Monthly Archives: June 2016

Engagement: The Missing Middle Approach in the Bebchuk–Strine Debate

Jasmin Sethi is Vice President and Matthew Mallow is Senior Managing Director and Chief Legal Officer at BlackRock, Inc. This post is based on a recent article by Ms. Sethi and Mr. Mallow. This paper comments on two papers issued by the program, The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here), and Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law by Leo E. Strine (discussed on the Forum here). Additional related research issued by the program includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), and Securing Our Nation’s Economic Future by Leo E. Strine (discussed on the Forum here).

In our article entitled Engagement: The Missing Middle Approach in the Bebchuk–Strine Debate, recently published in the NYU Journal of Law & Business, we contend that in the debate over whether more director or shareholder control would maximize firm value, a critical approach for influencing firm management effectively is missing. This approach is shareholder engagement, and it is growing in importance for asset managers and institutional investors in influencing the actions of directors and firm management.

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Is the Stock Market Just a Side Show? Evidence From Venture Capital

Bibo Liu is Assistant Professor at PBC School of Finance, Tsinghua University; Xuan Tian is Associate Professor of Finance at Indiana University. This post is based on a recent paper authored by Professors Liu and Tian.

Is the stock market just a sideshow or does it have real effects on economic activities? Conventional wisdom believes that stock prices merely reflect expectations about future cash flows. However, a growing strand of literature challenges this traditional view by arguing that financial markets as a whole have the ability of aggregating different pieces of information possessed by various market players and incorporating them into security price, which could be used to guide managers’ and investors’ real decisions.

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Oversight of the SEC

Mary Jo White is Chair of the U.S. Securities and Exchange Commission. The following post is based on Chair White’s remarks before the U.S Senate Committee on Banking, Housing, and Urban Affairs. The complete publication, including footnotes, is available here. The views expressed in this post are those of Chair White and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Thank you for inviting me to testify today [June 14, 2016] regarding the current work and initiatives of the U.S. Securities and Exchange Commission (SEC or Commission). The SEC is a critical agency that serves as the bulwark safeguarding millions of investors and the most vibrant markets in the world. Thanks to the exceptional work and commitment of our superb staff, the Commission has in recent years strengthened its operations and programs across the agency—aggressively enforcing the securities laws to punish wrongdoers, adopting strong measures that protect investors and our markets, and investing in the people and technology required to ensure that our markets remain the strongest and safest in the world. These and other efforts across our extensive areas of responsibility are all in furtherance of our essential mission: to protect investors; to maintain fair, orderly, and efficient markets; and to facilitate capital formation.

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CEO Overconfidence and Financial Crisis

Chih-Yung Lin is Associate Professor of Finance at Yuan Ze University. This post is based on an article authored by Professor Lin; Po-Hsin Ho of National Taipei University; Chia-Wei Huang, Associate Professor of Finance at Yuan Ze University; and Ju-Fang Yen of the Department of Statistics at National Taipei University.

Bank financial contagion is cited as a key feature of the financial crises, as problems at specific financial institutions rapidly morphed into a crisis for the entire financial system. Shocks to bank health have played a systematic role in worsening financial stability. Yet not all financial institutions suffered during these crisis years. In our article, CEO Overconfidence and Financial Crisis: Evidence from Bank Lending and Leverage, which was recently published in the Journal of Financial Economics, we propose a new perspective that manager overconfidence could explain the substantial heterogeneity in bank risk-taking behaviors during a boom, as well as the performance of these banks during the ensuing crisis years.

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Debt Restructurings and the Trust Indenture Act

Harald Halbhuber is counsel in the Capital Markets Group at Shearman & Sterling LLP. This post is based on a recent discussion paper by Mr. Halbhuber, available here.

In a case commonly referred to as Marblegate, a federal district court recently held that a debt restructuring by for-profit education provider EDMC violated a non-impairment provision in the Trust Indenture Act (TIA), a Depression-era statute governing bond indentures. The restructuring presented bondholders with a choice between exchanging their bonds for equity and being left with claims against an empty shell by virtue of a foreclosure by secured creditors. The decision, which is currently under review by the Court of Appeals for the Second Circuit, has attracted a lot of attention in bond markets and has affected debt restructurings across the country. According to the decision, the TIA prohibits debt restructurings outside bankruptcy that “impair” a dissenting bondholder’s recovery, even if they do not change payment terms or make the bonds payable in something other than cash. The decision relied heavily on the legislative history of the statute and concluded that transactions like the one in Marblegate were precisely what Congress intended to prohibit.

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The Optimal Size of Hedge Funds

Chengdong Yin is Assistant Professor of Finance at Purdue University. This post is based on a recent article by Professor Yin.

In my article, The Optimal Size of Hedge Funds: Conflict between Investors and Fund Managers, forthcoming in the Journal of Finance, I examine whether the standard compensation contract in the hedge fund industry aligns managers’ incentives with investors’ interests. One of the important ways in which hedge funds differ from traditional investment vehicles is in the design of managers’ compensation contracts. A key difference is that, in contrast to their peers in the mutual fund industry, hedge fund managers charge an additional performance-based incentive fee. The incentive fee allows hedge fund managers to charge part of fund profits as their compensation and is intended to motivate them to maximize fund performance.
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Citigroup: Delaware Court on “Holder Claims”

Meredith E. Kotler is a partner in the New York office of Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb publication by Ms. Kotler and Vanessa C. Richardson. This post is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Supreme Court recently addressed the issue of whether “holder claims”—claims brought by investors seeking damages based on continuing to hold stock in reliance on a company’s alleged misstatements, rather than buying or selling—are direct or derivative in nature. In Citigroup Inc., et al. v. AHW Investment Partnership, et al., No. 641, 2015, 2016 WL 2994902 (Del. May 24, 2016), the Court held that “the holder claims are not derivative because they are personal to the stockholder and do not belong to the corporation itself.”

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Tilton: Constitutional Challenge to SEC Administrative Proceedings

Jason M. Halper is a partner in the Securities Litigation & Regulatory Enforcement Practice Group at Orrick, Herrington & Sutcliffe LLP. This post is based on an Orrick publication by Mr. Halper, Paul F. RuganiKatherine L. Maco, and Bronwyn James.

On June 1, the Second Circuit in Tilton et al. v. SEC, No. 15-2103 (2d. Cir. Jun. 1, 2016), echoed recent Seventh and D.C. Circuit decisions (respectively, Bebo v. SEC, No. 15-1511 (7th Cir. Aug. 24, 2015), cert. denied, 136 S. Ct. 1500 (Mar. 28, 2016), and Jarkesy v. SEC, No. 14-5196 (D.C. Cir. Sept. 29, 2015)) in finding that constitutional or other challenges to SEC proceedings cannot go forward in court until the administrative proceeding ends; review can only be sought as an appeal from a final decision by the Commission. The Second Circuit’s decision in Tilton creates unanimity among the circuit courts that have addressed the issue to date, although, as we previously reported, the Eleventh Circuit is likely to rule on the issue sometime this year in Hill v. SEC, No. 15-12831. Unless the Eleventh Circuit bucks this trend and creates a circuit split, it now looks unlikely that the Supreme Court will weigh in on this issue (particularly because the Supreme Court previously denied a petition to review the Seventh Circuit’s decision in Bebo).

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Toward Better Mutual Fund Governance

Anita K. Krug is D. Wayne and Anne Gittinger Professor of Law at University of Washington School of Law. This post is based on Professor Krug’s chapter in the forthcoming book, Handbook on the Regulation of Mutual Funds. The full chapter is available here.

The financial crisis brought substantial change to the financial services industry, thanks largely to Congress’s post-crisis passage of the Dodd-Frank Act. Subjecting swaps and hedge fund managers to regulatory oversight and reforming the rules applicable to credit rating agencies are but a small sample those changes. Dodd-Frank did not, however, bring about any significant change the regulation of mutual funds—“pooled” investment entities that are regulated under the Investment Company Act of 1940 (“ICA”).

That circumstance may seem sensible, in that mutual funds are not widely regarded as having been a substantial contributor to the onset and severity of the financial crisis. Yet, the financial crisis did, in at least one respect, change the way that mutual funds operate. In particular, it produced a new model of mutual fund governance, one that may be superior to the governance model that has dominated the mutual fund industry for decades.

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When Are Weak Property Rights Optimal?’

Carmine Guerriero is Assistant Professor of Economics at the University of Amsterdam. This post is based on Professor Guerriero’s recent paper, available here.

While economists have long maintained that weak property rights are detrimental for development since they discourage effort and investment (Besley and Ghatak, 2010), legal scholars have argued instead that they can be optimal whenever transaction costs prevent consensual trade (Calabresi and Melamed, 1972). In my paper Endogenous Property Rights, forthcoming at the Journal of Law and Economics, I blend these two opposing ideas and I empirically document both the general incompleteness of property rights and their positive relationships with several measures of preference heterogeneity in 126 jurisdictions.

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