OnLine Law Review Articles and the Evoluation of Legal Scholarship (Part 2)

Law reviews recognize some of these limitations and have, to some degree, fought back.  Probably all of them have a web presence.  Some, however, have gone further and sought to publish a separate Internet journal that presumably publishes articles more quickly.  These pieces presumably go through a cite checking and editing process.  Some appear in Lexis and Westlaw. 

A cursory review of a number of journals, however, reveals that the pieces sought are typically short (sometimes very short), lightly footnoted (often not footnoted at all) and frequently in the nature of an opt ed or opinion piece.  Penn (in PENNumbra) seeks pieces not to exceed 3000 words (with footnotes not to exceed 1250 words) that are either response to articles or "debates".  Michigan, in First Impressions, seeks "opt-ed length pieces".  Columbia publishes "Sidebar," which targets "responses to scholarship that appears in its print edition, and original pieces on current legal issues."  Georgetown calls its online presence Ipsa Loquitur the "blog and online companion" to the Law Journal.  The students are specifically looking for "more informal blog posts as well as formal responses to in-print scholarship, scholarly debates, and case comments."

To the extent these pieces are lightly footnoted and short, they minimize the work that already excessively busy students must do to ensure publication.  On the other hand, to the extent they are essentially extended blog posts, there would likely be numerous online places where they could be published.  The value added of appearing on a law review site (other than the status that comes with the ability to add a prominent law school name to the citation) is unclear. 

A significant exception appears to be the Yale On Line Journal.  Originally called "the Pocket Part," the On Line Journal has a more developed philosophy and seeks "scholarship on recent legal and political developments and responses to scholarship published in the printed pages of The Yale Law Journal."  The pieces seem longer (1500 to 6000 words, not including footnotes) and have more detailed footnotes.  The current piece, The Supreme Court (of Baseball), is online without footnotes but an attached PDF Has 200 of them.  The submission guidelines are here.  In other words, the pieces are more scholarly, are likely published faster, and relate to current developments in the law.

So this leads to the question, what role should online journals play?  There is in the legal community a deep need for short, focused, thoughtful pieces on current developments.  This means something more than opt eds and opinions pieces (not because they aren't valuable but because there are plenty of existing outlets for these sorts of publications) but not as lengthy as traditional law review articles. 

Morever, the need is particularly important for inchoate developments.  Judges and clerks might benefit from analysis of cases on appeal (as we have noted on this Blog, law clerks read blog posts).  Regulators might benefit from analysis as they engage in the rulemaking process.  Imagine all of the provisions in Dodd-Frank that regulators are struggling to understand and implement.  Litigators developing strategies (say on the current spate of law suits arising out of the financial crisis) might benefit from creative theories. 

As an example, the DC Circuit recently struck down the SEC's shareholder access rule, Rule 14a-11. The underlying issues of shareholder access are widely known.  The DC Circuit's opinion, however, was a hybrid.  It turned on administrative law issues, an arcane area that can be very difficult to understand.  This is in part because administrative law contains any number of black letter principles that can be taught but also can be routinely ignored by the cours (with the Supreme Court likely the worst offender). 

So I wrote a short paper on the issues contained in the case, discussing some of the complexities involved in the interrelationship between corporate governance and administrative law, Shareholder Access and the Uneconomic Analysis:  Business Roundtable v. SEC.  The piece was then very quickly published in the online law review at the University of Denver Sturm College of Law after going through a quick editing and cite checking process.  The law review version is here.  The paper was downloaded frequently on SSRN during the first month of publication. 

The piece has the potential to have some long term value.  The DC Circuit's analysis will likely be discussed in the literature for years.  Rapid publication, however, was useful to a number of ongoing developments.  The SEC had to decide whether to seek rehearing or file for certiorari (it ultimately did not).  The SEC also had to decide whether to repropose the rule struck down in the case and, if so, how to deal with the court's criticisms (no public decision there yet). 

This suggests that scholarship is not a dichotomy between blog posts and traditional law reviews.  There is a need for intermediate scholarship, something thorough but short, involving current issues and published quickly.  Such scholarship would be particularly useful to decision makers, particularly when addressing issues or concerns outside of the decision maker's traditional area of expertise.  These pieces can have high influence but short shelf lives.  

For "intermediate" scholarship to become common, there will need to be more online outlets.  The outlets will need to accept pieces that, even though short, are well footnoted.  This may mean a larger law review staff.  Most importantly, however, this type of scholarship will only become common if the academic community sees the value and provides sufficient incentive. 

OnLine Law Review Articles and the Evoluation of Legal Scholarship (Part 1)

For most of the history of law teaching, the law review article was generally considered the highest form of legal scholarship, at least among academics.  Moreover, publications in one of the top journals was synonomous with quality.  This was true despite the fact that top law reviews often had a demonstrated bias for taking articles from their own faculty.  Nonetheless, it was the system and it was influential.  Reputation, tenure, and elevation among the hierarchy of law schools often turned upon the number of law review articles and their placement in top journals. 

The digital age has, however, eroded this system, although many are not yet fully aware of this.  While placement in a top journal remains di rigueur for academics, it has become less important to those actually relying on the work.  To the extent the paper is posted on one of the online services such as SSRN, anyone with a browser can find it, whether its in the Harvard or the Alaska Law Review (published by Duke by the way).  Decision makers (judges, legislators, regulators) are less interested in the where of publication and more interested in the what of teh contents (the type and quality of the analysis).

The digital age has also raised another concern with respect to law reviews.  In a digital age, they are slow, glacially slow.  For those articles designed to be written for the ages, the delay between submission and publication is probably not very important, even in the digital age.  The works of a Karl Llewellyn or a Justice Brandeis would likely have the same influence.  But for many scholars, the work will likely have a more immediate and short lived impact.  In those circumstances, a delay in publication matters.

Blogging has provided some competition.  It represents a mechanism in the digital age that allows for rapid analysis in a place that can be easily located.  Blogging can involve extensive discussions of cases or issues that rival those in law reviews.  (This Blog, for example, often has multiple part series on the same case or development).  As a result, blog posts are frequently cited in law review articles and by courts.  Although now a bit dated, take a look at the data in Of Empires, Independents, and Captives: Law Blogging, Law Scholarship, and Law School Rankings. 

But blogs have disadvantages.  For one thing, life on the Internet is a state of nature that Thomas Hobbes would recognize.  There are fewer rules and accepted conventions.  For another, blog posts do not get the benefit of cite checking and other student provided editing services associated with law reviews.  (This Blog, however, does have a student review process for student posts).

Which brings us to what I describe as "Intermediate Scholarship," something most apparent from online journals.  We'll pick this up in the next post.

Eyes Wide Open: New York Court of Appeals Upholds Broad Release of Claims in Centro Empresarial Cempresa S.A. v America Movil, S.A.B. de C.V.

In Centro Empresarial Cempresa S.A. v America Movil, S.A.B. de C.V., 2011 NY Slip Op 4720, 1 (N.Y. June 7, 2011), the court upheld the dismissal of Plaintiffs’ complaint alleging fraud, breach of contract, and breach of fiduciary duty arising out of the sale of their interests in Telmex Wireless Ecuador (Telmex México) to defendant América Móvil, holding that the claims were barred by the broad general release signed at the time of the transaction. 

Plaintiffs, two Ecuadorian holding companies, and Telmex México, a Mexican telecommunications holding company, formed Telmex Wireless Ecuador LLC (TWE) to acquire interests in Consorcio Ecuatoriano de Telecomunicaciones S.A. Conecel (Conecel), an Ecuadorian telecommunications company.  Plaintiffs received a minority stake in TWE.

In forming TWE, the three companies signed a number of agreements, including the “Agreement Among Members,” which gave Plaintiffs the right, in the event of a rollup of TWE into another entity, to obtain reasonable financial, accounting, and legal information, and to exchange their TWE shares for shares in the new entity.  In addition, the “Put Agreement” gave Plaintiffs the right to sell their TWE shares to TelMex at a floor price during certain windows between March 2002 and March 2006.

In September 2000, Telmex México rolled TWE into a new entity, América Móvil, S.A.B. de C.V. (América Móvil).  Plaintiffs alleged that they then repeatedly requested financial information and reports in order to negotiate a share exchange under the “Agreement Among Members,” but never received this information.  Further, Plaintiffs alleged that América Móvil falsely represented Conecel’s financial position in order to avoid distributing profits.  As a result, Plaintiffs exercised their March 2002 put option and sold 50% of their TWE shares to TelMex.

In July 2003, Plaintiffs agreed to sell the remainder of their TWE shares to Telmex at the floor price.  As part of this agreement, Plaintiffs signed two releases.  The “Members Release” released Telmex from “all manner of actions…past, present, or future” arising out of the agreement or out of ownership of interests in TWE.  The “Master Release” contained similar language, but included a clause excluding releases of claims involving fraud.

In 2008, Plaintiffs brought an action against Defendants in New York Supreme Court alleging fraud, breach of fiduciary duty, and breach of contract arising from Defendants’ failure to provide financial information and negotiate a share exchange in good faith. The trial court denied Defendants’ motion to dismiss on grounds that the action was barred by release.  On appeal, Plaintiffs argued that the “Members Release” did not encompass fraud claims, and that even if it did, it was fraudulently induced.  The Court of Appeals rejected this argument, reasoning that a release may encompass unknown fraud claims and may only be challenged as fraudulently induced if the challenge identifies deception distinct from the subject of the release.  Because Plaintiffs did not allege such a distinct instance of deception, the claim of fraudulent inducement failed.  Finally, the court declined to read the fraud claim exclusion of the “Master Release” into the “Members Release,” holding that it was the latter that governed Plaintiffs’ claims.

The court also rejected Plaintiffs’ arguments that they reasonably relied upon América Móvil’s representations as a fiduciary, concluding that Plaintiffs were sophisticated principals with “eyes wide open” to Defendants’ alleged propensity for fraud, yet failed to protect themselves properly when agreeing to the “Members Release.”

Because the “Members Release” that governed Plaintiffs’ claims was broad enough to encompass fraud, and was not induced by a fraud separate from that alleged in the claims, the court affirmed the Appellate Division’s dismissal of the case under CPLR 3211 [a] [5] (“Motion to dismiss cause of action” on grounds of release) and awarded court costs to Defendants.

The primary materials for this case may be found on the DU Corporate Governance website.

CFTC v. Walsh: Fraud and the Financial Benefits of Divorce

In Commodity Futures Trading Comm. v. Walsh, No. 91, (N.Y. June 23, 2011), the court held Janet Schaberg, the ex-spouse of Stephen Walsh, was entitled to keep assets awarded during her divorce, even if those assets turned out to be  proceeds from fraud.  Stephen Walsh and his partner, Paul Greenwood, are currently defendants in a pending case brought by the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”).  The CFTC and SEC allege Walsh and Greenwood defrauded public and private investors of more than $550 million between 1996 and 2009.  There is no evidence that Schaberg had knowledge of Walsh’s activities. 

After 25 years of marriage, Schaberg and Walsh filed for divorce in 2005.  In 2006, Schaberg and Walsh entered into a Stipulation and Settlement Agreement under New York Domestic Relations Law §236(B)(3).  Under the stipulation, Schaberg received ownership of two properties in New York and Florida valued at $6.7 million and relinquished her interest in the couple’s Port Washington, New York home, valued at $7.5 million.  Schaberg also received $5 million held in bank accounts and a distributive award of $12.5 million payable by Walsh in installments through 2020. 

The CFTC and SEC filed their complaints in 2009. In the complaints, the agencies sought disgorgement of proceeds from the fraud against Walsh, Greenwood, and Schaberg.  Schaberg argued her divorce settlement was not subject to disgorgement because she became a “good faith purchaser for the value of the assets” when she entered into her divorce stipulation. 

To determine whether Schaberg’s property was subject to the agencies’ injunctions, the court first considered whether marital property included proceeds of fraud under New York law.  New York state law defined marital property as “all property acquired by either spouse during the marriage but before entering into a separation agreement.” The court concluded that property attained with the proceeds of fraud did constitute marital property and because marital property encompassed all property acquired during the marriage, marital assets could be transferred to an innocent spouse even if illegally acquired. 

The CFTC and SEC argued that the court should recognize an exception based on the public policy of returning stolen property to its rightful owner.  The court rejected this contention noting that money, though acquired through fraud, cannot be earmarked or traced.  Additionally, the court noted public policies favoring finality of business transactions and divorces, which enable ex-spouses to move forward with their lives. 

The court next considered whether Schaberg acted in good faith and paid fair consideration for the property she acquired from the divorce.  The CFTC and SEC argued that Schaberg did not give fair consideration by relinquishing her right to other marital property because it was all created by fraud thus resulting in illusory consideration.  Schaberg argued that she provided fair consideration and became a good faith purchaser.  Debtor and creditor law in New York defined a good faith purchaser as someone who has given fair consideration without knowledge of the fraud.  (Debtor and Creditor Law §278 [1])  To determine whether Schaberg paid fair consideration, the court looked at whether Schaberg relinquished rights to any untainted marital property and non-tangible assets.  The court left the question of fair consideration to the federal courts but did note that Schaberg not only relinquished her interests in the estate owned by the couple but also her right to inherit from Walsh and any claims to maintenance. 

The court concluded Schaberg’s claims to her divorce proceedings prevailed over the victims’ claims for disgorgement because she acted in good faith and had no knowledge of the fraud.  The court also noted New York’s strong public policy for finality of divorce proceedings.

The primary materials for this case may be found on the DU Corporate Governance website. 

New Jersey Court Denies Plaintiffs’ Claims for Tort Damages Arising From Contractual Obligations

In Scherillo v. Dun & Bradstreet, Inc., 2011 WL 2610134 (D. N.J. June 30, 2011), the court granted the defendant’s motion for summary judgment finding that neither plaintiff can base their claims in tort when the obligations rose out of contractual obligations. In their individual complaints, the plaintiffs claimed that Dun & Bradstreet (“D & B”) negligently misrepresented thoroughly investigating Agape World, Inc. (“Agape”) and failed to reveal that Agape’s CEO had a securities fraud conviction from 1999. Agape purportedly provided high interest bridge loans for large construction projects and claimed to offer a 10% return on investment over a two-month period.

In 2007 and 2008, individual plaintiffs John Scherillo and Richard Racioppi invested more than $1 million in Agape. Each investor was concerned about the validity of the company and sought a risk assessment report from D & B.  The report indicated that there had been no criminal action against Agape’s management.  Relying on the D&B report, each plaintiff continued to invest significant amounts of money in Agape. In 2008, Racioppi and Scherillo were unable to withdraw their investments in Agape. Agape executives informed Racioppi and Scherillo that contracts were being delayed and all funds were frozen. The plaintiffs later found that Agape’s CEO was convicted of securities fraud in 1999, information that was omitted from the D & B report.

In March of 2009, each plaintiff filed a complaint against D & B alleging gross negligence and negligent misrepresentation.  Scherillo sought $75,000 in compensatory damages and $5 million in punitive damages while Racioppi sought $1 million in compensatory damages and $5 million in punitive damages.

On June 30, 2011, the court granted the defendant’s motion for summary judgment, finding that neither plaintiff could base their claims in tort when the obligations arose out of a contractual obligation. Specifically, the court found that “a tort remedy does not arise from a contractual relationship unless the breaching party owes an independent duty imposed by law.”  New Jersey imposed an independent duty only on physicians, attorneys, insurance brokers, and manufacturers. Here, the plaintiff’s contended that D & B assumed the duty to fully and properly disclose information. The plaintiffs, however, admitted in their complaints that this duty arose out of a contractual obligation. The court found that there was no independent duty to fully and properly disclose information. Thus, D & B was not under an independent duty imposed by law and the plaintiff’s claims were actionable only under contract law.  

The primary materials for this case may be found on the DU Corporate Governance website.

Book Review: Wang & Steinberg, Insider Trading, 3d Edition

As the SEC struggles in the courts (see Business Roundtable v. SEC and Gupta v. SEC), one area where the Commission has not incurred significant difficulty has been with respect to insider trading cases. 

The Commission continues to bring these cases and win them.  Moreover, recent actions have involved exam like fact patterns.  Some included allegations of a father tipping a son, a chemist in a government agency trading on confidential information, and a husband misappropriating information from a wife.  In one instance, the Commission asserted that the defendant "exploited his romantic relationship for a financial windfall."  In addition to officers and directors, the SEC has brought actions against participants in expert networks, portfolio managers at hedge funds, attorneys, analysts and even one former baseball player.

In short, insider trading represents an active and high risk area for those involved in the capital markets.  Moreover, the law is remarkably complex and requires an understanding of such issues as the existence of a duty of trust and confidence, the need for, and violation of, a fiduciary duty, and the status of third parties as temporary insiders.  Moreover, the risk is not only to individuals.  Employers can be liable for insider trading if reckless in allowing the behavior to occur. 

All of this suggests the need for a resource that can explain these requirements in a straightforward and thorough manner.  Insider Trading 3d Edition, Oxford Press, by Professors William K. S. Wang (Hastings) and Marc I. Steinberg (SMU) does exactly that. 

The book contains 15 chapters that examine the basics of insider trading under federal law, the causes of action under state law, and everything in between.  For example, Chapter 7 comprehensively deals with government enforcement.  Chapters 9, 10, and 11 contain clear analyses of Securities Act section 17(a), Rule 14e-3, and mail/wire fraud.  Chapter 13 provides a valuable discussion of compliance programs.

The most complete analysis of the theories of insider trading takes place in Chapter 5, where the book undertakes an extensive discussion of classical insider trading (Dirks v. SEC, 463 US 646 (1983)) and misappropriation (United States v. O'Hagan, 521 US 642 (1997)).  The chapter examines the type of "relationship" necessary to trigger a prohibition on classical insider trading (including the sometimes sticky issue of independent contractors) or to implicate the misappropriation doctrine (including government employees, doctors, and attorneys). 

Chapter 5 discusses whether the personal benefit requirement mandated for classical insider trading also applies in misappropriation cases (pp. 393-94; pp. 469-476) and contains a brief but important discussion of a very difficult issue:  Whether donations of stock to charity while in possession of material non-public information amounts to insider trading (pp. 396-397). 

The book is a must for anyone who wants to avoid insider trading/tipping liability or otherwise wants to understand this  Delphic area of the law.  

Law School, Economics, and the NYT

The NYT had an article that purported to look at the economics of law school (Law School Economics: Ka Ching!).  It is a good subject that deserves debate.  The piece in the NYT, however, did not do justice to the issue.  It mostly focused on New York Law School and its dean, containing a mish mash of points that were not all well defended.  

First, the article notes that "law schools toss off so much cash they are sometimes required to hand over as much as 30 percent of their revenue to universities, to subsidize less profitable fields."  True.  But its not a secret, open or closed.  Its in the open.  It explains why law schools continue to open.  Were they unprofitable and not supportive of the university setting them up (the common model is to have law schools attached to a university), it is hard to understand why new schools would open. 

Having said that, the article starts with this point but then promptly spends most of the text describing NY Law School.  As the article describes:  NY Law School is a "PRIVATE, stand-alone institution located in the TriBeCa neighborhood of downtown Manhattan".  In other words, it is a free standing law school, not part of a larger university, and presumably does not pay the tax to anyone.  So much of what follows is unrelated to this point.

Second, the article suggests that the dean of New York Law School, Richard A. Matasar, is somehow saying one thing but in practice doing something else.  Dean Matasar is supposed to be someone who contends that law school should put students first.  Yet at the same time, he has grown the size of the law school.  The implication is that these two approaches are inconsistent.

While it is true that every student admitted by NY Law School provides an income stream, this does not mean he is working against the interests of students.  In fact, the one statistic not mentioned in the article is that there are thousands of students every year who apply to law school and do not get in, mostly because they have low test scores.  Yet a low test score does not meant that these students will make bad lawyers.  By opening the doors, Dean Matasar arguably gives more students a shot at a career in law, some of whom would probably not matriculate to any other law school. 

Third, the article suggests that there is something wrong with increasing the number of students just when the job market was imploding.  For one thing, those admitted would have at least three years before they hit the job market.  Presumably, as already appears to be the case, the job market would be on the mend. Thus, the article instead notes that, with respect to the 2009 class, "if the experience of recent N.Y.L.S. graduates is an indication, many are in for a lengthy hunt."  But those students graduated during the recession.  While the students graduating in 2012 may have difficulty, it is not likely to be as difficult as those looking for work during the recession. 

In general, articles that point to the relationship between the number of newly created legal positions and the number of graduates usually omit to discuss thos positions that while not entirely legal benefit considerably from a law degree (dean of students at a university; head of HR in a corporation; member of the police force seeking officer status).

Fourth, the article asserts that the explanation for the rise in tuition at law schools is US News.  As the article notes, the "most bizarre" explanation for the increase "comes courtesy of the highly influential US News rankings."  It is true that US News ranks law schools in part based upon the expenditures per student.  But it is something altogether different to suggest that this drives law tuition upward.  There are plenty of reasons that drive of tuition unrelated to US News. 

Take NY Law School.  Perhaps NY Law raised tuition because of US News (rather than say because it is located in a high cost area).  But if ranking in US News was such a driving force, NY Law would likely have not admitted so many additional students (736 students in 2009, a 30% increase, according to the article, something the dean attributed to unexpected yield).  The surge in additional students does not help with US News.  They pay the same tuition and at best leave the per capita expenditures unchanged.  So while they provide additional funds, it does not generally help with the rankings.     

On the other hand, additional students can very much hurt US News rankings.  Unless there is massive hiring to compensate for large increases in the number of students, they hurt the faculty student ratio, another factor in the rankings.  Larger classes also put downward pressure on the median LSAT, the median GPA, and the acceptance rate, statistics that make up 25% of the US News rankings. (I've made no attempt to look at what actually happened in the case lf NY Law). Finally, when the students hit the job market, the hiring statistics are likely to suffer. 

US News does not, therefore, benefit schools that admit large numbers of students.  Quite the reverse.  In other words, what ever upward pressure US News puts on total tuition, it does not put equal pressure on class size.    

There are serious issues to discuss in this area.  Tuition has risen; the number of students are increasing; law jobs are likely harder to obtain.  But the article in the NYT makes too many disparate and often disconnected points in the context of a single law school to really advance the discussion.  

Board Diversity and "The Hottest New Companies"

The New Yorker has an article on Sheryl Sandberg, who jumped from Google to Facebook. How is it for women on the board of "the hottest new companies" in high tech?  Not good.  According to the article:

• Among the hottest new companies— Facebook, Twitter, Zynga, Groupon, Foursquare—none, as Kara Swisher reported in the blog All Things Digital, has a female director on its board. PayPal has no women on its five-member board; Apple has one of seven; Amazon one of eight; Google two of nine. When I asked Mark Zuckerberg why his five-member board has no women, his voice, which is normally loud, lowered to a whisper: “We have a very small board.” He went on, “I’m going to find people who are helpful, and I don’t particularly care what gender they are or what company they are. I’m not filling the board with check boxes.” (He recently added a sixth member: another man.) The venture-capital firms that support new companies have even sharper imbalances; Sequoia Partners lists eighteen partners on its Web site, none of them women.

Id. at p. 3.  So the problem of board diversity isn't a matter for old line companies but extends to the most innovative or as the New Yorker puts it, the hottest, companies.  

So Long, Sheila Bair

Sheila Bair’s five-year term as Chairman of the Federal Deposit Insurance Corporation (FDIC) ends today, Friday, July 8th. During her tenure, Bair racked up an impressive list of achievements. Notably, even with the recent wave of bank failures, Bair managed to use only the industry-supplied deposit insurance fund (DIF), and not taxpayer dollars to shut down and sell off hundreds of insolvent banks.

Reflected in her vigilance over the DIF was the broader view that financial institutions, their leaders and investors (and not the public) should bear the losses from their failures. This perspective appeared to inform her other policy choices.  Indeed, her final accomplishment was the FDIC board’s unanimous approval on Wednesday of a new rule to claw back banker pay. The rule permits the FDIC acting as liquidator, to demand the return of two years of pay of senior executives and directors who were substantially responsible for the bank’s collapse.

Also, Bair was a leading voice for establishing international limits on bank borrowing, with a total-assets-to-equity leverage ratio. Supplementing the easily-gamed risk-weighted measures, this simple leverage ratio could help block bank efforts to game the system with poorly designed or misused mathematical models. Bair fought successfully to expand the FDIC’s authority through the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. As a result, instead of choosing between a taxpayer-funded-bailout and a Lehman-style-chaotic bankruptcy, there is a third choice. The FDIC has the power to bring into receivership, liquidate and shutdown failing bank holding companies and certain other systemically important nonbank financial firms.  There are legitimate questions as to whether this “orderly resolution” authority will be used effectively, if at all. However, it’s existence encourages the ongoing debate over whether we still need to break up the banks in terms of lines of business to make them no longer too big or too interconnected to fail.

Perhaps the most admirable of her accomplishments was her ability to maintain clarity and dignity amid accusations that she was not a “team player.”  When that “team” scored points at the expense of the American people, in my view, her resistance deserves a badge of honor. The so-called team players who serve in public office do us no favors when they are “just following orders” of misguided leaders.

Bair was early to see the threat of predatory lending. From a previous position as Assistant Secretary of Financial Institutions at Treasury, before departing for a short term in academia, she tried in 2002 to end those practices and met substantial resistance.  Indeed, she would later testify before the Financial Crisis Inquiry Commission (“FCIC”) of the grave consequences of Alan Greenspan’s failure as Chairman of the Fed to use its authority under the Home Ownership and Equity Protection Act (HOEPA), to ban bad underwriting practices at both banks and “nonbank” institutions. According to the FCIC report:

“This was a missed opportunity, says FDIC Chairman Sheila Bair, who described the ‘one bullet’ that might have prevented the financial crisis: ‘I absolutely would have been over at the Fed writing rules, prescribing mortgage lending standards across the board for everybody, bank and nonbank, that you cannot make a mortgage unless you have documented income that the borrower can repay the loan.’” (emphasis added).

Also, Bair advocated strenuously for loan modifications to help prevent an avalanche of foreclosures.  Bair’s performance reminds us that people matter, not just the institutions which they inhabit.

In addition to being a public servant, Bair is also a former colleague from the University of Massachusetts, Amherst. While our paths overlapped, for about eighteen months, given that we were in different departments, I had only a few occasions to converse with her. However, I benefited greatly from her presence. Bair enriched our community with her interests in corporate governance and her contacts. While a faculty member, in 2005, Bair brought Senator Paul Sarbanes to visit and address a class of MBA students and also the wider University.  And, after she rose to be listed by Forbes magazine as the second most powerful woman in the world, Bair returned, including to speak about the financial crisis and also to deliver a commencement speech.  Not an academic by trade, Bair was welcomed by Isenberg School of Management, Dean Tom O’Brien. Though he refused to take credit for his foresight, O’Brien had a knack for attracting and nurturing original thinkers and rising stars to our school. In addition to Bair, for example, he brought in Nassim Taleb who taught at UMass for a year, during which time he worked on his soon-to-be-acclaimed book, The Black Swan.

With Bair goes one of the three “New Sheriffs of Wall Street” featured on the cover of Time magazine May 13, 2010.  The cover photo mirrored one from a decade earlier. The now iconic and ironic February 15, 1999 Timecover portrayed the “Committee to Save the World.”  In that image, Alan Greenspan stood smiling assuredly front and center, flanked by a twinkle-eyed Robert Rubin and a seemingly annoyed Lawrence Summers. The subtitle of the article promised “The inside story of how the Three Marketeers have prevented a global economic meltdown – so far.”  Missing from that photo, quite unfortunately, was someone who could have actually help prevent a global economic meltdown – Brooksley Born, whom we have discussed, here. Born would resign from the CFTC a few months after the Time article.

On last year’s cover, SEC Chairman Mary Schapiro appeared in the center spot where Greenspan had posed. Professor Elizabeth Warren, then head of the Congressional Oversight Panel on the TARP and Sheila Bair took the places inhabited by Rubin and Summers. The subtitle identified the trio as “The Women Charged with Cleaning up the Mess.” Just as the Three Marketeers were not able to save the world, and indeed created quite a mess, the New Sheriffs, cannot on their own clean it all up.  And certainly not without the ongoing support of the Congress. Administration and other financial regulators.

After all, the build up and burst of the housing bubble was not a weekend-long frat party. Greenspan had more than twenty years to wreak havoc. In his own estimation, under oath last year, he volunteered that he was wrong thirty percent of the time.  Two decades of leadership with that ratio proved disastrous. And though Rubin and Summers were not each fixtures as Treasury Secretaries and other Administration roles for that long, they did manage to champion the most damaging acts of financial market deregulation in the past century. These included the gradual erosion and ultimate repeal in 1999 through Gramm-Leach-Bliley of the Glass-Steagall Act’s separation of commercial from investment banking. Also included was the passage in 2000 of the Commodity Futures Modernization Act, which fostered the explosion of credit default swaps. Both of those took place after the photo was snapped.

Sadly, one member of the sheriff-cleanup-crew is moving on. Yet, she leaves our country, the financial system, and my former University far better than she found them.

This essay was previously published on July 8, 2011 on The Pareto Commons blog.

Leadership in New York and Gay Marriage

My legal career had the distinct fortune of beginning with clerkship with the Honorable Frank M. Johnson, Jr., the judge who, in the Middle District of Alabama, provided the crucial second vote (in a 2-1 decision) in striking down segregation in the buses of Montgomery and allowed Martin Luther King to march from Selma to Montgomery.  Listen to Martin Luther King say in a megaphone that Judge Johnson had just ruled that marchers had a "legal and constitutional right" to march (at minute 3.10 of the video).  At the time I clerked he had been elevated by President Carter to the US Court of Appeals for the 11th Circuit.

In hindsight, these decisions look obvious but at the time, Judge Johnson paid a heavy price for them.  In addition to the need for protection from the US Marshals because of the constant threats, a cross was burned on his lawn and his mother's house was dynamited.  The story is that President Nixon wanted to appoint Judge Johnson to the US Supreme Court but that his civl rights decisions were so unpopular, politicians from the south intervened and convinced Nixon to do otherwise.  It was a price he was willing to pay and required considerable courage. 

Less known, however, is that Judge Johnson showed the same courage with respect to gay rights.  Judge Johnson wrote the lower court opinion in Hardwick v. Bowers, 760 F.2d 1202  (11th Cir. 1985).  He, along with his friend, Judge Tuttle, struck down the anti-gay sodomy law in Georgia.  The story I heard from one of his later clerks was that he personally turned to Judge Tuttle in conference and said that he saw nowhere in the Constitution that made this practice illegal.  Judge Tuttle agreed.  Judges Johnson and Tuttle (in an opinion written by Judge Johnson) became the first federal appellate court to strike down this type of law. 

The Supreme Court would later reverse the decision in a 5-4 decision.  See  478 U.S. 186  (1986).   Justice Powell, the deciding vote in the case would later acknowledge that he had made a mistake in voting to overturn Judge Johnson's decision. 

The US Supreme Court eventually reversed its decision in Bowers in Lawrence v. Texas, 539 U.S. 558  (2003).  Judge Johnson didn't live to see the ultimate vindication of his lower court opinion in Bowers, having died in 1999.  But Mrs. Johnson did and in a conversation with her a year or so after the decision, she would read to me the sentence in Lawrence where the Court said that "Bowers was not correct when it was decided, and it is not correct today."  For her, that sentence could just as easily have been rewritten to say that Judge Johnson was right then and was right now. 

All of this comes back with the decision over the weekend in New York to allow gay marriage.  New York has taken a mighty step forward in eliminating a government sanctioned form of discrimination.  The NYT had an insightful piece on the behind the scenes process that resulted in the action.  What the piece makes very clear is that approval as not preordained but required the extraordinary intervention from a number of people, particularly the governor, Andrew Cuomo. 

In an era where politicians are mostly criticized for their self serving behavior, Governor Cuomo showed courage and leadership.  I can't help but think that his behavior is reminiscent of what Judge Johnson would have done had he been in the same position. 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (Regulatory Alternatives) (Part 8)

We are examining the combination between NYSE Euronext and Deutsche Borse.  The transaction will need to be approved by the SEC.  One way to avoid the SEC's oversight is for the NYSE to get out of the regulatory business.  Should this be considered?

It would certainly free the NYSE from an onerous level of SEC oversight.  The NYSE for example has mandatory limits on stock ownership and voting, restrictions that can't be changed without SEC approval. See Exchange Act Release No. 62032 (May 4, 2010) (“Specifically, no person (either alone or together with its related persons) is entitled to vote . . .  more than 10% of the then outstanding votes entitled to be cast on such matter. . . . In addition, no person (either alone or together with its related persons) may at any time beneficially own shares of stock of NYSE Euronext representing in the aggregate more than 20% of the then outstanding votes entitled to be cast on any matter.”).

Likewise the NYSE can't sell its own assets, at least those associated with the SROs, without SEC approval. See Exchange Act Release No. 53382 n. 64 (Feb. 27, 2006) (“In addition, pursuant to the Operating Agreement of New York Stock Exchange LLC, NYSE Group may not transfer or assign its interest in New York Stock Exchange LLC, in whole or part, to any entity, unless such transfer or assignment is filed with and approved by the Commission under Section 19 of the Act.").

Then there is the risk of liability.  NYSE-Euronext confronts the risk of controlling, aiding and abetting, and "a cause of" liability when the regulated entities fail to perform their regulatory function.  See Exchange Act Release No. 55293 (Feb. 14, 2007) (noting that controlling person of SROs "shall be jointly and severally liable with and to the same extent that the Exchange and NYSE Arca are liable under any provision of the Exchange Act, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action" and also noting possibility of aiding and abetting liability and Commission's authority to bring cease and desist orders against those who are "a cause of" a violation).

This is more than an academic possibility.  The SEC has brought actions against the SROs for failing to adhere to their regulatory mission.  See In re New York Stock Exchange LLC, Exchange Act Release No. 60391 (July 28, 2009) (cease and desist order for "failure to properly detect, investigate and discipline widespread unlawful proprietary trading by specialists on the floor of the NYSE"). 

Removing the regulatory function from the NYSE would free the entity from these restrictions.  Moreover, this has already been occurring.  The NYSE gave up most of its control over broker-dealers in the merger with FINRA. Likewise, much of the surveillance function has been taken over by FINRA.  SeeExchange Act Release No. 56145 (July 26, 2007) (discussing combination of “member regulation operations” from NYSE Group and NASD “ into a single self-regulatory organization;” transaction involved transfer of “member firm regulation and enforcement functions and employees from NYSE Regulation” to FINRA).  See also Exchange Act Release No. 62032 (May 4, 2010) (“The Financial Industry Regulatory Authority ("FINRA") performs some of the regulatory functions contracted out to NYSER pursuant to a separate multi-party regulatory services agreement with FINRA. These regulatory contractual arrangements closely parallel the regulatory arrangements for NYSE Amex that the Commission reviewed and approved in the NYSE Amex Approval Order.").

The remaining duties are modest, with one exception.  NYSE Regulation has four groups, Listed Company Compliance, Regulatory Policy and Management, StockWatch, and Regulation Administration and, at the end of 2010, had only about 50 people.  See Form F-4, at 409.  The only significant function, therefore, is the oversight of listing standards.

Any change in the regulatory scheme would probably have to encompass one of two models.  First would be to give all regulatory responsibility to the Securities and Exchange of Commission (or FINRA).  To some degree, this process is already underway. 

In the realm of listing standards, Congress assigned to the Commission the authority to write rules governing listing requirements for audit and compensation committees of the board.  Moreover, with respect to independent directors, Congress essentially allowed the SEC to define the term with respect to compensation committees by identifying factors that must be considered by the exchange.  

Shifting complete control of listing standards to the Commission would, therefore, hasten a process already underway.  To the extent this continued, it could result in a slow, piece meal process that would gradually deprive the exchanges of the benefits of regulation (the ability to determine the standards) while leaving them with the disadvantages (the SEC's extensive regulatory oversight).

Alternatively, the regulatory function could be mostly, if not entirely, left with NYSE Regulation (and FINRA).  NYSE Regulation could, however, be made entirely independent of the NYSE.  NYSE Regulation would become self funding.  A mechanism would need to be determined for designating directors of NYSE Regulation.  One possibility, which was suggested back in 2006, was to have the SEC appoint directors.  See Exchange Act Release No. 53382 (Feb. 27, 2006) (“This model would require the Commission to appoint directly the members of the entity overseeing NYSE Regulation.”). 

Both of these shifts would probably require legislation.  Moreover, it would be unlikely to happen unless the NYSE supported the change.  It would only occur, therefore, if the NYSE viewed the costs of the regulatory role as outweighing the benefits. 

As a passing note, while the issue of regulatory responsibility has been discussed in the context of NYSE Euronext, the same analysis would apply to any stock exchange that exists as a for profit business, including Nasdaq. 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (SEC Review and German Ownership) (Part 7)

So given these circumstances, what will the SEC confront when it is asked to approve this transaction?

Foremost, it will need to examine the independence of the exchanges owned by NYSE Euronext and the independence of NYSE Regulation.  So far, the Commission has indicated that no problems have arisen with for profit companies owning entities that perform regulatory functions.  See Exchange Act Release No. 62032 (May 4, 2010) (“The Commission's experience to date with the issues raised by the ownership by a holding company of one or more SROs has not presented any concerns that have not been addressed, for example, by Commission approved measures at the holding company level that are designed to protect the independence of each SRO.”).   Nonetheless, when the system was put in place in 2006, the approach involved prognostication.  Five years of experience provide an opportunity to examine actual experience.  The SEC should do this.

Second, the SEC will have to consider the role of the new holding company, a Dutch company and the configuration of the board of directors.  The holding company, a Dutch company, will presumably stand in the place of NYSE Euronext with respect to its authority over NYSE Regulation.  Directors of the Dutch holding company will presumably sit on the board of NYSE Regulation and the SROs.  Directors of the Dutch holding company will presumably have some say in any changes to the regulatory finance agreements used to fund NYSE Regulation.

The new holding company will have a majority of directors appointed by Deutsche Borse and, presumably, have a majority of non-US Persons.  When NYSE went public in 2006, this was not an issue. When it acquired Euronext in 2007, European ownership became significant. Euronext directors were guaranteed positions on the board.  Nonetheless, it was clear that NYSE directors would be in the majority.  See Exchange Act Release No. 55293 (Feb. 14, 2007) (“The proposed NYSE Euronext Bylaws provide that in any election of directors, the nominees who shall be elected to the NYSE Euronextboard of directors shall be nominees who receive the highest number of votes such that, immediately after such election: (1) U.S. Persons as of such election shall constitute at least half of, but no more than the smallest number of directors, that will constitute a majority of the directors on the NYSE Euronext board of directors; and (2) European Persons as of such election shall constitute the remainder of the directors on the NYSE Euronext board of directors.”).

In the current combination, however, Deutsche Borse will end up with 60% of the positions on the board.  See  Press Release from NYSE, Feb. 15, 2011 ("The Company will be lead by a one-tier board with 17 members - 15 directors plus the Chairman and CEO.  Of the 15 directors, 9 shall be designated by Deutsche Borse and 6 by NYSE Euronext.").  The chairman will be the CEO of Deutsche Borse and the CEO the CEO of NYSE Euronext.  See Form F-4, at 103. 

The arrangement will apparently continued for at least three years.  See Form F-4, at 160 ("Each of the directors will be nominated by the Holdco board of directors for re-election to the Holdco board of directors pursuant to a binding nomination at each of the annual general meetings of shareholders occurring in 2012, 2013 and 2014, except that the Holdco group chairman and the Holdco group chief executive officer will each also be nominated by the board of directors pursuant to a binding nomination for re-election to the board of directors at the annual general meeting of shareholders occurring in 2015.").  The same ratio applies on committees.  See Id. at 261("Each of the committees mentioned above will consist of three Deutsche Börse directors and two NYSE Euronext directors until the date of Holdco’s annual general meeting of shareholders occurring in 2015."). 

The SEC should, therefore, consider the impact of having a holding company board with a majority of directors designated by a foreign company on the regulatory mission.  This ought to include whether such directors (and such boards) have a different regulatory philosophy than the NYSE Euronext board and what impact, if any, it could have on the regulatory mission.   Perhaps this will not be a signficiant issue.  A majority of the board of NYSE Regulation must consist of "US persons".  See NYSE Regulation Bylaws, Article III, Section I ("A 'U.S. Person' shall mean, as of the date of his or her most recent election or appointment as a director any person whose domicile as of such date is and for the immediately preceding twenty-four (24) months shall have been the United States.").  Thus, irrespective of the nationality of the board of the holding company, NYSE Regulation's board will always have a majority of US Persons.

Nonetheless, these issues ought to be considered by the SEC when asked to approve the combintation. 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (Limits of Regulatory Independence) (Part 6)

We are discussing the possible combination of NYSE Euonext and Deutsche Borse.  The other place for influence by the holding company over the regulatory mission, at least in theory, arises from control over the SROs. 

Unlike NYSE Regulation, a majority of the directors of the boards of the SROs (NYSE Exchange, NYSE Arca and NYSE Amex), come directly from the holding company.  See Exchange Act Release No. 55026 (Dec. 29, 2006) ("a majority of the directors of each of the Exchange and NYSE Market must be directors of NYSE Euronext that satisfy the independence requirements of the board of directors of NYSE Euronext;").  They must, however, mostly consist of independent and a majority must be US Persons.  See also Exchange Act Release No. 58673(Sept. 29, 2008) ("In particular, all directors on the board of NYSE Regulation (other than its CEO) are, and will be, required to be independent of management of NYSE Euronext and its subsidiaries, as well as of NYSE, NYSE Arca,and NYSE Alternext US members and listed companies.").  See also Exchange Act Release No. 55293 (Feb. 14, 2007) (“Thus, a majority of the directors of each of the Exchange and NYSE Market must be U.S. Persons who are directors of NYSE Euronext that satisfy the independence requirements of the board of directors of NYSE Euronext."). 

While the SROs have contracted or delegated authority to NYSE Regulation, there is at least some residual front line regulatory obligations not assigned to NYSE Regulation.  Thus, NYSE Arca can initiate disciplinary actions.  NYSE Market (a subsidiary of NYSE Exchange) apparently retains some authority over listing standards.  See Exchange Act Release No. 53382 (Feb. 27, 2006) (“NYSE Market will have delegated authority to, among others, oversee the operation of NYSE Market, develop and adopt listing rules and rules governing the issuance of Trading Licenses, and establish and assess listing, access, transaction, and market data fees.").

In addition, however, the SROs ultimately retain the legal obligation for any decisions made by NYSE Regulation.  See Exchange Act Release No. 53382 (Feb. 27, 2006) (“New York Stock Exchange LLC, however, expressly retains ultimate responsibility for the fulfillment of its statutory and self-regulatory obligations under the Act.").  See also  Exchange Act Release No. 62032 (May 4, 2010) (“As with NYSE Amex, and notwithstanding these regulatory agreements, the Exchange retains ultimate legal responsibility for the regulation of its permit holders and its market and has full authority to take action to assure that its regulatory responsibilities are met.").  

As a result, they retain the legal right to overturn the actions of NYSE Regulation, excepting only some disciplinary actions.  Exchange Act Release No. 53382 (Feb. 27, 2006) ("New York Stock Exchange LLC will retain ultimate responsibility for such delegated responsibilities and functions, and any actions taken pursuant to delegated authority will remain subject to review, approval, or rejection by the board of directors of New York Stock Exchange LLC in accordance with procedures established by that board of directors (provided however, that action taken upon review of disciplinary decisions by the NYSE Regulation board of directors shall be final action of the New York Stock Exchange LLC).”).  See also Exchange Act Release No. 62032 (May 4, 2010) (“In connection with the foregoing arrangements, as stated above, the Exchange retains the authority to direct NYSER and FINRA to take any action necessary to fulfill the Exchange's statutory and self-regulatory obligations, and NYSER provides a report on regulatory matters at each meeting of the Exchange board."). 

In additoin, the SROs have less independence than NYSE Regulation with respect to compensation decisons.  NYSE Regulation has its own compensation committee.  NYSE Euronext recently received permission from the Commission to eliminate the compensation committee of NYSE Arca, with the authority transferred to the holding company.  In effect, the change reflected existing practice.  See Exchange Act Release No. 62032 (May 4, 2010) (because the Exchange CEO was an executive officer of the holding company, "his/her compensation [is already] established by the Company's board of directors, in conjunction with recommendations from the NYSE Euronext Human Resources and Compensation Committee.").  See also Exchange Act Release No. 62032 (May 4, 2010) (“These committees also will perform relevant functions for NYSE Group, the Exchange, NYSE Market, NYSE Regulation, Archipelago, NYSE Arca, and NYSE Arca Equities, as well as other subsidiaries of NYSE Euronext, except that the board of directors of NYSE Regulation will continue to have its own compensation committee and nominating and governance committee.").

Thus, the holding company now (and presumably after the merger with Deutsche Borse) has some ability to influence the activities of the SROs.

The Consequences of the NYSE-Deutsche Combination on Listing Standards (Changes to the Definition of Director Independence) (Part 5)

We are discussing the system for ensuring that the regulatory mission of NYSE Euronext remains independent of the company's for profit approach to business and the impact of the combination with Deutsche Borse on this regulatory mission.

In addition to funding, the holding company also has some potential to exercise influence over the regulatory mission through the presence of interlocking directors.  At least one member from NYSE Euronext also sits on the board of NYSE Regulation.  See NYSE Regulation Bylaws, Article III, Section 1 ("the remaining Directors shall be comprised of members of the board of directors of NYSE Euronext that qualify as independent under the independence policy of the board of directors of NYSE Euronext"). 

This is old news and was noted at the time of the creation of NYSE Regulation.  See Exchange Act Release No. 53382 n. 64 (Feb. 27, 2006) (“The SIA and TBMA recommend that the NYSE be required to create greater structural separation by reducing or eliminating NYSE Group representation on the New York Stock Exchange LLC and NYSE Regulation boards and by permitting direct member representation on those boards.”).

The NYSE Euronext director must, however, be independent.  In general, independence does not include persons affiliated with listed companies or members of the exchange.  See NYSE Euronext  "Independence Policy"  Since initial approval in 2006, the independence policy has twice been changed (both times with approval from the Commission).  Each time, the change has been designed to narrow the definition of director independence. 

The policy originally excluded persons affiliated with any listed company.  See Exchange Act Release No. 62032 (May 4, 2010) (“Generally, a director will not be independent if the director has a relationship with . . . an issuer listed on the NYSE or NYSE Arca.").  In the merger with Euronext, however, that changed.  Directors were allowed to have an affiliation with "foreign private issuers" listed on the Exchange.  See Exchange Act Release No. 55293 (Feb. 14, 2007) (director must be independent from "any issuer of securities listed on the Exchange or NYSE Arca, unless such issuer is a 'foreign private issuer' as defined under Rule 3b-4 promulgated under the Exchange Act.").  See also Rule 3b-4, 17 CFR 240.3b-4 (defining foreign private issuer).   

Recognizing the potential conflict, those directors associated with a foreign private issuer could not sit on the board of NYSE Regulation.  See Exchange Act Release No. 55293 (Feb. 14, 2007) (“However, the Independence Policy states an executive officer of an issuer whose securities are listed on the Exchange or NYSE Arca (regardless of whether such issuer is a foreign private issuer) and a director of an affiliate of a member organization of the Exchange, NYSE Arca, or NYSE Arca Equities cannot qualify as an independent director of the Exchange, NYSE Market, or NYSE Regulation.”).  See also Independence Policy of NYSE-Euronext(adding NYSE Amex to the list). 

This exclusion was apparently sufficient to resolve any concerns on the part of the Commission.  See Exchange Act Release No. 55293 (Feb. 14, 2007) ("The prohibition on these persons [executive officers of foreign private issuers listed on the NYSE] serving as independent directors of the Exchange, NYSE Market, and NYSE Regulation should help assure that the boards of directors of the Exchange, NYSE Market, and NYSE Regulation are controlled by persons not subject to potential conflicts of interest"). 

Nonetheless, the changes have allowed for listed companies (albeit foreign ones) to have representatives on the NYSE Euronext board.  Moreover, while they cannot sit on the boards of NYSE Regulation or the SROs, they presumably have influence at the holding company level.  Thus, they may have influence over issues at the holding company level that affect NYSE Regulation . 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (The Issue of Funding) (Part 4)

We are discussing the combination between NYSE Euronext and Deutsche Borse and the impact on the regulatory function performed by NYSE Euronext. 

Much of the regulatory function possessed by NYSE Euronext has been transferred to NYSE Regulation (which in turn has transferred much of the function to FINRA).  To insulate the regulatory function from for profit influence, NYSE Euronext set NYSE Regulation up as a non-profit with an independent board.  Nonetheless, there are still at least theoretical avenues that can be used by NYSE Euronext to exert influence over NYSE Regulation.  One of them concerns funding. 

Although NYSE Regulation has an independent board, it obtains its funding from other entities within the NYSE Euronext complex.  Since going public in 2006, the holding company has agreed to provide "adequate funding" to NYSE Regulation.  NYSE Regulation has in place a service agreement with the assorted regulated entities (and, apparently the holding company), each apparently agreeing to pay NYSE Regulation for the services.  See Exchange Act Release No. 53382 (Feb. 27, 2006) (NYSE specified that an "explicit agreement" would be executed "among various of the NYSE [Euronext] entities to provide adequate funding for NYSE Regulation").   See also Exchange Act Release No. 55003 (Dec. 22, 2006) ("There is also an explicit agreement among NYSE Group, the Exchange, NYSE Market, Inc. and NYSE Regulation to provide adequate funding to NYSE Regulation.").

The approach has apparently not changed singificantly since NYSE demutualized and went public in 2006.  See Exchange Act Release No. 55293 (Feb. 14, 2007) ("In addition, there will be an explicit agreement among NYSE Euronext, NYSE Group, the Exchange, NYSE Market and NYSE Regulation to provide adequate funding for NYSE Regulation, as is currently the case among the NYSE Group entities."); see also Exchange Act Release No. 62032 (May 4, 2010) (“Finally, NYSE Euronext has agreed to provide adequate funding to NYSE Regulation to conduct its regulatory activities with respect to NYSE, NYSE Arca and, from and after closing of the transaction, NYSE Alternext US. In addition, NYSE Alternext US will not use any regulatory fees, fines or penalties collected by NYSE Regulation for commercial purposes."). 

These agreement, however, provide a possible mechanism for control by the NYSE Euronext over NYSE Regulation.  Without adequate funding, NYSE Regulation could not perform its regulatory mission.  These concerns were raised at the time NYSE first went public.  See Id.  ("One commenter . . .  does not believe that the undertaking by the NYSE that there will be an explicit agreement among NYSE Group, New York Stock Exchange LLC, NYSE Market, and NYSE Regulation to provide adequate funding for NYSE Regulation is sufficient. Another commenter believes that the governing documents of NYSE Regulation should explicitly provide the sources of its funding."). 

The Commission, however, viewed the arrangement as sufficient.  See Id.  ("The Commission finds that the proposed funding of NYSE Regulation's regulatory responsibilities, which includes the assessment of member and other fees, as well as funding from other entities for which NYSE Regulation will be providing regulatory services, is designed to provide sufficient funding to NYSE Regulation to enable it and New York Stock Exchange LLC to carry out their responsibilities consistent with the Act."). 

There has been no evidence of inadequate funding.  On the other hand, the system for funding NYSE Regulation is not transparent.  Unlike some of the underlying documents (operating agreements, bylaws, etc.) created by the different entities, the funding agreements are apparently not public.  As a result, the funding issue will need to be examined closely by the Commission and made part of the public record. 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (Part 3)

The model put in place by the NYSE generated, over time, some potential conflicts of interest.  As a stock exchange, NYSE Euronext sometimes found itself having to oversee its own activities.  NYSE Euronext has relied extensively on both NYSE Regulation and FINRA to address these potential conflicts.   

At the time the NYSE went public, the NYSE predictably wanted to list the shares on its own exchange.  The decision created circumstances whereby the NYSE would have to monitor itself for compliance and potentially bring enforcement actions against itself.  The Commission noted the concerns over "self-listing." 

• The Commission believes that such "self-listing" raises questions as to an SRO's ability to independently and effectively enforce its own and the Commission's rules against itself or an affiliated entity, and thus comply with its statutory obligations under the Act.  For instance, an SRO might be reluctant to vigorously monitor for compliance with its initial and continued listing rules by the securities of an affiliated issuer or its own securities, and may be tempted to allow its own securities, or the securities of an affiliate, to be listed (and continue to be listed) on the SRO's market even if the security is not in full compliance with the SRO's listing rules. Similar conflicts of interest could arise in which the SRO might choose to selectively enforce, or not enforce, its trading rules with respect to trading in its own stock or that of an affiliate so as to benefit itself.

Exchange Act Release No. 53382 (Feb. 27, 2006).  

The NYSE dealt with the potential conflict by, among other things, providing that NYSE Regulation would monitor the holding company for continued compliance with listing and trading requirements and would file quarterly reports with the Commission.   Notification of non-compliance with listing standards and any plan to remedy the deficiency also had to be reported to the Commission.  Finally, the NYSE committed to an annual compliance audit conducted by an independent accounting firm.  See Exchange Act Release No. 53382 (Feb. 27, 2006).  The requirements are reflected in NYSE Rule 497.

At the same time, the merger between the NYSE and Archipelago Holdings, Inc. resulted in the NYSE acquiring the Pacific Stock Exchange (renamed NYSE Arca).  See Exchange Act Release No. 52497 (Sept. 22, 2005) (approving acquisition of Pacific Stock Exchange by Archipelago).  The NYSE owned a member firm of NYSE Arca (Arca Securities).  Arca Securities was apparently placed under the supervision of NYSE Regulation, something made explicit some years later.  See Exchange Act Release No. 58681 (Sept. 29, 2008) ("NYSE Regulation will monitor Arca Securitiesfor compliance with NYSE Arca's trading rules, and will collect and maintain certain related information.").  Arca Securities is also subject to review by FINRA.  Id.   

This oversight, coupled with responsibilities assigned to FINRA, was viewed by the Commission as adequate protection against any conflict of interest.  See Exchange Act Release No. 58673 (Sept. 29, 2008) (“ the Commission believes that FINRA's oversight of Arca Securities, combined with NYSE Regulation's monitoring of Arca Securities' compliance with NYSE Alternext US's trading rules and quarterly reporting to NYSE Alternext US's CRO, will help to protect the independence of NYSE Alternext US's regulatory responsibilities with respect to Arca Securities.”). 

The solution, therefore, relied upon the independence of NYSE Regulation.  The analysis by the Commission largely addressed the problem of disparate oversight or enforcement.  It did not address whether self listing or ownership of an Amex member provided the holding company with an incentive to weaken the regulatory burden of listed companies and members in general.  Of course, had that issue been analyzed, the NYSE Euronext and Commission likely would have relied upon the independence of NYSE Regulation and its ability to resist any pressure even if the holding company were so motivated. 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (Ensuring Regulatory Independence) (Part 2)

We are discussing the impending combination between NYSE Euronext and Deutsche Börse AG.  

As we noted, the NYSE demutualized and became a for profit company back in 2006.  Demutualization raised concerns that the status could conflict with the regulatory mission of the Exchange.  As part of the SEC approval process, the holding company (then NYSE Group) took a number of steps to ensure the independence of the regulatory function.  (They are described on the NYSE web site here). 

The main (but not the only) mechanism for doing so was the creation of a separate entity, NYSE Regulation, to perform most of the regulatory functions.  NYSE Regulation is a New York non-profit.  See Exchange Act Release No. 53073 (Jan. 6, 2006) ("NYSE Regulation, a New York Type A not-for-profit corporation, will perform the regulatory responsibilities currently conducted by NYSE for New York Stock Exchange LLC and will contract to perform many of the regulatory functions of the Pacific Exchange for Archipelago."). 

Simply creating a non-profit to perform regulatory functions did not guarantee freedom from "for profit" influence.  Instead, efforts were made to protect the regulatory function by providing for an independent board of directors.  The board of NYSE Regulation, as the  bylaws provide, can only include independent directors, with the exception of the executive director of NYSE Regulation. 

The applicable definition of independent for NYSE Regulation is the one used by the holding company and essentially excludes anyone who is affiliated with a member of the exchange or a listed company.  See Exchange Act Release No. 53382 (Feb. 27, 2006) (“Each member of the NYSE Group board of directors, other than the chief executive officer, must be independent from (i) NYSE Group and its subsidiaries, (ii) any member or member organization of New York Stock Exchange LLC or the Pacific Exchange, and (iii) any company whose securities are listed on New York Stock Exchange LLC or the Pacific Exchange.”).  The independence policy for the NYSE Euronext board is here. 

The effort to insulate NYSE Regulation from for profit influence, however, went further.  The board of NYSE Regulation can include directors from the holding company but these directors cannot constitute a majority of the NYSE Regulation board.  See Exchange Act Release No. 53382 n. 64 (Feb. 27, 2006) (“The chief executive officer of NYSE Regulation will be a director of NYSE Regulation and a majority of the directors of NYSE Regulation will be persons who are not NYSE Group directors, but who otherwise qualify as independent under the independence policy of the NYSE Group board of directors”).

Moreover, NYSE Regulation has considerable influence over the selection of the remaining directors (non-affiliated directors).  Under the NYSE Regulation bylaws, the Nominating and Governance Committee nominates the non-affiliated directors and the Exchange (the only member of NYSE Regulation) must elect them.  See NYSE Regulation Bylaws  ("The member of the Corporation shall appoint or elect as Non-Affiliated Directors the candidates nominated by the Nominating and Governance Committee of the Corporation").  Two of the directors must, however, be selected by a committee designed to allow for industry input.  See also NYSE Regulation Bylaws, Article III, Section 5 (describing system for nominating fair representation directors).  See also Exchange Act Release No. 53382 (Feb. 27, 2006) (“The Fair Representation Directors will compose part of the majority that are Non-Affiliated Regulation Directors. . .").    

In addition to an independent board of directors, the board of NYSE Regulation has its own compensation committee, allowing greater independence in resolving compensation matters for NYSE Regulation.  Both the nominating and the compensation committee may include directors appointed by the holding company but they may not comprise a majority.  See Exchange Act Release No. 53382 n. 64 (Feb. 27, 2006) (“It will create a nominating and governance committee and a compensation committee, each of which will be comprised of a majority of Non-Affiliated Regulation Directors. The compensation committee will be responsible for setting the compensation for NYSE Regulation employees. The nominating and governance committee will bear responsibility for nominating Non-Affiliated Regulation Director candidates.”). 

In other words, NYSE Regulation has considerable independence from the holding company.  Many of these protections were only added after the SEC review process  began back in 2006.  Currently, NYSE Regulation has eight directors.  One of the directors is the CEO of the non-profit.  Six others are independent of the holding company.  Only one, Ellyn Brown, also sits on the board of NYSE-Euronext (as well as the Board of Governors of FINRA; see Form F-4 at 332).  She also sits on three NYSE Regulation committees, including compensation, nomination, and review. 

The Consequences of the NYSE-Deutsche Combination on Listing Standards (Part 1)

With Nasdaq and ICE havingbowed out (the antitrust concerns apparently insurmountable),  the combination between NYSE Euronext and Deutsche Borse looks like it will proceed.  The deal will ultimately be submitted to the SEC for approval.  For the proxy/registration statement on the transaction, go here. 

Ordinarily, the combining of two for profit companies wouldn't require SEC approval (although a stock deal may require a registration statement that must be declared effective by the agency).  What makes this acquisition different, however, is that NYSE Euronext is a for profit company with important regulatory responsibilities.

NYSE Euronext is a holding company that owns a variety of subsidiaries that perform regulatory functions.  Specifically, the Exchange (New York Stock Exchange LLC, a New York limited liability company) is a self regulatory organization subject to SEC oversight, as is Amex (NYSE Amex LLC, a Delaware limited liability company) and NYSE Arca (the old Pacific Stock Exchange, also a Delaware LLC).  

SROs in the form of national stock exchanges must register with the SEC and perform significant regulatory tasks.  See Exchange Act Release No. 62032 n. 115 (May 4, 2010) (“Specifically, an exchange must be able to enforce compliance by its members and persons associated with its members with federal securities laws and the rules of the exchange.”).

Regulation within the NYSE complex is mostly but not entirely handled by NYSE Regulation, a New York non-profit and a subsidiary of the Exchange.  The articles of incorporation for NYSE Regulation are here.  The SROs have executed servicing or delegation agreements that give to NYSE Regulation responsibility for most regulatory tasks.  See Exchange Act Release No. 53382 (Feb. 27, 2006) (“After the Merger, NYSE Regulation will hold all of the assets and liabilities related to the regulatory functions currently conducted by the NYSE.").  See also Exchange Act Release No. 62032 (May 4, 2010) (“NYSE [Amex] will enter into a regulatory contract with NYSE Regulation ("NYSE Regulation RSA"), under which NYSE [Amex] will contract with NYSE Regulation to perform all of NYSE Alternext US's regulatory functions on NYSE Alternext US's behalf.”). 

The authority delegated to NYSE Regulation is very broad.  The Exchange even delegated away the right to review disciplinary matters.  See Exchange Act Release No. 53382 n. 154 (Feb. 27, 2006) (“New York Stock Exchange LLC has delegated such authority to NYSE Regulation pursuant to the NYSE Delegation Agreement, and has explicitly stated in such agreement that action taken by NYSE Regulation shall be final action of the exchange. Thus, New York Stock Exchange LLC will not be able to review any disciplinary action taken by NYSE Regulation.”).

NYSE Regulation has, in turn, transferred most of its regulatory function to FINRA.  Much of the broker-dealer oversight function was transferred in the merger with the NASD, when FINRA was created.  In addition, as the prospectus-registration statement for the combination describes: "FINRA [in 2010] assumed these regulatory functions for NYSE Euronext’s U.S. equities and options markets, NYSE, NYSE Arca and NYSE Amex" and, as a result, "a substantial majority of the NYSE Regulation staff was transferred to FINRA." 

NYSE Regulation, however, retains some supervisory authority.  See Form F-4, at 60 ("NYSE Regulation ultimately remains responsible for overseeing FINRA’s performance of regulatory services for NYSE Euronext’s markets, and NYSE Regulation has retained staff associated with such responsibility, as well as for rule development and interpretations, oversight of listed issuers’ compliance with financial and corporate governance standards and real-time stockwatch reviews").  In addition, NYSE Regulation retains oversight of listing standards through its Listed Company Compliance division.  

The combination between NYSE Euronext and Deutsche Borse provides an opportunity to reexamine the regulatory role of NYSE Euronext.  At the time the NYSE became a for profit company back in 2006, the tension between the need to profit maximize and to fulfill regulatory responsibilities was much discussed.  See Exchange Act Release No. 53382 (February 27, 2006).  NYSE put in place a series of prophylactic mechanisms designed to insulate the regulatory function from the for profit influence. 

These protections will need to be carefully weighed by the Commission in approving the acquisition.  Moreover, unlike 2006, there are now five years of actual experience to be examined.  In addition, the SEC will need to consider the impact of a combination that will result in a board of directors dominated by non-US directors and the impact that this could have on the regulatory mission of NYSE Euronext. 

We will examine these issues in this series of posts.

43rd Annual Rocky Mountain Securities Conference Coverage: Corporate Governance in a Changing Regulatory and Enforcement Climate

The final session of the conference focused on governance issues in the post Dodd-Frank environment.  The panel included Cathy Krendl, Krendl Krendl Sachnoff & Way, P.C.; John Olson, Gibson, Dunn & Crutcher, LLP; Jason Day, Perkins Coie; and Josiah Hatch, Ducker, Montgomery, Aronstein & Bess, P.C.

The panel highlighted many issues regarding Dodd-Frank and its effect on corporate governance.  A few of note include: (1) Say on Pay, (2) Proxy Access, (3) Independent Compensation Committees and Compensation Consultants, and (4) Risk Management Oversight.

Initially, the panel discussed Say on Pay and options for responding to an negative recommendation from ISS.  The panel stated that while the shareholder vote has no legal consequences, it does have reputational consequences and many corporations have responded by changing their compensation packages to receive a positive vote recommendation from ISS. 

Next, was a discussion of Proxy Access.  The panel discussed the “3-3 Rule”, which has been stayed awaiting adjudication at the 2nd Circuit.  The main challenge to the rule was that the SEC failed to meet its obligation under the 34 Act for investigating the Rule’s impact on competition and for failing to perform an in-depth cost-benefit analysis. 

Finally, the panel discussed the Board’s responsibilities regarding Risk Management.  The panel emphasized the regulatory rules currently existing including NYSE Rules, SOX 404 regarding internal controls, and the SEC disclosure rules.  The SEC is primarily interested in a disclosure of the Board’s role in overseeing risk management and how this system is affecting the management of the company.  Although, this seems good for shareholders the panel mentioned the strong Business Judgment Rule protection offered in this area, citing In re Citigroup Inc. S'holder Derivative Litig., 964 A.2d 106 (Del. Ch. 2009).

This concludes our coverage of the 43rd Annual Rocky Mountain Securities Conference. We would like to thank all the presenters and speakers for their insights and the Colorado Bar Association for allowing us to attend.  Thank all our followers for another great conference and we look forward to next year.  

43rd Annual Rocky Mountain Securities Conference Coverage: The Defense Response: Initiatives, Cooperation and Other Expansive Enforcement Concepts

The Enforcement Panel included Randall Fons of Morrison & Foerster, LLP; David Zisser of Davis Graham & Stubbs LLP; Mike Cillo of Daivs & Ceriani PC; and Holly Sollod of Holland & Hart LLP. This panel offered the opposite viewpoint on the topic of enforcement from the perspective of defense counsel.  The panel focused on the issue cooperation with the SEC.

The SEC uses several tools when cooperating with defendants; such as cooperation agreements, non-prosecution agreements, and expedited immunity used in conjunction with the Department of Justice. Notably, panelist Holly Sollod had a case in which a cooperation agreement was used during litigation in the middle of an active enforcement action with her client. This is unusual as such agreements tend to happen at an earlier stage.

The important aspects a defense attorney must be mindful of include: the level of assistance provided, the truth of the information, and whether the client was the first to come to them with the information; the importance of the underlying issue; the harm involved and whether the client is a repeat; the societal implications of holding somebody responsible and what the public response might be; and an evaluation of the client that may be cooperating, particularly exploring their reputation and their opportunity to commit further violations. The most important factor is how early an individual attempts to cooperate. The SEC favors agreements with those that come to them first with particular information, thus encouraging more immediate cooperation. In the instance of Ms. Sollod’s case, she was able to obtain such an agreement because, despite the fact that the action had already been initiated, her client was the first to offer cooperation.

The panelists also voiced criticism over this cooperation process, particularly the lack of transparency into entering cooperation agreements.  It is difficult to recommend cooperation to a client when there is no standard for the degree of cooperation or the standard protections that come along with them, or the manner in which the SEC and the Justice Department treat those that come forward with information to make a cooperation agreement.  The mechanics, protections, and assurances are not yet solidified enough to cause broad acceptance and reliance on such agreements. It is essential that any protection in an agreement last indefinitely and not just for the period of time that the information is being shared, otherwise the witness may find testimony being used against him or her in the future.

Finally the perspective of defending corporations was discussed, particularly in the face of the encouragement of whistleblowers. It is essential that corporations install open communication for whistleblowers which allows the company to get ahead of any allegations, make people feel comfortable in coming to the company before going to the SEC, thereby enabling the corporation to launch its own internal investigations. Once a whistleblower brings information to the attention of the company, the company has 90 days to react reasonably; not doing so will open the company up to SEC sanctions. In addition, the whistleblower is considered to have brought the matter to the SEC when he or she brings it to the company for timing purposes. The SEC’s emphasis is for the company to respond quickly and appropriately so that further enforcement and investigation effort is not needed.  

According to the panel, corporations are at a significant disadvantage when targeted by the SEC because the SEC can investigate for an indefinite amount of time. This allows the SEC to wait to file a case until all the relevant material is together, whereas if the company gets a tip about wrongdoing, they have only 90 days to correct transgressions, build a defense, and possibly set up a cooperation agreement.