is here, over at eCCP, and differs somewhat from Thom’s.

The takeway excerpt is:

Credit Suisse has important implications for antitrust practice. The decision’s effect is to narrow the scope of antitrust law and to invite efforts by regulated industries to narrow it still further. The court’s “clearly incompatible” standard is new and (though it purports not to) seems to water down considerably the old “plain repugnancy” test of Gordon v. New York Stock Exchange, Inc. 422 U.S. 659, 682 (1975). Under the new incompatibility standard, there no longer has to be an actual conflict between antitrust and other federal law for antitrust implicitly not to apply. Even a mere regulatory overlap may now be sufficient to trigger antitrust immunity. (Recall that in Credit Suisse the Court assumed that both antitrust and the SEC disapproved of the tying and other practices in question, and yet the Court still considered the two bodies of law incompatible on account of the regulatory overlap.) ….

Going forward, the Court will need to tighten the rule in Credit Suisse if it wants antitrust to continue to operate as Congress intended it to in conjunction with the compartmentalized maze of federal regulatory law. No one thinks that securities firms should be exempt from the legal obligations that generally flow from non-securities law (antitrust aside). If we expect to hold securities and other regulated firms accountable for torts and breaches of contract, or for crimes and discrimination, then why not also hold them accountable for antitrust violations? If Congress says otherwise, that is one thing. But if Congress is silent on the question, a federal agency should not have have any more power than a state to confer antitrust immunity upon those that it regulates. Of states we require a clearly articulated policy that presents an actual conflict, not merely the possibility of future potential incompatibility. From federal agencies we should not expect any less.

Just yesterday, in its historic decision in Leegin, the Court strongly reaffirmed its confidence in the Rule of Reason’s workability by overturning Dr. Miles and extending the rule’s reach to vertical RPM. That workability should make us equally confident that antitrust can peacefully coexist with the reguatory state.

Securities fraud class-actions are down. In an op-ed in yesterday’s WSJ, Joseph Grundfest observed that both the number of such actions and the dollar value of total damages claims have dropped dramatically since mid-2005. Why has this decline occurred? Grundfest considers several possible reasons.

First, the decline might be due to the criminal prosecution of Milberg Weiss, the leading securities fraud plaintiff firm. Grundfest rejects that explanation:

[T]here is no shortage of plaintiff class-action lawyers in America, and the barriers to entry in class-action securities fraud are quite low. The lawyers who abandoned Milberg in droves haven’t forgotten how to file class action complaints, and their incentives to sue every firm in sight remain as strong as ever.

Next, Grundfest considers whether the decline is due to recent “strong equity markets, combined with low volatility.” He rejects that explanation because “the change in the litigation market is rather sudden in comparison to a relatively smooth shift in the larger stock market patterns” and because “current activity levels are low even when measured by pre-boom standards” (i.e., even when compared to levels preceding the boom-bust period of the late 1990s).

Finally, Grundfest considers a theory he deems more plausible: there are fewer securities fraud class actions because there is less fraud, and there is less fraud because the government (post-Enron, WorldCom, and Sarbanes-Oxley) has more effective tools for prosecuting fraud:

From this perspective, class-action securities litigation is in decline because there is a new, tougher and superior enforcement mechanism in place. The SEC and the Department of Justice now insist that any corporation suspected of a sufficiently serious fraud conduct an internal investigation that will finger the executives responsible. The corporation must also cooperate in prosecuting these executives. This enforcement technique is stunningly effective, if often overbearing. It eliminates the government’s need to conduct expensive and lengthy investigations and provides the authorities with extraordinary leverage over every executive suspected of wrongdoing. Private litigation doesn’t have an equivalent deterrent effect because it can’t threaten executives with jail and because damages are almost always paid by corporations and insurers, not the executives who cause the fraud.

I’m wondering what others think about this theory. It would be interesting to see whether both accounting fraud and non-accounting fraud claims have decreased by similar proportions. The recent government enforcement efforts have been focused on accounting fraud, so if we’re seeing a greater decrease in accounting fraud claims than in non-accounting fraud claims, then Grundfest’s “supply side” story may be plausible. If non-accounting fraud claims have been decreasing by a similar proportion, then it would seem the decrease should be attributed to something else.

In any event, I’d be reluctant to infer from Grundfest’s statistics that increased prosecutorial activity is desirable. I’d echo Larry Ribstein’s query:

Does the dip in securities litigation suggest that the corporate criminal prosecutions have been worth these costs? … [E]ven if we do have less fraud to litigate, I’d wonder whether it’s been worth the price. Do we have less risk-taking? A zero fraud world is not necessarily paradise.

Grundfest, of course, is well-aware that stepped up prosecutorial activity can have serious negative effects. Not too long ago, he wrote eloquently about the downsides of such prosecutorial activity in the New York Times. Some highlights:

The Supreme Court has overturned Arthur Andersen’s conviction for obstruction of justice in the Enron case. But to Andersen, the court’s ruling doesn’t matter, the original trial at which it was convicted didn’t matter and the verdict at any coming trial won’t matter. Andersen was destroyed when it was indicted.

… Andersen’s demise did serve as a stern reminder to corporate America that prosecutors can bring down or cripple many of America’s leading corporations simply by indicting them on sufficiently serious charges. No trial is necessary.

… Prosecutors are aware of their power, as are potential corporate defendants. Both sides have therefore reached an entente cordiale in which no major corporation has been forced out of business since Andersen’s demise. Instead, corporations have entered into deferred-prosecution agreements, paid huge penalties, and undertaken fundamental internal reforms, all under conditions that allow the corporation to survive.

… The upside of this arrangement is clear. Corporations now have an even more powerful incentive to abide by the law, to root out wrongdoing, and to cooperate with governmental authorities. Unbridled prosecutorial discretion will not end fraud in corporate America, but wrongdoing will certainly decline as executives learn that they are expendable if a prosecutor simply threatens the corporation.

… The downside is just as clear. The prosecutor’s decision to indict is largely immune from judicial review. The prosecutor acts as judge and jury. Traditional due process safeguards, like the right to confront witnesses, can’t protect the potential corporate defendant. The innocent can therefore be punished as though they are guilty, and penalties imposed in settlements need not bear a rational relationship to penalties that would result at a trial that will never happen.

According to the Financial Times (via CFO.com), the Big Four accounting firms will recommend in a joint paper to be released tomorrow that the current system of quarterly reports be scrapped for “real-time, internet based reporting encompassing a wider range of performance measures.” It will be interesting to see what exactly they have in mind. In particular, how will liability issues be addressed? Obviously, more frequent and quicker disclosure is good for market efficiency but increases the chances of misstatements and omissions of material facts. Oh, yeah, the SEC is going dis-imply Rule 10b-5 private causes of action and cap auditor liability, so maybe increased liability exposure isn’t a big concern. But seriously, in addition to potential 10b-5 liability, how will the proposal impact incorporation by reference into registration statements and the attendant potential Section 11 and 12 liability?

In a post over at Co-op, Dave Hoffman wonders why so many in the blogoshpere are publicly outraged by Jeff Skilling’s 24-year sentence, but not, seemingly, by similar-length sentences for drug crimes.  Larry and Christine Hurt (hers is the fifth comment down on Dave’s post) deftly handle the response.

As I noted a while back:

there is a huge and under-appreciated difference, even — yes, it’s true — in the business world, between the bad behavior of private individuals and firms and that of the government.  Among other things, the former is generally localized, susceptible to economic pressures, and, quite often, ambiguous in its effect.  The latter is far-reaching, corruptible, difficult to constrain, and largely immune to economic limits.  And these are just the utilitarian concerns.  These differences are all-too-well appreciated in other contexts (and I often find myself in embarrassing agreement with the crackpots on left-wing radio who fulminate against the exercise of excessive state power when it comes to wire-tapping, war-making, the drug war and online gambling), but here, where the social costs are so enormous, there is naive belief in the government rather than skepticism.  It’s outrageous.

The social costs I refer to here are those attributable to over-deterrence of risky, innovative, entrepreneurial behavior.  In point of fact, although I find sentences for minor drug crimes to be outrageous, as well, I seriously doubt that the social consequences of over-deterrence loom as large.  (But if Dave thinks public criticism of one requires public criticism of the other, he should now feel satisfied, right?)

The problem in the drug war context is quite different, at least for me.  Given a social (or at least government) policy of deterring drug use, perhaps draconian sentences are required and appropriate (given the difficulty of deterrence).  But I happen to think the policy itself is idiotic and the practice shouldn’t be deterred in the first place.  In that sense, I think punishments for drug use are approximately infinitely too large.  But there’s little sense in quibbling over the length of sentencing and optimal enforcement policy given my priors.  

The same doesn’t go for corporate fraud:  It should be deterred.  The question there, however, is how to do so optimally, given the staggering social costs of over-deterrence; the risk of self-aggrandizing, politically-motivated, error-prone prosecution; and the reality of pretty good, existing agency-cost controls.  Was Skilling’s prosecution, conviction and sentencing here optimal from a deterrence standpoint?  I doubt it, and so do many others.

So Skilling’s sentence is problematic not only because, as Larry points out, it is probably disproportionate to the actual crime (which I take it is the point Dave wants to see the rest of us make about drug prosecutions), but also and primarily because the costs of excessive prosecution are so large.

(I hasten to add that the costs of the drug war are also large and socially wasteful.  But I think almost all of the waste in the drug war comes not from over-deterrence (although that probably causes some social harm) but from the misdirected costs of prosecution.  Which seems like a relevant distinction to me.)

UPDATE:  Christine expands magisterially on her comments to Dave’s post.

Since 1997, the SEC’s Manual of Publicly Available Telephone Interpretations has been available online (see here). It is also searchable on Westlaw (see the FSEC-MISC database). The manual contains a bevy of interpretations of various SEC regulations. As to legal status of these interpretations, the manual states as follows:

The responses discussed in this manual do not necessarily reflect the views and policies of the Commission or the Division of Corporation Finance. These responses are not rules, regulations, or statements of the Commission. Further, the Commission has neither approved nor disapproved these responses. The responses discussed in this manual do not necessarily contain a discussion of all material considerations necessary to reach the conclusions stated. Accordingly, these responses are intended as general guidance and should not be relied on as definitive. There can be no assurance that the information in this manual is current, as the positions expressed may change without notice.

Nonetheless, securities practitioners routinely rely on manual statements in large part because it provides the only “authority� on the minutiae of various securities regulations. This is similar to widespread reliance on SEC no-action letters notwithstanding SEC pronouncements that no-action letters do not constitute official expressions of SEC views (for an excellent analysis of the legal status of no-action letters, see Donna Nagy, Judicial Reliance on Regulatory Interpretation in SEC No-Action Letters: Current Problems and a Proposed Framework, 83 Cornell L. Rev. 921 (1998)). And courts do frequently defer to interpretations reflected in no-action letters, although Professor Nagy argues automatic deference is inappropriate.

So what about the legal status of manual interpretations? My quick research found nothing definitive on the issue. While nine SEC releases and twenty-eight no-action letters cite the manual, only a single judicial opinion does. Should manual provisions be viewed the same as no-action letters? They seem less formal than no-action letters but, unlike no-action letters, are not addressed to a specific party under a backdrop of specific facts.

Following up on this post, according to this Reuters article the Justice Department has filed a “statement of interest” asking the court to dismiss the PCAOB constitutionality case.

[T]he lawsuit was filed “at the wrong time, in the wrong court” and should be dismissed. It said a challenge to the constitutionality of PCAOB must first be reviewed by the U.S. Securities and Exchange Commission.

The New York Post is reporting (see here) that a law firm is trying to put together a class action of those who purchased shares in Vonage’s IPO through its directed share program.  As discussed here and here, the marketing of the program ran afoul of some technical SEC requirements.

See here! Skilling was found guilty of 19 counts (incl. conspiracy, fraud, false statements and insider trading). Lay was found guilty on 6 counts (fraud and conspiracy).

I imagine both men will make model prisoners, although Lay might be the better prisoner, since he is very good at closing his eyes to bad things and ignoring signs of trouble. (We are talking about potentially *decades* in jail, as we all know. I will be curious to see how that plays out. For the record, I do not think inmate attire is fitted for cuff-links, such that Lay might want to leave his trademark ‘links at home. Or perhaps he will pawn them to pay for his appeals. . .or fines of some sort . . . or recompense to his investors. . . .)

John Hueston, the prosecutor, made a statement a short while ago in which he said two things in particular that caught my attention:

1. He said something about the verdict proving that a CEO cannot just *not* ask questions. (Forgive the double negative, but one of the compelling points for the jury, in the prosecutor’s eyes, was that Lay failed, in part, by not pushing for information - not asking questions - ignoring the red flag information that was right in his lap - not acting in good faith! See here and here for my “Not in Good Faith” manifesto. Who would have thought that the same sort of the fundamental failings that trouble me about director behavior would translate so well (relatively speaking) to the criminal context when dealing with officers?)

2. In addition, Mr. Hueston emphasized that it is no longer acceptable to hide behind lawyers and accountants. I sure *hope* so! I wonder how long it will be before we have multiple sets of outside lawyers and accountants reviewing financials to ensure that nobody is hiding behind anyone. I see this as akin to when Boards started demanding their own counsel, apart from the GC and apart from the outside corporate counsel. I, for one, would be DELIGHTED if multiple layers of accounting and legal review turn out to be a short-term impact of today’s verdict. Even if the costs are duplicative and significant, those costs are still LESS than the cost to investors of another Enron-esque catastrophe.

As you’ve probably heard, Vonage’s IPO was a flop. It closed down 12.6% from its IPO price of $17. This represented the weakest first day performance of an IPO in nearly two years. It also greatly magnifies the apparent technical violations of the Securities Act I blogged about yesterday (see here). As Voange disclosed in its prospectus, it failed to comply with Rule 433 for its email blast and Rule 134 for its voicemail blast, and as a result these “could be determined to be . . . illegal offer[s] in violation of Section 5 of the Securities Act, in which case recipients could seek to recover damages or seek to require us to repurchase their shares at the IPO price.�

For Vonage, the best “defenseâ€? to any claimed violation would have been a nice first day pop followed by the stock staying above its IPO price until the one year statute of limitations ran. In such an event, there would have been no economic motivation for any investor to bring a lawsuit. Alas, that didn’t happen. If Vonage gets sued, it’s prospectus indicates it will rely on an “insignificant deviationâ€? defense. Per its prospectus: (more…)

You might have noticed that the current Bausch & Lomb product recall is on my list of things to blog about. Let us start in on it:

As you likely know, Bausch & Lomb announced a worldwide recall yesterday of its MoistureLoc product. This recall comes about a month after B&L disclosed concerns about and discussions with the FDA regarding a rare eye infection (Fusarium keratitis) that had cropped up among some number of MoistureLoc users (and users of other products, made by other companies, it is worth noting). At that point, in April, B&L suspended sales in the US of its MoistureLoc product.

The CEO of B&L told us yesterday that investigations have shown that there had been no contamination or tampering with the MoistureLoc product, which leads B&L to deduce that “some aspect of the MoistureLoc formula may be increasing the relative risk of Fusarium infection in unusual circumstances.” To be safe, B&L is recalling the product, while B&L continues to investigate the link between the infection and MoistureLoc.

Three things are interesting to me:

1. The wires tell us that the FDA just released a report chastising B&L for not reporting in a timely fashion 35 cases of eye infections reported by its MoistureLoc users in Singapore and for not notifying the FDA immediately when B&L withdrew its product from the Singapore market in February (well before B&L pulled the product in the US). (I could not get my hands on the FDA report, hence my introduction “the wires tell us.�)

2. The MoistureLoc solution has apparently been used since late 2004. In December of 2005, a class-action suit was filed against B&L by a woman who claimed that she suffered an eye infection as a result of using B&L’s solution, and the infection ultimately required her to get a corneal transplant.

3. The RiteAid and Target directors have not yet responded to a fax (or e-mail) I sent to them last month, asking whether I should stop using their generic eye care products (in the event that their products were made by B&L and/or Alcon).

Allow me to expand on these three things: Points two and three above are interesting to me because they would make good facts for an exam question. Specifically, I view B&L’s disclosure failures and the fact that B&L was on notice of potential problems months ago as raising fun securities fraud and director liability (for good faith failures) issues.

On the issue of securities fraud, B&L appears to have been holding off on filing 10Qs and 10Ks for months. Initially, the reason given was unrelated to the MoistureLoc eye infection issues. My question is “at what point did B&L know enough about the eye infection potential that it became material disclosure that *had* to be made, such that the failure to make the disclosure while making *other* disclosure constituted securities fraud?�

Remember the balancing test from Basic v. Levinson – essentially balance the contingency against the impact it would likely have if it came to pass? It seems to me that (a) getting sued by a bunch of folks who have serious eye problems (including blindness- God forbid), (b) having to pull a relatively significant product, and (c) losing consumer confidence in other unrelated products are all things that I would peg as “material enough� (for lack of a better phrase) under Basic to merit disclosure sooner rather than later. I understand that making disclosure sooner rather than later raises the risk of alienating investors if it later turns out that the fungal infection issue is a non-starter. But we are talking about eyes here, people; not toenail fungus infections.

On the director liability front, I would love to know how much the B&L directors knew about the potential MoistureLoc concerns and when they knew it. I see this as a policy sort of exam question – “if you are called by your friend Sue, a director for Generic Eye Care Inc., and she tells you that the COO of Generic mentioned something while on the links with her about a class action suit related to eye infections but the COO said this sort of litigation was de rigeur in the medical products world, and Sue asks you if she needs to raise a red flag with her fellow directors, what do you tell her? Remember that the modern board is a ‘monitoring board,’ at best.�

With respect to point three above, I faxed (or e-mailed) letters to the Boards of Directors of both Target and Rite-Aid back in April when I heard about B&L’s product recall, asking whether either of their private label eye solutions (which I use) were actually B&L products about which I should be concerned. I also asked in the letter what I should do, in terms of using the products and/or getting my eyes examined.

In a *shocking* turn of events, I have not yet heard back from even a single director.

Option backdating was on page one of the W$J again yesterday (here). The story was spurred by comments made by UnitedHealth’s CEO, William W. McGuire, during UnitedHealth’s First Quarter 2006 Results Teleconference on Tuesday. UnitedHealth’s option grants to Dr. McGuire were among those cited as suspicious by a March 18 page one W$J (article here; earlier blog post here).

The Journal’s analysis raises questions about one of the most lucrative stock-option grants ever. On Oct. 13, 1999, William W. McGuire, CEO of giant insurer UnitedHealth Group Inc., got an enormous grant in three parts that — after adjustment for later stock splits — came to 14.6 million options. So far, he has exercised about 5% of them, for a profit of about $39 million. As of late February he had 13.87 million unexercised options left from the October 1999 tranche. His profit on those, if he exercised them today, would be about $717 million more.

The 1999 grant was dated the very day UnitedHealth stock hit its low for the year. Grants to Dr. McGuire in 1997 and 2000 were also dated on the day with those years’ single lowest closing price. A grant in 2001 came near the bottom of a sharp stock dip. In all, the odds of such a favorable pattern occurring by chance would be one in 200 million or greater. Odds such as those are “astronomical,” said David Yermack, an associate professor of finance at New York University, who reviewed the Journal’s methodology and has studied options-timing issues.

Dr. McGuire addressed the issue during Tuesday’s teleconference (click here for the transcript). Among other things, he recommended that that UnitedHealth: (more…)

In today’s W$J, Holman Jenkins stands up for short-sellers, and rightly so. Those folks have taken a bit of a beating lately. They’ve been sued by companies like Biovail and Overstock.com and trashed on talk shows like CBS’s 60 Minutes.

[NOTE: I originally linked to the 60 Minutes segment, but I just realized that the segment includes a warning that unauthorized Internet display is prohibited. The segment is available on Overstock’s website here. Just scroll down to the event on March 26, 2006 — “Biovail Story on CBS’s 60 Minutes.”]

Attacks on short-sellers are nothing new. Those investors — who borrow the stock of companies they believe is overvalued, sell it, and then repurchase it (hopefully at a lower price) before the date by which it must be returned — make their money by betting against companies. This, many believe, is evil. Indeed, Malaysian law deemed short-selling to be grounds for caning (yes, getting smacked with a cane) until just two weeks ago!

Those who reflexively jump on short-sellers for, as Jenkins puts it, “push[ing] down stocks owned by widows, orphans, and other helpless shareholders” assume that higher stock prices must always be better for investors than lower ones. Tell that to the folks who bought Enron at $90/share. They certainly wish there had been more shorting of Enron stock.

In addition to the “investor reliance” losses occasioned by overvaluation, such mispricing can lead to destruction of significant corporate value. Harvard Business School Professor Michael Jensen has recently explained why this is so in his fantastic paper Agency Costs of Overvalued Equity. Jensen shows that a higher stock price is not always better for investors. Indeed, a high but unjustified price can be downright bad for holders of a stock.

Short-sellers play a crucial role in sniffing out those stocks that are priced higher than they ought to be and helping to bring their prices down. In theory, corporate managers and professional stock analysts would take steps to correct overvaluation, but there are good reasons to believe that neither group is up to the task. (For why this is so, see below the fold.) (more…)

An article in today’s W$J reports on former Qwest CEO Joseph Nacchio’s planned defense in a criminal insider trading action brought by the SEC. The defense is perplexing.

The SEC has accused Nacchio of selling $101 million of Qwest stock while in possession of inside information that the firm wasn’t doing as well as its public statements would suggest. The Journal reports that

Mr. Nacchio’s attorneys have said in court that his defense will rest partly on a claim that he expected the company to do well despite its difficulties because he had secret information about classified, national security-related contracts he believed Qwest would win.

Come again? Is Nacchio claiming that it was OK for him to sell while in possession of material non-public bad news regarding company prospects because he also possessed material non-public good news? Is this a “two wrongs make a right” theory? Or is Nacchio saying that he shouldn’t be liable because he was really attempting to (irrationally?) hurt himself by selling while in possession of material non-public good news? The defense is odd.

In an attempt to figure out what Nacchio’s strategy is, I took a look at some recent filings in the case. In a document filed on January 18, Nacchio’s lawyers state:

The “material” information Mr. Nacchio is alleged to have possessed at the time of the stock sales in question (January 2 - May 29, 2001) related to the company’s ability to achieve its quarterly earnings targets. Thus, in order to prove the charged offense of insider trading, the government must prove not just that securities fraud was taking place at the company in the release of misleading financial information to the public, but that it was taking place with Mr. Nacchio’s knowledge prior to his sales of Qwest stock. This alleged inside information must be “material.”

Based on this statement (which is itself perplexing), I surmise that Nacchio’s defense (or this part of it, at least) is that two “wrongs” do make a right because the second piece of non-public information to which Nacchio was privy when he traded (i.e., the likelihood of the lucrative defense contracts) would make the first piece (i.e., various bits of bad news at the company) immaterial. In other words, the theory seems to be that the totality of non-public information of which Nacchio was aware would not be something a rational investor would consider important in deciding how to invest (and thus would not be material), for Nacchio’s private negative information was counterbalanced by private positive information.

Interesting. We’ll see where it goes. (I’m not optimistic for Nacchio.)

If anyone has other theories regarding Nacchio’s planned defense or knows of any decisions evaluating this “two wrongs” theory, please let us know.