Monthly Archives: November 2009

Effective Board Engagement with Shareholders

This post comes to us from Simon Wong of Northwestern University Law School.

Shareholders around the world are seeking greater dialogue with boards of directors of investee companies on an expanding array of topics. For example, demands by investors in the US and other markets for greater shareholder rights – such as an advisory vote on remuneration – are in part efforts to engage the board on important governance issues. In a recent article, available here, I draw upon my experience in the UK and other markets to offer practical suggestions to boards on improving engagement with their shareholders.

To start, boards should strive to build a long-term, trust-based relationship with their most significant shareholders. In practice, this means that the board – particularly the chairman, lead independent director and remuneration committee chair – should interact directly with shareholders rather than delegating this function to the investor relations team.

The focus on building trust means that regular meetings are important, as relationships and goodwill are built through repeated encounters. Meetings with shareholders do not have to be especially formal. In most situations, casual conversation often works better. Quality of discussion, particularly when sensitive topics are on the agenda, is often inversely proportional to the number of people in the room. As a principle, both sides should strive to minimize the number of attendees.

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Noncompetition Agreements

(Editor’s Note: This post comes from Mark Garmaise of UCLA Anderson School of Management.)

For most firms, the human capital of their employees is a core asset, but it is one over which they cannot exercise full ownership. Noncompetition agreements (also known as covenants not to compete) are contracts that restrict workers from joining (or forming) a rival company, and they represent one of the most important mechanisms binding employees to a firm. In my forthcoming Journal of Law, Economics and Organizations paper, Ties that Truly Bind: Noncompetition Agreements, Executive Compensation, and Firm Investment, I make use of time-series and cross-sectional variation in noncompetition enforceability across the states of the United States to analyze the effects of these agreements.

I start my analysis by considering two contrasting theoretical models. In the first model (Model A), I study the effects of noncompetition enforceability on a firm that is deciding whether to make a non-contractible partially firm-specific investment in the human capital of its manager. In my second model (Model B), managers also have the option to make a non-contractible investment in their own general human capital. I make use of data on state regulations and the Execucomp database of executive compensation to test the predictions of Models A and B by analyzing the effects of noncompetition enforceability. I first show that noncompetition are quite commonly utilized; I find that 70.2% of firms use them with their top executives. I then perform two types of tests. My time-series tests consider changes in noncompetition enforceability law that took place in Texas, Florida, and Louisiana. These tests employ firm fixed effects to analyze the impact of the legal shifts, controlling for all firm-specific variables. My cross-sectional tests analyze differences in enforceability across all states. I argue that noncompetition law is particularly important to firms with substantial within-state competition since covenants not to compete typically have limited geographic scope and are easiest to enforce in the same legal jurisdiction. I then use the interaction between enforceability and the extent of in-state competition as a measure of the power and relevance of noncompetition law for a given firm. I include state fixed effects in our cross-sectional tests to control for differences between states unrelated to noncompetition enforceability, and I also control for industry effects.

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Raising the Bar: Re-Establishing Director Credibility

This post is based on a Skadden, Arps, Slate, Meagher & Flom LLP client memorandum by Mr. Atkins.


This article highlights that publicly traded business corporations and their directors have lost the confidence and trust of many, leading to an onslaught of proposed federal legislation which, if enacted, will catapult the federal government into the role of primary regulator of those companies and directors, which heretofore have been regulated under state law. This article further suggests that to stem this tide of federal intervention in an area central to our private enterprise system, U.S. public company directors must act promptly in a concerted, clear and convincing way to restore their credibility. Finally, this article proposes a program for doing so, premised on those directors voluntarily embracing a set of “Basic Principles of Director Oversight” publicly reflecting focused and real commitment by the directors to comprehensive, high-quality board oversight of corporate affairs.

The Current Environment

The financial crisis of 2008-2009 appears to have been largely overcome and the economic abyss it threatened has been averted. In its wake, however, is another quite serious threat. This threat is the product of a combination of circumstances: the psychological trauma of the financial crisis, severe real damage to the economic well-being and prospects of many Americans, a painful recession marked by massive job losses and unemployment, and, ultimately, an overwhelming need to lay blame. The target of this blame for many is American Capitalism — our private enterprise system — and, in particular, those with the responsibility for overseeing it, the boards of directors of the public companies which drive the system.

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Proxy Access: Where Are We Now And Where Should We Go

This post is based on a client memorandum by Charles Nathan of Latham & Watkins LLP, Rhonda Brauer of Georgeson and Raluca Papadima of Latham & Watkins LLP.

The SEC rule proposal for proxy access drew more than 500 comment letters, many of which suggested significant and often conflicting revisions to the proposed rule and identified issues that were not addressed by the proposed rule.

Because of the complexity of the substantive issues and the importance of proxy access to corporate governance, the SEC has deferred action on proxy access until early 2010, with the result that a SEC proxy access regime will not be in place for the 2010 proxy season.

Additionally, three SEC commissioners have made clear that they are not prepared to adopt an amendment permitting shareholder proposals for proxy access as an interim or final outcome, and that they remain focused on adopting a prescriptive federal rule that mandates proxy access for public companies.

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Fiduciary Outs: The Intricacies Of A Concept Run Amok

Editor’s Note: 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.

Recently, in the Mergers and Acquisitions course at Harvard Law School, four preeminent M&A practitioners discussed deal protection and fiduciary outs in merger transactions with Vice Chancellor Leo Strine, Jr., who teaches the class.  The panelists were Philip Gelston, a corporate transactional partner at Cravath, Swaine & Moore LLP; Stuart Grant, co-founder of Grant & Eisenhofer P.A.; Paul Rowe, a litigation partner at Wachtell, Lipton, Rosen & Katz; and Audra Cohen, a mergers and acquisitions partner at Sullivan & Cromwell LLP.

The panel discussed Delaware’s significant deal protection decisions, including Smith v. Van Gorkom, Paramount Communications, Inc. v. Time Inc., Paramount Communications, Inc. v. QVC Network Inc., Quickturn Design Sys., Inc. v. Shapiro, ACE Ltd. v. Capital Re Corp. (in which the Vice Chancellor wrote the decision of the Chancery Court level) and Omnicare Inc. v. NCS Healthcare, Inc.  There was then discussion of the advisory opinion in CA, Inc. v. AFSCME Employees Pension Plan and its implications.

The video of the panel is available here (Quicktime .mov file). (video no longer available)

A New Capital Regulation For Large Financial Institutions

If there is one lesson to be learned from the 2008 financial crisis, it is that large financial institutions (LFIs) are too big to fail. Whether the too-big-to-fail doctrine is based on economic thinking (the cost of a large failure is too high) or political reality (the pressure to save LFIs is too strong), the conclusion is the same: we need to rethink how we regulate these institutions. In A New Capital Regulation For Large Financial Institutions, which I recently presented at the Law, Economics and Organizations seminar here at Harvard Law School, my co-author Luigi Zingales and I view the goal of regulation as being to preserve the incentive effects of bankruptcy while avoiding the possibility that an LFI is insolvent with respect to its systemic obligations: interbank lending, derivatives and deposits.

We introduce a new capital requirement system designed specifically for LFIs. Our mechanism mimics the way margin calls function. LFIs will post enough collateral (equity) to ensure that the debt (all the debt, not just the deposits and derivative contracts) is paid in full with probability one. When the fluctuation in the value of the underlying assets puts debt at risk, LFI equity holders are faced with a margin call and they must either inject new capital or lose their equity. There are three main differences between margin calls and our new capital requirement system: the trigger mechanism, the action taken if the trigger is activated, and the presence of an additional cushion of junior long-term debt.

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SEC Reverses Position on Rules for Excluding Shareholder Proposals

This post is based on a Sullivan & Cromwell LLP client memorandum.

October 27, 2009, the SEC’s Division of Corporation Finance issued a Staff Legal Bulletin changing prior guidance on the application of Rule 14a-8(i)(7), and expanding the scope of matters that the Division considers permissible subjects for shareholder proposals in company proxy statements. Rule 14a-8(i)(7) permits a company to exclude a shareholder proposal from the company’s proxy statement insofar as the proposal deals with a matter relating to the company’s ordinary business operations.

In the Staff Legal Bulletin, the Division reverses its prior positions that proposals relating to environmental, financial or health risks and proposals related to CEO succession planning may be excluded under Rule 14a-8(i)(7). The Division’s action met with approval from environmental activists who have long sought to include shareholder proposals related to climate change issues in corporate proxy statements.

The Division also clarified that both companies and shareholder proponents may alert the Division in advance of their intent to submit correspondence in connection with a no-action letter request under Rule 14a-8.

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Corporate Governance Provisions Added to Financial Reform Bill

Senator Dodd unveiled his 1,136-page financial reform bill discussion draft today, which proposes a variety of new financial industry regulations and regulatory agencies. While the bill focuses on these wide-ranging and controversial financial reform proposals, a number of corporate governance reforms are also buried in the bill on pages 755 to 762, and are largely taken, albeit in somewhat weakened form, from Senator Schumer’s proposed Shareholder Bill of Rights Act. As we have previously commented, these governance reforms, while presented as a means of enhancing corporate governance and restoring stability to American companies, are likely to have just the opposite effect. See the Wachtell, Lipton, Rosen & Katz memoranda “A Crisis Is a Terrible Thing to Waste: The Proposed ‘Shareholder Bill of Rights Act of 2009’ Is a Serious Mistake,” posted on the Forum here, and “Corporate Governance in Crisis Times,” posted on the Forum here.

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Private Fund Investment Advisers Registration Act Approved by House Committee

This update focuses on the House Financial Services Committee’s consideration and approval on October 27, 2009 of H.R. 3818, the Private Fund Investment Advisers Registration Act of 2009. The full text of the bill as amended by the Committee is not yet available.

Overview of Process

While few things are predictable and nothing is certain about the legislative process, the Private Fund Investment Advisers Registration Act has a decent chance of becoming law in a form not unlike that which was reported out of the House Financial Services Committee last week. The once-controversial bill was the subject of a remarkably bipartisan mark-up, particularly in contrast to the Consumer Financial Protection Agency Act (H.R. 3126) mark-up, which followed shortly thereafter. Most amendments to the bill were adopted by near-unanimous voice votes, and the Committee approved the bill, as amended, by a vote of 67 to 1 (Representative Ron Paul (R-TX) was the lone dissent).

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Lessons for M&A Advisors in Crafting Engagement Letters

This post is based on a Wachtell, Lipton, Rosen & Katz memorandum by David A. Katz, William Savitt, and Ryan A. McLeod.

A federal court decision interpreting an investment bank’s engagement letter on a motion to dismiss highlights the risk that—absent careful drafting—financial advisors may be held liable to third-party beneficiaries on both contract and fiduciary duty claims. Baker v. Goldman Sachs, Civ. No. 09-10053-PBS (D. Mass. Sept. 15, 2009).

The financial advisor represented a closely held company, founded and controlled by the Bakers, in connection with its review of potential strategic transactions in early 2000. Allegedly relying on the financial advisor’s advice, the company entered into a stock-for-stock merger agreement with a Dutch buyer, and the deal closed in June 2000. Just months later, the Wall Street Journal uncovered a massive accounting fraud at the Dutch buyer, whose shares subsequently lost all value and whose collapse cost the Bakers their investment. Seeking to recoup some of their losses, the Bakers filed suit against the financial advisor for breach of contract and fiduciary duty. The financial advisor moved to dismiss, arguing that its engagement agreement was with the closely held company alone and that it owed neither fiduciary nor contractual duties to the Bakers.

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