Monthly Archives: July 2010

Preventing Investor Harm Should be SEC Priority Number One

Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at a recent open meeting of the SEC, which are available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners or the Staff.

The entire securities industry and its participants … whether it is issuers, intermediaries, fund companies, or other market participants would not be able to function, much less profit, without the trust of investors and the public as a whole. Pay to play activity—where intermediaries direct contributions in order to obtain advisory pension plan business—undercuts this basic trust by harming investors and damaging the reputations of regulated institutions and the securities industry as a whole.

As an SEC Commissioner, you quickly learn that there will always be someone somewhere engaging in securities fraud because the temptation is always there. Likewise, the temptation to engage in pay to play activity is all too clear. As you have already heard today, public pension plans control trillions of assets and represent one-third of all U.S. pension assets. The advisory business generated from these plans is tantalizing in terms of both the fees and the reputational benefit.


Key Changes to the EU Prospectus Directive

Eduardo Gallardo is a partner focusing on mergers and acquisitions at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn Client Alert.

This Alert summarizes certain key changes to the EU Prospectus Directive (2003/71/EC) which were approved by the EU Parliament on June 17, 2010 (the “Amending Directive”). These changes are the result of several months of discussions among the European Commission, the European Parliament and the European Council and various market participants.

The Amending Directive will come into force 20 days from publication in the Official Journal, which is expected to occur in September or October of 2010. EU Member States are required to implement the Amending Directive into national law within 18 months following its entry into force (March or April 2012). Accordingly, issuers will have some time to consider the proposed changes for debt and equity offerings in the EU. However, issuers of wholesale debt securities with minimum denominations of EUR 50,000 (or equivalent) that are listed on an EU-regulated market should note that the Amending Directive increases the minimum denominations to EUR 100,000 both for purposes of the Prospectus Directive and the Transparency Directive (2004/109/EC). As a result, issuers wishing to continue to benefit from the exemption from periodic reporting for issuers of wholesale debt securities under the Transparency Directive will need to ensure that they issue in denominations of EUR 100,000 if issuing after the date of entry into force of the Amending Directive.


Delaware Provides Guidance Regarding Discounted Cash Flow Analysis

John Finley is co-head of the Mergers and Acquisitions Group at Simpson Thacher & Bartlett LLP. This post is based on a Simpson Thacher memorandum. 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.

Two recent opinions from the Delaware Court of Chancery, both authored by Vice Chancellor Leo E. Strine, Jr., provide important guidance for the preparation and use of a discounted cash flow (DCF) analysis in appraisal and other merger-related proceedings. [1]

In Global GT LP v. Golden Telecom, Inc., C.A. No. 3698-VCS (Del. Ch. April 23, 2010), shareholders successfully challenged the pre-merger value of a Russian telecommunications company, Golden Telecom, Inc., in an appraisal proceeding. The valuation experts for both the shareholders and the company each primarily relied on the DCF method of valuation but arrived at meaningfully different results: $139 per share (shareholder valuation expert) versus $88 per share (company valuation expert). Vice Chancellor Strine ultimately arrived at an appraised value of approximately $125 per share (Golden was originally purchased at $105 per share) after making determinations with respect to the key differences between the experts’ competing DCF valuations. In particular, the Vice Chancellor made determinations with respect to the following key elements of the DCF:


Increased Disclosure Requirements and Corporate Governance Decisions

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This post comes to us from Xue Wang of the Accounting Department at Emory University.

In the paper, Increased Disclosure Requirements and Corporate Governance Decisions: Evidence from Chief Financial Officers in the Pre- and Post-Sarbanes Oxley Periods, which is forthcoming the Journal of Accounting Research, I examine how the new internal control disclosure requirements mandated by SOX affect annual corporate governance decisions regarding CFOs. The “disclosure of type” hypothesis argues that increased disclosures on internal controls mitigate information asymmetry between the board and the CFO by credibly disclosing the quality of firms’ internal controls, thus distinguishing good CFOs from bad ones. As a result, it predicts lower pay and higher turnover for low-quality CFOs.


Summary and Implementation Schedule of the Dodd-Frank Act

Margaret E. Tahyar is a partner and member of the New York Financial Institutions Group at Davis Polk & Wardwell LLP. This post relates to a Davis Polk Client Memorandum summarizing the Dodd-Frank Act, which is available here, and accompanying regulatory implementation slides, which are available here. Additional posts on the Dodd-Franks Act are available here.

The Dodd-Frank Wall Street Reform and Consumer Protection Act will soon be the law of the land, assuming Senate passage. With the President’s signature, the bill will mark the greatest legislative change to financial supervision since the 1930s.

This legislation will affect every financial institution that operates in this country, many that operate from outside this country and will also have a significant effect on commercial companies. As a result, both financial institutions and commercial companies must now begin to deal with the historic shift in U.S. banking, securities, derivatives, executive compensation, consumer protection and corporate governance that will grow out of the general framework established by the bill. While the full weight of the bill falls more heavily on large, complex financial institutions, smaller institutions will also face a more complicated and expensive regulatory framework. This memorandum, written by a broad cross-specialty team of derivatives, bank regulatory, broker-dealer, funds, corporate governance and executive compensation teams at Davis Polk, summarizes the major provisions of the bill in bullet point form. For those who would like to dip into only the sections relevant to them, the table of contents contains hyperlinks. The accompanying Davis Polk Regulatory Implementation Slides are designed to show the effectiveness and implementation timeline of these provisions.


New Sentencing Guidelines for Corporate Defendants

Holly Gregory is a Corporate Partner specializing in corporate governance at Weil, Gotshal & Manges LLP. This post is based on a Weil Gotshal briefing by Thomas C. Frongillo, Lisa R. Eskow, and Caroline K. Simons.

On April 7, 2010, the United States Sentencing Commission approved significant changes to Chapter 8 of the Federal Sentencing Guidelines, which applies to organizations convicted of criminal offenses. In particular, these amendments affect the requirements for establishing an “effective compliance program” — a means of mitigating institutional punishment in the wake of criminal conduct. Barring rejection or changes from Congress, the amendments take effect automatically on November 1, 2010.

One important change expands an organization’s eligibility for a reduced sentence if it has an effective compliance and ethics program in place at the time an offense occurs. Additional amendments clarify what constitutes an appropriate response to criminal conduct as part of an effective compliance program. And, notably, the Commission rejected controversial proposals regarding independent monitors and document retention policies that some had argued would prevent flexibility in tailoring context-appropriate compliance programs and responses. On balance, the amendments reflect a give-and-take approach designed to encourage better internal and external reporting of suspected criminal conduct as a means of detecting and deterring crime, especially at the executive level.


An Open Proposal for Client Directed Voting

James McRitchie is the publisher of

According to the SEC, “client directed voting” will be included in a forthcoming concept release on “proxy plumbing” issues and SEC Chairman Mary L. Schapiro now indicates review by the Commission is forthcoming (see this post on the Forum). It is critical that shareowners become familiar with this term. The SEC can shape their concept release to facilitate entrenchment, by essentially reestablishing a limited form of broker voting, or their framework can further the interests of shareowners and the larger society through an open and competitive system.


Historically, most retail shareowners toss their proxies. During the first year under the “notice and access” method for Internet delivery of proxy materials, less than 6% voted. This contrasts with almost all institutional investors voting, since they have a fiduciary duty to do so. “Client directed voting” (CDV), a term coined by Stephen Norman, is seen by many as a solution for getting more retail shareowners to vote, ensuring companies get a quorum, and helping management recapture a good portion of the broker-votes cast in their favor that evaporated with recent reforms. An open form of CDV, could result in similar impacts but would also create much more thoughtful and robust corporate elections.


Collateral, Risk Management, and the Distribution of Debt Capacity

This post comes to us from Adriano Rampini of the Finance Department at Duke University, and S. Viswanathan, Professor of Finance at Duke University.

In our paper, Collateral, Risk Management, and the Distribution of Debt Capacity, which is forthcoming in the Journal of Finance, we provide a dynamic model of collateralized financing in which collateral constraints are endogenously derived based on limited enforcement. In the model, firms have access to complete markets, subject to collateral constraints, and thus are able to engage in risk management. We show that there is an important connection between firm financing and risk management since both involve promises to pay by the firm, which are limited by collateral.

Our model predicts that firms with low net worth exhaust their debt capacity and hedge less, since financing needs override hedging concerns, consistent with the empirical evidence. In contrast, this evidence is considered a puzzle from the vantage point of the standard theory of risk management, which takes investment as given. Rampini and Viswanathan (2009) study an infinite horizon model and show that the same trade-off between financing and risk management obtains generally.


Practical Implications of CNX Gas on Controlling Shareholder Acquisitions

Charles Nathan is Of Counsel at Latham & Watkins LLP and is co-chair of the firm’s Corporate Governance Task Force. This post is based on a Latham Watkins M&A Commentary by Mr. Nathan, Barry Bryer, Bradley C. Faris, Derrick Farrell and Mark D. Gerstein. 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 recent decision by Delaware Vice Chancellor Laster, In re CNX Gas Corporation Shareholders Litigation, [1] develops the “unified standard” for reviewing controlling shareholder freeze-out transactions. The unified standard provides that business judgment rule review is available for freeze-outs that are both: (1) negotiated and recommended by a special committee, and (2) “approved” by a majority of the minority shareholders. Delaware courts historically have applied different standards of review depending on whether the controlling shareholder freeze-out is structured as a negotiated merger or a unilateral tender offer. Negotiated mergers have been reviewed under an entire fairness doctrine. In contrast, unilateral tender offers have been able to obtain the benefits of the business judgment rule, albeit under an evolving set of procedures. If adopted by the Delaware Chancery Court for negotiated merger transactions and ultimately sanctioned by the Delaware Supreme Court, the unified standard would eliminate the dichotomy between controlling shareholder freeze-out deal structures and, if properly construed and applied, provide additional flexibility for transaction parties to obtain the benefits of business judgment rule review. CNX Gas marks another interesting and potentially important decision by Vice Chancellor Laster, currently in his first year on the bench, and suggests he is likely to continue to seek to shape Delaware corporate law in the future.


Restriction on Removing PCAOB Members Violates Separation of Powers

John Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. This post is based on a Gibson Dunn alert by Mr. Olson, Douglas R. Cox, Lewis H. Ferguson, Michael J. Scanlon and Jennifer J. Schulp, and relates to the decision of the U.S. Supreme Court in Free Enterprise Fund v. Public Company Accounting Oversight Board, which is available here.

Today, the United States Supreme Court issued its opinion in Free Enterprise Fund v. Public Company Accounting Oversight Board, No. 08-861. The Public Company Accounting Oversight Board (“Board”) was created by the Sarbanes-Oxley Act of 2002 to regulate accounting firms that conduct audits of public companies. The five members of the Board are appointed by the Securities and Exchange Commission (“SEC”), and are removable by the SEC only “for good cause shown” and “in accordance with” certain procedures. This “dual for-cause” removal regime–wherein a Board member is only removable for good cause shown by the SEC, whose Commissioners the President may not remove at-will–was described by the Court as “novel” and “highly unusual.”


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