Yearly Archives: 2007

Corporate Social Policy and the SEC

Posted by Lance E. Lindblom, The Nathan Cummings Foundation, on
Wednesday, November 14, 2007
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This post comes to us from Lance E. Lindblom, President and CEO of the Nathan Cummings Foundation. Lance recently gave a presentation on shareholder activism at Harvard Law School; a post describing that talk is available here.

Along with Laura J. Shaffer, Director of Shareholder Activities for the Nathan Cummings Foundation, I have prepared an op-ed on shareholder proposals requesting improved disclosure on major corporate social policy issues, including environmental risk and health care costs. The op-ed runs as follows:

Last year, nearly 40% of the shares of Standard Pacific Corporation, one of the nation’s largest builders of homes, supported a request for disclosure relating to the company’s approach to energy efficiency. The company’s response? This issue is none of your business.

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Corporate Integrity and Corporate Performance

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, November 13, 2007

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On Monday, November 6, Ben Heineman, Jr., former General Counsel of GE, presented at the Law School’s Law and Finance Seminar. Heineman offered his insights on the role that general counsels play in corporate affairs, emphasizing how they can help ensure that the firm is managed to achieve both high performance and high integrity.

The discussion drew on two recent articles Heineman has published based on his experiences as general counsel of one of the world’s largest companies. The first, Avoiding Integrity Land Mines, was published in the Harvard Business Review last spring and is available here. The second piece, Caught in the Middle, was recently published in Corporate Counsel and can be downloaded here.

A video of Heineman’s presentation at the Law and Finance Seminar can be viewed online here.

The Future of Securities Regulation

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, November 12, 2007
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Brian Cartwright, General Counsel of the SEC and a 1980 graduate of Harvard Law School, recently delivered an address entitled The Future of Securities Litigation. The talk offers a fascinating perspective on how we can expect securities markets–and the SEC’s regulatory approach–to change in the coming years.

The speech emphasizes what Brian calls “deretailization,” or the dwindling presence of retail investors in securities markets. Retail investors, who once owned more than 90% of publicly traded equity, now own less than 30%. Moreover, retail investors do not trade some assets at all, including the billions of dollars annually raised in 144A debt offerings. (Some institutions have recently moved to raise equity in 144A offerings as well.) And private equity and hedge funds, which frequently take publicly traded firms private, generally exclude retail investors altogether.

Over the last twenty years, Brian explains, these asset classes have come to dominate capital markets, and retail investing–once the focus of much regulatory behavior–is no longer central to modern securities markets. Instead, individual investors now choose among intermediaries competing for their funds–with the intermediaries, rather than the individual, directly participating in the capital markets.

In light of these trends, the speech argues, regulators should focus their efforts on ensuring that individuals have the necessary tools to choose among intermediaries. That kind of regulation, Brian explains, might ensure that individuals understand that a mutual fund’s past performance may not repeat itself; that additional disclosure allows investors to calculate an actively managed fund’s alpha, or market-adjusted performance; and that investors are able to evaluate a fund’s market-adjusted performance against the fund’s expenses.

The full text of the speech is available here.

Michael Jensen’s and Werner Erhard’s Talk on Integrity

Posted by Robert Jackson, Managing Editor, Harvard Law School Corporate Governance Blog, on
Friday, November 9, 2007

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Last week, in Harvard Law School’s Seminar in Law, Economics, and Organization, Professor Michael Jensen and Werner Erhard presented a paper on integrity that they co-authored with Steve Zaffron. The slides used in their talk are available here.

The abstract of their paper, entitled Integrity: A Positive Model that Incorporates the Normative Phenomena of Morality, Ethics, and Legality, runs as follows:

“We present a positive model of integrity that provides powerful access to increased performance for individuals, groups, organizations, and societies. Our model reveals the causal link between integrity as we distinguish and define it, and increased performance and value-creation for all entities, and provides access to that causal link. Integrity is thus a factor of production as important as knowledge and technology, yet its role in productivity has been largely ignored or unnoticed by economists and others.

The philosophical discourse, and common usage as reflected in dictionary definitions, leave an overlap and confusion among the four phenomena of integrity, morality, ethics, and legality. This overlap and confusion confound the four terms so that the efficacy and potential power of each is seriously diminished.

In this new model, we distinguish all four phenomena–integrity, morality, ethics, and legality–as existing within two separate realms. Furthermore, within their respective realms, each of the four belongs to a distinct and separate domain. Integrity exists in a positive realm devoid of normative content. Morality, ethics and legality exist in a normative realm of virtues, but in separate and distinct domains.

This new model: 1) encompasses all four terms in one consistent theory, 2) makes clear and unambiguous the ‘moral compass’ potentially available in each of the three virtue phenomena, and 3) provides this clarity in a way that raises the likelihood that the now clear moral compasses can actually shape human behavior.

This all falls out primarily from the unique treatment of integrity in our model as a purely positive phenomenon, independent of normative value judgments. Integrity is, thus, not about good or bad, or right or wrong, or what should or should not be.

We distinguish the domain of integrity as the objective state or condition of an object, system, person, group, or organizational entity, and define integrity as: a state or condition of being in whole, complete, unbroken, unimpaired, sound, perfect condition.

We assert that integrity (the condition of being whole and complete) is a necessary condition for workability, and that the resultant level of workability determines the available opportunity for performance. Hence, the way we treat integrity in our model provides an unambiguous and actionable access to the opportunity for superior performance, no matter how one defines performance.

For an individual we distinguish integrity as a matter of that person’s word being whole and complete. For a group or organizational entity we define integrity as what is said by or on behalf of the group or organization being whole and complete. In that context, we define integrity for an individual, group, or organization as: honoring one’s word.

Oversimplifying somewhat, honoring your word, as we define it, means you either keep your word or, as soon as you know that you will not be keeping your word, you say that you will not to those who were counting on your word and clean up any mess caused by not keeping your word. By “keeping your word” we mean doing what you said you would do and by the time you said you would do it.

Honoring your word is also the route to creating whole and complete social and working relationships. In addition, it provides an actionable pathway to earning the trust of others.

We demonstrate that the application of cost-benefit analysis to one’s integrity guarantees you will not be a trustworthy person (thereby reducing the workability of relationships); and, with the exception of some minor qualifications, also ensures that you will not be a person of integrity (thereby reducing the workability of your life). Your performance, therefore, will suffer. The virtually automatic application of cost-benefit analysis to honoring one’s word (an inherent tendency in most of us) lies at the heart of much out-of-integrity and untrustworthy behavior in modern life.

In conclusion, we show that defining integrity as honoring one’s word provides 1) an unambiguous and actionable access to the opportunity for superior performance and competitive advantage at both the individual and organizational level, and 2) empowers the three virtue phenomena of morality, ethics and legality.”

Keynote slides of the presentation are available here.

Are Regulators and Stock Exchanges Irresponsible?

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Thursday, November 8, 2007

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Editor’s Note: This post comes to us from Shann Turnbull, Principal of the International Institute for Self-Governance.

I have recently released a new paper, entitled Correcting the Failures in Corporate Governance Reforms, in which I argue that constructive governance reform will require regulators to recognize and address the shortcomings of existing reforms. I invite readers to respond to one of the central claims of the paper: that regulators and stock exchanges cannot responsibly permit directors to retain absolute power over corporate affairs.

Among other proposals, the paper recommends that regulators prohibit corporate charters from granting directors the sort of “inappropriate powers” described by Bob Monks and Allan Sykes in Capitalism Without Owners Will Fail. For example, Directors typically are provided absolute power to manage their own conflicts of interest. As power tends to corrupt and absolute power tends to corrupt absolutely, how can regulators and those overseeing the various stock exchanges responsibly allow directors to possess such powers?

One explanation may be that regulators and exchanges have become captive of corporate interests. Monks articulates this claim in a short video available here. In my 2004 paper, Agendas for Reforming Corporate Governance, Capitalism and Democracy, I described a series of policy reforms that would give shareholders and stakeholders alike an incentive enhance the political and social legitimacy of large corporations.

Correcting the Failures in Corporate Governance Reforms posits that a contributing cause of the failure of corporate governance reforms is a knowledge gap with respect to how corporate constitutions can be designed both (1) to improve the control of complex firms to enhance their competitiveness and (2) to introduce self-enforcing co-regulation. In The Governance of Firms Controlled by More Than One Board, I offered a series of design criteria for such constitutions, based in part on case studies of self-governing, stakeholder-controlled firms.

The knowledge gap described in Correcting the Failures in Corporate Governance Reforms was pointed out by Al Gore in a 1996 speech in which he described “the growing disconnects between science and democracy.” “Page through a directory of members of Congress,” Gore noted, “and you’ll find well over 150 lawyers, but only six scientists, two engineers, and one science teacher among the 535 people in the House and the Senate. As a result, scientific concepts sometimes elude the vast majority of our elected officials.”

As I argued in The Science of Corporate Governance, the design of governance controls in modern firms is itself a scientific inquiry, requiring careful observation of the science of information and control. Yet those fields are generally ignored in the education of corporate and constitutional lawyers–as well as in the training of social scientists in schools of government, public administration and business.

One of the most fundamental principles of information science is that regulation can only be amplified indirectly through co-regulating agents. This, of course, explains the current failure of top-down regulation of corporate governance, which has taken place largely without bottom-up co-regulation by stakeholders.

Scientific analysis of corporate governance controls offers a methodology that will permit corporations to become self-governing and thus reduce the role of government in corporate affairs. Regulators would do well to incorporate that methodology as they address the failure of corporate governance reforms around the world.

Correcting the Failure in Corporate Governance Reforms is available for download here.

Poison Pills in a Comparative Perspective

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, November 7, 2007
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Editor’s Note: This post comes to us from Till Immanuel Lefranc at Harvard Law School. Till invites comments at till.lefranc [at] gmail.com.

The French Commercial Code was amended in 2006 in order to make poison pills possible in France. Only two months after the amendments were enacted, the general meeting of fifteen large companies gave its board authority to adopt a pill. Comparing French and American poison pills is interesting for two main reasons:

(1) France is likely to face same problems that the Delaware courts have been dealing with for more than twenty years. Corporate directors may have legitimate reasons for refusing an acquisition, such as finding time to obtain a higher price from a third party. But directors may also be acting out of self interest, and use the pill to entrench themselves–to the detriment of shareholders. How will French institutions regulate the pill to prevent this type of conduct from happening?

(2) On the other hand, the French pill has been carefully designed to mitigate those risks. A new pill must be approved by a general meeting of shareholders, and rights can only be issued by the board with shareholder consent. If shareholders do give the board authority to issue rights, that authority is valid for a maximum of 18 months.

I have prepared a Memorandum that sets forth a comparative analysis of the French poison pill and its implications. The Memorandum is available for download here.

Employers Scoring in Whistleblower Actions

Posted by Robert Jackson, Managing Editor, Harvard Law School Corporate Governance Blog, on
Tuesday, November 6, 2007
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This post comes to us from Jonathan Hayter of the National Law Journal.

The National Law Journal recently published Employers Scoring in Whistleblower Actions, which documents the consistent victories firms have enjoyed against former employees who claim the company retaliated against them for reporting corporate fraud. The Sarbanes-Oxley Act prohibits retaliation against such “whistleblowers,” but since the Act became law five years ago, only 17 retaliation complaints among more than 1,000 filed have been found to have merit.

As the piece explains, Sarbanes-Oxley’s retaliation provision only protects employees reporting a violation of the securities laws, a fraud on shareholders, or a violation of SEC regulations. One reason for employees’ low success rate, then, might be that plaintiffs have attempted to use the Act’s whistleblower protections when reporting corporate conduct not covered by the Act. Another explanation, the piece notes, might be that employers have taken greater care since the passage of the Act to avoid retaliation–and the litigation likely to follow.

The plaintiff’s bar, of course , sees matters differently, urging that a narrow interpretation of whistleblower protections has discouraged employees from coming forward in cases of corporate fraud. As the article points out, the Act requires only that a whistleblower show that he “reasonably believed” that reportable corporate conduct had taken place to be entitled to protection. Plaintiffs’ argue in the piece  that the Administrative Law Judges reviewing whistleblower cases have required employees to meet a higher standard, demanding proof that corporate fraud actually took place before affording the employee protection from retaliation.

The full article is available here.

Delaware Court Refuses to Require Disclosure of Internal Projections

Posted by Theodore Mirvis, Wachtell, Lipton, Rosen & Katz, on
Monday, November 5, 2007
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This post is from Theodore Mirvis of Wachtell, Lipton, Rosen & Katz. 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.

It may not have been a Chancellor who famously said: “Predictions are difficult to make, especially about the future.” But as the Chancellor‘s recent opinion in Checkfree, summarized here, demonstrates, the point is not lost in Rodney Square.

In declining to follow a path to a per se rule requiring disclosure of all projections before a merger vote can take place–Checkfree involved projections used by investment bankers in their fairness-opinion analysis–the Chancellor elegantly cabins the Netsmart opinion to a case of partial disclosure, recalling the other adage about “too much of a good thing.”

Shareholders Saying “No”: Freeze-Outs and the Case of Cablevision

Posted by Steven M. Haas, Hunton & Williams LLP, on
Thursday, November 1, 2007
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This post is from Steven M. Haas of Hunton & Williams LLP.

Historically, merger proposals have almost always been approved by target-company shareholders. In fact, the Wall Street Journal recently reported that, since 2003, only 7 of 1,200 transactions have been voted down at shareholder meetings.

Yet the M&A world has now seen this happen twice in the past four months. First, Carl Icahn’s proposal to acquire Lear was rejected in July, even after a last-minute increase in price. Then, on October 24, the Dolan family’s go-private proposal was rejected by Cablevision’s minority shareholders. There have also been several close calls this year, including the Inter-Tel merger, which was headed for defeat until quick maneuvering by the board gave shareholders more time to consider, and ultimately approve, the transaction. Other deals, such as the acquisitions of OSI Restaurant Partners and Clear Channel Communications were delayed, and their terms improved, to help gain shareholder support.

Shareholder opposition seems to reflect a growing sentiment that many of the deals over the past two years were undervalued–particularly private equity-sponsored transactions. It also demonstrates increased coordination among shareholders, including investors who are not traditionally considered “activists.”

Finally, these events provide evidence of the increased power of proxy-advisory firms such as Institutional Shareholder Services. ISS recommended against the Lear and Cablevision proposals. It also heavily influenced voting on the Inter-Tel merger, initially recommending against the deal and then changing its position–but only after the shareholders’ meeting had been postponed.

The failed Cablevision transaction, however, is in a league of its own, because it involved a proposal initiated by a large controlling shareholder. Through a dual-class stock structure, the Dolan family controls about 74% of the company’s voting power; and, beginning in 2005, the Dolans began trying to acquire the outstanding minority shares to take the company private. Cablevision then formed a two-member special committee, and in May the Dolans signed a merger agreement that offered a 51% premium to Cablevision shareholders and required a majority of the minority shareholders to approve the deal.

Cablevision is a Delaware corporation, so the deal was subject to entire-fairness review under Kahn v. Lynch Communications Systems. In that case, the Delaware Supreme Court held that freeze-outs are subject to entire-fairness review because minority shareholders are inherently coerced by the majority and may vote in favor of a freeze-out simply to avoid retaliation. Under Kahn, the use of a special committee and a majority-of-the-minority provision can shift the burden of proof to the plaintiff, but neither affects the standard of review. And Delaware law offers no added benefit to controlling shareholders if, as in Cablevision’s case, both procedures are employed–although this would presumably be a factor in the court’s analysis.

In a 2005 article in The Business Lawyer entitled The Dilemma That Should Never Have Been: Minority Freeze-Outs in Delaware, Peter Letsou and I argued that Delaware’s per se rule of entire-fairness review of freeze-outs should not apply in many cases. There, we rejected the notion that minority shareholders are inherently coerced by a majority stockholder, and concluded that a freeze-out should be reviewed under the business-judgment rule if:

(1) The freeze-out has been approved by a properly functioning special committee of independent directors;

(2) The freeze-out has been effectively approved by a majority of the minority; and

(3) The controlling stockholder has fulfilled its disclosure obligations and has abstained from abusive or otherwise illegal conduct.

Guhan Subramanian advanced similar arguments in his 2005 article Fixing Freezeouts. Vice Chancellor Leo Strine has also addressed the issue, offering thoughtful analysis and a proposal for reform in his opinion in the Cox Communications shareholder litigation. I also advanced a similar argument in a 2004 piece in the Virginia Law Review entitled Toward a Controlling Shareholder Safe Harbor.

The Cablevision deal is additional evidence against the needlessly broad standard of review required under Kahn, and demonstrates the ability of minority shareholders to “say no” to a controlling stockholder. It also illustrates the effectiveness of majority-of-the-minority shareholder approval conditions, particularly where there are several large minority shareholders who can work together to increase the likelihood that an undervalued proposal will be rejected.

In Cablevision, the minority shareholders got the last word–for now, at least. Delaware law would be well-served if the Delaware Supreme Court revisited Kahn in light of this evidence, easing the standard of review for freeze-outs so long as certain procedural conditions are met. This would give controlling shareholders a real incentive to utilize a majority-of-the-minority approval condition, which seems to have worked rather well in Cablevision’s case.

Countrywide’s Corporate Governance: Definitely Subprime

Posted by J. Richard Finlay, Centre for Corporate & Public Governance, thecentreforgovernance.org, on
Wednesday, October 31, 2007
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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.

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