Diaspora Bonds and US Securities Regulation
an interview with Anupam Chander of University of California, Davis School of Law
Susan Acquista | University of California, Davis, School of Law
John Ly

Posted Sunday, May 1, 2005
5 U.C. Davis Bus. L.J. 20 (2005)

A graduate of Harvard College and Yale Law School, Professor Chander clerked for Chief Judge Jon O. Newman of the Second Circuit Court of Appeals and Judge William A. Norris of the Ninth Circuit. He practiced law in New York and Hong Kong with the firm of Cleary, Gottlieb, Steen & Hamilton, representing foreign sovereigns in international financial transactions. Before joining the law faculty at the University of California, Davis, he was a member of the faculty at Arizona State University.

Professor Chander teaches and writes in the area of international law, citizenship, cyberlaw, intellectual property law, and corporate law. He is also an occasional contributor to a legal column on Findlaw.com. His recent publications include: Diaspora Bonds, N.Y.U. L. Rev. (2001) (Ass'n of American Law Schools Scholarly Paper, Honorable Mention); Whose Republic?, University of Chicago Law Review (2002); The New, New Property, Texas Law Review (2003); Minorities, Shareholder and Otherwise, Yale Law Journal (2003); and The Romance of the Public Domain, California Law Review (2004).

Background

This interview will focus on issues raised in Professor Chander's article entitled, Diaspora Bonds, which was published in the New York University Law Review in 2001. The article deals with the phenomenon of diasporas. The term, diaspora, refers to dispersion of ethnic communities across the globe. Originally, the word was used to describe the spread of the Jewish people from the destruction of the temple of Jerusalem up to the present time. Modern scholars, however, have used the word to refer to the distinct and sometimes amorphous ethnic minority communities that frequently reside in western industrialized countries. In his article, Professor Chander explores the legal issues surrounding the growth of these diasporas, which includes a case study on the Resurgent India Bond, the subject of the interview.

Q: Professor Chander, can you briefly describe your research on diasporas and their impact on what you dub, "diaspora bonds" which were issued by certain governments to raise capital?

A: Diaspora bonds as particular securities instruments became my way of thinking of diasporas more generally. My interest in the topic arose out of the fact that I worked as a securities lawyer in New York doing lots of sovereign bonds. During this time, I worked on private deals involving bonds for Ecuador, Guatemala, Colombia, and a variety of other governments. As a result, I had seen lots of bonds being issued on the international market. And then I saw a peculiar bond, called the Resurgent India Bond, which was first issued in 1998, after India blew up a few nuclear bombs. After the detonation of the bombs, the US and much of the rest of the world issued sanctions against India to try to punish India for engaging in an act of nuclear proliferation. India, of course, had already demonstrated its ability to develop these weapons in the 1970s when it blew up an atomic bomb. In 1998, the number and size of detonations in its western desert of Rajasthan provoked more criticism from the international community. To make matters worse, about a week or so later, Pakistan followed India's lead when it pulled out its own nuclear weapons and blew them up as well.

The sanctions that followed against both India and Pakistan were very serious, and one issue that developing countries have is a need for foreign exchange. The foreign exchange is badly needed to pay foreign debts - to buy oil, for example - and on the international market, countries need hard cash. Rupees, the Indian currency, just did not cut it. The problem with sanctions is that they dry up a country's foreign exchange.

As a result, what India did in the summer of 1998 was to rapidly collect four billion in hard cash from its diaspora. I say this was a peculiar sovereign bond for two reasons. First, it made no effort to comply with US securities laws. In effect, India was raising capital from within the US, but it was doing so outside of the US securities laws. It didn't register the instruments, it didn't suggest that they were private placements of securities, and it didn't follow either of the typical paths for selling securities in the US. The legal interpretation that follows must be that this bond was not subject to the securities law because it was a certificate of deposit. It was a savings instrument offered by the state Bank of India, which therefore made it more credible. But more importantly, it was outside of the purview of the U.S. securities laws entirely and would actually be covered by the banking laws. There is an odd distinction in U.S. law between instruments that raise capital which are covered by the banking laws and instruments that raise capital which are covered by the securities law. Since India made no motion toward complying with US securities law, its theory must be that the diaspora bonds were banking instruments outside the scope of the securities laws.

Beyond the legal aspect of the bonds, the second peculiar feature of these bonds is that they were only available for purchase by the Indian diaspora. Only non-resident Indians, as defined by the terms of the instruments, were permitted to purchase the bonds. This is odd because it raises the question of why a country trying to raise capital would limit the number of potential investors. Normally a country would want anyone and everyone to invest whether or not they are part of the diaspora. This interesting feature of the bond made it an important instrument for looking at issues of diaspora in general. Specifically, how the relations of expatriates by one or more generations to their homeland is being transformed in a world where transportation and communication technologies have shifted dramatically.

Q: Why did India restrict the sale of these bonds to only non-resident Indians, or the Indian diaspora?

A: There are a number of reasons why India limited investors to members of the Indian diaspora, but we cannot know for sure because India never gave an official explanation. One reason might be that India thinks a diaspora investor is a better investor. A better investor in the sense that, if things get tough for the Indian government and there are problems in repayment, then maybe the diaspora investor will not push too hard in seeking a return on the investment. That's one possibility, and it may in fact be supported by history. The principle forerunner of the Resurgent India Bonds is the State of Israel Bonds. The State of Israel Bonds, which have been around almost as long as the state of Israel itself, have been raising capital throughout the world, principally in the West and especially in the US, to fund development in Israel. Some two hundred million's worth of these bonds have matured, yet the purchasers have not collected. It's possible, then, that some of these bonds may have been gifts. This is a possible explanation, but I think it is unlikely.

Another explanation is that this is a reflection of what the practical market is likely to be and a way of advertising to that market. India knows that the only people likely to buy these bonds are in the Indian diaspora, so the bonds are designed to appeal to those people. Even the title of these instruments, Resurgent India Bonds, is meant to evoke an image of India's glorious past returning after the development of nuclear technology. The notion of this title is that India has become a strong power again. So the thought is that those are the people who are going to buy these things, and India can offer the bonds as a privilege that only they have. It's a good marketing technique to present the bonds as an opportunity only for Indian expatriates. I think this is the most likely explanation why India restricted sale of the bonds to the Indian diaspora. But like I said before, we don't know for sure since India has never issued an official policy explanation.

Q: Why did the Indian government design these bonds to circumvent US securities regulations?

A: As any corporation that is publicly listed in the United States will tell you, the US securities laws are something to be worried about. This is partly because it is easily possible to be sued under the US securities laws. Basically, public corporations in the US expect to be sued. There are shareholder lawsuits everyday, and they extract a lot of money from publicly-held companies. The US has a very big securities plaintiff's bar to make sure that if there is the possibility of a securities violation, that possibility will be investigated. And shareholders will file suit if it appears to be a basis on which they can extract some money, principally through a settlement. So if India can offer these instruments in the United States, but yet avoid being subject to the almost inevitable shareholder lawsuits, then India will be able to have had its cake and eat it too. This is the ideal - raising capital without having to suffer from the fear of the US plaintiff's attorneys. And this fear is a serious fear. It's a basis on which many companies throughout the world, when they are choosing where to list, chose to list in London or Frankfurt rather than in New York.

Also, it's not just US securities laws, but US procedure as well. Historically, US procedure has tended to be viewed by the world as being plaintiff friendly, at least in comparison to other countries. A Supreme Court decision issued just this week, a unanimous decision, makes the proof necessary at the very start even more substantial, hoping thereby to limit to some extent the number of strike suits, the kind of harassing suits, that corporations face.[1] But there's a very delicate balance we want to strike here. I'm not trying to attack the US securities laws or US procedure as wrong. Rather, I'm trying to illustrate the need for offering investors a forum and a dispute resolution method that is effective when corporations that have raised capital from these forums have not been entirely truthful about their prospects on the one hand. While, on the other hand, there is also a need to prevent a very zealous plaintiff's bar from extracting settlements because the very threat of a lawsuit is itself enough to cause serious concern in public boards of directors everywhere.

Q: The Resurgent India Bonds included forum selection and choice of law clauses that stated that any litigation arising from the issuance of these bonds would occur in Indian courts and be governed by Indian law. However, US law requires that all securities must be registered with the SEC and comply with US securities regulations. If these regulations generally cannot be waived, how will India attempt to enforce the forum selection and choice of law clauses in their bonds?

A: The first point is that US securities laws are mandatory laws. They cannot be waived. You can't, as an investor, say, "It's okay, I don't need the protection of the US securities laws. They are given to you whether you want them or not. You can't, as an issuer, say, "We'll sell these securities to investors at half price in exchange for the investor's agreement to waive the protections of the US securities laws." The US does not respect freedom of contract in this way. Basically, you cannot waive the protections of the US securities laws; they are mandatory laws. They are not default rules.

However, there are cases, such as the Lloyd's cases, whereby Courts of Appeals throughout the country have held otherwise in litigation involving the Lloyd insurance markets. The Lloyd insurance market functions in an unusual way. In this market, individuals provide the capital for the market. These individuals don't actually "pony up" cash. Rather, they serve as a kind of insurance to this insurance market. So if the market goes bad, these people, called "Names," promise to provide the capital that is needed to cover the lawsuits. These "Names," historically characterized as "English gentlemen," were reported to promise that they would contribute their wealth "down to the last cufflink" if necessary. That's the deal struck between the "Names" and the Lloyd insurance market.

But insurance, like banking, is outside the realm of the securities laws, even though these deals are also sort of like securities. The question then arises in these cases is whether or not a choice of law agreement that involves a US "Name" who signs with the Lloyd market is enforceable because it divests the US laws of any power by sending all disputes to arbitration in London. And if the US securities laws are mandatory, how can you divest an American investor of the power to sue in the US under the US securities laws? Well, these cases actually uphold that exception by saying that US investors have sufficient protections under English law. This is a little ironic because the US operated under securities law very similar to that of Britain before the Securities Acts of 1933 and 1934, and it was precisely English law that we found inadequate. Nevertheless, these cases support the divesture of US securities laws. It may well be the fact that Courts of Appeals were creating an exception for Lloyd's cases alone - something of a "Lloyd's exception." But that would make the law less legitimate since it discounts the reasoning of these courts. No, the courts have always said that they looked at English law and found it provided adequate protection for investors.

If that is the case, then Indian law is much like English law since it originated from the same common law tradition. This is why there is a heavily regulated banking industry in India. Other cases involve certificates of deposit (CDs) in Mexico and efforts by plaintiff companies in the US to sue under those CDs using US securities law. These cases raise the issue of whether the investments were actually CDs issued by banks subject to banking rules or securities subject to securities law. So I don't know what the answer is. I don't know whether the Lloyd's cases suggest a new opening for making the securities laws not mandatory-for making them a kind of default set of rules. It's a fascinating set of cases, and a serious move from the tradition of the US securities law.

Q: Some scholars have argued that issuers of securities should be allowed to choose any nation's securities laws, and that the market will adjust the price of the instruments to reflect the level of protection afforded to investors. Will US securities law consider these arguments and take a more flexible approach to choice of law clauses, such as the one found in the Resurgent India Bonds?

A: The basic suggestion of law and economics scholars is to say that people should be able to choose. They say that choice is better, that markets are better, and that regulation just gets in the way. The natural progression from this is to say that we should let people who are investing make choices as to what regulatory regime they will follow. The model suggested by scholars like Roberto Romano, Stephen Choy, and Andrew Guzman is to allow issuers to propose an issuance that will be governed by the law of Ontario, for example, or whichever regulatory regime the issuer chooses. And the investor has the choice to invest in the security or not. Basically, the issuer can say that an issuance will be governed by whatever law he thinks will be most attractive to the investor. This issuer-choice proposal suggested by Romano, Choy, and Guzman would treat the U.S. securities laws as default laws, which could be contracted out of by the parties. Of course, if the parties did not make such a contract the US securities laws would apply.

The idea is a fascinating thought experiment, and it's not as radical as it may seem. It turns out that corporate law makes exactly that same choice. A corporation can have all of its assets outside the state of Delaware and never even set foot in that state, but yet be a Delaware corporation. In the US, you can set up a corporation regardless of where your business is located, where you have your assets, or who your customers are. What's really happening is the corporation is just choosing law. All the corporation does is incur small incorporation fees, including paying an agent to receive process. By doing so, a corporation can simply set up shop physically here but legally elsewhere. This means that the corporation can choose its own "housekeeping" law. That is to say, if you have a California company being run out of San Francisco by California actors, but you can be actually operating under Delaware law. This means that you're corporate housekeeping will be governed by Delaware law. And the way you raise capital, the way you buy and sell corporate assets, and the relationship between the shareholder and the company are governed by Delaware law. But, this does not mean that you could divest yourself of California consumer protection laws or California environmental laws. You still have to pay the smog check, for example, for all of your cars. Nevertheless, this is what Roberta Romano uses for her model - this notion of expanding dramatically the choice of law that corporations have to raising capital.

The problem with the model is that these proposals were floated at the end of the 1990's, and the scandals that have since erupted from ENRON, MCI, and all the way up to Martha Stewart have been understood by people as reflecting a failure of the market. The market proved itself unable to ferret out wrongdoing. People were throwing money into these companies in what turned out to be a foolish decision, and this led Congress to want to have a more demanding regulatory regime - not a potentially less demanding regulatory regime. It certainly made Congress shy from allowing for deregulation that would be implicit in the issuer-choice model. As a result, I don't see any immediate kind of regulatory change beyond these odd Lloyd's cases that works this kind of change in its own way. I don't see the SEC or Congress moving toward a more permissive stance anytime soon, even with the deregulatory administration that's in place now.

Q: Given that the SEC and Congress is not likely to allow more permissive choice of law rules governing the issuance of securities, will more countries choose to issue diaspora bonds modeled after the Resurgent India Bonds to avoid US securities laws?

A: Well, I don't see the end-run around the US securities laws as being very popular, unless it's done in a way like the Lloyd's cases. But I do think that the idea of turning to the diaspora for funding is becoming increasingly popular. There are a lot of nations which have extended diasporas. Mexico, for example, has a very large diaspora in the United States. There are Mexican flags being flown in our hometown of Davis, California. And when you have large, wealthier expatriate populations who still feel some kinship with their homeland, it's likely that countries will turn to them for capital, especially in times of urgent need. So I expect that these kinds of instruments will continue to happen on occasion as the world's population becomes ever more mobile and countries become about raising capital from afar.



[1] See Dura Pharmaceuticals v. Broudo, No. 03-932, 2005, WL 885109 (holding that an investor may not establish loss causation by alleging that security price was inflated because of misrepresentation)