The emergency measure meant to protect shares of 19 financial companies from abusive short-selling is set to expire tomorrow. The SEC has said that it will not extend the rule. Instead, it plans to propose a new rules on short-selling that will apply across all US equities markets. But that rule could be months in the offing.
It’s not clear what effect the emergency rule had. Some market participants say the requirement that short sellers manually locate and pre-borrow shares slowed down short trading. Others say that shares in every one of the 19 protected companies–including mortgage giants Fannie Mae and Freddie Mac and Lehman Brothers–were widely available for borrowing, and that any slow down was minimal.
The new rules could take a variety of forms. A reintroduction of the old uptick rule, which required short sellers to wait for stocks to move higher before they added a short position, is unlikely. But some say a modified uptick rule, essentially a circuit breaker that would prohibit shorts if a stock was rapidly declining, may be introduced. Other possibilities include mandatory disclosure of short positions and the application of some version of the emergency rule to all shares traded on US exchanges.
One dark-horse possibility emerged recently in Pakistan, where some investors recently urged that a ban on all stock declines be adopted. Freddie Mac chief executive Richard Syron could not be reached for comment.
Is The SEC Staff Out Of Control?
By John Carney
Universal Healthcare Proxy Rulings May Indicate The Lunatics Are Running The Asylum
Is the staff of the Securities and Exchange Commission pursuing its own activist agenda without adequate supervision by agency heads?
Many SEC observers were caught off guard yesterday when the New York Times broke the news that the SEC has been requiring major US corporations to include shareholder proposals supporting universal healthcare in official proxy materials. This seemed to be a departure from many recent decisions by the SEC’s commissioners restraining or rejecting innovative regulations favored by special interest shareholder groups. Why had the SEC suddenly embraced this radical rule favoring proposals on political issues only indirectly tied to corporate governance?
The answer may lie in the disarray at the top ranks of the SEC.
More on the SEC staff’s activist lark after the jump.
President Bush nominated Washington University Law School professor Troy Paredes to the Securities and Exchange Commission yesterday. If confirmed by the Senate, Paredes would replace DealBreaker’s favorite SEC commissioner Paul Atkins. We’d feared that the loss of Atkins, who’s been a consistent critic excessive financial regulation, would be a blow to the SEC. But Paredes looks like a strong successor to Atkins.
Paredes, who is 37 years old, teaches classes on corporations, securities regulation, corporate finance, and the theory of the firm at the St. Louis school. His published work has focused on the political and psychological causes of excessive financial market regulation, as well as the psychology of corporate decision making. The choice has been endorsed by Larry Ribstein, a professor at the University of Illinois College of Law and the author of the Ideoblog.
Paredes has written that the SEC’s decision to require hedge fund managers to register with the commission—a policy which was later struck down by the federal courts—may have been a reaction to the accounting scandals of the late nineties. The commission “did not want to get caught flat-footed and criticized again” after taking a beating from following the collapse of Enron and WorldCom. In an era when everyone seems to have their own pet plan of new regulations following the subprime disaster, this sounds like exactly the kind of approach we need on the SEC.
We fully expect that Paredes will come into criticism from people whose tacit assumption is that only enthusiasts for regulatory growth should be placed in positions of power at regulatory agencies. Bush is right to ignore this question begging approach by appointing an insightful critic.
Bush Nominates Law Professor Troy Paredes To SEC [Dow Jones Newswires]
The Securities and Exchange Commission is on a three case losing streak in its attempts to sue hedge-fund managers who close out short positions with stock bought through private placements.
Since October, judges in three cases rejected the U.S. Securities and Exchange Commission’s argument that closing out short positions with shares bought in private offerings is illegal. The SEC sued hedge-fund managers that engaged in the transactions.
“If the SEC losses are ultimately upheld, they’re going to result in funds’ being able to short more easily,” said Steven Siesser, a partner at law firm Lowenstein Sandler in New York who counsels placement agents and investors in sales of “private investment in public equity,” or PIPEs.
The federal agency also argues in the three cases that the managers violated insider-trading laws by shorting stock before a private sale was announced. Prosecutors make a similar claim in a criminal case.
It’s vaguely reassuring to see courts discovering that there may actually be limits to insider trading laws.
SEC Struggles to Pin Insider Trading on Fund Sales [Bloomberg]
Implementing the “internal controls” provisions of Sarbanes-Oxley has been immensely costly for publicly held businesses in the United States while the concrete evidence of it’s benefits has been scant. By some estimates, the direct costs of implementation are as high as $35 billion each year. And the real costs might be even higher. Nonetheless, because non-compliance with Section 404 can be disastrous for a public company due to regulatory sanctions and massive stock declines, companies continue to spend and spend to implement Section 404.
It’s clear the regulation is broken but we’re unlikely to be rid of it any time soon. The regulation’s defenders insist the regulation is helping us avoid the kind of accounting scandals we saw in the late nineties, and that government enforcement of the regulation is necessary because the market can’t be trusted to regulate itself. There’s some truth in this argument: the market won’t necessarily price internal controls over financial accounting at the price regulators think is appropriate, much less at some level that optimizes efficiency over the long term.
But it’s a half truth because it rests on a double standard. It insists we focus on the reality of imperfect markets but not notice the reality of imperfect government. There’s no evidence that the government has arrived at the right level of internal controls, or that it can efficiently police this regulation.
Yesterday we got a reminder of the reality of imperfect government when the General Accounting Office declared that the Securities and Exchange Commission had a material weakness in the internal controls over its own financial reporting. This is a serious blow to the SEC’s credibility, which avoided getting tagged with the “material weakness” finding last year only by promising to improve things. But things haven’t improved. Indeed, they may now be worse.
Fortunately for the SEC, there is no market accountability for government agencies. You can’t short the SEC, and lawmakers are unlikely to penalize the commission by denying it authority or funds. Indeed, we expect that this GAO finding will somehow become an argument for the SEC to get more funding. That’s the way it works in our nation’s capital: failure is only evidence of the need to get more of the people’s treasure.
And for those of you who miss the irony of this we’ll make it clear: the SEC is the agency charged with enforcing Section 404 on public companies. Of course, no government agency has ever let the glass facades of its own house prevent it from throwing stones.
SEC Flunks Internal Controls Audit [CFO.com]
The myth of shareholder democracy holds a powerful sway over public opinion. The comments we’ve received on our two articles on the proxy access rules now up for comment at the Securities and Exchange Commission demonstrate that people continue to be bedeviled by the misguided analogy with democratic political regimes.
One of the mental levers the mythologists of shareholder democracy use to make their case is a kind of demonology of corporate managers. Although corporate insiders, especially chief executives, have demonstrably lost power in recent years to shareholders and independent directors while the risks of running a public company have increased, the continued climb of executive pay seems to have convinced many that executives are somehow fleecing shareholders. The evidence for this is underwhelming, however. While bad characters exist in executive suites and board rooms, they hardly justify enacting wide-ranging corporate governance reforms. Bad CEOs make bad law.
It’s important to remember that our system of corporate governance has generated enormous wealth for shareholders and workers over the years, bringing us unprecedented prosperity. We should exercise caution when seeking major reforms, especially when the costs of those reforms will be difficult to measure and the reforms will be next to impossible to reverse. By creating a uniform, national rule for proxy access, the proposed reforms would shut off jurisdictional competition and experimentation between the states. Worse, the proxy access reform is clearly viewed by many of its proponents as a first step in what they view as a revolution in corporate governance. There will be more to come. The proxy access reforms are precedent not a final resting place.
Some of the most thoughtful criticism of our first essay came from Beth Young, who I believe is the author of the Shareholder Proposal Handbook and a senior research associate at the Corporate Library.
We rough up Young’s objections to our articles after the jump.
The Proxy Access Threat To Individual Investors
By Keith Hahn
Or: Why Christopher Cox Should Reject The New Proxy Access Rule
Sometime in the next few weeks, Securities and Exchange Commission chairman Chris Cox will likely have to decide how he will vote on a pair of competing rules on shareholder access. One “proxy access” rule would shift power from boards of directors to cliques of outside shareholders by permitting certain shareholders and groups of shareholders to include in company proxy materials proposals for amendments to bylaws that would mandate procedures to allow shareholders to nominate board of director candidates. The other preserves longstanding rules that make it difficult and costly to for dissidents to mount proxy fights.
The SEC’s commissioners are evenly divided along partisan lines on the question. The Democratic commissioners favor increased proxy access. The Republicans favor the status quo. Cox holds the deciding vote. Which way will Cox vote? We’re not in the predictions game. But if we take Cox at his word about his own agenda at the SEC, it seems clear that he should vote against the new proxy access rules.
After the jump, we look at how the new proxy access rule hurts ordinary investors.
Securities and Exchange Commission Chairman Chris Cox holds the swing vote in one of the most important questions of corporate control currently being considered by the government. Sometime soon he’ll have to decide whether to support the proxy access proposals put forward by the Democratic commissioners or cast his lot with Republican proposals to maintain the status quo.
As is so often the case, at the heart of the matter is a confused concept. In particular, the concept of shareholder democracy seems to have broken out of its academic box and run rampant through the minds of some otherwise sensible people. Fortunately, the proxy access proposals are the subject of two of the most important articles published today—one from law professor Lynn Stout in today’s Wall Street Journal and the other from Larry Ribstein on Ideoblog.
Stout takes the argument for shareholder democracy head on, arguing that the “proposed proxy access rule is driven by the emotional claim, unsupported by evidence, that American corporations benefit from ‘shareholder democracy.’” Current shareholders, who are only temporary owners with easy entrance and exit strategies, have incentives to exploit and loot a company for immediate gains—which is exactly what some well-known activist shareholders have been urging on public companies. A stronger shareholder franchise will only acerbate the problem, Stout says.
What makes US companies function so well is the fact that they are managed by strong central boards and run by powerful managers. “Successful corporations are not, and never have been, democratic institutions. Since the public corporation first evolved over a century ago, U.S law has discouraged shareholders from taking an active role in corporate governance, and this ‘hands off’ approach has proven a recipe for tremendous success,” Stout writes.
Ribstein is less enthusiastic about traditional models of corporate governance. In fact, he thinks that the traditional public corporation may be on its way out—or at least in for some real evolution. But he agrees with Stout that attempts to force change on corporations through a new national regulation on proxy access are a very bad idea. “[T]he reason why the SEC should keep its hands-off here has more to do with the appropriate limits of SEC power than with the substance of the proposal. This is a matter of internal corporate governance which should be for the states,” Ribstein writes. “There is no justification for making this a federal matter unless you buy in to the shareholder democracy myth.”
What neither Ribstein nor Stout touch on today is the actual mechanism for the disfunction of shareholder democracy. Both understand that it won’t work as promised but they don’t spell out the reasons why. But fortunately you read DealBreaker, so you are about to learn why.
Clearing up the puzzle of shareholder democracy after the jump.
Filing annual reports and auditing financial statements according to US GAAP standards is excruciating for all public companies but for NEC electronics, it’s become a debilitating factor in their American depository receipts trading on our exchange.
The company formerly known as Nippon Electronic Company’s ADRs will no longer be traded on the Nasdaq as of today. Not only are they unable to file their Form 20-F for the fiscal year rounding up in March ’06, they announced their US filings dating back to 1999 are unreliable.
According to a report by CNN Money, the NEC said a restatement (of their annual report) “is not practicable” because of the complexities involved in determining the necessary adjustments. We previously reported that the Europeans are also taking issue with our accounting principles and filing standards and realize we’re seeing a trend here.
Are our accounting standards REALLY that difficult? Is this our problem or theirs? Have our accounting rules become so arcane they’re driving companies away from us? A bunch of you have your CFA designation – tell us what’s going on here.
Nasdaq Takes Step to Delist NEC Corp. [Wall Street Journal]
NEC Will Not File Fiscal 2006 Report [CNNMoney.com]
Ever the persistent bunch, the Europeans will stop at nothing to get a slice of that delectable American pie. If it’s not attempting to rename the simple hot dog into something called a Frankfurters, it’s our wallets they are after. Now it seems they want the SEC to confirm to their dodgy accounting principles. The New York Times reported today, “In a letter released yesterday, the European Association of Listed Companies said the Securities and Exchange Commission should allow the use of international accounting standards but should not insist that companies follow all the standards. Instead, the group said, the S.E.C. should accept modifications imposed by the European Commission.
Such a change, if approved by the S.E.C., would reduce the power of the International Accounting Standards Board, which is based in London and sets rules now used in many countries.
Currently, companies whose securities are registered in the United States must either prepare their financial statements in accordance with American rules (known as generally accepted accounting principles, or GAAP), or reconcile them to those rules. The proposed S.E.C. rule would eliminate that requirement starting next year.”
Sure, sure. It would probably help our exchanges out by making it easier for foreign companies to list on US exchanges. And there are some advantages to those fancy European principals based accounting standards. But we’re still suspicious of letting the E.U. start issuing instructions to the SEC.
Just keep your mayonnaise off our freedom fries you Belgian busy-bodies!
A Plan to Let S.E.C. Accept Foreign Rules Is Opposed [New York Times]