Monthly Archives: June 2010

Lessons for Boards from the Deepwater Horizon Tragedy

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisition and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton firm memorandum by Mr. Lipton and Benjamin M. Roth.

There is no doubt the oil industry, corporate America, the United States and foreign governments and people across the globe will learn many lessons from the tragic events in the Gulf of Mexico. For boards of directors across many industries, these events highlight the critical importance of effective board oversight of risk management.

Most companies face numerous layers of risk in their daily business activities. As we have previously written (see, e.g. “Risk Management and the Board of Directors,” available on the Forum here), the board’s role is not to manage a company’s day to day risk management processes and procedures, but rather to properly oversee the risk management functions of the company by setting the right “tone at the top”. The board should satisfy itself that the company’s risk management processes are designed and implemented consistent with corporate strategy and the associated level of risk tolerance and are functioning properly. The board should also satisfy itself that the company fosters a culture of risk-aware and risk-adjustment decision making.


A New Era for UK Financial Regulation

This post comes to us from Chris Bates, a partner in the London office of Clifford Chance, and is based on a Clifford Chance client briefing by Mr. Bates, Carlos Conceicao, Simon Gleeson, Michael Smyth and Max Savoie. The post relates to a recent speech by the UK’s Chancellor of the Exchequer, George Osborne, which is available here.

On 16 June 2010 the UK’s Chancellor of the Exchequer, George Osborne, unveiled sweeping reforms to the way financial institutions will be regulated in the UK in his first annual ‘Mansion House’ speech. The Chancellor plans to dismantle the Financial Services Authority (FSA), the current UK integrated regulator of firms and markets, and the UK’s tripartite system of regulation. Prudential supervision will be transferred to a new body under the Bank of England and a separate agency will be created to tackle serious economic crime. The other functions of the FSA will be organised in a new Consumer Protection and Markets Authority. The Chancellor promised to implement these and other changes to the UK’s regulatory architecture by the end of 2012. The Financial Secretary to the Treasury, Mark Hoban, has now also made an oral statement in Parliament giving further details of the government’s plans.


Versata and Selectica File Briefs in Appeal of NOL Pill Case

Editor’s Note: This post relates to the appeal from the decision in Selectica, Inc. v. Versata, Inc., which was discussed on the Forum here. The briefs in the appeal are available here and here. 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.

Versata, Inc. and Selectica, Inc. have filed briefs in Versata’s appeal of the Delaware Chancery Court’s decision in Selectica, Inc. v. Versata, Inc. [1].  That decision was discussed on the Forum in this post by David Katz.  In brief, Vice Chancellor Noble upheld the use by Selectica of a rights plan or “poison pill” that had a 4.99% threshold, which was designed to protect certain non-operating losses (NOLs) of Selectica.  Versata had deliberately triggered the rights plan by purchasing 6.7% of Selectica’s common stock.  After Versata refused to enter into a standstill agreement that would allow the Selectica board more time to consider their response, the board implemented the exchange feature of the rights plan, diluting Versata’s holding to 3.3%.


Hicksian Income in the Conceptual Framework

Shyam Sunder is the James L. Frank Professor of Accounting, Economics, and Finance at Yale University.

In the paper, Hicksian Income in the Conceptual Framework, which is forthcoming in Abacus, my co-authors (Michael Bromwich and Richard Macve both at the London School of Economics) and I provide an analytical and critical case study of the use of income theory in accounting policy making.

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are undertaking a joint project to converge and improve their respective conceptual frameworks for financial accounting and reporting. The overall approach was outlined in an important paper Revisiting the Concepts in May 2005 (FASB/IASB, 2005) which emphasized that ‘to be principles-based, standards cannot be a collection of conventions but rather must be rooted in fundamental concepts’. At the time of issue this was presented as an authoritative manifesto of how the two Boards intended jointly to undertake this convergence and improvement, based on and building on their existing frameworks, even though there had not been any prior exposure to allow public comment as to whether some more radical approach would be appropriate.


Don’t Gut Proxy Access

Editor’s Note: This post is based on an op-ed article by Lucian Bebchuk published today on the New York Times’ Dealbook, available here. Lucian Bebchuk is a professor of law, economics and finance at Harvard Law School, author of “The Case for Shareholder Access to the Ballot” and “The Myth of the Shareholder Franchise,” and co-author of “Private Ordering and the Proxy Access Debate.”

The Senate’s representatives on the conference committee finalizing financial regulatory overhaul have proposed weakening the proxy-access provisions included in both the House and Senate bills. The senators’ amendment would prevent shareholders owning less than 5 percent of a company’s shares from ever placing director candidates on a corporate ballot.

Hard-wiring such an ownership threshold in the financial regulatory bill would be a significant setback for shareholders and corporate governance reform.

While shareholder power to elect new directors is supposed to serve as a foundation for our system of corporate governance, American shareholders seeking to replace incumbent directors face considerable legal impediments. Lowering these impediments would make directors more focused on shareholder interests. The case for doing so is supported by empirical evidence indicating that arrangements increasing directors’ insulation from removal are associated with lower company value and worse performance.


Money Market Fund Reform in the United States

Editor’s Note: This post comes to us from Andrew J. Donohue, Director of the Division of Investment Management at the Securities and Exchange Commission, and is based on a recent keynote address by Mr. Donohue to the Annual Policy Seminar of the European Fund and Asset Management Association, the full text of which is available here. The views expressed in the post are those of Mr. Donohue and do not necessarily reflect those of the SEC, the Commissioners or the Staff.

Money market fund reform continues to be an area of great importance to money market investors and the capital markets on both sides of the Atlantic Ocean. In the United States alone money market funds today hold approximately $2.9 trillion of assets [1] and they comprise over 25 percent of all U.S. mutual fund assets. [2] U.S. and European based money market funds play a critical role in the U.S. and the world economy, and although they may have taken somewhat different paths in their economic and regulatory development in Europe, there are more similarities than differences. In the United States, for instance, money market funds arose as a cash alternative to bank deposits principally for retail investors during the 1970s when interest rates were high but regulatory requirements capped interest rates banks could pay on deposits. [3] In this way, money market funds fulfilled a retail niche by providing a relatively high market-driven rate of return to investors with an expected high degree of safety. Since then the industry and its investor base have changed. Now, about two-thirds of money market fund assets are in institutional money market funds (or classes), and U.S. money market funds now provide institutional as well as retail investors with an important cash management tool. [4] Money market funds have grown from a convenience provided by fund managers who primarily offer equity and bond funds to becoming the primary engine for a substantial portion of the short-term credit in the U.S. economy. This includes over 40 percent of outstanding commercial paper and approximately 65 percent of short-term municipal debt. [5] Another significant development among U.S. money market funds is their concentrated nature: over 70 percent of all money market fund assets reside in the top ten money market fund complexes; for institutional money market funds, including tax-free funds, over 75 percent of assets are held in the top ten complexes. [6] I understand that in Europe, on the other hand, money market funds started primarily as institutional investments and have only recently moved into the retail space. [7]


Further Discussion of the Senate Comprehensive Financial Reform Bill

This post comes to us from David S. Huntington, partner in the Capital Markets and Securities Group at Paul, Weiss, Rifkind, Wharton & Garrison LLP, and is based on a Paul Weiss client memorandum by Mr. Huntington, Mark S. Bergman, Robert M. Hirsh and Manuel S. Frey. The post provides further analysis of the Senate’s Restoring American Financial Stability Act of 2010, which was first described in this post, and outlined in this post, as well as these other posts.

On May 20, 2010, the United States Senate passed, by a margin of 59 to 39, the Restoring American Financial Stability Act of 2010 (the “Bill”), which is aimed at strengthening the U.S. financial system and preventing future crises. The Bill is comprehensive in scope, proposing significant changes to the structure of federal financial regulation and new substantive provisions that apply to a broad range of market participants, including public companies that are not financial institutions. Among other elements, the Bill includes proposals for executive compensation and corporate governance reform, hedge fund adviser registration, heightened regulation of over-the-counter derivatives and asset-backed securities and new rules for credit rating agencies. The Bill also proposes significant changes to the authority of the Federal Reserve Board and the Securities and Exchange Commission as well as enhanced oversight of large bank and non-bank financial institutions.

This memorandum summarizes the key provisions of the Bill, based on available sources. Prior to being signed into law, the Bill must be reconciled with a parallel bill passed by the House of Representatives last December. This process is expected to be completed in the coming weeks. The final bill is expected to more closely resemble the Senate Bill with some potentially significant changes.


Law and Financial Development

John Armour is the Lovells Professor of Law and Finance at the University of Oxford.

In the paper, Law and Financial Development: What We Are Learning from Time-Series Evidence, which was recently made publicly available on SSRN, my co-authors (Simon Deakin at the University of Cambridge; Viviana Mollica at Queen Mary University of London; and Mathias Siems at the University of East Anglia) and I explore the empirical evidence regarding the legal origins hypothesis. It is widely believed that legal institutions matter for financial development. According to the ‘legal origins’ hypothesis developed by La Porta et al. and their collaborators, legal systems vary considerably in the way they regulate economic activity. A principal cause of this diversity is the role played by the different legal traditions or ‘origins’ of the common and civil law (La Porta et al., 2008). It is argued that countries whose legal systems have a common law origin emphasize freedom of contract and the protection of private property, whereas those with civil law roots favor an activist role for the state. These legal differences seem to have tangible economic effects. Common law systems have been found to have more dispersed share ownership (La Porta et al., 1999), more liquid and extensive capital markets (La Porta et al., 1998), and more highly developed systems of private credit, than civilian ones. In part through the Doing Business reports of the World Bank, these findings have come to influence policy reform in ‘dozens of countries’ over the past decade (La Porta et al., 2008:326). Reforms to corporate and bankruptcy law have seen a strengthening of shareholder and creditor rights, particularly the former.


Other People’s Money: The Unrealized Conflicts of Securities Lending

Mark Lebovitch is a partner at Bernstein Litowitz Berger & Grossmann LLP specializing in corporate governance litigation. This post is based on an article in the most recent edition of BLB&G’s Advocate for Institutional Investors by Timothy DeLange and Ian Berg.

The primary goal of most institutional investors, such as public pension funds, is to prudently invest their assets and develop a portfolio that will accommodate long-term financial needs. Accordingly, these investors typically hold large blocks of individual securities in their portfolio, hoping that the value of those securities will appreciate over time. Over the past twenty years, institutional investors and other large stock holders have increasingly used these long-term holdings to reap short-term profits through “securities lending” programs.

Securities lending utilizes long-term stock holdings that would otherwise sit idle by temporarily lending them out on a cash-collateralized basis and investing the cash in safe, short-term investments for a modest return. Borrowers typically use the securities to cover short positions, to hedge positions or to take advantage of arbitrage opportunities. Although the concept of securities lending dates back more than a century, the practice became widespread in the 1970s when custodial banks initiated formal programs to broker loans involving their custodial clients.


The Relation Between Firm-Level Corporate Governance and Market Value: A Study of India

This post comes to us from N. Balasubramanian, Professor of Finance at the Indian Institute of Management, Bangalore; Bernard S. Black, Professor of Finance and Law at Northwestern University and Professor of Finance and Law at the University of Texas at Austin; and Vikramaditya Khanna, Professor of Law at the University of Michigan.

In our paper, The Relation between Firm-level Corporate Governance and Market Value: A Study of India, which was recently made publicly available on SSRN, we provide a detailed overview of the practices of publicly traded firms in India, and identify areas where governance practices are relatively strong or weak, relative to developed countries. We also examine whether there is a cross-sectional relationship between measures of governance and measures of firm performance.

We find that most firms meet the board independence rules under Indian law, which require either 50% outside directors or 1/3 outside directors and a separate CEO and board chairman, but 13% (38 firms) do not. The board chairman often represents the controlling business group or other controlling shareholder. Firms are more likely to comply with audit committee requirement, although 1% do not. Related party transactions are common (67% of firms have RPTs representing 1% of more of revenues), but approval requirements for them are often weak. For transactions with a controlling shareholder, only 7% (1%) of firms require approval by non-conflicted directors (minority shareholders). However, 78% of firms nominally require RPTs to be on “arms-length” terms, and 94% disclose them to shareholders. Only about 2/3rds of firms provide annual reports on their websites. For those which do not, there is no good alternate source. Executive compensation is modest by US standards, but CEOs face only a small risk of dismissal. Only about 75% of firms allow voting by mail, even though this has been legally required since 1956. Government enforcement actions against firms are almost nonexistent.


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