Yearly Archives: 2009

A Mid-Year Review of SEC Enforcement in 2009

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Saturday, July 18, 2009
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Editor’s Note: This post is by Eduardo Gallardo’s colleagues Mark Schonfeld, John Sturc, Barry Goldsmith, Eric Creizman, Jennifer Colgan Halter, Akita St. Clair, Ladan Stewart and Matthew Estabrook.

Without question, the first six months of 2009 have been a period of sharply increased enforcement activity at the Securities and Exchange Commission. The financial crisis, the new administration, new SEC leadership, increased funding and the focus of Congress and the media have all combined to encourage heightened government scrutiny. And even though it has only been a few months since a new Chairman took office, already there are tangible signs that the SEC has taken a more aggressive enforcement posture. In this alert, we review the changes the new SEC leadership has instituted and is considering, the observable impact of the new administration on enforcement activity and significant cases in key areas that reflect the agency’s evolving enforcement program.

I. Overview of Changes

A. The Backdrop

The events of 2008 led directly to the current enforcement agenda. The collapse of the subprime mortgage market, the ensuing credit crisis, the demise of several major investment banks and, perhaps most of all, the Madoff case led to a loss of confidence in the agency’s ability to protect investors. This loss of confidence was manifested in Congressional hearings and an intensified media spotlight. At the same time, the SEC’s Inspector General has issued a number of reports critical of the agency, and Congress intensified pressure on the SEC and Department of Justice to bring cases in the wake of the financial crisis. At a March hearing of the Senate Judiciary Committee on the law enforcement response to the financial crisis, Senator Patrick J. Leahy declared, “I want to see prosecutions…. I want to see people go to jail.”

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Special Purpose Vehicles

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, July 17, 2009
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This post comes from Mei Feng of the Katz Graduate School of Business, University of Pittsburgh, Jeffrey D. Gramlich of the University of Southern Maine School of Business and Copenhagen Business School, and Sanjay Gupta of the Eli Broad College of Business, Michigan State University.

We investigate the use, determinants, and earnings effects of special purpose vehicles. Based on a proxy of SPV activity that can be applied to a broad cross-section of firms over time, we find a two-and-a-half fold monotonic increase in the percentage of firms using at least one SPV during the eight-year period from 1997 through 2004. Tobit regressions of the determinants of SPV use show that SPV activity increases with financial reporting incentives and economic and tax motivations, but strong corporate governance tends to mitigate their use. In addition, the evidence is consistent with SPVs arranged for financial reporting purposes being associated with earnings management, whereas the same does not appear to be the case for SPVs set up mainly for economic, tax, and other reasons.

Using a sample of 6,473 firms from 1997 to 2004, we obtain 22,604 firm-year observations for which the requisite data are available. SPV use appears highest among industry groups that tend to be leasing-activity intensive, such as trading, real estate, and construction, traditionally viewed as one of the main activities involving SPV use. We also find relatively high SPV use in banking and telecommunications, consistent with these industries providing new avenues for SPV use during the 1990s, such as the securitization of financial assets and broadband capacity.

With respect to investigating the determinants of SPV use, Tobit regression results show that SPV activity is increasing in financial reporting incentives and economic motivations, but strong corporate governance mitigates SPV use. Specifically, we find that SPV use is positively related to: (1) leverage, (2) CEO bonus compensation, (3) availability of funds, and (4) demand for tax benefits, but decreasing in board independence and independent directors’ stockholdings. These results are robust to a variety of sensitivity tests, including the use of other model specifications besides Tobit (e.g., logit and OLS), different sample selection criteria, and alternative definitions of the dependent and independent variables. In terms of economic magnitude, inter-quartile increases in leverage, availability of funds, intangible assets, and board independence result in changes in expected SPVs of 1.31, -0.36, 1.05, and -1.04, respectively. These effects are quite large given that more than 70 percent of our sample observations have zero or one SPV. Also, SPV use is increasing in firm size, consistent with larger firms having greater technical expertise to handle the complexity of structured financing arrangements.

With respect to examining SPVs’ role in earnings management, we use the Tobit regression results to parse the number of SPVs for each firm-year into those predicted by financial reporting motivations, those predicted by economic considerations, and those predicted by other variables. We then investigate the relation between these predicted SPV components and two measures of earnings management – discretionary accruals and frequency of small profits or losses. We hypothesize that SPVs arranged for financial reporting reasons are likely to be positively associated with earnings management measures, whereas we do not expect a similar relation for SPVs arranged for other reasons. Our evidence based on both univariate and regression tests is consistent with this hypothesis. The economic magnitude of this association appears to be substantial. For example, when the number of predicted SPVs for financial reporting purposes increases by one, on average the probability that a firm reports a small gain instead of a small loss increases by 18 percent.

The full paper is available for download here.

Responding to Unsolicited Takeover Offers

Posted by A. Gilchrist Sparks, Morris, Nichols, Arsht & Tunnell LLP, on
Thursday, July 16, 2009

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This post is by A. Gilchrist Sparks of Morris, Nichols, Arsht & Tunnell LLP.

In an article entitled “Responding to Unsolicited Takeover Offers,” my partner Frederick H. Alexander provides an overview of the issues a board may consider in evaluating a company’s governance profile given the potential increase in unsolicited offers in the current market environment. The article explains that despite the downturn in M&A activity during the past two years, current market conditions make some companies vulnerable to unsolicited bids. Indeed, hostile bids accounted for 47% of the M&A transactions in the first two months of 2009, compared with 24% in 2008 and 7% in 2004. Against this backdrop, the article discusses forms that unsolicited acquisition offers may take as well as the considerations and constraints relevant to directors in determining their responses.

The article also provides the following checklist of critical issues that directors should consider to avoid becoming the target of a harmful takeover offer attempt and determine the most appropriate course of action should the company be approached by an unsolicited bidder.

Assemble a solid team of experts. Operating in the M&A market has traditionally required a wide range of expertise that the board may not have internally. The need for skills and preparedness is only accentuated by the challenges of the current economic and financial environment. In particular, directors should ensure they have ready access to in-house and outside legal and financial advice as well as experts in investor relations and proxy solicitation.

Understand shareholder base and intentions. Board members and senior executives should have a full understanding of shareholders’ intentions, as they may be critical both from a preventive standpoint and in determining the right defensive strategy. Stock surveillance firms and proxy solicitors may help the corporation actively monitor the larger investors as well as those who engage in large accumulations of stock or extraordinary trading patterns. The company should also consider investigating groups of investors or other possible (undisclosed) voting arrangements to determine whether a bidder is acting alone or has the support of others.

Maintain proactive external relations. Credibility with institutions, analysts and proxy advisors may be crucial in responding to unsolicited bids, so it is important to maintain good lines of communication. Investor relations teams, in particular, can help corporate leaders identify key shareholder allies and nurture those relationships, for example, by regularly informing them—in compliance with Regulation FD and insider trading rules—on new business decisions affecting strategy and long-term shareholder value as well as the financial metrics and valuations on which those decisions were based. Similarly, a proactive outreach to governance analysts and proxy advisors is essential to communicate and persuade on the rationale for adopting defensive devices that could otherwise become the subject of public criticism.

Review certificate of incorporation and bylaws. A board should review charter and bylaw provisions for the purpose of assessing the strength of the corporation’s general defensive profile. Structural and procedural defenses should be updated so that they reflect legal developments and, when possible, best practices. In doing so, directors should be mindful of the following considerations.

Some defensive actions (e.g., classified board structures or disabling action by written consent) can only be adopted bilaterally through a board resolution and subsequent shareholder approval. Others, such as bylaw provisions and poison pills, may be adopted unilaterally by the directors, but may be helpful only if already in place when the company receives the unsolicited bid.

• If the decision is to depart from governance standards that are widely supported by proxy advisory firms and influential shareholder groups, the reasons why directors believe doing so is in the shareholders’ best interests should be clearly articulated.

• Many legal advisors recommend that the company should consider addressing instances of undisclosed derivative/hedging positions (such as cash-settled swaps) and the vulnerability resulting from depressed stock valuations. A bylaw requiring that the advance notice of shareholder proposals or nominations be accompanied by more detailed disclosure of all equity (including synthetic and temporary) holdings as well as a poison pill of limited duration may help to achieve these goals.

Develop coherent procedures and a unified response. The board of directors should be comfortable that the company has ad hoc internal communication and reporting procedures to deal effectively with the threats of a hostile takeover. Most important, any evidence of a potential bidder should be promptly escalated to the top (at a minimum, the chairman of the board, the governance committee chair, and the CEO should be informed) so that it receives the appropriate level of attention. For the purpose of developing an actionable response plan, board members should seek the close collaboration of senior management, albeit while remaining mindful of potential conflicts of interest.

Although a board receiving an unsolicited bid will face a number of decisions, directors ultimately choose from among three possible outcomes:

1. Sale to the bidder

2. An alternative transaction

3. Remaining independent

To fulfill their fiduciary duties of care and loyalty, directors should decide the corporation’s response to the bidder based on a thorough discussion and understanding of the implications of each alternative. This may require reassessing strategic goals in light of macroeconomic trends and industry developments as well as exploring alternative approaches to business growth.

The article is available here.

Uses and limits of conventional corporate governance instruments

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, July 16, 2009
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This post comes to us from Simon Wong, Independent advisor and Adjunct Professor of Law at Northwestern University School of Law.

As a way to contribute to the current debate on corporate governance reforms, I have written a practitioner-based article, to be published in two parts by the Global Corporate Governance Forum of the World Bank Group, examining the uses and limits of five commonly employed corporate governance instruments – transparency, independent monitoring by the board of directors, economic alignment, shareholder rights, and financial liability.

Entitled Uses and Limits of Conventional Corporate Governance Instruments: Analysis and Guidance for Reform, my article discusses how the individual instruments have worked in practice, including instances when they have failed to achieve their intended objectives and, in some cases, worsened the governance ailments that they were designed to cure. For example, the rapid growth of executive compensation persisted – and in some countries, accelerated – after the introduction of individual executive pay disclosure. In the financial sector, the shift toward a board dominated by independent directors ultimately proved to be its Achilles’ heel as weak industry knowledge meant that non-executive directors (NEDs) were unable to pick up on warning signs of imprudent risk taking by management. In addition, quarterly reporting of financial results has resulted in excessive short-termism, as management obsesses over meeting analysts’ earnings forecasts for each quarter because missing the “consensus estimates” by even one cent could pummel the share price and discredit management.

Even when these instruments have worked as intended, there are limits to their utility. For example, the structural issues that boards confront – such as potentially conflicting “watchdog” monitoring and strategy development roles, part-time status, vast information asymmetry, and boardroom group dynamics – mean that they will never be as objective and challenging of management as shareholders and others wish them to be. Likewise, there are limits to the use of economic incentives as an alignment tool, the most significant being that people are motivated by more than the prospect of financial gains. Due to free-rider problems, lack of competence (particularly for institutional investors with large portfolios), and conflicts of interest, shareholders may not be well-positioned to rigorously monitor boards and management, particularly in markets with dispersed ownership.

In this article, I also provide suggestions to improve the application of these instruments. For example, to enhance the board’s ability to understand the company’s business, its membership should comprise a substantial proportion, but not necessarily a significant majority, of independent directors. Ideally, boards should feature a diversity of perspectives, substantial formal independence, and strong company and industry knowledge.

When populating the board, it is also important to pay attention to the relative status of people in the boardroom, particularly vis-à-vis the CEO. Discussions with chairmen and direct observations of boardroom dynamics have revealed that CEOs are not always attentive to the views of non-executive directors whom they perceive to be less qualified than they are. At the same time, NEDs who are in awe of a CEO can be overly deferential to management.

On executive compensation, my recommendations include: 1) when setting the level of pay, carefully scrutinize the firms that are included in the benchmark group, 2) evaluate performance of executives through a multi-year lens and stagger payouts over several years, 3) attach performance conditions to the vesting of share awards, and 4) require executives to have “skin in the game” even after they have departed the firm.

In the area of shareholder rights, I caution policymakers – before introducing an advisory vote on remuneration (or “say on pay”) – to consider whether shareholders will devote the necessary time and develop sufficient expertise to evaluate each pay proposal on its merits, whether diverse investor views on executive pay will serve as an impediment in holding boards accountable, and whether the broader legal framework provides a sufficiently enabling environment.

My article concludes with a discussion of how policymakers should approach corporate governance reforms generally, with a view to strengthen the effectiveness of the conventional set of corporate governance instruments. Specifically, I make six suggestions: 1) calibrate reforms to fit the surrounding context, particularly ownership structure and the broader business environment; 2) assess how an instrument will influence the behavior and focus of the affected parties; 3) be prepared to take difficult decisions because the inherent complexity of certain issues means that simple solutions, while tantalizing, are unlikely to work; 4) ensure coherence of tools employed with the legal, regulatory, and tax regimes; 5) employ “carrots” – such as fast track issuance of securities and corporate governance-based stock listing tiers – as well as “sticks,” and 6) focus on values and culture.

The latest draft of my article is available here.

Country- and Firm-Level Determinants of Law Compliance

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, July 15, 2009
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This post comes to us from Alberto Chong of the Inter-American Development Bank and Mark Gradstein of Ben-Gurion University.

In our paper, Is the World Flat? Country- and Firm-Level Determinants of Law Compliance, which was recently accepted for publication in The Journal of Law, Economics, and Organization, we revisit the effects of a country’s institutional framework on individual firms’ behavior, in particular focusing on their propensity to comply with legal rules. We focus on the compliance with legal rules, primarily for two reasons. The substantive one has to do with the apparent importance of institutions such as the rule of law and legal enforcement for economic performance. The practical reason is that our data contain proxies for law compliance by thousands of business firms from a wide range of countries that display large institutional variation.

While the data contain information on several aspects of law compliance, such as the scope of corruption, bribery, and the extent of informality—by which we mean the propensity of firms to hide output—the main analysis focuses on the latter. This analysis reveals that many of the available firm-level characteristics are indeed relevant for explaining the variation in informality. For example, firm size matters; smaller firms appear to be hiding a larger share of output, while exporting firms and those with foreign ownership appear to be hiding less. Yet, there is strong evidence that most of the variation is driven by differences across countries in their respective levels of institutional quality, thus rejecting the null hypothesis in favor of what is implied by our theoretical model. In particular, commonly used measures of institutional strength emerge as the most statistically significant variables.

We use the same methodology to explain the variation in other proxies for noncompliance with the rule of law, such as corruption and bribery. Generally, the results are similar to—and often even stronger than—those obtained for informality: while firm characteristics matter, most of the relevant variation is explained by country-wide measures for institutional strength, and less so by firm-specific characteristics.

Our conclusion is that countries still matter in providing institutional infrastructure, which determines to a large extent the context within which firms operate.

The full paper is available for download here.

Delaware’s Art of Judging

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, July 14, 2009
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This post comes to us from Katrina Dewey, CEO & Publisher, Lawdragon, Inc. 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.

Richard Posner should have been a U.S. Supreme Court justice.

I flash on him as I watch Vice Chancellor Leo Strine of the Delaware Court of Chancery stride back and forth before a rapt audience of hundreds of Harvard Law Students in October 2007.

Strine’s brilliance is staggering, his energy enormous; a boiling rage for the law of the now that is in your face and seething. He relishes skewering fat cats like Hannibal Lecter loves fava beans and a nice Chianti.

And there is Posner, just like it was yesterday. It was 1984, and I am a first-year law student at the University of Chicago. He is a 7th U.S. Circuit Court of Appeals Justice, law professor, author and the anchor of the legendary economic analysis that will come to define the law of an era.

It is civil procedure class and he is sucking the marrow out of the injustice of the federal docket being littered with so many lost limbs – and really, is a lost limb to a poor person actually worth $10,000, or whatever the legal minimum for federal court jurisdiction is at the time. I know I am seeing genius. I am also slightly nauseated, but can see this is a rare legal mind which shifts a generation of jurisprudence to evaluate cases based on economic incentives and motivations.

Over the years, the legend of Posner, now 70, as the best legal mind of his generation has only grown, while the test for the Supreme Court had veered, Scalia aside, toward the Stepfordian.

And here is Strine, 45. He is called the most brilliant jurist of his generation. He works doggedly and is as subtle as an ice pick, whether dealing with dozens of AIG apologists, IBP’s demand that Tyson Foods consummate its poultrigarchy or a dispute over property rights to a suburban Wilmington shopping mall. I’m not surprised that he ran for more than 4,730 days straight, stopping only in a bid for sanity. He is a product of small-town Delaware, soccer, Skadden Arps and politics, having served as chief counsel to Gov. Thomas Carper, now a U.S. Senator.

And then there’s Delaware Supreme Court Chief Justice Myron Steele, who owing to a certain mettle and the tides of the times, was not known on the national scene until recent years, but who is every bit the measure of his younger colleague.

Strine and Steele are in many ways a mirror image of one another that refracts the past of Delaware law and U.S. corporate governance as their divergence reflects its future.

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World Markets for Mergers and Acquisitions

Posted by Michael S. Weisbach, Fisher College of Business at The Ohio State University, on
Monday, July 13, 2009
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This post is by Michael S. Weisbach, of The Ohio State University.

In our recently completed working paper, World Markets for Mergers and Acquisitions, we investigate the extent to which valuation differences and other international factors motivate cross-border mergers and acquisitions. Valuation differences between acquirers and targets can be broken into three components: Differences in country-level stock market movements, differences in firm-specific stock price movements relative to country-level indices, or appreciation or depreciation of the currencies in which acquirers’ and targets’ securities are traded. Each of these components potentially reflects an alternative source of valuation difference that could motivate mergers.

We estimate the effect of these factors on merger propensities using a sample of 56,978 cross-border mergers occurring between 1990 and 2007. In our sample, 80% of completed cross-border deals between 1990 and 2007 targeted a non-US firm, while 75% did not involve a US firm as an acquirer. The majority of acquirers (90%) are from “developed” countries, while the other 10% being from “developing” countries. Furthermore, the vast majority of cross-border mergers involve private firms as either bidder or target: 96% of the deals involve a private target, 26% involve a private acquirer, and 97% have either private acquirers or targets.

Our results suggest that valuation differences between acquirers and targets significantly affect the likelihood of a cross-border merger. The cross-border acquirer is more likely to be from a country whose currency has appreciated relative to the target’s currency and whose country’s stock market has outperformed the target firm’s country’s market. In addition, if the companies are public, the acquirer’s firm-specific abnormal performance is likely to be better than the target’s. The estimated effects are fairly large: Our estimates imply that a 100% difference in country-level stock returns between two countries leads to a 17.4% increase in the expected number of acquisitions of the worse performing country’s firms by the better-performing country’s firms. Similarly, a 75% appreciation of one country’s currency relative to another’s leads to a 50.4% increase in the number of acquisitions of firms in countries with relatively depreciated currency.

There are two potential (though not mutually exclusive) explanations for the stock-return differences between acquirer and targets prior to the acquisitions. First, the returns can affect changes in the relative wealth of the two countries. Second, the returns can reflect differential divergence from fundamentals. Our evidence is more consistent with the wealth explanation than the misvaluation explanation.

The full paper is available for download here.

FDIC Proposal May Inhibit Private Equity Investments in Failed Banks

Posted by Edward D. Herlihy, Wachtell, Lipton, Rosen & Katz, on
Sunday, July 12, 2009
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This post is by Edward D. Herlihy, Craig M. Wasserman, Richard K. Kim and Lawrence S. Makow of Wachtell, Lipton, Rosen & Katz.

The FDIC recently issued a proposed policy statement laying down stringent new ground rules for private equity investments in failed banks. Currently, private equity firms face significant regulatory challenges in structuring investments in banks and thrifts. The Federal Reserve (in the case of bank acquisitions) and the OTS (in the case of thrift acquisitions) remain the principal regulators determining capital, governance and control considerations relating to permissible bank/thrift acquisition structures. However, the FDIC’s proposed policy statement would impose meaningful additional capital and related qualifying considerations in order for a private equity sponsored vehicle to acquire a failed bank being sold by the FDIC.

The proposed policy statement appears to be primarily focused on structures used to acquire failed banks involving multiple investors – typically private equity funds – where no investor would be deemed to control the bank going forward for regulatory purposes. By doing so, the investors minimize the amount of regulation to which they would be subject. Structures along these lines were used to acquire both Indymac and BankUnited. The proposed policy statement would impose a number of new restrictions on these types of structures and are summarized below:

• Capital Support. Investors would be expected to commit that an acquired depository institution be initially capitalized at a minimum 15% Tier 1 leverage ratio for at least three years – nearly four times the minimum ratio to be deemed adequately capitalized. Failure to meet this capital minimum would result in the institution being treated as “undercapitalized” for purposes of Prompt Corrective Action, triggering harsh regulatory measures, such as a requirement that the institution file a capital plan, restrict the payment of dividends and restrict asset growth.

• Source of Strength. Investment vehicles would be expected to serve as a source of strength for their subsidiary depository institutions and would be expected to sell equity or engage in capital qualifying borrowings as necessary.

• Cross Guarantee of Affiliated Institutions. Investors and investor groups whose investments constitute a majority of the investments in more than one depository institution would be expected to pledge to the FDIC their proportionate interests in each such institution to pay for any losses to the Deposit Insurance Fund resulting from the failure of, or FDIC assistance provided to, the other affiliated institutions.

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Identifying and Deflating Asset Bubbles

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Saturday, July 11, 2009
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Editor’s Note: This post is by Hugh C. Beck, a member of the Securities and Exchange Commission staff.

Despite its ostensible focus on stability, the Obama administration’s financial reform proposal offers no plan to prevent asset bubbles like the one in subprime loan securities that triggered the current crisis. Although expected, this outcome is disappointing because it appears to be based on an exaggerated fear that a policy against bubbles would fail.

The truth is a regulator directed by Congress to identify and deflate bubbles should succeed if the following conditions are met:

1. Systemically-significant financial institutions are required to continuously disclose their risk exposures to the regulator;

2. The regulator is given on-demand access to all repositories of non-public business and personal economic data; and

3. The regulator is not the Federal Reserve or a council of regulators in which the Fed has primary sway.

The first condition is straightforward. The regulator will not be able to assess the danger of potential bubbles to the financial system unless it has a clear understanding of systemically-significant firms’ exposures to them.

The second condition derives from the fact that financial asset prices are based primarily on participants’ evaluations of publicly available information because securities laws generally prohibit trading based on non-public information. SEC enforcement of such prohibitions is imperfect but credible.

A bubble inflates as public information about an asset class diverges from private information possessed by the public information’s sources. Accordingly, the key to deflating a bubble is to gather relevant private information, compare it to the corresponding public data, and then publish the comparison for all market participants to see.

Consider, for example, the twin bubbles in home prices and securities backed by subprime home loans. High volumes of subprime loans made at low rates benefitted originators (who collected fees without bearing default risk because their loans were packaged and sold) and to a lesser extent their subprime borrowers (who in essence got cheap rent on homes they could not afford to buy).

In response to these incentives, subprime originators and borrowers misrepresented borrower income and other information to make the loans and rates appear reasonable. For a time, rising home prices fed by subprime borrower demand masked the inability of borrowers’ actual incomes to support repayment of the loans. The absence of immediate consequences for fudging led to greater fudging, expanding over time the gap between public information on subprime loans and originators’ private information.

Could the government have gathered private information to identify and deflate these bubbles? Yes – in fact, it did. The IRS collected annual income data for virtually every subprime borrower. Comparing this data with public data on borrower incomes would have revealed much of the information gap responsible for the twin bubbles. This analysis was not done because no other regulator had access to the data and spotting asset bubbles was far outside the tax agency’s mission.

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Implications of the elimination of broker discretionary voting

Posted by Annette L. Nazareth, Davis Polk & Wardwell LLP, on
Friday, July 10, 2009
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This post is by Annette L. Nazareth’s colleagues John H. Butler, Ning Chiu, Nora M. Jordan, Louis L. Goldberg, Kyoko Takahashi Lin, Barbara Nims and Mutya Fonte Harsch.

The SEC recently voted (3-2) to eliminate broker discretionary voting in director elections for meetings held on or after January 1, 2010. Previously, brokers were permitted to vote uninstructed shares in uncontested director elections, which were classified as “routine” under NYSE Rule 452. The rule change, which was adopted as proposed, could make it more difficult for directors to be elected under a majority voting standard, as we discussed in our previous newsflash, SEC Proposes Elimination of Broker Discretionary Vote in Director Elections for 2010.

As a result of this change, the number of votes in favor of board-nominated directors will be reduced, since brokers have typically followed the recommendations of incumbent boards in casting their discretionary votes. Other notable implications include:

• The rule change will affect most U.S. public companies, because the restriction applies to the actions of NYSE-registered brokers, regardless of the exchange on which a company is listed.• In most cases, the new rule should have little effect on a company’s ability to achieve a quorum, since a broker would continue to be able to return a proxy with a vote on a “routine” item – such as the ratification of auditors.

• Brokers are and will remain unable to vote uninstructed shares in contested elections.

The rule change does not apply to registered investment companies. However, the new rule codifies two previously published interpretations relating to investment companies that do not permit broker discretionary votes (i) for material amendments to investment advisory contracts and (ii) on any proposal to obtain shareholder approval of an investment company’s investment advisory contract with a new investment adviser.

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