Yearly Archives: 2008

Treasury Encourages Development of Covered Bonds in the U.S. and Issues “Best Practices”

Posted by Margaret E. Tahyar, Davis Polk & Wardwell LLP, on
Friday, September 19, 2008
,
More from: ,

This post is from Margaret E. Tahyar of Davis Polk & Wardwell LLP.

My colleagues Randall Guynn and Joerg Riegel and I have recently written a memorandum entitled Treasury Encourages Development of Covered Bonds in the U.S. and Issues “Best Practices”, which discusses the Treasury Department’s issuance of Best Practices for U.S. Covered Bonds intended to set standards for the development of a covered bond market in the U.S. The memorandum describes the salient terms of the Best Practices and discusses other recent events in the development of regulatory support and a market infrastructure (such as electronic trading or acceptance of covered bonds as collateral) for covered bonds. The memorandum also analyzes the current U.S. legal structure supporting covered bonds and comments on the possible development of market practices.

The memorandum is available here.

SEC Constrains Short Selling: Too Little Too Late

Posted by Edward D. Herlihy, Wachtell, Lipton, Rosen & Katz, on
Thursday, September 18, 2008
, ,
More from: ,

This post is from Edward D. Herlihy, Wachtell, Lipton, Rosen & Katz. Earlier memoranda and posts on this Blog by the author may be accessed here and here. The SEC’s new rules on short-selling issued yesterday are available here. A subsequently issued statement by the SEC is available here.

The SEC yesterday announced three actions addressing short selling. Its actions are too little too late.

First, the SEC adopted a rule requiring short sellers and their broker-dealers to deliver securities by the settlement date (three days after the transaction date) and imposing penalties for failure to do so. In addition, the SEC eliminated the option market-maker exception to the three day delivery requirement. Finally, the SEC adopted a new anti-fraud provision making it unlawful for sellers to deceive specified persons about their ability or intention to deliver securities by the settlement date. This last rule is not necessary and will not help eliminate abusive short selling practices.

The measures adopted by the SEC yesterday fall far short of the type of bold measures needed to constrain the abusive short selling and rumor mongering taking place. The securities markets continue to be in a crisis and there continues to be a significant disruption to their fair and orderly functioning.

As we have previously said, the SEC should immediately re-impose, under its emergency powers, the “Uptick Rule.” In addition, the SEC must now consider other very strong measures such as using its emergency powers to place limitations on short sales for a period of time to restore a fair and orderly market. Also, it is essential for the SEC to scrutinize short sellers and their related transactions, including options and credit default swaps to determine whether these strategies are contributing to the severe dislocations taking place in the marketplace.

Finally, the SEC should promptly make public the results of their examinations of the short selling activities and take immediate enforcement action against those who are engaging in this abusive manipulative conduct.

Time is of the essence and the SEC must act now.

Panel Discussion on Corporate Litigation

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, September 17, 2008

More from: , ,

The Harvard Law School Program on Corporate Governance is pleased to announce the availability of the video of its event on corporate litigation. The event, which was held earlier this month, is the first of the Program’s series entitled Introduction to Corporate Practice. The series’ aim is to expose students to leading practitioners and their perspective on corporate practice—What do they enjoy about their jobs? What issues do they deal with? And what does it take to succeed in their field? The videos are made public as a resource for law students and young lawyers everywhere who are considering corporate practice.

The three panelists at the corporate litigation event were:

  • Theodore N. Mirvis, a partner in the litigation practice at Wachtell, Lipton, Rosen & Katz, as well as a member of the advisory board of the Program on Corporate Governance and a frequent contributor to the Blog.
  • Allan J. Arffa, who is co-chair of the litigation department at Paul, Weiss, Rifkind, Wharton & Garrison LLP.
  • Andrew S. Tulumello, who is a vice-chair of the class action and complex litigation practice group and a vice-chair of the crisis management group at Gibson, Dunn & Crutcher LLP.

Each member of the panel gave introductory remarks, and answered questions from the audience. Allan Arffa started the event by describing the work of a corporate litigator, contrasting it with other types of corporate legal work. Andrew Tulumello added that litigators often deal with “messes”, which they have to assess and navigate for their clients, and which often result in disputes that are very difficult to settle outside of the courtroom. Ted Mirvis spoke about the unique thrills of deal litigation, such as the quick turnaround time and the highly qualified specialized judges. He also emphasized the importance of having a good reputation with these judges. The panel offered their perspectives on career planning issues, including working for a large versus a small firm, the types of characteristics they felt were central to the success of associates, and the types of courses they believed to be the most useful for aspiring corporate litigation associates.

A video of the panel discussion is available for download here.

Beneficial Ownership – By-Law Disclosure Proposal

Posted by Philip A. Gelston, Cravath, Swaine & Moore LLP, on
Tuesday, September 16, 2008
, ,
More from: ,

This post is from Philip A. Gelston of Cravath, Swaine & Moore LLP.

My partner James C. Woolery and I have prepared a memorandum entitled “Beneficial Ownership – By-Law Disclosure Proposal,” in which we propose an innovative by-law amendment as a response to the threat posed to a company by the secret accumulation of its shares by activist investors. Secrecy is often achieved in this context through the use of total returns swaps and other derivatives, which may allow the accumulation of a large, and sometimes dominant, position in the target company. Despite legal claims that these derivative holdings are not the same as beneficial ownership – claims being tested in litigation arising from the recent CSX proxy fight – in reality activists demand that targets, and their board of directors, defer to the activists as though they were full owners of the stock represented by the derivatives.

In the memorandum we discuss a number of techniques corporations have used to protect against this threat, and we outline a proposal that involves amending advance notice by-laws governing shareholder proposals to include new continuous disclosure obligations. Compliance with this disclosure obligation is a prerequisite for giving effective notice of an intention to nominate directors or present business at a stockholders’ meeting. To our knowledge, a by-law incorporating the concepts we outline in our proposal has not yet been adopted by any corporation.

Our memorandum is available here.

Founders, Heirs, and Corporate Opacity in the U.S.

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, September 15, 2008
, ,
More from: , ,

This post comes to us from Ronald Anderson and Augustine Duru of the Kogod School of Business at American University, and David Reeb of the Fox School of Business at Temple University.

In our forthcoming Journal of Financial Economics paper entitled Founders, Heirs, and Corporate Opacity in the U.S., we investigate the impact of founder and heir shareholders on corporate opacity and whether, and how, they use their influence to affect firm performance.

We argue that founders’ and heirs’ unique and dominant control positions provide particularly strong incentives to diminish corporate transparency. We explore two hypotheses with regard to these controlling shareholders and transparency. Our first hypothesis centers on the notion that founders and heirs affect corporate transparency to entrench themselves and extract private benefits of control. However, a plausible alternative is that large shareholders have the incentive to collect information and the power to monitor managers. As a result, founders or heirs, acting as committed monitors with relatively undiversified stakes in the firm, may provide control and oversight that substitute for the disciplinary role of transparency. Further, if these controlling shareholders act as effective monitors, corporate opacity potentially provides competitive and cost advantages to the firm. Both the monitoring and entrenchment arguments suggest a positive relation between founder and/or heir shareholders and corporate opacity. However, the entrenchment hypothesis suggests corporate opacity allows these controlling shareholders to accrue private benefits of control. To differentiate between these non-mutually exclusive arguments, we examine whether the interaction of founder and/or heir ownership and corporate opacity affects outside shareholder wealth.

We test these arguments using the 2,000 largest U.S. firms from 2001 through 2003. Of our total sample, founder-controlled firms constitute 22.3% and heir-controlled firms comprise 25.3% with average equity stakes of approximately 18% and 22%, respectively. The analysis further indicates that founder controlled firms tend to be smaller, riskier, and more R&D intensive than manager or heir controlled firms. We develop an opacity index to gauge the relative opaqueness of our sample firms and find that both founder and heir ownership exhibit a significant and positive relation to opacity. We also find that founder and heir controlled firms exhibit a negative relation to performance in all but the most transparent firms. Surprisingly, additional tests reveal that concerns about divergences in ownership versus control management type, dual class shares, and board influence appear to be substantially less important than corporate opacity in explaining the performance impacts of founder and heir control. Finally, we decompose corporate opacity into disclosure and market scrutiny components, finding that the disclosure quality component appears to be of greater importance to investors. However, irrespective of whether these controlling shareholders create and/or stay in the firm because of corporate opacity, our analysis suggests that founders and heirs in large, publicly traded firms exploit opacity to extract private benefits at the expense of minority investors.

The full paper is available for download here.

Delaware Courts Reaffirm High Bar for Personal Liability of Disinterested Directors

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, September 13, 2008
, , , ,
More from: , , ,

This comes to us from Gar Bason, Phillip Mills and Justine Lee of Davis Polk & Wardwell. 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 late July, Delaware Vice Chancellor Noble issued a decision in Ryan v. Lyondell denying the directors of Lyondell Chemical Company the protection of the company’s exculpatory charter provision for the alleged breach of their fiduciary duties in connection with the sale of Lyondell. Not surprisingly, V.C. Noble’s decision generated concern that directors may be subject to personal liability for breach of their fiduciary duties even where there is no allegation of self-interest. However, two separate Delaware Chancery Court opinions issued more recently reaffirm the high bar required to prove that directors have breached their duty of loyalty via “bad faith conduct” that cannot be exculpated. As Vice Chancellor Strine states in his September 2nd opinion in In Re Lear Corporation, “a very extreme set of facts would seem to be required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties.”

DGCL Section 102(b)(7) provides that corporations may exculpate their directors from monetary liability for a breach of the duty of care, but not for conduct that is not in good faith or a breach of the duty of loyalty. In analyzing what constitutes conduct not in good faith, the Delaware Supreme Court in In Re Walt Disney and Stone v. Ritter has made clear that it is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence.) Courts have focused on the concept of an “intentional dereliction of duty,” which necessarily entails an intent component, in the finding of bad faith. However, in Lyondell, V.C. Noble held that the failure of the board of directors of a target company to actively engage itself in the CEO-dominated sale of the company—even though the negotiated price represented a substantial (45%) premium to market and no competing bids emerged post-signing—could constitute something more than gross negligence and may rise to the level of bad faith, posing a risk to directors of personal liability. While the Lyondell decision was arguably driven by the procedural posture of that case and the limited summary judgment record available at that stage of the proceedings, the decision sparked concern that the Court was rolling back the protection afforded by 102(b)(7) and expanding the potential sphere of personal liability for directors in a sale of control where there was no allegation of self-dealing.

These concerns should largely be allayed by the more recent decisions issued by Chancellor Chandler and V.C. Strine, respectively. In McPadden v. Sidhu, Chancellor Chandler examined the actions of the board of directors of i2 Technologies in the sale of its wholly owned subsidiary to a management team led by Anthony Dubreville, the subsidiary’s then vice president. The complaint alleged a number of fiduciary violations on the part of the board, including tasking Dubreville with leading the sales process even though it knew he had previously expressed concrete interest in purchasing the company, engaging in little or no oversight of the sales process even though it knew Dubreville had expended limited efforts to solicit offers for the company, and authorizing the use of management projections created under Dubreville’s direction. While the allegations in McPadden appear considerably more egregious than those alleged in Lyondell, Chancellor Chandler finds that the complaint alleges actions that were recklessly indifferent or unreasonable but fails to allege that the directors “acted in bad faith through a conscious disregard for their duties.” He therefore concludes that the directors were exculpated by the Section 102(b)(7) provision in the company’s charter and granted the directors’ motion to dismiss for failure to state a claim.[1]

Similarly, in In Re Lear Corporation, V.C. Strine examined and dismissed for failure to state a non-exculpated claim for breach of fiduciary duty allegations against the directors of a target company. In this case, shareholders alleged that the Lear directors had acted in bad faith by agreeing to a “No-Vote Termination Fee” in exchange for a bump in merger consideration while knowing that the price increase would likely not be sufficient to attract a majority vote in favor of the transaction. Unsurprisingly, V.C. Strine held that the complaint failed to create an inference of mere negligence or gross negligence, much less the “far more difficult task of stating a non-exculpated duty of loyalty claim.” However, in his discussion V.C. Strine goes beyond the facts of the Lear case in comments that seem directed at Lyondell:

Boards may have to choose between acting rapidly to seize a valuable opportunity without the luxury of months, or even weeks, of deliberation—such as a large premium offer—or losing it altogether. . . . Courts should therefore be extremely chary about labeling what they perceive as deficiencies in the deliberations of an independent board majority over a discrete transaction as not merely negligence or even gross negligence, but as involving bad faith.

While there may continue to be some differences of approach towards this issue among the Chancery court judges, Chancellor Chandler’s and V.C. Strine’s reaffirmations of the high bar required to assert personal liability against directors for breach of their duty of loyalty are further buttressed by a letter opinion that V.C. Noble himself issued in Lyondell on August 29. In this letter opinion, V.C. Noble made clear his view the Lyondell decision “did nothing more than to assess the application (or potential application) of well-settled law under the peculiar and underdeveloped facts of this case.” Future rulings in this case (whether on appeal to the Delaware Supreme Court or on a more fully developed record in the Chancery Court) will provide greater clarity, but in declining to certify interlocutory appeal of his decision in Lyondell, V.C. Noble appeared eager to allay concerns that the decision may have raised, declaring that “the reports of the death of Section 102(b)(7) (and the consequent possibility for the ‘resuscitation’ of a Van Gorkom-esque liability crisis) in Delaware law are greatly exaggerated both with regard to the application of Lyondell’s exculpatory charter provision in this case, and certainly with regard to the application of a Section 102(b)(7) provision defense in any other case.”

• See a copy of John P. McPadden v. Sankiv. S. Sidhu, Civ. A. No. 3310-CC (Del. Ch. Aug. 29, 2008)

• See a copy of In re Lear Corp. S’holder Litig., Const. C.A. No. 2728-VCS (Del. Ch. Sept. 2, 2008)

• See a copy of Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. July 29, 2008)

• See a copy of Ryan v. Lyondell Chemical Co., C.A. No. 3176-VCN (Del. Ch. Aug. 29, 2008)

Notes:
[1] Separately, we note that Chancellor Chandler permitted the claim for breach of fiduciary duty to proceed as against Dubreville, the employee who led the management buyout. Chancellor Chandler held that, as an officer of the company, Dubreville owed it the same fiduciary duties of care and loyalty as owed by the directors, but is not entitled to the protections of the exculpatory provision, which is only available to directors.

Ryan v. Lyondell Chemical Co.

Posted by Charles M. Nathan, Latham & Watkins LLP, on
Friday, September 12, 2008
, ,
More from: ,

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

In a rare decision on a post-closing motion in Ryan v. Lyondell Chemical Co., the Delaware Court of Chancery addressed the question of whether the independent members of a target company’s board of directors were entitled to summary judgment on claims that they breached their fiduciary duties by conducting an inadequate sale process. Although the court suggested that the transaction’s 45 percent premium was likely to prove exceptional, that the price was certainly “fair” and that the agreed deal protection measures might prove to be “reasonable,” the limited record of a passive board process in a CEO-dominated transaction with no market check likely mandated a trial to assess the open factual matters.

The decision highlights (1) the judicial perception of CEO-dominated M&A processes and the implications of those negative views on the ability of defendants to secure dismissal of claims prior to trial, (2) the critical importance of developing a thorough record of board evaluation (with financial and legal advisors) early in any strategic process, whether company-initiated or defensive, of the most effective means of maximizing shareholder value, and (3) the equal importance of building a record of careful board deliberation, with the assistance of legal and financial advisors, as to the effect of deal protection terms on the likelihood of subsequent bidders emerging and bidding full value.

A memo on the decision is available here, and the court’s opinion may be accessed here.

The Corporate and Securities Professors’ Brief in Bebchuk vs. Electronic Arts

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Thursday, September 11, 2008
, , ,
More from:
Editor’s Note: This post is from Jeffrey N. Gordon of Columbia Law School.

I filed earlier this week an amici curiae brief — on behalf of forty-six corporate and securities law professors from twenty-eight law schools around the country — in the case of Lucian Bebchuk vs. Electronic Arts, Inc.. The case is pending before the United States District Court for the Southern District of New York. The professors’ amici curiae brief is available here.

The case focuses on a shareholder proposal that was submitted by Lucian Bebchuk to Electronic Arts (EA). The proposal is precatory and recommends that the board submit to a shareholder vote a charter or bylaw amendment that, if adopted, would require the company (to the extent permitted by law) to include in the company’s proxy materials qualified proposals for a bylaw amendment. For a proposal to be qualified, the proposal would have to meet certain significant requirements, including being submitted by a shareholder(s) with more than 5% of the company’s stock. The proposal is available here.

EA excluded the proposal from the company’s ballot, and the case focuses on whether the SEC’s shareholder proposal rule (Rule 14a-8) allows the company to do so. The U.S. Chamber of Commerce weighed in, filing an amicus curiae brief in support of EA. The Chamber’s amicus brief is available here and EA’s brief is available here. The response brief filed by Bebchuk’s counsel is available here.

The professors’ amici curiae brief, filed in support of Bebchuk’s position, focuses on two central arguments made in defense of excluding the proposal whose acceptance could have significant implications far beyond the current case:

(1) Preemption Argument: EA and the Chamber argue that Rule 14a-8 preempts the field in determining access to the issuer’s proxy statement and thus would invalidate an internal corporate governance arrangement otherwise permissible under state law that would require a company to include some proposals that the Rule permits the company to include or exclude.

Acceptance of the preemption argument would have far-reaching consequences, invalidating any charter or by-law provisions that provide shareholders with access to the company’s proxy materials. As the professors’ brief points out, this argument is directly opposite to the Chamber’s position in its submission to the SEC last year that “state law defines the rights of shareholders, including…the extent to which they have access to the company’s proxy…” This argument is also directly opposite to the view expressed by the Second Circuit in AFSCME vs. AIG. In this case, taking as settled law that a bylaw expanding shareholder access to the company’s proxy beyond Rule 14a-8’s minimum requirements is permissible, the Court stated that such bylaws “are certainly allowed … under the federal securities laws.”

The professors’ brief explains that Rule 14a-8 sets minimum requirements as to which proposals must be included, leaving companies with discretion whether to include other proposals, and that state law arrangements may regulate how companies use this discretion. Furthermore, the brief explains that, rather than preempt state law in this area, Rule 14a-8 in fact co-exists with and critically relies on state law to regulate how issuers operate within the zone of discretion the Rule leaves them.

(2) Indirect Consequences Argument: EA argues that the proposal may be excluded under the election exclusion provision of Rule 14a-8(i)(8) because the recommended charter or by-law provision, if adopted, could one day, after a sequence of steps which may or may not occur, lead to the inclusion of a bylaw related to director nomination or election.

Acceptance of the indirect consequences argument would lead to substantial expansion in companies’ ability to exclude shareholder proposals. EA essentially asks the Court to rewrite the election exclusion to apply not only to proposals that relate to director election and nomination procedures but also to proposals related to by-law amendment procedures. The professors’ brief explains that the Court should not accept this invitation to expand considerably companies’ power to exclude proposals.

The corporate and securities law professors joining this brief as amici, listed alphabetically, are:

Robert Ashford
Professor of Law
Syracuse University College of Law

Ian Ayres
William K. Townsend Professor
Yale Law School

Laura N. Beny
Assistant Professor of Law
University of Michigan Law School

Lisa E. Bernstein
Wilson-Dickinson Professor of Law and
Co-Director, Institute for Civil Justice
University of Chicago Law School

Bernard S. Black
Professor of Law
University of Texas Law School
Professor of Finance
McCombs School of Business

Stephen Choi
Murray and Kathleen Bring Professor of Law
New York University School of Law

John C. Coffee
Adolf A. Berle Professor of Law
Columbia Law School

James D. Cox
Brainerd Currie Professor of Law
Duke University School of Law

George W. Dent, Jr.
Schott-van den Eynden Professor of Business Organizations Law
Case Western Reserve University School of Law

John J. Donohue
Leighton Homer Surbeck Professor of Law
Yale Law School

Melvin A. Eisenberg
Koret Professor of Law
Boalt Hall
University of California at Berkeley

Charles M. Elson
Edgar S. Woolard, Jr., Chair
Professor of Law
Director of the John L. Weinberg Center for Corporate Governance
Lerner College of Business & Economics
University of Delaware

READ MORE »

The 10b-5 Guide: A Survey of 2007 Securities Fraud Litigation

Posted by Holly Gregory, Weil, Gotshal & Manges LLP, on
Wednesday, September 10, 2008
, ,
More from: ,

This post is from Holly Gregory of Weil, Gotshal & Manges LLP.

My partners Robert F. Carangelo, Paul A. Ferrillo and Caitlyn M. Campbell have recently issued the 2007 edition of Weil, Gotshal & Manges‘ The 10b-5 Guide: A Survey of 2007 Securities Fraud Litigation. The Survey includes a detailed assessment of an extraordinarily active year in securities law in which securities fraud class action filings increased by 43%, fueled in part by the subprime mortgage crisis, and the Supreme Court handed down two significant opinions. The Survey also contains summaries of recent decisions concerning the federal securities laws, including Tellabs, Inc. v Makor Issues & rights, Ltd and Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., and highlights particular topic areas, such as the heightened pleading requirements under the Private Securities Litigation Reform Act of 1995, secondary liability and loss causation.

The Survey is available here.

Share Repurchases and Pay-Performance Sensitivity of Employee Compensation Contracts

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, September 9, 2008
, , ,
More from:

This post comes to us from Ilona Babenko of the Department of Finance at the Hong Kong University of Science and Technology.

In my forthcoming Journal of Finance paper, Share Repurchases and Pay-Performance Sensitivity of Employee Compensation Contracts, I explore how share repurchases affect existing employee compensation contracts and offer a new explanation for the popularity of stock buybacks. Specifically, at the time of a share repurchase, employees are not permitted to tender their unvested shares, and the pay-performance sensitivity of their contracts increases. This increased employee ownership (measured by the dollar change in compensation per dollar change in firm value) creates stronger incentives for employees to provide effort, but also exposes them to greater risk. For example, a repurchase of 7% of common shares provides a 7.5% increase in employee incentives and can substitute for about half of a typical annual equity grant. Given the incentive effect of stock buybacks, managers (who make payout decisions) can benefit from stock repurchases by effectively forcing higher incentives on employees (who do not influence the firm’s payout policy).

Using a sample of 1,295 open market repurchase announcements and hand-collected data on employee stock option programs over the 1996 to 2002 period, I find that announcement returns are larger in firms with larger repurchase programs and many unvested stock options. The effect is most powerful when employees (not managers) have large amounts of unvested ownership and when firms intensively use human capital. In addition, I find that the method of payout chosen by the firm (stock repurchase versus dividend increase) is affected by the compensation structure at the firm. I find that repurchases are more likely to be announced when employees hold many unvested stock options, particularly when firms have a greater need for human capital, as measured by their R&D expenses and Tobin’s Q. Consistent with the diversification motive of risk-averse employees, I find that stock option exercises are positively related to the fraction of repurchased equity. A one-standard deviation increase in the fraction of repurchased equity is associated with a 30% increase in stock option exercises by managers and a 19% increase by employees, controlling for factors such as stock returns, market-to-strike ratios, and contemporaneous option grants, among others. The increase in stock option exercises is more pronounced for firms with highly volatile stock returns, supporting the view that employees exercise their stock options because of the increased risk exposure.

The rationale for open market share repurchases proposed in this paper is unrelated to the undervaluation and excess cash distribution motives explored elsewhere in the payout literature. While my empirical and theoretical results do not rule out undervaluation or other repurchase motives, the argument of this paper is that managers also repurchase stock to boost employee incentives.

The full paper is available for download here.

Page 12 of 29
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 … 29