Volume 18
Volume 18.1
All Stick and No Carrot? Reforming Public Offerings
Stephen J. Choi and A.C. Pritchard
The SEC heavily regulates the traditional initial public offering (IPO). Those regulatory burdens fuel interest in alternative paths for private companies to go public, “regulatory arbitrage.” The SEC’s response to the emergence of alternatives, most recently SPACs and direct listings, has been to re-assert the regulatory protections in a traditional IPO, including heightened liability under Section 11 of the Securities Act. The SEC’s treatment of the traditional IPO regulatory process as a one-size-fits-all regime ignores the weaknesses of this process, in particular the informational inefficiency of the book-building process. In this essay we argue that the agency’s focus in regulating issuers going public should be on promoting market pricing driven by sophisticated investors with access to credible disclosure. We propose an alternative approach that provides issuers with a clear choice in going public: (1) provide disclosures for a seasoning period prior to listing their securities for public trading, with corresponding reductions in regulatory requirements for going public (the “carrot”); or (2) impose heightened liability on company’s going public without a seasoning period, not only for registration statements, but also for the company’s periodic disclosures released during a post-offering seasoning period (the “stick”). We argue that such a regime would push issuers to maximize the joint welfare of both issuers and investors.
Misaligned Measures of Control: Private Equity’s Antitrust Loophole
Aslihan Asil, John M. Barrios, and Thomas G. Wollmann
Agencies and legislators have raised concerns that acquisitions backed by private equity (PE) threaten competition, but few, if any, have offered explanations as to why they pose a unique threat. In this article, we argue that many PE-backed acquisitions may avoid antitrust enforcement because they escape detection. Under the Hart-Scott-Rodino Antitrust Improvements Act, parties intending to merge must notify federal authorities and wait for clearance. However, various exemptions exist based on the size of the transaction, parties involved, and proportion of control conferred by the merger. Recent work demonstrates that to police mergers effectively, agencies must be informed about transactions in their incipiency, meaning that in many economically important industries, the contours of the premerger notification program under the Act are, in practice, the same as the contours of the substantive legal standard. We show that when the Act’s exemptions are applied to PE’s standard investment structure, which use an array of intermediate special purpose vehicles to minimize taxes, share risks, and distribute fees, PE-backed acquisitions that would otherwise be reportable may be exempt. We support our argument with merger and filing data.
The Securities and Exchange Commission as Human Rights Enforcer?
Jena Martin and Rachel Chambers
On April 28, 2022, the Securities and Exchange Commission (SEC) announced that it had charged Brazilian mining company Vale with misleading investors about safety issues prior to a deadly dam collapse that killed hundreds and led to significant environmental harm in the Brazilian state of Minas Gerais. The action against Vale was largely seen as the agency’s first significant move after it had created an Environmental, Social, and Governance (ESG) Task Force within the Division of Enforcement, the purpose of which is to identify and investigate ESG-related violations.
This action against Vale also emerged at a time when scholars, practitioners, and regulators, are engaged in a larger debate regarding what role the SEC should have in regulating corporate actions and statements that are connected to human rights harms. Here, we move the debate forward by offering a first-of-its kind analysis regarding whether the SEC’s Division of Enforcement—as the country’s leading financial markets enforcer—should broaden its focus to include issues that would traditionally fall within a business and human rights, i.e., non-financial, framework.
Our analysis comes at a particularly prescient time in the agency’s history: on March 4, 2021, the SEC announced the creation of an “Enforcement Task Force” that would focus on ESG. In this article, we argue that there are three developments, in particular, that have led to the Division of Enforcement’s prioritization of this issue. First, institutional investors have become increasingly engaged with corporations (e.g., through shareholder proposals and shareholder litigation) regarding issues that implicate broader societal impacts. A second development relates to the impact that external rule setters have had on ESG reporting by corporations, particularly in the global context. Finally, the Division of Enforcement’s actions comes at a time when the agency, more generally, has embarked on a rulemaking process surrounding ESG disclosure requirements for both corporations and institutional investors.
We believe that these three developments, in turn, have created mutually reinforcing notions regarding what the “reasonable” investor considers material (a key element in securities fraud litigation). As a result, the landscape regarding what types of cases are brought under securities fraud may broaden significantly soon. Is this, however, a welcome development? We conclude that, while not ideal, the SEC’s potential to expand case law in this area may prove to be a key tool that business and human rights advocates use to hold corporations accountable for its abuses.
Volume 18.2
The Dollar Dilemma: Hegemony, Control, and the Dollar’s International Role
John Crawford
The U.S. dollar serves both as the domestic currency of the United States and as the dominant international currency for trade, settlement, and reserve purposes. The dollar’s international status provides significant benefits for the United States, but one aspect of the global dollar system as it currently operates is inherently destabilizing: offshore entities, outside the ambit of U.S. supervision and regulation, routinely issue short-term dollar-denominated liabilities—“money claims”—in ways that make them vulnerable to runs and panics. I argue in this article that there are compelling reasons for U.S. monetary authorities to try to reassert control over this activity, but that there are practical limits to their ability to do so if the dollar is to maintain its role as the dominant international currency. The trade-offs involved in balancing dollar dominance against control and stability can be managed but not entirely resolved, creating a dilemma for U.S. monetary policy. This article provides a comprehensive analysis of this dilemma and assesses possible policy reforms in light of the tensions it creates.
No Peeking: Addressing Pretextual Inspection Demands by Competitor-Affiliated Shareholders
Lynn Bai and Sean Meyer
This article exposes how private Delaware companies are vulnerable to pretextual inspections in the name of valuation by shareholders who are affiliated with competitors. The Delaware Court of Chancery’s 2020 decision in Woods v. Sahara Enterprises, Inc., which deviated from established law by switching the initial burden of proof of the shareholder’s motive to the target company, exacerbated this vulnerability. This article argues for reversing that decision and proposes changes in multiple areas of law to help companies fend off prying competitor-shareholders who abuse statutory inspection rights for unfair advantages in competition.
Are Employee Non-Compete Agreements Coercive? Why the FTC’s Wrong Answer Disqualifies It from Rulemaking
Alan J. Meese
The Federal Trade Commission recently proposed a rule banning nearly all employee noncompete agreement (“NCAs”) as unfair methods of competition under Section 5 of the Federal Trade Commission Act. The proposed rule reflects two complementary pillars of an aggressive new enforcement agenda championed by Commission Chair Lina Khan, a leading voice in the Neo-Brandeisian antitrust movement. First, such a rule depends on the assumption, rejected by most prior Commissions, that the Act empowers the Commission to issue legislative rules. Proceeding by rulemaking is essential, the Commission has said, to fight a “hyperconcentrated economy” that injures employees and consumers alike. Second, the content of the rule reflects the Commission’s repudiation of consumer welfare and the Sherman Act’s Rule of Reason as guides to implementing Section 5.
Affected parties will no doubt challenge the Commission’s assertion of authority to issue legislative rules. This article assumes for the sake of argument that the Commission possesses the authority to issue such rules enforcing Section 5. Still, prudence can counsel that an agency refrain from issuing rules before it has fully educated itself about the nature of the economic phenomena it hopes to regulate. Such prudence seems particularly appropriate when the Commission has very recently adopted an entirely new substantive standard governing such conduct. Deferring a rulemaking does not mean inaction. The Commission could develop competition policy regarding NCAs the old-fashioned way, investigating and challenging such agreements on a case-by-case basis.
The Commission rejected these prudential concerns and proceeded to ban nearly all NCAs, assuring the public that it had educated itself sufficiently about the origin and impact of NCAs to conduct a global assessment of such agreements. The Notice of Proposed Rulemaking (“NPRM”) offered three rationales for the proposed rule, drawn from a late 2022 Statement of Section 5 Enforcement Policy. First, the Commission opined that NCAs are “restrictive” because they prevent employees from selling their labor to other employers or starting their own business in competition with their employer. Second, NCAs result from procedural coercion, because employers use a “particularly acute bargaining advantage” to impose such agreements. Third, NCAs are substantively coercive, because they burden the employee’s right to quit and pursue a more lucrative opportunity.
The first rationale applied to all NCAs. The second and third applied to all NCAs except those binding senior executives. Such executives, the Commission said, bargain for such agreements with the assistance of counsel and presumably receive higher salary and/or more generous severance in return for entering such NCAs. Because NCAs also have a “negative impact on competitive conditions,” the NPRM also concluded that they are presumptively unfair methods of competition. The Commission conceded that NCAs can create cognizable benefits. Nonetheless, the Commission concluded that such benefits do not justify NCAs, for two reasons. First, less restrictive means can “reasonably achieve” such benefits. Second, such benefits do not exceed the harms that NCAs produce.
The Commission also rejected the alternative remedy of mandatory precontractual disclosure of NCAs for two interrelated reasons. First, such disclosure would not prevent employers from using overwhelming bargaining power to impose such restraints. Second, disclosure would not alter the number or scope of NCAs and thus would not reduce their aggregate negative economic impact. The procedural coercion rationale played an outsized role in the Commission’s Section 5 analysis, informing the findings that NCAs are also “restrictive” and substantively coercive. Moreover, the outsized emphasis on procedural coercion dovetailed nicely with the Neo-Brandeisian claim that ordinary Americans are routinely helpless before large concentrations of private economic power. Indeed, when the Commission released the NPRM, Chair Khan separately tweeted that NCAs reduced core economic liberties.
Still, the Commission offered no definition of “coercion” or explanation of how to determine whether employers have used coercion to impose NCAs on employees. Instead, the Commission articulated several subsidiary determinations regarding the characteristics of employers and employees that, taken together, established that employers always possess and use an acutely overwhelming bargaining advantage to impose nonexecutive NCAs. Thus, the Commission emphasized that labor market power is widespread, due in part to labor market concentration, most employees are unaware of NCAs before they enter such agreements, NCAs generally appear in standard form contracts, employees rarely bargain over such agreements, most employees live paycheck-to-paycheck and thus have no choice but to accept NCAs, and individuals negotiating over terms of employment discount or ignore the possibility that they will depart from the job they are about to accept and thus downplay the potential impact of an NCA on their future employment autonomy.
This article contends that the Commission’s procedural coercion rationale for condemning nonexecutive NCAs does not withstand analysis. In particular, the Commission’s various subsidiary determinations that support the procedural coercion rationale have no basis in the evidence before the Commission, contradict such evidence and/or disregard modern economic theory regarding contract formation. For instance, a recent study by two Department of Labor economists finds that the average Herfindahl-Hirschman Index in American labor markets is 333, the equivalent of thirty equally-sized firms, each with a 3.33 percent market share, competing for labor in the same market. A previous version of the study was published on the Department of Labor’s website several months before the Commission issued the proposed rule. The NPRM offers no contrary evidence regarding the proportion of labor markets that are concentrated. “Hyperconcentration of labor markets” is apparently a myth.
Moreover, the NPRM ignores record evidence that sixty-one percent of employees know of NCAs before they accept the offer of employment. The NPRM’s failure to address these data is particularly strange, insofar as the NPRM cites the very same page of the academic article where these data appear three different times for other propositions. The Commission also erred when it assumed that employers with labor market power will use such power coercively to impose even beneficial NCAs. This assumption would have made perfect sense in 1965. However, since the 1980s, scholars practicing Transaction Cost Economics have explained how firms with market power, including labor market power, will not use that power to impose beneficial nonstandard agreements, including NCAs. The Commission was apparently unaware of this literature.
Nor does the lack of individualized bargaining and reliance on form contracts suggest that employers use power coercively to impose NCAs. Form contracts often arise in competitive markets and reduce transaction costs. Background rules governing contract formation, robust state court review of NCAs and exit by potential employees can constrain employers’ ability to obtain unreasonable provisions and induce employers to pay premium wages to compensate employees for agreeing to NCAs. These considerations may explain why a majority of employees who had advanced knowledge of NCAs considered the agreements reasonable, a finding the NPRM ignores.
Nor does it matter that most employees work paycheck-to-paycheck. The Commission ignored the possibility that such individuals may be employed when seeking a new job, bargain from a position of relative security and can thus “walk away” from onerous NCAs. The Commission also ignored economic literature establishing that the presence of some such individuals in a labor market can ensure that employers offer reasonable terms to all potential employees, including unemployed job seekers.
Refutation of the procedural coercion rationale for banning nonexecutive NCAs requires reconsideration of the other two rationales as well. For instance, nonexecutive NCAs are the result of voluntary integration and thus not procedurally coercive or substantively coercive, either. Moreover, because some nonexecutive NCAs are voluntary, the Commission must abandon its erroneous assumption that the beneficial impacts of NCAs necessarily coexist with coercive harms. Proper assessment of business justifications requires the Commission to ascertain the proportion of NCAs that constitute voluntary integration, revise downward its estimate of coercive harms and reassess NCAs’ relative harms and benefits. This revision could result in a determination that NCAs’ benefits in fact exceed their harms. Finally, recognition that beneficial NCAs are the result of voluntary integration requires the Commission to reconsider the mandatory disclosure remedy, which the Commission rejected based on the erroneous belief that employers use bargaining power to impose even fully-disclosed and beneficial NCAs. Such reconsideration could of course lead to revising the scope of the proposed ban or rejection of any ban.
The Commission may well be entirely capable of assessing the global impact of NCAs on economic variables such as price, output, and wages. However, the Commission rejected such a rule of reason approach in favor of a standard that turns in part on the process of contract formation. Thus, the Commission necessarily took on the task of gathering information regarding the process of forming NCAs and of assessing that data in light of applicable economic theory. The Commission’s demonstrably poor execution of this task reveals that it lacks the capacity to conduct a generalized assessment of NCAs under a governing standard that treats procedural coercion as legally significant.
Because it lacks the capacity to assess the process of forming nonexecutive NCAs, the Commission should withdraw the NPRM and start over. There are two alternative paths the Commission may take to develop well-considered competition policy governing NCAs. First, the Commission could revert to the rule of reason approach it rejected in 2021. The Commission could draw upon its considerable study of the impact of NCAs on wages, prices and employee training and promulgate a rule that bans those agreements the Commission believes produce net harm, after reconsidering regulatory alternatives such as mandatory disclosure.
Second, the Commission could continue to embrace its new Section 5 standard but take an “adjudication only” approach to implementation. The Commission could simultaneously take other steps through various forms of public engagement to educate itself about contract formation in general and the formation of NCAs in particular. The Commission could build on data it has to this point ignored regarding various attributes of employers, employees and labor markets more generally. Adjudication and self-education could be mutually reinforcing. Self-education could inform the Commission’s determination of which NCAs to challenge, while information generated in adjudication could improve the Commission’s knowledge base about NCAs. Ultimately this two-track approach could generate sufficient information to justify a well-considered rule governing NCAs.
Volume 18.3
Every Billionaire Is a Policy Failure
Ann M. Lipton
2022 Twitter Shutdown Rumors / #RIPTwitter - Hello, I Wish To Register a Complaint, Know Your Meme, https://knowyourmeme.com/photos/2483004-2022-twitter-shutdown-rumors-riptwitter.
Order-by-Order Competition as a Regulatory Restraint on Off-Exchange Market Making: Its Historical Path and Future Outlook
Stanislav Dolgopolov
This Article looks at various regulatory approaches to order-by-order competition, which effectively serves as a regulatory restraint on the business model of off-exchange market making, as reflected in the past, present, and potential future. More specifically, this Article describes the earlier considerations of regulatory changes to enhance order-by-order competition, analyzes models of competition in the context of the current market structure and the key role played by off-exchange market makers, and assesses the approach recently proposed by the regulators, including several measures that supplement or interact with the stated goal of order-by-order competition. The Article concludes by considering the pace of regulatory change in light of the underlying complexity, challenges, and tradeoffs.