Volume 14
Volume 14.1
When, As, and If: How an Obscure Security Could Make Initial Public Offerings More Efficient
Frederick A. Elmore IV
Public equity markets face increasing competition from private sources of capital. Once a rich and reliable source of diversified wealth creation, the growth of relatively inexpensive substitute financing sources has attenuated the size and diversity of the public markets. While looking for ways to make the public securities markets more attractive, Congress should consider taking a cue from the market’s past. When-issued trading could help reduce the transaction and agency costs associated with the current firm-commitment IPO process, making public markets more attractive and accessible to private companies. As an independent signal and unbiased estimate of the underlying security’s secondary market price, the when-issued market price could provide greater certainty about aggregate demand for the offering and allay agency concerns, potentially leading to lower underpricing spreads. The resulting increase in efficiency of the IPO pricing process would benefit capital formation by making the transition to public markets more attractive to private companies. The creation of a regulated when-issued market for IPOs could be accomplished with a simple amendment to the Securities Act and a new SEC regulation pursuant to Section 12(d) of the Exchange Act.
Protecting Retail Investors: A New Exemption for Private Securities Offerings
Thomas M. Selman
The Securities and Exchange Commission (“SEC” or “Commission”) has embarked upon a comprehensive review of the framework for the exemption of securities offerings from the Securities Act of 1933 (“Securities Act”). The author proposes that the SEC open private placements to more retail investors, while better protecting them from hucksters and scammers. Many have questioned whether the wealth tests in Rule 506 ensure that “accredited investors” are sophisticated. Fewer commentators have written about the Rule 506 exemption for non-accredited investors. Issuers to non-accredited investors must comply with modest principles, but the non-accredited investor must otherwise fend for himself or receive assistance from a “purchaser representative” upon whom the rule imposes no obligation. This article recommends an exemption to better protect both accredited and non-accredited investors. Any investor, whether or not accredited, would be permitted to purchase a private offering if he or she has retained a purchaser representative who is a registered broker-dealer or investment adviser required to act in the investor’s best interest. Issuers to non-accredited investors would also be relieved of unnecessary regulatory burdens, such as requirements that the issuer appraise investor knowledge and experience, make disclosures to the investor and limit the number of non-accredited investors. Reducing these burdens could open new investment opportunities for retail investors while strengthening their legal protection.
Inadvertent Partnerships and Fiduciary Duties
Emeka Duruigbo
Individuals and American companies, who enter into negotiations for potential collaborative business opportunities within and outside the United States, risk their proposed venture being judicially characterized as a general partnership. “Inadvertent partnerships” are generally characterized as general partnerships formed through the parties’ conduct in a potential joint enterprise, irrespective of the parties’ intentions to form one. These types of partnerships currently exist in sufficient numbers to warrant the attention of scholars, practitioners, and policymakers. Being characterized as a general partnership results in significant legal implications, such as personal liability of the partners for debts and obligations of the business.
Recently, these issues resurfaced in a Texas case arising out of a business relationship between two energy companies evaluating the feasibility of a joint pursuit of an oil pipeline construction project. One of the Texas companies abandoned the proposed deal, and entered into a commercial arrangement with a Canadian company for the construction of the oil pipeline. Finding that a partnership had been formed, and the duty of loyalty breached, the jury awarded the plaintiff company more than $500 million in damages. However, the Texas Court of Appeals overturned the verdict, and recently, the Supreme Court of Texas affirmed the Court of Appeals’ decision.
The fact that parties entering into a business relationship can constitute a general partnership, without any intention of ever becoming partners, is particularly worrisome in light of the potential exposure each party faces. Specifically, each party could be held personally liable to third parties for the acts or contracts of one of the other parties, including those they have not explicitly authorized. Even more troubling, those parties could also face damaging financial consequences for breaching a fiduciary duty to those whom they never intended to owe such duties.
In the wake of this unexpected and ground-shaking Texas trial court decision, many proposals have surfaced in an effort to prevent such situations from reoccurring in the future. Some of these proposals include adding a statutory amendment that only recognizes general partnerships formed under a written partnership agreement, encouraging contractual modifications to the duty of loyalty, and having parties undertake due diligence actions while negotiating a deal in order to avoid their relationship being categorized as a general partnership when they did not intend to form one. Nevertheless, these proposals are fraught with serious problems that challenge both their utility and practicability. Therefore, this Article explores a different and somewhat unexplored line of inquiry. Specifically, this Article proposes a statutory amendment that would keep fiduciary duties among partners as the default rule, thus, continuing to protect partners who want their relationship to be governed by such duties, while also allowing other partners to contract out of these duties when they do not believe they would serve a useful purpose. This amendment is especially valuable to sophisticated parties; particularly those who did not intend to form a partnership. Under the proposed statutory amendment, it would suffice for the parties to include a simple sentence in their negotiation document or agreement disavowing an intent to create a partnership, and stating that, even if their relationship is eventually characterized by a court or tribunal as a partnership, the parties have agreed not to owe each other the duties of care and loyalty.
A Case of Mistake Identity: Questioning the U.S. Supreme Court’s Contract Theory of Arbitration
Cornelis J.W. Baaij
The United States Supreme Court explains its expansive application of the Federal Arbitration Act (“FAA”) by utilizing a pluralist theory of contract, which integrates principles of contractual autonomy and operational efficiency. A contract theory of arbitration justifies the state’s enforcement of arbitration agreements and the resulting arbitral awards. However, circular reasoning in the Court’s precedent reveals a category mistake. The Court’s reasoning suggests that the value of autonomy and efficiency are only instrumental to a third, unexpressed policy principle. By looking to the FAA’s broader legislative background, on which the Court relies, this Article demonstrates that the theory best capable of explaining the Court’s precedent is not one of contract, but one of government, namely, a theory of laissez-faire capitalism under which the state pledges its coercive force to a quasi-judicial branch of the private sector. This finding warrants a reassessment of the conditions under which state power is to be extended to support arbitration, and thus, whether a Congressional course-correction is warranted.
Volume 14.2
More JoMo less FoMo: The Case for Voluntary Disclosure of Uncertain Information in Securities Regulation
Ido Baum & Dov Solomon
The “fear of missing out” (“FoMo”) is a phenomenon that influences human behavior with regard to future events, and helps explain why investors have such a high demand for information regarding unfolding corporate events. Given the imprecise nature of this information, the uncertainties that it implicates, and its importance to investors, information about unfolding events has received special attention in securities regulation. Although the disclosure regimes of securities regulation appear to operate in a globally harmonized and synchronized system, this Article reveals the stark differences that currently exist between the United States' and European Union's rules governing the disclosure of this crucial type of information. Moreover, this Article counterintuitively argues that, in the case of information about future events, less is more. Specifically, this Article reveals that the trend towards the “joy of missing out” (“JoMo”) is in fact a better response for regulating the disclosure of uncertain future information. This Article innovates by demonstrating how a regulatory architecture that builds on the interplay between insider trading prohibitions and voluntary disclosure is superior to a mandatory disclosure regime. This type of regulatory structure creates a more efficient and less cluttered supply of material information to investors, while also reducing compliance and enforcement costs, thereby bolstering the performance of financial markets.
What Ethical & Strategic Employers Should Do about Arbitration
Dale B. Thompson & Susan A. Supina
Recent Supreme Court jurisprudence on arbitration presents significant obstacles to the protection of employee rights and interests. In this Article, the authors appeal to a different forum: ethical and strategic employers (and their lawyers). In addition to recommending changes to general arbitration policies, this Article outlines two specific situations where fundamental changes are necessary. In regards to handling masses of claims brought by similarly affected employees, this Article suggests a novel process: “clustered arbitration.” Specifically, clustered arbitration would enable employees to pool their resources in a cluster of arbitral nodes, while also offering an option of a limited appeal. However, in cases of sexual harassment, this Article argues that ethical and strategic employers must go further. In particular, the authors recommend a carve-out from mandatory pre-claim arbitration for claims of sexual harassment. By adopting these recommendations, employers can improve long-run performance, and may save arbitration from itself.
Merchant Authorized Consumer Cash Substitutes
Steven Stites & Norman I. Silber
Devising a Royalty Structure That Fairly Compensates a Franchisee for Its Contribution to Franchise Goodwill
Robert W. Emerson & Charlie C. Carrington
When a franchise's ownership and goodwill distribution under a franchising agreement are the subject of a dispute between two parties, the characterization of the parties' franchise relationship is often contested. For example, in disputes arising from issues related to franchise network creativity, transfers, and terminations, parties in a franchising agreement typically make assertions about the nature of their relationship according to what they hope to gain from the resolution of the particular dispute, rather than facing the truth about their franchisor-franchisee relationship. Accordingly, these types of disputes have generated a large degree of uncertainty about the true nature of franchise goodwill, while also obscuring how certain components of the franchise business model are defined.
In order to resolve these issues, this Article suggests incorporating a clear set of goodwill guidelines and expectations in franchise royalty structures, which would make franchise goodwill more coherent and transactable. Specifically, this Article proposes adopting a “variable” royalty structure, which would fluctuate in response to the goodwill contribution by franchisees. Under this variable royalty structure, franchisees' royalty rates would decrease in response to above average performance (i.e., a franchisee's superior “contribution”) and increase in response to below average performance (i.e., a franchisee's “free riding”). By producing a formal method for computing franchise goodwill, this variable royalty arrangement could add much needed clarity and consistency to goodwill treatment in the franchising context. Additionally, franchisors could also benefit from this variable royalty structure by incentivizing good franchisee behavior through systemic goodwill--i.e., providing the franchisee “just” compensation through reduced royalty rates.
In short, the proposed variable royalty system intends to simultaneously balance power in the franchising relationship, bring consistency to the legal identity of franchisees, and mitigate franchisee free riding.
Red, Yellow, Or Green Light?: Assessing the Past, Present, and Future Implications of the Accredited Investor Definition in Exempt Securities Offerings
Blake W. Delaplane
Since issuing its landmark decision in SEC v. Ralston Purina, the Supreme Court has energized decades of discussion in the courts, across various federal agencies, and in the marketplace, regarding which investors can “fend for themselves.” In light of additional clarification provided by the Securities and Exchange Commission (“SEC”) in subsequent rulemakings, investors now have more extensive guidance on the “accredited investor” definition. This definition is crucial because it decides who gets to invest in exempt securities offerings, which are typically less liquid, higher returning, and less volatile than other securities. However, the accredited investor definition does not simply act as a door to the exempt offerings marketplace that swings wide open when approached by investors holding appropriate financial profiles. Rather, this definition may also determine how much the door swings open at all. Today, the exempt marketplace has grown to nearly $3 trillion in capital raised per year. For better or for worse, the accredited investor definition remains a key vehicle through which retail investors may seek to diversify their portfolios, access higher returns, and reduce volatility in recessionary times. Under the leadership of Jay Clayton, the SEC has amended the accredited investor definition once more. This Article argues that, going forward, the SEC should consider regulatory proposals that will narrowly tailor the pool of investors qualifying as “accredited” under the Ralston Purina rubric, and to consider other ways in which the SEC can ensure investors in exempt offerings are able to “fend for themselves.” In light of the SEC's most recent rulemaking, an honest review of prior SEC guidelines is neccesary to shed light on how to ideally legitimize efforts to democratize the exempt offering marketplace through amending the accredited investor definition.