Monthly Archives: July 2010

The Future of the Board of Directors

Editor’s Note: Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a recent speech by Mr. Lipton to the New York Stock Exchange Chairman & CEO Peer Forum.

In an effort to think about the board of directors of the future, we need to start with what we expect the board to do today and the rules we have set governing how directors are selected, how they function and how they relate to shareholders – not only the legal rules but also the aspirational “best practices” that we have allowed to influence corporate and director behavior.  We also need to look at how corporate management and boards are perceived by the media, the public and elected officials in the post-financial crisis era.

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How Did Financial Reporting Contribute to the Financial Crisis?

This post comes to us from Mary Barth, Professor of Accounting at Stanford University, and Wayne Landsman, Professor of Accounting at the University of North Carolina at Chapel Hill.

In our paper, How Did Financial Reporting Contribute to the Financial Crisis? forthcoming in the European Accounting Review, we scrutinize the role that financial reporting for fair values, asset securitizations, derivatives, and loan loss provisioning played in contributing to the Financial Crisis. Because banks were at the center of the Financial Crisis, we focus our discussion and analysis on the effects of financial reporting by banks. We begin by discussing the objectives of financial reporting and bank regulation to help clarify that information standard setters require firms provide to the capital markets and information required by bank regulators for prudential supervision will not necessarily be the same. This distinction is important to understanding why financial reporting played a limited role in contributing to the Financial Crisis.

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Action by Written Consent: A New Focus for Shareholder Activism

This post comes to us from Ethan Klingsberg, a partner at Cleary Gottlieb Steen & Hamilton LLP focusing on mergers and acquisitions, leveraged buy-outs and corporate and SEC matters, and is based on a Cleary Gottlieb Steen & Hamilton client memorandum by Mr. Klingsberg, Laurent Alpert, Janet Fisher, Victor Lewkow and Lillian Raben.

Shareholder proposals advocating that corporations provide shareholders with the right to act by written consent in lieu of a meeting reappeared on ballots this proxy season after a hiatus of several years and have won average shareholder support of over 54%. While these proposals are nonbinding and the number of companies with such proposals on the ballot in 2010 is relatively small – a total of 16 companies, according to RiskMetrics – the level of shareholder support is striking and will likely encourage proponents to advance proposals at more companies next year.

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SEC Proposes Consolidated Audit Trail

Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum.

The Securities and Exchange Commission (the “SEC”) recently proposed to require the Financial Industry Regulatory Authority and the national securities exchanges (collectively, the “SROs”) to adopt a plan (the “Plan”) for the development, implementation and maintenance of a consolidated audit trail (“CAT”) for the listed equities and options markets.

The SEC’s proposal would set in motion a vast, multi-year project that would culminate in the creation of a comprehensive, real time data repository for all information concerning orders and executions. This repository would permit the SEC and the SROs the ability to query and analyze in real time all trading activity in covered securities. The CAT would ultimately revolutionize securities surveillance and enforcement by eliminating many of the delays and much of the imprecision resulting from the disparate, unlinked and in many cases manual processes that currently exist. However, the SEC’s proposal would place on the SROs a very significant cost and burden of developing and operating the industry utility that will be the core of the CAT, retooling current surveillance methodologies and enforcing compliance by member broker-dealers. Broker-dealers also would have to shoulder considerable costs of compliance.

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Reducing Insider Trading Risk at Hedge Fund Advisers

This post come to us from Andrew Vollmer, a partner in the Securities Litigation and Enforcement Group at Wilmer Cutler Pickering Hale and Dorr LLP. Mr. Vollmer was Deputy General Counsel of the Securities and Exchange Commission from 2006 until early 2009.

My recent article on “How hedge fund advisers can reduce insider trading risk,” in the Journal of Securities Law, Regulation & Compliance, Vol. 3, No. 2 (2010), discusses some of the approaches that hedge fund managers use to prevent insider trading violations. They include avoiding agreements to keep information confidential and giving heightened attention to business communications between hedge fund personnel and close family members or personal friends. The article also describes the many legitimate reasons that analysts at money managers have to communicate in private with senior management of public companies and ways hedge fund advisers can police the insider trading risks associated with those communications.

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Resetting the Trigger on the Poison Pill: Selectica’s Unanticipated Consequences

Randall Thomas is a Professor of Law and Business at Vanderbilt University. This post relates to a recent paper by Professor Thomas and Paul Edelman, Professor of Law and Mathematics at Vanderbilt, which is available here. The paper pertains to the recent decision of the Delaware Chancery Court in Selectica, Inc. v. Versata Enterprises, Inc.; other posts discussing the decision are available 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.

In a recent paper, Paul Edelman and I critically examine the Delaware Chancery Court’s recent decision in Selectica, Inc. v. Versata Enters., Inc., 2010 Del. Ch. LEXIS 39 (Del. Ch. March 1, 2010). In that case, applying the Unocal test to the use of the NOL pill against a potential acquirer, the Court rejected Versata’s claim that this new type of Rights Plan precluded a successful proxy contest for corporate control. The Court held that a Rights Plan must “render a successful proxy contest a near impossibility or else utterly moot, which was given the specific facts at hand,” a standard that it felt that Versata did not meet and therefore it upheld the NOL pill. While NOL pills can only be used in a limited set of circumstances, typically by companies suffering severe financial distress, the Chancery Court’s language in its opinion could easily support extending this result to all Rights Plans, leading the standard trigger level on all Rights Plans to drop to 4.99 percent.

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Versata Files Final Brief 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 and here. Versata’s final reply in the appeal is available 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. has filed its final reply in its appeal of the Delaware Chancery Court’s decision in Selectica, Inc. v. Versata, Inc. [1], ahead of oral argument in the appeal scheduled for next week.  The decision was discussed on the Forum in this post by David Katz and summarized here.  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%.

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Credit Default Swaps and the Empty Creditor Problem

Patrick Bolton is a Professor of Finance and Economics at Columbia University.

In the paper, Credit Default Swaps and the Empty Creditor Problem, which was recently made publicly available on SSRN, my co-author, Martin Oehmke of Columbia University, and I propose a limited commitment model of credit default swaps.

While many commentators have raised concerns about the ex-post inefficiency of the empty-creditor problem that arises when a debt-holder has obtained insurance against default but otherwise retains control rights, our analysis shows that credit default swaps add value by acting as a commitment device for borrowers to pay out cash. Hence, CDS have important ex-ante commitment benefits. Specifically, they increase investment and, by eliminating strategic default, can make existing projects more efficient. However, we also show that when creditors are free to choose their level of credit protection, they will generally over-insure, resulting in an empty creditor problem that is inefficient ex-post and ex-ante. This over-insurance occurs even when CDS markets perfectly anticipate the inefficient behavior of empty creditors, and leads to excessive incidence of bankruptcy and too little renegotiation with creditors relative to first best.

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Supreme Court Limits Federal “Honest Services” Fraud Statute

Edward Greene is a partner at Cleary Gottlieb Steen & Hamilton LLP focusing on corporate law matters. This post is based on a Cleary Gottlieb Alert Memo and relates to the U.S. Supreme Court decisions in Skilling v. United States and Black v. United States, which are available here and here.

Since the enactment of the “honest services” fraud statute, 18 U.S.C. § 1346, which defines the scope of the federal mail and wire fraud statutes to include the use of interstate means of communication to effect a “scheme or artifice to defraud … another of the intangible right of honest services,” federal prosecutors have used the provision in numerous cases to combat public and private corruption, and alleged corporate wrongdoing – even in situations where the defendant does not directly obtain money or property from the alleged victims of the fraud. Today, the U.S. Supreme Court issued two opinions that significantly restrict the scope of this statute. Skilling v. United States, 561 U.S, No. 08-1394 (June 24, 2010); Black v. United States, 561 U.S., No. 08-876 (June 24, 2010).

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