Those Short-Sighted Attacks on Quarterly Earnings

Robert C. Pozen  is a senior lecturer at MIT’s Sloan School of Management. Mark Roe is a professor at Harvard Law School. Related research from the Program on Corporate Governance includes Corporate Short-termism—In the Boardroom and in the Courtroom by Mark Roe (discussed on the Forum here); and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

The clamor against so-called corporate short-term thinking has been steadily rising, with a recent focus on eliminating the quarterly earnings report that public firms issue. Quarterly reports are said to push management to forgo attractive long-term projects to meet the expectations of investors and traders who want smooth, rising earnings from quarter to quarter.

The U.K. recently eliminated mandatory quarterly reports with the goal of lengthening the time horizon for corporate business decision-making. And now Martin Lipton, a prominent U.S. corporate lawyer, has proposed that U.S. companies’ boards be allowed to choose semiannual instead of quarterly reporting. The proposal resonates in Washington circles: Presidential candidate Hillary Clinton has criticized “quarterly capitalism” as has the recently departed Republican SEC Commissioner Daniel Gallagher.

But while quarterly reporting has drawbacks, the costs of going to semiannual reporting clearly outweigh any claimed benefits.


Regulatory Approvals for Bank M&A

Edward D. Herlihy is a partner and co-chairman of the Executive Committee at Wachtell, Lipton, Rosen & Katz. The following post is based on a Wachtell Lipton memorandum by Mr. Herlihy and Richard K. Kim.

The Federal Reserve’s approval last week of M&T’s pending acquisition of Hudson City has prompted a great deal of speculation as to the current state of the regulatory approval process for bank mergers and acquisitions. Announced over three years ago, on August 27, 2012, the M&T/Hudson City transaction has taken longer to receive Federal Reserve approval than any other bank merger. Many in the industry have interpreted the delay in receiving approval for the merger as representing a policy change by the Federal Reserve. As discussed below, we view the transaction as largely an idiosyncratic event that is a result as much of timing as any policy shifts by the Federal Reserve. With this approval, taken together with the others that the Federal Reserve has issued over the past several months, there is now more clarity and certainty to the regulatory approval process for bank M&A. With the exception of the largest systemically important banks, there is no regulatory policy impeding bank mergers.


SCOTUS Declines Petition on Insider Trading Ruling

Brad S. Karp is chairman and partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss client memorandum.

Today [October 5, 2015], the United States Supreme Court declined to hear the petition for a writ of certiorari (the “Petition”) filed by the United States Department of Justice (“DOJ”) in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), a landmark decision that dismissed indictments against two insider trading defendants. By declining to hear the Petition, the Supreme Court ensured that the Second Circuit’s decision in Newman will remain binding in the Second Circuit and influential across the country.

As we explain below, two of Newman’s holdings are particularly important: first, that the government must prove that a remote tippee knew or should have known of the personal benefit received by a tipper in exchange for disclosing nonpublic information; and second, that the benefits alleged by the government in United States v. Newman were not sufficient to support a conviction, as they were not sufficiently “consequential.”


Delaware’s Respect for Informed Stockholder Approval of Mergers

William Savitt is a partner in the Litigation Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Savitt, Ryan A. McLeod, and Nicholas Walter. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In an important ruling last week, the Delaware Supreme Court reaffirmed that control of Delaware companies lies in the boardroom and held that the deferential business judgment rule is the “appropriate standard of review for a post-closing damages action” when a third-party merger “has been approved by a fully informed, uncoerced majority of the disinterested stockholders.” Corwin v. KKR Fin. Holdings LLC, No. 629, 2014 (Del. Oct. 2, 2015) (en banc).

The ruling affirms the Court of Chancery’s dismissal of a case challenging KKR’s $2.6 billion acquisition of KKR Financial Holdings LLC (“KFN”), about which we previously wrote. Attacking the trial court’s ruling, stockholder plaintiffs argued that KKR was KFN’s controlling shareholder (notwithstanding its small equity stake) because a KKR affiliate managed KFN’s day-to-day operations pursuant to a management agreement. The Supreme Court disagreed and confirmed that a minority stockholder will not be considered a controller without “a combination of potent voting power and management control such that the stockholder could be deemed to have effective control of the board without actually owning a majority of stock.” Because KKR was not a controlling stockholder, the transaction was not subject to entire fairness review.


The Spotlight on Boards

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton and Sabastian V. Niles. Mr. Niles is counsel at Wachtell Lipton specializing in rapid response shareholder activism and preparedness, takeover defense, corporate governance, and M&A.

The ever evolving challenges facing corporate boards, and especially this year the statements by BlackRock, State Street and Vanguard of what they expect from boards, prompts an updated snapshot of what is expected from the board of directors of a major public company—not just the legal rules, but also the aspirational “best practices” that have come to have almost as much influence on board and company behavior.

Boards are expected to:


An End to Disclosure-Only Settlements?

Monica K. Loseman is a partner in the Litigation Department at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn publication authored by Ms. Loseman, Nicholas A. KleinBrian M. Lutz, and Meryl L. Young. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In an opinion last week [September 17, 2015], the Delaware Court of Chancery, following other recent decisions from that Court, strongly signaled that stockholder lawsuits in Delaware attacking mergers may no longer be resolved by a corporate defendant providing additional disclosures to stockholders in exchange for a broad release of claims against all defendants. Signaling the end to what has become common practice in stockholder litigation routinely challenging mergers, Vice Chancellor Glasscock noted in his decision approving a settlement in In re Riverbed Technologies that, “in light of this Memorandum Opinion,” expectations that the court will approve such broad releases in exchange for additional disclosures “will be diminished or eliminated going forward.”

The settlement arose out of stockholder litigation concerning a going-private transaction. In the settlement, Riverbed agreed to make supplemental disclosures in an SEC filing prior to the stockholder vote and pay plaintiffs’ attorney’s fees, in exchange for defendants receiving a full release from liability for all claims arising out of the merger.


Active Ownership

Oğuzhan Karakaş is Assistant Professor of Finance at Boston College. This post is based on an article authored by Professor Karakaş; Elroy Dimson, Professor of Finance at London Business School; and Xi Li, Assistant Professor of Accounting at Temple University. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Allen Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

In our paper, Active Ownership, forthcoming in the Review of Financial Studies, we analyze highly intensive engagements on environmental, social, and governance (ESG) issues by a large institutional investor with a major commitment to responsible investment (hereafter “ESG activism” or “active ownership”). Given the relative lack of research on environmentally and socially themed engagements, we emphasize the environmental and social (ES) engagements throughout the paper and use the corporate governance (CG) engagements as a basis for comparison.


Will a New Paradigm for Corporate Governance Bring Peace?

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here); The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here); and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.

The decades-long conflict that is currently raging over short-termism and activist hedge funds strikes me as analogous to the Thirty Years’ War of the 17th Century, albeit fought with statistics (“empirical evidence”), op-eds and journal articles rather than cannon, pike and sword. I decided, after some thirty-six years in the front line of the army defending corporations and their boards, that pursuing the thought might result in an essay more interesting (and perhaps a bit more amusing) than my usual memos and articles.

In 1618, after two centuries of religious disputation and tenuous co-existence, the ascension of the staunchly partisan Ferdinand II as Holy Roman Emperor sparked a revolt that disrupted the balance of power in Europe and began the Thirty Years’ War. The War quickly involved the major powers of Europe. The conflict resulted in the Peace of Westphalia and the redrawing of the religious and political map of Europe, a new paradigm for the governance of Europe.

In 1985, a century of disputation as to the roles of professional management, boards of directors and shareholders of public companies similarly resulted in the disruption of the balance of power and general prosperity. In the two decades immediately preceding 1985, corporate raiders had perfected the front-end-loaded, two-tier, junk-bond-financed, bust-up tender offer, using tactics such as the “Highly Confident Letter” to launch a takeover without firm financing, “greenmail” (accumulating a block of stock and threatening a takeover bid unless the target company repurchases the block at a premium to the market) and litigation attacking protective state laws. Public companies did not have sufficient time or means to defend against corporate raiders. The battles culminated in two key 1985 decisions of the Delaware Supreme Court that restored the balance of power between boards of directors and opportunistic shareholders. In the Unocal case, the court upheld the power of the board of directors to reject, and take action to defeat, a hostile takeover bid, and in the Household case, it sustained the legality of the poison pill, which I had introduced three years earlier in an effort to level the playing field between corporate raiders and the companies they targeted.


The Effect of Relative Performance Evaluation

Frances M. Tice is Assistant Professor of Accounting at the University of Colorado at Boulder. This post is based on an article authored by Ms. Tice.

In the paper, The Effect of Relative Performance Evaluation on Investment Efficiency and Firm Performance, which was recently made publicly available on SSRN, I examine the effect of explicit relative performance evaluation (RPE) on managers’ investment decisions and firm performance. Principal-agent theory suggests that firms can motivate managers to act in shareholders’ interest by linking their compensation to firm performance. However, firm performance is often affected by exogenous factors, and as a result, performance-based compensation may expose managers to common risk that they cannot directly control. In such cases, RPE enables the principal to compensate managers on their effort and events under their control by removing the effect of common shocks from measured performance, thus improving risk sharing and incentive alignment. However, RPE use as implemented in practice may not be effective in addressing agency costs because of potential peer group issues, such as availability of firms with common risk or a self-serving bias in peer selection. In addition, prior research also suggests that a large gap in ability between the RPE firm and peers (“superstar effect”) may actually reduce managers’ effort because the probability of winning is low. Therefore, the question of whether explicit RPE use in executive compensation does indeed reduce agency costs remains unanswered in the empirical literature.


SEC Interpretation of “Whistleblower” Definition

Nicholas S. Goldin is a partner at Simpson Thacher & Bartlett LLP. This post is based on a Simpson Thacher publication by Mr. Goldin, Peter H. BresnanYafit Cohn, and Mark J. Stein.

On August 4, 2015, the Securities and Exchange Commission (“SEC”) issued an interpretive release to clarify its reading of the whistleblower rules it promulgated in 2011 under Section 21F of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The release expressed the SEC’s view that the employment retaliation protection accorded by the Dodd-Frank Act and codified in Section 21F is available to individuals who report the suspected securities law violation internally, rather than to the SEC. [1]


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