Securities Mosaic is a fantastic resource for anyone working in the securities field. It provides comprehensive information in six key areas: disclosure, laws, rules, guidance, news, and compliance centers. In addition, the site features SM Blogwatch, which republishes posts from various securities-related blogs, including this one.

Yesterday, I was formally welcomed to the SM Blogwatch family by Peter Schwartz, a smart, swell guy. My welcome, although warm, included a few remarks that I just can’t let lie. The comments concern the Law and Economics “movement,” which we at TOTM purportedly represent.

I first take issue with the claim that the TOTM bloggers “preach[] from the pulpit of Law and Economics.” That comment suggests that we all believe that efficiency should be the goal of the law. Among folks who find economic analysis to be a useful tool for analyzing legal rules (and my guess is that all the TOTM bloggers would put themselves in that category), there’s a good deal of disagreement over whether efficiency should always be our goal. Personally, I embrace “positive L&E” (I think the common law is generally efficient and that economic analysis is a useful tool for analyzing legal rules), but I eschew “normative L&E,” which posits that efficiency is a sufficient condition for favoring a legal rule. I don’t know what my co-bloggers think about normative L&E, but I think a person “preach[ing] from the pulpit of Law and Economics” would have to place a higher value on efficiency than I personally am willing to do.

Now don’t get me wrong. I think positive L&E is incredibly useful, and, all else being equal, I’d always prefer the efficient rule over the inefficient one. I should therefore defend L&E against a couple of other slams in the SM Blogwatch welcome.

First, Peter contends that “[a]t its foundation, the Law and Economics movement has no framework for addressing the concept and reality of power.” I honestly don’t know what that means. If Peter’s claiming that L&E has nothing to say about market power, I’d suggest that he thumb through practically any contemporary antitrust treatise. Economic analysis has lots to say about how market power emerges, what problems it causes, the conditions under which it is self-correcting, and when government intervention is appropriate. If he’s talking about political power (i.e., the power to wield state-sanctioned coercion), I’d say that L&E folks — at least the market liberals among us — are highly attuned to the dangers such power poses and offer the best possible policy prescription for minimizing those dangers: laissez faire.

Peter goes on to criticize the “Law and Economics movement” for

inspir[ing] amongst its members an overpowering zeal and certitude (the Truth be Mine and it can be Thine) that often crosses the line into realms of faith, evangelism, and judgment (if you are not with me, you may also not be against me, but you are probably a liberal and so, by definition, not terribly bright, you poor unwashed soul).

With respect to the Austrian-inspired economic analysis that I personally find persuasive, that characterization is exactly backward.

A fundamental and profound insight of the Austrians (e.g., F.A. Hayek) was that the information necessary to determine how resources ought to be allocated to maximize social welfare is not given to anyone in its entirety. (See, e.g., here.) It is because I am so remarkably uncertain about how production and consumption decisions should be made that I advocate taking the maximally modest position: that which leaves resource allocation decisions to those closest to the action, most aware of their own preferences, etc.

As Josh has previously observed, those who (like Peter) criticize market liberalism for involving an unjustified “faith” have got things turned around. To quote Don Boudreaux once again:

Saying ‘Let the market handle it’ is to reject a one-size-fits-all, centralized rule of experts. It is to endorse an unfathomably complex arrangement for dealing with the issue at hand. Recommending the market over government intervention is to recognize that neither he who recommends the market nor anyone else possesses sufficient information and knowledge to determine, or even to foresee, what particular methods are best for dealing with the problem.

To recommend the market, in fact, is to recommend letting millions of creative people, each with different perspectives and different bits of knowledge and insights, each voluntarily contribute his own ideas and efforts toward dealing with the problem. It is to recommend not a single solution but, instead, a decentralized process that calls forth many competing experiments and, then, discovers the solutions that work best under the circumstances . . . .

While declaring ‘Let the government handle it’ comes across as a solution, it’s no such thing. Instead, it is merely a sign of a simple and baseless faith — a simple and baseless faith that people invested with power will not abuse it; that political appointees possess or will find better answers than will millions of people pursuing solutions in their own ways, and staking their own resources and reputations on their efforts; that only those ’solutions’ that are spelled out in statutes and regulations and that have officials paid to implement them are true solutions.

Back during GW’s first term, when various folks were positing that the economy was in a recession, my mother said something along the lines of “I know that we are not in a recession because people are still buying bras from Victoria’s Secret.” True story.

My mom’s point, for those of you who have never bought a bra at Victoria’s Secret, was that as long as people had the discretionary cash to spend $32 on a bra (ONE bra) at VS as opposed to, say, $7 for a bra from JC Penney’s, there was enough cash in the average consumer’s pocket to refute any notion that we needed to worry about a weakening economy.

It is good to see confirmation that my mother’s sophisticated economic reasoning holds up in the mainstream, however, as is evinced by today’s Starbuck’s article from Reuters. It is unclear whether the University of Chicago will come recruit my mother or whether she would be better off approaching them herself.

(My personal test of the strength of the economy hinges on whether we still have private equity markets (as long as we still have private equity, we are A-ok), but I am not quite as sophisticated as my mother.)

Deven Desai at Concurring Opinions discusses an interesting article on law.com reporting that my old boss, Judge Frank Easterbrook, will soon become Chief Judge of the Seventh Circuit. Interestingly, the article suggests, and the judge in an interview confirms, that not very much about the Seventh Circuit is likely to change. The court is already performing at an exceptionally high level, and a sensible goal for any incoming chief judge would be in the main to stay the course. That said, the article does suggest that there may be a few incremental changes in the years ahead, including the possibility of having some district judges serve on appellate panels.

I have closely watched the work of the Seventh Circuit for a decade and am confident in predicting that whatever administrative innovations end up being adopted in the next seven years, the main thing for those outside the circuit to watch for will remain the outstanding and influential opinions that the fine judges on the court continue to produce in case after case.

Holman Jenkins reports that a group of economists led by Milton Friedman and Harry Markowitz are getting behind the idea of putting an end to the expensing of options. It is a great column. Jenkins goes on to discuss options backdating and makes the following points, which will sound unfamiliar to TOTM readers:

• “In no generic sense can one say executives “inflated” their pay or “stole” from shareholders. Backdated packages were not more “lucrative” — it’s fallacious to assume that the alternative package consisted of an identical number of options at a less advantageous price.”

• “Backdating did not provide “guaranteed” or “risk free” profits. It did not “undermine the incentive purpose” of options.”

• “It seems likely that companies, after all, did correctly report the number of options and their price to shareholders. Let it be remembered, too, that millions of these options were cancelled or expired unexercised.”

Geoff made exactly these points in this space months ago (and also more recently, here). Personally, I am thrilled to see a column that focuses on the real questions surrounding backdating: (1) Why do firms backdate? (2) What are the consequences of backdating? and (3) What is the theory of harm, if any, upon which we are going to base civil and criminal prosecutions? It is remarkable, but not incredibly surprising, how little attention has been paid to these questions in favor of the Gretchen Morgenstern-style rants that Professor Ribstein enjoys dismantling weekly.

Geoff’s earlier post frames the backdating issue in terms of the important economic (and legal) questions involved. For example, Geoff makes the following basic (and sadly overlooked) points:

1. Backdated options have incentive effects too.
2. Regulatory quirks involving accounting rules may have provided firms the incentive to backdate.
3. If we are to believe that some 2,000 companies engaged in some form of backdating, many did not appear to be hiding it.
4. There may be no harm whatsoever resulting from backdating. To borrow from Geoff: “It’s not like the options cruise along for a period of time out of the money (and priced by the market accordingly) and then are miraculously turned into at the money or in the money options the moment they are exercised. Rather, the day the options are issued, they are issued with a strike price AS IF they had been issued on an earlier date when the market price was lower. But there’s no lie here – it’s just a convenient way of providing more compensation.”
5. And finally, there are a number of instruments available to compensate executives with or without backdating. I’m not sure if anyone really believes that in the absence of backdating the actual level of compensation would decrease, despite the fact that this assumption seems necessary to the theory of harm most frequently discussed.

Assuming for the moment that backdating is as rampant as the Lie study, media reports, and sudden wellspring of law firm and litigation consultant “backdating” teams suggests, it might be prudent to ask: “why?” and something along the lines of “so what?” The only answers to the “so what” question have been assertions about shareholder exploitation and comparisons to Enron. As to “why backdating,” there seems to be little interest in figuring out what economic and institutional conditions led to the widespread adoption of option backdating and whether the practice is an efficient element of a compensation contract or something more sinister. Rather, we get mostly claims that backdating is a function of widespread fraud or compensation committee naiveity. As I explain below the fold, I don’t think either of these theories get us very far in terms of explaining backdating. (more…)

The current SSRN top tens for corporate, corporate governance, and securities law are after the jump. (more…)

According to Bar None, an op-ed by Jack Turner in today’s NYT, “history shows that, however commendable the reasoning, efforts to control how people drink — or eat, or smoke — tend to backfire.” I’ve made a similar argument in discussing smoking bans.

Advocates of such bans (often citing the work of “norms scholars,” such as Larry Lessig and Dan Kahan) frequently defend the bans on grounds that they alter social norms. The argument is that smoking bans provide a de facto community statement that public smoking is unacceptable and thereby embolden non-smokers to confront smokers who are inconveniencing them. Facing heightened public hostility toward their habits, smokers are likely to revise their preferences regarding smoking. Thus, by making smoking more socially costly, bans reduce the number of smokers.

Of course, this is a good thing only if actual social utility is increased by reducing the incidence of smoking. Ban advocates assume that it is for the obvious reason that smoking carries serious health risks. But ban advocates generally are not in a position to judge the cost side of reducing smoking, for they do not know the degree of utility smokers experience by smoking. Smokers themselves, who these days are aware of the risks of smoking, appear to believe that the benefits they experience from the activity outweigh the costs. It is thus not at all clear that social welfare will be enhanced by eliminating smoking.

But even if it were clear that society would be better off with less smoking, this sort of “norm management” may be a bad idea. Sweeping smoking bans may actually increase the incidence of smoking. A large percentage of smokers acquire the habit at a young age, and they frequently do so because smoking is “cool.â€? Smoking is cool, of course, because it’s rebellious. The harder anti-smoking forces work to coerce people into stopping smoking, and the more they engage the government and other establishment institutions in their efforts, the more rebellious — and thus the “cooler” — smoking becomes. As an empirical matter, then, it is not clear whether sweeping smoking bans — highly intrusive regulatory interventions — actually reduce the incidence of smoking in the long run.

Nazi Germany may provide an example of this sort of “norm backlash.” According to a report in the British Medical Journal, “Germany had the world’s strongest antismoking movement in the 1930s and early 1940s, supported by Nazi medical and military leaders worried that tobacco might prove a hazard to the race.” It bombed:

German smoking rates rose dramatically in the first six years of Nazi rule, suggesting that the propaganda campaign launched during those early years was largely ineffective. German smoking rates rose faster even than those of France, which had a much weaker anti-tobacco campaign. German per capita tobacco use between 1932 and 1939 rose from 570 to 900 cigarettes a year, whereas French tobacco consumption grew from 570 to only 630 cigarettes over the same period.

While this post hoc evidence is admittedly anecdotal, it’s consistent with Turner’s point that paternalism tends to backfire. Norm managers proceed at their own peril.

The First Annual Conference on Empirical Legal Studies will be held at the University of Texas Law School October 26-27. A preliminary program is available here with links to abstracts and articles. I’m absolutely thrilled to be participating in the conference, and am most of all looking forward to reading what looks like a very interesting and diverse set of empirical papers. Here’s the conference annoucement:

The conference will feature original empirical and experimental legal scholarship by leading scholars worldwide, from a diverse range of fields. There is no charge to academics and interested students to submit papers or to attend the conference. The Conference is jointly organized by Cornell Law School, NYU School of Law and the University of Texas School of Law. The 2007 and 2008 Conferences will be held at New York University School of Law and Cornell Law School , respectively. The conference organizers are: Jennifer Arlen (NYU), Bernard Black (Texas), Theodore Eisenberg (Cornell), Michael Heise (Cornell) and Geoffrey Miller (NYU).

See you there.

Similar to Gretchen Morgenson’s recent attack on Rule 144A offerings (discussed by Larry Ribstein here), page C1 of yesterday’s W$J assails PIPE offerings (see here). PIPE stands for “private investment in public equity” and is a financing technique used by many small and mid-size public companies. In a typical PIPE, a company privately negotiates a sale of unregistered equity or equity-linked securities to institutional investors. As part of the deal, the company agrees to register the resale of the equity securities, typically within 30 days. The securities are priced at a discount to the applicable public market price to reflect the fact the original issuance is unregistered. PIPEs offer a number of advantages as a financing technique, including quick time to market (no pre-offering delay for SEC filings, abbreviated documentation) and an equity financing option for companies with market caps or deal sizes too small for a registered equity follow-on offering.

The Journal article, however, does not focus on the advantages of PIPE deals. Instead, it seems to try to vilify them. The article begins by talking about a lawyer who pleaded guilty to conspiring to commit securities fraud and then notes that PIPEs are referred to as “toxic converts” and “death-spiral financings.” But it fails to point out that these labels only apply to PIPE deals involving the issuance of convertible securities where the conversion price floats with the market price of the company’s common stock. Many, many PIPE deals do not involve this feature. The article also decries the fact that hedge funds are investing in PIPEs and “often start shorting the company’s stock even before the financing deal is signed or publicly announced.” This is bad according to the article because hedge funds “are simply looking to profit from the short sales, rather than help the company’s prospects.” Shocking!!!

The real importance of PIPEs, which the article mentions but certainly doesn’t highlight, is that they provide an option for many companies that otherwise would be unable to secure financing. Sure the terms may sometimes be onerous or even toxic, but at least the alternative is there for the board to consider. Bottom line: notwithstanding the Journal article, there is nothing inherently wrong PIPE deals.

1.  FTC Chairman Deborah Majoras on “The Federal Trade Commission in the Online World: Protecting Competition and Protecting Consumers.” (HT: Antitrust Review)
2.    Two interesting posts by Randy Picker here and here.

3.    Brian Leiter on the factors that help and hurt most for entry-level law school faculty candidates, with a promise to elaborate soon.

4.    Lots of advice for 2Ls (here, here, and here).

5.    Vic Fleischer at the Glom on “Which Fields Are Essential?”

According to this WSJ article, Google has asked the SEC to declare that Google is not an “investment company” and therefore not subject to the Investment Company Act of 1940. This seems like an odd request, but it highlights the broad sweep of the definition of investment company. Section 3(a)(1)(C) of the ICA provides that an investment company is any issuer “engaged . . . in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 percentum of the value of such issuer’s total assets (exclusive of Government securities and cash items) on an unconsolidated basis.” The problem for Google is the “owning” language. Google currently owns about $5.8 billion in marketable securities and has total assets of $14.4 billion. Hence, it’s right at the 40% threshold. Google also has $4 billion in cash, some of which it would like to invest in marketable securities . However, moving cash to securities would result in in Google blowing through the 40% threshold, thus the exemption request. Both Microsoft and Yahoo! have faced the same issue in the past and filed exemption requests which the SEC granted.

Our law librarian pointed me to Stu’s Views Law & Lawyer Cartoons website (www.stus.com) which contains cartoons for various corporate law cases (among other things). Here’s two examples:

So what are the cases?

My position in the areas of securities law and corporate law has consistently been that painful shareholder lawsuits are generally likely to be much more effective deterrents than toothless legislation (SOX?) or rulemaking by an agency ill-equipped or disinclined to ruthlessly enforce its rules.  I have taken this position in my writing with respect to investment banking research analysts, I have taken this position with respect to attorneys, and I have taken this position with respect to corporate directors.  (I am soon to re-articulate my position with respect to attorneys at an upcoming conference at Columbia - mark your calendar.)

In at least one of my articles, however, I cite (for purposes of disagreeing with) Peter Oh’s article titled “Gatekeeping,” in which he takes the position that the SEC is well-situated to be an effective gatekeeper.  Peter’s position is idealistic, in my view, and, having worked for the SEC and observing the agency over the past decade, I am of the option that the SEC is hamstrung by political pressure (see, e.g., resignations of Donaldson and  Pitt) and thin resources.  Mind you, the SEC is staffed with brilliant lawyers, accountants, and economists, and the SEC certainly can and should be an astoundingly effective gatekeeper, but sometimes reality gets in the way.

Exhibit A:  The WSJ had an article today about an SEC lawsuit against some scammers who appear to have duped 64 investors out of $1.6 million.  This suit is similar to many brought by the SEC - small-scale scammer, clearly scamming, as easy a target as fish in a barrel.  The SEC will likely take the scammers discussed in the article off the street, which will be a good thing, but I have to say that I’d much rather the SEC go after the bigger scammers who have impacted (negatively) more investors.  Granted, the SEC has relatively recently (past decade) snarked at a bunch of heavy hitters - Goldman and E&Y and Enron among them - but how much can the SEC really do with its (1) limited funding and (2) awkward political position (the way the Pitt/Donaldson terms ended sat very poorly with me)?

Mind you, I support the SEC fully, and I think we (corp. and secs. scholars) should be encouraging our students to consider working for the SEC (incredible experience and super, super mission).  I have nothing but the best things to say about the senior folks I was able to watch in action while at the SEC - Arthur Levitt, Harvey Goldschmid, David Becker, Dick Walker, Steve Culter, etc. - but I think that, as an “institutional” matter, the SEC is not going to soon be the knight in shining armor it could be.  There are just too many currents to swim against.  Or at least let me just say that I will not sleep better tonight knowing that the SEC is going after Dante Jarvis, in Hicksville, NY.

This new chapter in the forthcoming Handbook of Law and Economics (Polinsky & Shavell, eds.) from Avery Katz, Benjamin Hermalin, and Richard Craswell looks like essential reading for anyone interested in economic analysis of contracts and contract law.  Here’s the abstract/introduction:

This paper, which will appear as a chapter in the forthcoming Handbook of Law and Economics (A.M. Polinsky & S. Shavell, eds.), surveys major issues arising in the economic analysis of contract law. It begins with an introductory discussion of scope and methodology, and then addresses four topic areas that correspond to the major doctrinal divisions of the law of contracts. These areas include freedom of contract (i.e., the scope of private power to create binding obligations), formation of contracts (both the procedural mechanics of exchange, and rules that govern pre-contractual behavior), contract interpretation (what consequences follow when agreements are ambiguous or incomplete), and enforcement of contractual obligations. For each of these sections, we address the economic analysis of particular legal rules and institutions, and, where relevant, connections between legal arrangements and associated topics in microeconomic theory, including welfare economics and the theory of contracts.

Like Thom, I also have spent the last few weeks reading Herbert Hovenkamp’s excellent new antitrust book, The Antitrust Enterprise: Principles and Execution. I am looking forward to Thom’s review in the Texas Law Review, and wholeheartedly agree with him that Hovenkamp’s book is an important and significant contribution to the antitrust literature (see also Randy Picker’s book review here describing “The Antitrust Enterprise as The Antitrust Paradox for a post-Chicago antitrust landscape”). I’m still digesting most of the book, and perhaps will share some more thoughts in this space later on, but thought I would chime in with some thoughts on two issues relevant to my own research on slotting contracts, discounts, and competition for product distribution.

Hovenkamp endorses a generally sensible approach to antitrust treatment of manufacturer payments, e.g. quantity and market-share discounts, slotting allowances, and Lepage’s-type bundled discounts. Hovenkamp recognizes that discounting is a “pervasive feature of the American economy,” and that “quantity and market-share discounts are virtually always competitive unless they amount to outright exclusive dealing,” but he adds that “even exclusive dealing is competitively harmless in most circumstances.” Hovenkamp appears to have greater reservation about the potentially exclusionary effects of bundled discounts, but ultimately concludes that administrative costs justify a lenient antitrust rule:

Even though the theory of the bundled discount is properly analogized to tying or exclusive dealing rather than predatory pricing, an administratively prudent rule might insist on a showing the the discounted package is priced below average variable cost.

As I’ve noted in this space previously, and this paper (now in print at 23 Yale Journal on Regulation 169) antitrust rules should reflect the welfare benefits generated as shelf space payments are ultimately passed on to consumers:

If the retail sector is competitive, which is almost always the case as a result of low barriers to entry, these payments are passed on to consumers regardless of form. These payments create first order benefits for consumers in the form of lower prices and higher quality. A coherent antitrust policy will recognize that these payments are a form of the competitive process, namely price competition, and should be treated as such.

Further, where anticompetitive exclusion is the competitive concern, antitrust law would be best served by establishing safe-harbors for distribution contracts unlikely to create anticompetitive effect, i.e. short-term contracts or contracts foreclosing less than 40% of distribution assets. This approach applies to competition for distribution generally, and is not limited to bundled discounts. Thom’s post and analysis in his Minnesota Law Review piece offer sensible and similarly-minded policy proposals for evaluating bundled discounts. With all of that said about the general sensibility of Hovenkamp’s approach here, I have two quibbles upon which I will expand below the fold.

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