Monthly Archives: October 2007

Countrywide’s Corporate Governance: Definitely Subprime

This post is from J. Richard Finlay of Centre for Corporate & Public Governance.

Countrywide Financial is a name that has come to be synonymous with the subprime meltdown that has shaken investors and sent the world’s central bankers scrambling to rejigger their playbook. Less attention has focused on Countrywide’s corporate governance and compensation practices, however. Therein lie some important clues to what is behind the turmoil now being felt by the company and its stakeholders.

The lesson of Countrywide is instructive at a time when there is considerable pressure to retreat from Enron-era reforms, with many claiming they are too costly and not necessary. On the contrary, Countrywide shows that improvement is far from universal when it comes to corporate governance and that, once again, excessive CEO pay is still the Typhoid Mary of the boardroom, showing up time and again just before calamity strikes, as it did with Enron, WorldCom, Tyco, Adelphia, Nortel, and more. It also shows that a single company’s misjudgments can carry profound consequences for other corporations, public institutions and a wider community of interests, which is why society itself has a considerable stake–separate and apart from that of shareholders–in seeing CEO pay returned to reasonable levels.


Mandatory Disclosure and Stock Returns: Evidence from the Over-the-Counter Market

This post is from Allen Ferrell of Harvard Law School.

My paper Mandatory Disclosure and Stock Returns: Evidence from the Over-the-Counter Market just came out in the June edition of the Journal of Legal Studies. The paper examines the effects of the extension of the Exchange Act reporting requirements to the over-the-counter (“OTC”) market in 1964. This was the most important extension of reporting requirements in U.S. history–aside from the original securities acts themselves.

The paper documents substantial reductions in stock price volatility in the OTC market as a result of the disclosure requirements. This is consistent with the variance-bound finance literature (including Kenneth West‘s Dividend Innovations and Stock Price Volatility (1988), and Stephen LeRoy‘s and Richard Porter‘s The Present-Value Relation (1981)), which predicts that increased disclosure should reduce firm-specific volatility in the presence of discounting. The paper also documents positive abnormal returns associated with the market anticipating passage of the 1964 amendments. This is consistent with the view that increased transparency should reduce firm value expropriated by insiders, resulting in greater value for shareholders (as described in Andrei Shleifer‘s and Daniel Wolfenzon‘s Investor Protection and Equity Markets (2002)).

The full paper is available here.

Europe’s Highest Court Strikes Down Takeover Protections in German Company

This post is from Theodore Mirvis of Wachtell, Lipton, Rosen & Katz.

Many car advertisements on TV bear a legend explaining that the driving depicted is by professional drivers on a closed track–and warning viewers not to try the twists and turns at home. Well, maybe something like that could or should be said of the European Court of Justice‘s recent decision, a precis of which appears here, striking down Germany’s “Volkswagen law” and seeming to pave the way for Porsche to acquire the company.

One might recall the earlier periods over here when state anti-takeover statutes bit the dust one by one, yielding to a perceived national policy of unrestrained takeover activity and opposition to the local interest of states (especially non-chartering states) in preserving the independence of their corporate residents. There are probably more twists and turns to come as the EC works out what is meant by the “free movement of capital.”

Another Blockbuster Merger Decision From Vice Chancellor Strine

This post is from Steven M. Haas of Hunton & Williams LLP. In August, Vice Chancellor Leo E. Strine, Jr. upheld a special committee’s decision to postpone a stockholder meeting on the day of the meeting so that the company could solicit more support for a pending merger in Mercier v. Inter-Tel . In the analysis that follows, Travis Laster and I consider the implications of Inter-Tel for Delaware’s merger jurisprudence. 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.


As a doctrinal matter, Inter-Tel will stir much debate. Vice Chancellor Strine held that Unocal reasonableness should be the sole standard of review for decisions related to shareholder meetings on mergers, and that the more exacting standard announced in Blasius should be limited to director elections. The Vice Chancellor hinted that he might favor such an approach in Chesapeake v. Shore as well as in Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, an article he co-authored with Chancellor William T. Allen and now-Justice Jack Jacobs in The Business Lawyer in 2001.

Applying Unocal, Vice Chancellor Strine holds that the directors’ actions were “reasonable in relation” to a “legitimate corporate objective.” Nevertheless, after conducting his Unocal analysis, the Vice Chancellor also found a “compelling justification” for the board’s decision under Blasius, concluding that “compelling circumstances are presented when independent directors believe that: (1) stockholders are about to reject a third-party merger proposal that the independent directors believe is in their best interests; (2) information useful to the stockholders’ decision-making process has not been considered adequately or not yet been publicly disclosed; and (3) if the stockholders vote no . . . the opportunity to receive the bid will be irretrievably lost.”

Here are some other highlights of the opinion that emphasize more mundane issues:

1. The Vice Chancellor did not appear troubled by the fact that the Board “postponed” the meeting rather than convening the meeting for the sole purpose of adjournment. The Delaware General Corporation Law speaks only of adjournment, not of postponement. It has nevertheless been the widespread practice that a meeting can also be “postponed” without being convened and adjourned, and Inter-Tel supports this approach.

2. Inter-Tel does not resolve whether the “postponed” meeting must be treated as a new meeting for purposes of the notice to stockholders required under the DGCL. For a merger vote under Section 251, notice must be given at least 20 days in advance of the meeting. For an adjourned meeting, a new notice is not required if the date of the meeting is moved in a single adjournment by less than 30 days. The issue of sufficient notice for the postponement may have been raised by the parties but mooted when the Board again reset the date of the meeting so there would be enough time to satisfy a 20-day minimum-notice requirement. The argument that a “postponed” meeting should be treated as an “adjourned” meeting for purposes of shareholder notice therefore remains unaddressed.


The Year of Living Dangerously for GCs

Editor’s Note: This post comes to us from Jonathan Hayter of the National Law Journal.

The National Law Journal recently published The Year of Living Dangerously for GCs, which highlights the unprecedented increase this year in federal prosecutions of general counsels of major corporations. In the first nine months of this year, the article explains, the government initiated fraud proceedings against nine general counsels–including in-house advisors at Apple and Comverse, among others.

Several of the cases, including the recent indictment of Kent Roberts, formerly General Counsel at McAfee, involve prosecutions of attorneys allegedly involved in relatively recent options backdating scandals. In others, however, the government has alleged more traditional wrongdoing–such as in the case of Kevin Heron, former General Counsel of Amkor Technology, who was recently indicted for insider trading.

The increase in prosecutions of general counsels has given rise to concern that the attorney-client privilege between management and in-house counsel has been seriously compromised. Executives are unlikely to trust an attorney, the article argues, who may later be pressured to disclose privileged information or else face federal prosecution. (As the article notes, a Senate bill currently under consideration would bar federal agencies from conditioning prosecutorial leniency on disclosure of privileged information. Andrew Tuch recently posted here about a report by former Delaware Chief Justice E. Norman Veasey indicating that the in-house bar remains concerned about the implications of federal prosecutions on corporate privilege even following the issuance of the McNulty Memorandum.)

Though Congress declined to pass legislation last year that would have required corporate attorneys to disclose evidence of wrongdoing, SEC Chairman Christopher Cox has made clear that he expects general counsels to play a more substantial role in disclosing corporate fraud. Thus, the article suggests,this year general counsels face in a difficult quandary: management is disinclined to tell them anything, but if fraud is later revealed the government is likely to assume that they knew about everything.

The full article is available here.

Investor Litigation in the United States: Is It Working?

Jay W. Eisenhofer, a partner in the law firm Grant & Eisenhofer P.A., recently presented his paper Investor Litigation in the U.S.–The System is Working here at Harvard Law School. Co-authored by Gregg S. Levin, the paper is critical of efforts to “discredit” the “long-established mechanism” of investor class actions.

Investor Litigation in the U.S. discusses the reported decline in the international competitiveness of U.S. capital markets, considers recent evidence on the listing premium enjoyed by firms cross-listing in the U.S., confronts the so-called “circularity argument” often levelled at the securities litigation system, and canvasses corporate governance reforms said to have directly resulted from shareholder litigation. The paper concludes that the “current system of investor rights has resulted in lower costs of capital and higher valuations” and that no case can be made for radical litigation reform.

The full paper is available for download here.

Delaware Business Entity Law Database

This post is from Andrea Unterberger of the Corporation Service Company. 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.

The Corporation Service Company has recently made available to readers of this Blog the Delaware Business Entity Law database, which includes a wide range of Delaware materials of interest to practitioners and academics alike. The database includes Volumes 1 and 2 of Delaware Laws Governing Business Entities in a searchable format, plus links to statutes, case annotations and opinions. The site’s research tools allow users to create electronic bookmarks and to take notes anywhere on the site. Users can also print, email and export search results. The site also includes the unique features found in the printed version of these materials, such as blackline amendment notes and new annotations.

Readers can access the Delaware Business Entity Law database by going here and using the login “[email protected]” and password “delaware”. Free access to the site expires on December 23.

Classified Boards Once Again Prove Their Value to Shareholders

This post is from Theodore Mirvis of Wachtell, Lipton, Rosen & Katz.

When you’re right, you’re right. And when you’re wrong, you are very wrong. Here is yet more evidence of the value to stockholders of staggered boards. Anyone listening up there in that ivory tower?

The Power of Proxies and Shareholder Resolutions

On October 15, Lance E. Lindblom, President and CEO of The Nathan Cummings Foundation, gave a presentation at Harvard Law School on shareholder activism. Based in New York City, The Nathan Cummings Foundation is a grant-making body committed to democratic values, social justice, and building a socially and economically just society. With an endowment of over $500 million, the Foundation uses its shareholder status to vote proxies and file shareholder resolutions in a manner consistent with achieving its mission and discharging its fiduciary obligations.

In his presentation, Mr. Lindblom explained why the Foundation has adopted an activist role as shareholder, drawing links between social justice and long-term shareholder value. Since January 2007, the Foundation has cast 536 votes on 155 proxies, including 417 on company resolutions and 119 on shareholder proposals. The Foundation casts its votes in accordance with its own proxy voting guidelines and using information supplied by Institutional Shareholder Services.

Mr. Lindblom explained the circumstances under which the Foundation will vote on–and raise–shareholder proposals. He noted that a shareholder proposal drawing substantial support is more likely to encourage management to engage shareholders on the issue. Since 2003, the Foundation has filed over 30 shareholder resolutions with 22 corporations. Mr. Lindblom noted that shareholder resolutions have resulted in change at companies including General Electric, The Home Depot, Anadarko Petroleum and Apache Corporation. Moreover, he explained, investor coalitions like the Interfaith Center on Corporate Responsibility and the Investor Network on Climate Risk have substantially increased institutional leverage with corporate management on issues including climate change, energy efficiency and corporate political contributions.

In wide-ranging comments in response to questions from Lucian Bebchuk, Beth Young and Harvard Law School students, Mr. Lindblom discussed the merits of reforming the rules that allow investors to file shareholder resolutions, the corporate costs imposed by shareholder activism, and the extent to which some resolutions advocate positions harmful to broader shareholder interests.

A webcast of Mr. Lindblom’s talk can be viewed here.

Proxy Access and Shareholder Empowerment

Editor’s Note: This post comes to us from J.W. Verret, a former Olin Fellow in Law and Economics who has written extensively on corporate governance matters. Lynn Stout previously posted on her Wall Street Journal op-ed on the SEC’s upcoming vote on proxy access here; Jay Brown responded to that piece in this post; and Lucian Bebchuk recently posted here on a comment letter submitted to the SEC by thirty-nine law professors on this subject.

I certainly admire Professor Stout‘s work on corporate governance, which has substantially informed my understanding of the issue of shareholder primacy. I cannot agree, however, with the views set forth in her recent Wall Street Journal op-ed on the SEC’s upcoming vote on shareholder proxy access, which urges the SEC to substantially restrict shareholder access to the corporate ballot.

Professor Stout suggests that manager-friendly access rules are responsible for the fact that many of the largest companies are headquartered in the United States, and shareholder-friendly rules explain the absence of large companies in the United Kingdom. But the cross-Atlantic comparison is shaky at best. A variety of macroeconomic differences offer a more cogent explanation for the disparity between the U.S. and the U.K. in headquartering large firms than board sensitivity to shareholder communications. (Moreover, as Jay Brown previously argued on this Blog, many of the largest firms headquartered prior to recent pro-shareholder reforms in the United Kingdom.).

The conventional wisdom has always been that institutional investors are unwilling to engage in substantive oversight of their investments because of conflicts of interest and collective-action problems. Activist hedge funds are changing that calculus because they are able to internalize future reputation benefits from oversight. As I explain in my forthcoming article Pandora’s Ballot Box, or a Proxy With Moxie?, these activists benefit from improved capital flows from institutional investors through reputational benefits, and can use their reputational capital to engage in more cost-efficient saber-rattling in future contests. That reputation benefit only works, however, if the activist fund builds value for the large, long term investors that dominate the electorate.

Skeptics of shareholder empowerment, among whom Professor Stout and Professor Stephen Bainbridge are the leading voices, tend to ignore two critical policy considerations. First, Delaware corporate law has ensconced the shareholder franchise as the basis for its elegant and risk-savvy review mechanism of board decisions, both in the form of the business-judgment rule and the demand requirement for derivative litigation. Second, the relevant question with respect to shareholder empowerment is not how well the status quo has performed in the past, but how much better markets might perform under narrowly tailored proxy reform that would make elections a realistically balanced endeavor.

In Pandora’s Ballot Box, or a Proxy With Moxie?, I set forth my own proposal for proxy reform, which utilizes an instantaneous-runoff voting method and preferential voting to empower a majority of shareholders to supervise the board with minimal cost to the proxy process. My proposal also would address Martin Lipton‘s central objection to most proxy reform by avoiding the election of special-interest directors. The article, which will appear in the The Business Lawyer  shortly, is available for download here.

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