Monthly Archives: November 2009

A Costly Lesson in the Rule of “Loser Pays”

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, November 2, 2009
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(Editor’s Note: This post is based on an op-ed piece published in today’s print edition of the Financial Times and is available here.)

The UK is reviewing rules governing its civil justice system, including class actions. Lord Justice Jackson is expected to publish a report in the next few months that will take up a number of proposals, including proposals to abolish the “loser pays” rule in collective lawsuits. Yet US experience – as illustrated by a current case before the US Supreme Court – may provide a useful caution. Jones v. Harris Associates L.P., argued on November 2, 2009, demonstrates that lowering the “loser pays” barrier could have serious consequences.

In the US, of course, each side in a lawsuit – including class actions ­ pays its own costs regardless of outcome, and plaintiff lawyers can often extract a settlement that covers their costs (plus a bit), even if the case would lose at trial. A prime example is Jones v. Harris. In that case, plaintiffs’ attorneys allege a financial adviser breached its duties by overcharging clients of its collective investment schemes (mutual funds) for services. In the trial court, they lost. The adviser, after all, had produced above-average returns over many years in return for fees well within industry norms – and well below typical advisory fees in the UK. But the case has survived two rounds of appeal – despite independent trustees having negotiated the fees on behalf of investors, despite investors having approved the fees, and despite the fact that investors are free to liquidate at net asset value at any time and move their funds elsewhere in a highly competitive market.

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Securitization and Moral Hazard

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, November 2, 2009
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This post comes from Ryan Bubb and Alex Kaufman of Harvard University.

 

Perhaps no academic paper has done more to convince scholars and policymakers that mortgage securitization led to lax screening by lenders and fueled the subprime crisis than did the recent paper by Keys, Mukherjee, Seru, and Vig (forthcoming in the Quarterly Journal of Economics, 2010) (hereafter, KMSV, who published a post in June on the Forum, which is available here). In an innovative paper, they argue that mortgage purchasers follow a “rule of thumb” in deciding which loans to purchase: they are, for exogenous reasons, much more willing to buy mortgage loans given to borrowers with credit scores above 620 than those given to borrowers with credit scores below 620. In a dataset containing only securitized loans, they find that loans made to borrowers just above 620 (where securitization is easy) default at a higher rate than those just below and argue that this is strong evidence that securitization really did result in lax screening by lenders.

In a new paper, Securitization and Moral Hazard: Evidence from Lender Cutoff Rules, which we recently presented at the Harvard Business School / Harvard Economics Finance Lunch Seminar, we reexamine the credit score cutoff rule evidence with a better dataset and through a theoretical lens that assumes rational equilibrium behavior and reach a very different conclusion.

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Some Tender Offer Quirks

Posted by David Fox, Kirkland & Ellis LLP, on
Monday, November 2, 2009
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This post is based on a Kirkland & Ellis LLP client memorandum by David Fox, Daniel E.Wolf, and Susan J. Zachman.

Much has been written about the advantages of structuring a friendly acquisition as a tender offer followed by a back-end squeeze-out merger as compared to a single-step merger. Some of these perceived benefits include speed to closing, avoiding adverse recommendations from proxy advisory firms such as RiskMetrics (ISS) and mitigating the risk of “empty voting.” With SEC clarifications to the “best price” rules in 2006 and the occurrence of a few all-equity sponsor buyouts, we have seen a significant uptick in tender offer activity in both the private equity (e.g., Apax/Bankrate and Apollo/Parallel Petroleum) and strategic (Bristol Myers/Medarex and J&J/Omrix) spaces. In considering a tender offer structure, practitioners should be aware of a number of quirks that have come to light in recent tender offer transactions that may impact or offset the advantages of using this structure.

The policies and practices of index and quantitative funds with respect to participation in tender offers vary widely. Many such funds will not tender into an offer where the market price is above the offer price. Moreover, many will not tender into an offer at all, regardless of the relationship of the market price to the offer price, so long as the stock is still included in the relevant index the fund is mirroring or tracking. In situations where there is significant holding of the target stock by these funds and reaching the minimum tender condition is a close call, these policies and practices can be determinative of success or failure. In addition, to the extent such fund decisions are in fact affected by market price at the time of the expiration of the tender offer, these practices create an additional opportunity for arbitrageurs interested in the success (or failure) of a tender offer to influence the outcome of the offer by effecting minor price movements above or below an offer price. Finally, even if a tender offer is successful in achieving the minimum condition, the ability of an acquirer to reach the minimum threshold (usually 90 percent) required to effect a short form merger on the back end (and thereby avoid the expense and delay of a full-blown proxy statement) may be constrained by the behavior of those funds that will not tender under any circumstances while the stock is still in the relevant index.

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Implementing Proxy Access Under Delaware Law

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, November 1, 2009
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This post comes to us from John Mark Zeberkiewicz and Joseph L. Christensen of Richards, Layton & Finger, P.A. 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 SEC recently announced that it would delay voting on the adoption of its mandatory proxy access regime to consider the comments and feedback it received in response to its proposed Rule 14a-11. Meanwhile, at the state level, corporate practitioners are closely following whether (and, if so, in what form) Delaware corporations will voluntarily adopt proxy access bylaws pursuant to the recent amendments to the DGCL. In a brief article appearing in the latest issue of The Review of Securities & Commodities Regulation, we compare Delaware’s approach of authorizing corporations to adopt narrowly tailored proxy access bylaws to the SEC’s approach of prescribing a generally applicable proxy access rule. We illustrate the differences between the two approaches by describing a model proxy access bylaw adopted under the DGCL and pointing out various ways in which that model bylaw could be modified to meet the needs of a particular corporation. Some highlights of the model bylaw are as follows:

  • Granting the proxy access right to the stockholder or group with the greatest holdings (14a-11 grants the right based on a first-in-time system)
  • Requiring the stockholder proponent (and each member of a group) to continue to hold shares through the date of the meeting
  • Prohibiting the stockholder proponent (and each member of a group) from materially increasing its ownership stake for a specified period
  • Excluding nominations from proponents whose nominees have failed to gain substantial support in prior elections
  • Requiring a stockholder nominee to submit a conditional resignation that would become effective upon a finding that information included in the proponent’s nomination request, or information furnished by the proponent and included in the proxy statement, was false or misleading
  • Requiring proponents to indemnify the corporation against any liability, loss or damage arising out of a stockholder nomination submitted pursuant to the bylaw

The article is available here and the model bylaw (with annotations explaining ways in which various provisions may be modified) is available here.

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