until that fantastic day arrives (and I do anxiously await it), we are stuck in this second-best world.  It is at the margins of this world that we operate and decide on what steps to take for incremental positive change.  I see my proposals as that � Larry disagrees.  At the end, I believe we both agree that it ultimately the citizenry�s welfare that we are after.  I would again like thank the Manhattan Institute (Jim Copland and Walter Olson specifically) for setting this up and Larry for debating a most unworthy opponent.

[1] Burton G. Malkiel, The Efficient Market Hypothesis and its Critics, 17 J. Econ. Perspectives 59, 80 (2003).

Sarbanes-Oxley: is it just about small firms? - PointOfLaw Forum

Thanks to Ted Frank and Walter Olson for inviting me to do some posting over here on corporate governance matters.
I just caught up with this draft report by the SEC�s Advisory Committee on Smaller Public Companies. It�s got a lot of interesting stuff in it, including a proposal to exempt the smallest firms from mandatory compliance with SOX�s internal controls provision. I'm skeptical whether this goes far enough. SOX is bad for all firms -- it's not just about small firms. Also, there's only so much the SEC can do about SOX -- Congress needs to act. Here's some thoughts and suggestions.

The constitutionality of Sarbanes-Oxley - PointOfLaw Forum

Larry Ribstein and Steve Bainbridge take on Broc Romanek on the question raised by the Free Enterprise Fund lawsuit, which we discussed Feb. 9. Professor Bainbridge also commented on the suit on TCS Daily.

Professor Ribstein, along with Henry Butler, will also be arguing that Sarbanes-Oxley is also just plain bad when they present their paper at AEI March 13.

PSLRA at age 10 -- where next? - PointOfLaw Forum

Kenneth M. Lehn, a former chief economist of the SEC, weighs in (WSJ sub) on the effects the Private Securities Litigation Reform Act (PSLRA) has had in the ten years since its passage, finding that it has been mildly helpful but not the hoped-for cure to shareholder-suit ills. His recommendations:

First, defendants are not currently allowed to appeal motions to dismiss federal class-action securities suits. Congress should pass legislation allowing them to do so.

� Second, damages should be calculated in terms of the per-share inflation of a company's stock price due to alleged fraud, not in terms of aggregate damages. Estimates of aggregate damages require estimates of the number of shares that were purchased during the class period at an allegedly inflated price and subsequently held or sold at a price after the alleged fraud is discovered. But there is no scientifically valid way of estimating the number of these shares. Instead of using untested models that often result in highly inflated aggregate damages, damages should be thought of in terms of per-share inflation, with investors required to come forward to prove their claims.

� Third, the current system of compensation in private securities litigation should take into account what investors receive from the relatively new Fair Funds, which are an outgrowth of Sarbanes-Oxley. Under Sarbox, the Securities and Exchange Commission is allowed to pool disgorgement and civil monetary penalties that defendants pay in settlements to it. The SEC then attempts to distribute the monies in the Fair Funds to investors who were harmed by the defendants' actions. If the total distributions made to harmed investors under the Fair Fund exceed the total damage investors incurred because of the alleged fraud, then investors should not be allowed to collect damages in private securities litigation.

Is the PCAOB constitutional? A Competitive Enterprise Institute paper by Hans Bader and John Berlau argues that this institution, established by Sarbanes-Oxley, and whose members are appointed by the SEC, violates the Appointments Clause. Donna Nagy identifies similar problems in the Notre Dame Law Review. And now the Free Enterprise Fund of the Competitive Enterprise Institute has filed a lawsuit, on behalf of an accounting firm aggrieved by PCAOB's onerous reporting requirements, arguing just that, with legal superstars Kenneth Starr, Michael Carvin, and Viet Dinh on the briefs. But because Sarbanes-Oxley has no severability provision, if the PCAOB is found unconstitutional, the whole law falls. (Kara Scannell and Brody Mullins, "Suit Seeks to Overturn Sarbanes-Oxley Law", Wall Street Journal, Feb. 8; Wall Street Journal op-ed, Feb. 8; Amy Borrus, "Who Watches Accounting's Watchdog?", Business Week, Feb. 8; complaint). Congress rejected these arguments when it drafted the law due to an analysis by Harvard Professor Elena Kagan, which does not appear to be on the web. Larry Ribstein comments, and Hans Bader himself debates the issue in the comments to this Volokh post.

Today's Sarbanes-Oxley reading - PointOfLaw Forum

Larry Ribstein has a must-read post on "the yawning gap between what the promoters of SOX and corporate crime prosecutions are saying about the results of their efforts, and the reality," another reviewing the evidence of the adverse impact SOX is going to have on the New York City economy as it loses business to more efficiently-regulated capital markets, and a third exploring the "time bomb" SOX creates for businesses as plaintiffs' lawyers learn to be creative and concoct new theories of civil liability over trivial and immaterial actions that could be argued to violate of the law. And, finally, Ribstein rebuts Arthur Levitt's WSJ editorial defending SOX for small businesses: if SOX is so critical to small-business need to attract capital, why not allow businesses to choose whether to opt out?

Save the date: Ribstein, along with Henry Butler, will be presenting a paper on Sarbanes-Oxley at AEI for the AEI Liability Project the morning of March 13. More details as they become available.

Steve Jobs, Disney, Pixar, and Apple - PointOfLaw Forum

Larry Ribstein on how the Disney-Pixar merger, combined with the breadth of Sarbanes-Oxley, will create all sorts of opportunities for mischievous plaintiffs' attorneys.

Sarbox compliance - PointOfLaw Forum

Brian Doherty at Reason interviews four business people. Sarbanes-Oxley compliance consultant Stephen Stanton:

One thing that defies common sense is that the law requires controls to be documented, so anytime you change your process you have to go back in time to readjust your reporting. Anytime you change the way you do business, install new software, start a new line of business, you need those changes documented. So all of a sudden change is the enemy; creative destruction is a bad thing. We actively encourage clients: Don't change your system; don't upgrade anything; don't change anything for the last three months of the year.

So it really stifles innovation, stifles growth.

Bainbridge vs. Nocera - PointOfLaw Forum

"Securities regulation: end the dual approach" - PointOfLaw Forum

Lyle Roberts, of 10b-5 Daily blog fame, has published an opinion piece in the National Law Journal on the SEC's relatively new role in arranging compensation for investors. An excerpt:

In the heady legislative rush surrounding the passage of Sarbanes-Oxley, the prospect of having both the SEC and private plaintiffs' attorneys work to compensate injured investors probably seemed like a great idea. Multiple investigations and lawsuits over the same conduct, however, waste scarce resources that otherwise could go to investor compensation.

Two areas are particularly problematic: corporate defense costs and plaintiffs' attorney fees. The SEC has no power to stop a private lawsuit from proceeding while it conducts its own civil action. Accordingly, a corporation must battle on two fronts, with all of the attendant defense costs. Meanwhile, the private plaintiffs' attorneys may be able to free-ride on the SEC's efforts and still get paid high contingency fees.

Sarbox discussed - PointOfLaw Forum

Symposium in progress at the NYU Journal of Law and Liberty (via Zywicki).

A Valentine to Sarbanes-Oxley - PointOfLaw Forum

That's what the W$J news side offered up the other day. Larry Ribstein provides a corrective.

Yet another Sarbanes-Oxley problem - PointOfLaw Forum

According to Larry Ribstein, the law's provision requiring audit committees to set up snitchlines -- excuse me, information channels to facilitate anonymous whistleblowing -- conflicts with various laws of the home countries of foreign firms that do business in the U.S., leaving them in a compliance bind.

Sarbanes-Oxley is 3 - PointOfLaw Forum

...years old tomorrow, and Larry Ribstein has "celebratory" suggestions.

Will Milberg Weiss Become the 'Enron' of the Plaintiffs' Bar? - PointOfLaw Forum

Over the weekend, the Wall Street Journal carried an editorial making the case that the possible indictment of the firm, or some of its partners, for illegal kickbacks made to one of its frequent plaintiffs would become the "Enron" of the plaintiffs' bar. (Past coverage here).

For many reasons the comparison is not apt. The Enron story, so far as it is known, involved corporate managers manipulating accounting records to inflate the company's revenues. The Seymour Lazar/Milberg Weiss story, so far as it has been reported, involves allegations of kickbacks from the firm to one of its clients. The former situation involved fraudulent conduct, intended to bilk public markets, the latter allegedly involves wrongful conduct intended to manipulate the justice system.

One parallel between the cases that commentators have not yet discussed is the problem of ensuring just behavior when participants believe they can get "easy money". The culpable parties at Enron believed they could make easy money through a stock market Ponzi scheme where their manipulated earnings resulted in a climbing stock price. The allegations in the Lazar/Milberg Weiss case are that the plaintiffs' attorneys believed they could get quick settlements, netting them easy contingent fees, if only they could capture the role of lead counsel through a pliable named plaintiff.

The real scandal in the Lazar/Milberg Weiss situation is that our civil justice system has countenanced this "easy money" attitude amongst officers of the court.

If the public response to Enron was the Sarbanes-Oxley Act, the public response to this latest scandal should be to eliminate the causes of "easy money" litigation.

SOx compliance costs - PointOfLaw Forum

Foley & Lardner is out with a new survey (PDF) finding it costs 30 percent more to keep your books legal if you're an ordinary-sized publicly held company (via Christine Hurt). More: Larry Ribstein has reflections on Sarbanes-Oxley after three years, with an SSRN paper.

The Travails of Richard Scrushy - PointOfLaw Forum

Tom Kirkendall comments on the extended deliberations of the jury in the trial of Richard Scrushy.

The judge had to appoint an alternate juror after one of the regular jurors became ill. The addition of the alternate (who had not been present during deliberations) means that the jurors must re-start deliberations from the beginning. The judge even went so far as to collect all of the juror's notes and charts to ensure that they could not re-use anything they had developed before the alternate joined them.

The jury had previously told the judge they were deadlocked on June 3, only to be told to try harder. No one can know for sure, but the longer the deliberations continue, the more likely a hung jury or acquittal.

Scrush was at one point considered the poster child for criminal enforcement of the Sarbanes-Oxley Act. But if a case that appears to be as straightforward as his can't get a jury verdict in under a month, one wonders whether prosecutors will ever be able to put together a case under SOX.

Tell Us What You Really Think - PointOfLaw Forum

Professor Roberta Romano does tells us what she thinks of SOX in this Yale Law Review article snappily titled "The Sarbanes-Oxley Act and the Making of Quack Corporate Governance."

The paper nicely summarizes the law and finance literature applied to corporate governance.

Sarbox woes - PointOfLaw Forum

The SEC, reports Prof. Ribstein, is blaming the law's perceived burdens on accountants. AP and the NLJ fill in details about the agency's gestures toward reevaluating Sarbanes-Oxley in the light of widespread complaints, while John Berlau of the Competitive Enterprise Institute sums up some of those complaints (earlier posts).

Major pain for IT departments - PointOfLaw Forum

That would be Sarbanes-Oxley, which was sold to the public as a control on mendacious top execs and their accountants. One of Virginia Postrel's correspondents gives particulars. And Larry Ribstein, who's been providing encyclopedic coverage of unintended Sarbox effects, adds another: pressure for companies to delist their stocks, which (if they succumb to the pressure) results in a shrinkage of disclosure.

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