Monthly Archives: November 2007

“Say on Pay” Shareholder Advisory Votes on Executive Compensation

This post is from Charles M. Nathan of Latham & Watkins LLP.

Our firm has recently released a new M&A Commentary on proposals requiring an annual shareholder vote on executive compensation, known as “Say on Pay” proposals, that many public companies are likely to face during the 2008 proxy season. The Commentary, entitled “Say on Pay” Shareholder Advisory Votes on Executive Compensation: The New Frontier of Corporate Governance Activism, provides management and boards with a strategic overview of the issues these popular shareholder proposals are likely to raise–and describes the implications that will follow if the proposals pass. Among other things, the Commentary notes that:

The advent of “Say on Pay” for a company means, as a practical matter, that its executive pay policies and procedures will have to meet ISS guidelines on executive compensation or suffer a very strong risk of ISS recommending that shareholders vote “No on Pay.” Such a negative vote, if not addressed promptly by modifying executive compensation to fit ISS guidelines, will almost certainly lead to an ISS withhold vote recommendation against the compensation committee and perhaps the entire board.

The full Commentary is available online here.

SEC Votes to Permit Exclusion of Shareholder Proxy Access Proposals

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

The SEC’s vote affirming the exclusion of stockholder proposals seeking access to the company’s proxy to run a director election proxy fight has drawn this short and sweet applause from the attorneys most involved in the fight at Wachtell, Lipton, Rosen & Katz.

RiskMetrics’ Martha Carter on Activism and Governance

Martha Carter, who heads the design of corporate governance policies at RiskMetrics, recently gave a presentation at the Shareholder Activism class here at Harvard Law School. In her talk, Carter offered an assessment of last year’s proxy season; the issues likely to arise during the coming proxy season; and an account of the issues receiving the most attention from investors.

A video of Martha’s talk is available for download here. (video no longer available) The materials accompanying her initial remarks can be viewed online here.

Commissioner Nazareth Speaks on Today’s SEC Vote

We have hosted several posts on the SEC’s consideration of shareholder access to the ballot, including this post by Lucian Bebchuk on a comment letter submitted to the SEC by thirty-nine law professors and this post by Lynn Stout on her Wall Street Journal op-ed on the subject.

The SEC today voted 3-1 to adopt a rule permitting companies to exclude from the corporate proxy shareholder proposals on ballot access for director elections. Although the text of the final rule is not yet available, the SEC has released a forceful speech by the lone dissenter, Commissioner Annette Nazareth, expressing her disappointment in the SEC’s decision.

The speech is worthwhile reading for anyone interested in the future of the ballot-access issue. Commissioner Nazareth’s talk concludes:

Shareholder rights face a long uphill battle with this Commission. I hope we have not completely lost the opportunity to address these issues thoughtfully. Given that all 40 of the largest markets outside the U.S. give investors in public companies the ability to nominate and remove directors, this recognition of shareholder rights is long overdue. Chairman Cox has clearly stated his intention to move forward with proxy access in the very near future. I fervently hope that is the case and that this effort succeeds in the coming year.

The full text of Commissioner Nazareth’s speech is available here.

GAAP in Peril

This post is from Carl Olson of the Fund for Stockowners’ Rights.

Effective corporate governance requires reliable and consistent financial statements. Investors depend upon auditors to verify what management has done each year in innumerable corporate transactions. For decades, the American generally-accepted accounting principles (GAAP) have admirably and ably provided reliable reporting on a vast array of modern business situations.

Yet a serious drive to eliminate American GAAP, and replace them with the International Financial Reporting Standards (IFRS), is underway. A coalition has led a well-financed campaign to “dumb down” the financial reporting system that we all have grown to know, love, and trust.

Corporate management, of course, are behind this drive, hoping for their own convenience to be less accountable. This is understandable. But major American accounting firms have, surprisingly, joined with management. And the Securities and Exchange Commission, under Chairman Christopher Cox, has put more widespread use of the IFRS onto its active agenda.


Chancery Orders Production of Records for Periods Prior to Stock Ownership

This post is from Francis G.X. Pileggi of Eckert Seamans Cherin & Mellott, LLC. 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 Delaware Court of Chancery issued a decision last week of both practical and theoretical importance for corporate lawyers. The opinion is Melzer v. CNET Networks, Inc., and there are at least three reasons why this case is noteworthy.

First, the court held that Section 220 of the Delaware General Corporation Law, which is the statutory basis on which stockholders can demand books and records of a company, enables plaintiffs under certain circumstances to receive documents for a period prior to their stock ownership. In order to allow a pleading to be prepared with details of alleged “systemic and sustained” lack of oversight by the board (the well-known Caremark standard), the Court allowed the plaintiffs to access materials prepared before they became stockholders.

Second, the case is interesting because it began as a derivative action filed in federal court in California. The California case was dismissed by the federal judge, however, who instructed the plaintiff to avail himself of the provisions of DGCL Section 220. The parties now appear to be headed back to California, where the plaintiff will be able to amend the complaint in light of the discovery authorized in this opinion.

Finally, the case is striking because the defendant admitted that it engaged in the backdating of stock options, which is the factual basis of the underlying claims. In a separate blog post that can be found here, I offer more analysis of those facts and the court’s application of Delaware law to this fascinating case.

Corporate Governance Objectives of Labor Union Shareholders

This post is from Steven Kaplan of the University of Chicago.

The SEC has been considering the issue of increased shareholder access to the corporate proxy and director elections. Labor union pension funds have been among the more vocal proponents of increased access, arguing that such access will lead to improved financial performance. Business groups, such as the Business Roundtable, have argued against increased access on the grounds that such access would encourage special-interest shareholders and would decrease shareholder value. The desirability of increased shareholder access, then, depends to a large degree on the extent to which labor unions (and other politically minded shareholders) pursue the interests of shareholder value rather than their own self-interest.

One of our Ph. D. students, Ashwini Agrawal, has written one of the first papers that addresses this issue. Ashwini noticed that in 2005, the AFL-CIO (the central federation of labor unions in the U.S.) split into two groups. Several of its member unions, representing roughly 35% of its members, left to form a new organization–the Change To Win (CTW) coalition. This exogenous shift in AFL-CIO membership allows Ashwini to examine changes in the voting behavior of AFL-CIO affiliated shareholders toward management and director nominees.

The results are striking. Ashwini finds that AFL-CIO affiliated pension funds are significantly more supportive of director nominees once the AFL-CIO no longer represents workers at a given firm (roughly 74% after versus 55% before). At the same time, AFL-CIO affiliated pension funds do not change their voting behavior when the AFL-CIO still represents workers at a given firm. Ashwini finds the opposite pattern in voting behavior for a pension fund associated with the CTW coalition. Finally, he finds no change in voting behavior for mutual funds.

These differences suggest that labor unions use their pension funds to pursue labor relations issues at the expense of shareholder value. And they suggest that there is some truth to the concerns that increased shareholder access might have unintended consequences.

Ashwini’s full paper, Corporate Governance Objectives of Labor Union Shareholders, is available for download here.

Study of Majority Voting in Director Elections

This post comes to us from Claudia H. Allen of Neal, Gerber & Eisenberg LLP.

We have recently released the November 2007 edition of the Study of Majority Voting in Director Elections, which demonstrates that majority voting for the election of directors, which has been characterized by its advocates as a tool for increasing director accountability, has become the prevailing election standard among large, public companies. As issuers prepare for the 2008 proxy season, a few statistics and examples drawn from the Study underscore that majority voting has become a relatively mature, as well as widespread, movement.

Majority Voting in the S&P 500 and Fortune 500. 66% of the companies in the S&P 500 and over 57% of the companies in the Fortune 500 have adopted a form of majority voting, notwithstanding robust levels of merger and acquisition activity early in 2007 that resulted in several firms with majority voting going private. By way of contrast, when the Study was initially published in 2006, only 16% of the companies in the S&P 500 had adopted a form of majority voting.


Public Enforcement of Securities Laws: Preliminary Evidence

This post is from Howell Jackson of Harvard Law School.

I recently presented my new discussion paper with Mark Roe, Public Enforcement of Securities Laws: Preliminary Evidence, at the Conference on Empirical Legal Studies at the New York University School of Law. The paper develops a measure of securities-enforcement intensity and examines financial outcomes worldwide in light of enforcement activity. The abstract of the paper follows:

The legal consequence of economic actors ignoring their legal obligations, such as laws that protect outside investors in firms, is a recurring issue. Recent scholarship examines the relative importance of private enforcement for investor protection on the one hand–via disclosure and lawsuits among contracting parties–and public enforcement on the other–via financial, regulatory, and even criminal rules and penalties. Recent financial work has seen the former to be more important than the latter. Yet much recent legal scholarship has seen private enforcement of securities laws in the United States as poorly designed, with firms–and, hence, wronged shareholders–often bearing the cost of insiders’ errors and disclosure failure. To better understand the relative importance of public and private enforcement, we here develop an enforcement variable based on securities regulators’ staffing levels and budgets. We then examine financial outcomes around the world–such as stock market capitalization, trading volume, number of domestic firms, and number of IPOs–in light of these measures of public enforcement and find that more intense public enforcement regularly correlates with strong financial outcomes. In horse races between our measures of public enforcement and the measures of private enforcement prominent in recent financial scholarship, public enforcement is typically at least as important as private enforcement in explaining important financial market outcomes around the world.

The full paper is available for download here.

Programmed Stock Trading Plans Eyed

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

The National Law Journal recently published Programmed Stock Trading Plans Eyed, which highlights recent efforts by corporate boards to ensure that executives’ stock-trading plans meet the requirements of Rule 10b5-1. That Rule permits firms to trade the company’s stock for the benefit of insiders on the basis of a predetermined plan, but corporate directors are concerned that the SEC may be preparing to bring enforcement actions on the ground that executives made changes to their plans while in possession of inside information.

Those concerns, the piece explains, stem from recent allegations that Countrywide Financial executive Angelo Mozilo, who allegedly made changes to his 10b5-1 plan in the midst of recent mortgage-market turmoil. Those claims, combined with the recent conviction of former Quest CEO Joseph Nacchio, have led boards to seek counsel as to whether their executives have made changes to the plans that run afoul of the Rule, especially because the plans are generally prepared by outside brokerage houses rather than in-house counsel or members of the board.

The SEC’s attention, the article explains, has been drawn to the issue in part by a recent study by Alan Jagolinzer of Stanford Business School. That study, which can be downloaded here, found that insiders with 10b5-1 plans managed to generate abnormal forward-looking returns larger than their colleagues who did not have such plans. Following the release of the study, the Director of the SEC’s Division of Enforcement, Linda Chatman, commented that the Commission “wanted to make sure that people are not doing [with 10b5-1 plans] what they did with stock options.” To date, the article notes, the SEC has not yet brought an enforcement case based on changes to a Rule 10b5-1 plan, but boards of directors have begun the process of learning exactly how and when an executive can make changes to such plans.

The full article is available for download here.

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