Monthly Archives: November 2010

Proposed Regulations Would Expand ERISA Fiduciary Exposure

Posted by James Morphy, Sullivan & Cromwell LLP, on
Tuesday, November 9, 2010
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James Morphy is a partner at Sullivan & Cromwell LLP specializing in mergers & acquisitions and corporate governance. This post is based on a Sullivan & Cromwell client memorandum.

On October 21, 2010, the Department of Labor (“DOL”) proposed regulations (the “Proposed Regulations”) that would, if adopted, significantly expand the circumstances in which a person will be treated as a fiduciary under the Employee Retirement Income Security Act of 1974 (“ERISA”) by reason of providing investment advice for a fee to an employee benefit plan. A fiduciary under ERISA is subject to strict prudence and conflict of interest standards and it is the DOL’s expressed intention in making the changes to enhance its “ability to redress service provider abuses that currently exist in the market, such as undisclosed fees, misrepresentations of compensation arrangements, and biased appraisals of the value of employer securities and other plan investments.” Because many financial institutions have regular interactions with employee benefit plans and their fiduciaries—as counterparties, service providers, agents, and so forth—the Proposed Regulations are widely relevant for the financial services industry.

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Corporate Governance Reforms and the Allocation of International Capital Flows

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, November 8, 2010
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The following post comes to us from Yao Lu of the Finance Department at Tsinghua University.

In the paper, Corporate Governance Reforms and Firm-Level Allocation of International Capital Flows, recently made publicly available on SSRN, I investigate how investor protection (IP) of acquirer and target countries affects international capital flow allocation at the firm level. A simple model provides an explanation for a well documented but little understood phenomenon on international capital flows—namely, foreign acquirers’ tendency to target better-performing firms in emerging markets. When the acquirer country has stronger IP than the target country, the foreign acquirer’s controlling shareholder values control premiums less than the controlling shareholder of the local target firm. Within a given legal environment, controlling shareholders of better-performing firms consume fewer private benefits because of the greater opportunity costs of foregoing profitable investment projects and, hence, they may demand lower control premiums. Lower control premiums, in turn, make these firms more attractive to foreign acquirers, who are subject to stronger-IP regulations and consume fewer private benefits. This tendency to select better-performing targets becomes weaker (stronger) as the IP gap between the acquirer and target countries decreases (increases), because smaller (larger) IP gaps cause less (greater) disagreement on the value of control premiums at the country level.

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Reviewing Asset-Backed Securities – Increasing Transparency

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, November 7, 2010
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Editor’s Note: Kathleen L. Casey is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Casey’s statement at a recent open meeting of the SEC, which is available here. The views expressed in the post are those of Commissioner Casey and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff. The post relates to a proposed SEC rule on issuer review of assets in offerings of asset-backed securities; the release is available here.

We are proposing rules today that are mandated by, or that are intended to implement, provisions in the Dodd-Frank Act relating to issuer and third-party review of the assets underlying asset-backed securities.

I believe that, properly crafted, these rules will provide decision-useful information to investors by enhancing transparency into the asset review process undertaken by issuers and by making available to investors the results of asset reviews conducted by issuers and third parties.

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Private Ordering in the Brave New World of Proxy Access

Posted by Charles M. Nathan, Latham & Watkins LLP, on
Saturday, November 6, 2010
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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 Corporate Governance Commentary.

The SEC has stayed the effectiveness of its proxy access rules during the pendency of litigation challenging their validity on administrative law procedural grounds.  The stay has effectively bought public companies a year to prepare fully for the advent of SEC-mandated proxy access.  The existing SEC proxy access rules do not purport to preempt state law governed bylaws establishing reasonable conditions to the right to make nominations and reasonable qualifications for directors to be seated on a board. We don’t think it likely that, even if required to rectify procedural errors by an adverse court decision, the SEC will vary this aspect of its rules.  Companies should take advantage of the one year “grace” period and review their bylaws carefully to determine if they should be amended in light of the likely advent of proxy access. In doing so, companies should be mindful that, no matter the outcome of the SEC’s proxy access rules, traditional proxy contests and corporate governance activist pressure to reshape board composition will increasingly diminish the ability of nominating committees to be the sole arbiters of nominees for director.

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CEO-Director Connections and Corporate Fraud

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, November 5, 2010
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The following post comes to us from N.K. Chidambaran of the Finance and Economics Department at Fordham University, Simi Kedia of the Finance and Economics Department at Rutgers University, and Nagpurnanand Prabhala of the Finance Department at the University of Maryland.

In the paper, CEO-Director Connections and Corporate Fraud, which was recently made publicly available on SSRN, we study the propensity of firms to commit financial fraud using a sample of SEC enforcement actions from 2000 to 2006. Controlling for year effects, Fama-French 48-industry effects, and several firm characteristics, we find a significant relation between fraud probability and CEO-board connectedness.

The nature of this relation depends on the institutional origin of the connection. While nonprofessional connectedness due to shared educational and non-business antecedents increases fraud probability, professional connections formed due to common prior employment decrease fraud. The positive effects of professional connectedness are pronounced only when individuals share prior service as executives. The impact of professional-connections persists after the 2002 Sarbanes-Oxley Act while nonprofessional connections lose significance after SOX.

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An SEC Insider’s Guide to Reform

Posted by Luis A. Aguilar, Commissioner, U.S. Securities and Exchange Commission, on
Thursday, November 4, 2010
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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 recent remarks at the University of California at Berkeley, 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.

Today I want to speak with you about financial regulatory reform. This is a pivotal time for the financial service industry and for its regulators. It was, after all, just over two years ago that Lehman Brothers collapsed and the American financial system went into tailspin followed by massive government bailouts. On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) into law. It will result in changes to the regulatory framework, operations and supervision of the financial services industry. A few of these changes include — the new Financial Stability Oversight Council, the new Consumer Financial Protection Bureau, and a new mechanism for seizing and liquidating large financial companies on the verge of failure, to a host of other changes.

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Managerial Attributes, Incentives, and Performance

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, November 3, 2010
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The following post comes to us from Jeffrey Coles, Professor of Finance at Arizona State University, and Zhichuan Frank Li of the Finance Department at Arizona State University.

In the paper, Managerial Attributes, Incentives, and Performance, which was recently made publicly available on SSRN, we examine the relative importance of firm- and manager-specific heterogeneities in determining the primary aspects of executive incentives and the implications of those incentives for firm policy, risk, and performance. We focus on the sensitivity of managerial wealth to stock price (delta) and the sensitivity of expected managerial wealth to stock volatility (vega) for top-five corporate executives.

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The Airgas Case and Our Work on Staggered Boards

Posted by Lucian Bebchuk, John Coates, Alma Cohen and Guhan Subramanian, Harvard Law School, on
Tuesday, November 2, 2010
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Lucian Bebchuk, John Coates, Alma Cohen, and Guhan Subramanian teach at Harvard Law School. Their academic work on staggered boards is available here, 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.

The Delaware Supreme Court is going to be hearing arguments soon in the case of Airgas vs. Air Products. In its briefs, as well as in oral argument before the Chancery Court, Airgas used our academic work on staggered board as evidence for its position. However, our academic articles, and the empirical evidence put forward in them, support the opposite position.

The case before the Delaware courts arose from Air Products’ unsolicited offer for Airgas. Facing opposition from Airgas to its offer, Air Products ran a competing slate for the August 2010 annual meeting and was able to replace one-third of the directors. (Airgas has a staggered board and thus only one-third of its directors came up for re-election at that annual meeting.) Air Products also succeeded in getting majority support for passing a bylaw moving up Airgas’ next annual meeting to January 2011, thus creating the possibility that another one-third of the directors could be replaced then.

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Top-Up Options – Looking Better and Better

Posted by George R. Bason, Jr., Davis Polk & Wardwell LLP, on
Tuesday, November 2, 2010
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George Bason is the global head of the mergers and acquisitions practice at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum by Mr. Bason, William M. Kelly, Phillip R. Mills, Justine Lee and Scott B. Luftglass.

As the percentage of tender offers in friendly transactions has risen in recent years, so too has use of so-called “top-up options.” Yet, despite their prevalence, the validity of top-up options has not been addressed squarely by the Delaware courts and continues to be challenged by the plaintiffs’ bar. However, two separate rulings from the Delaware Court of Chancery this week suggest that the use of top-up options is likely to present little litigation risk.

A top-up option gives the acquiror the right, upon successful completion of a tender offer at or above the minimum condition level (usually 50%), to purchase newly issued shares of the target so as to increase its ownership in the target to greater than 90%. Under Delaware law, once an acquiror crosses the 90% ownership threshold, it may complete the back-end squeeze out through a simple short-form merger. The purpose of the top-up option is to expedite the closing of the merger (and thus the receipt of the consideration by the target’s stockholders) once a majority (but less than 90%) of the target’s stockholders have endorsed the transaction by tendering their shares.

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CEO Compensation and Board Structure Revisited

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, November 1, 2010
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The following post comes to us from Katherine Guthrie of the Mason School of Business at the College of William and Mary, Jan Sokolowsky of the University of Michigan, and Kam-Ming Wan of the School of Economics and Finance at the University of Hong Kong.

In our forthcoming Journal of Finance paper entitled CEO Compensation and Board Structure Revisited, we reexamine the results of Chhaochharia and Grinstein (CG, Journal of Finance, 2009; available here on the Forum). In response to the corporate scandals in 2001/2002, the NYSE and Nasdaq imposed director independence requirements for listed companies. CG find that CEO pay decreases by about 17% in firms with noncompliant boards relative to firms with a majority of independent directors.

Using CG’s data and methodology, we find that their results are driven by two outliers. First, Steve Jobs’ total pay dropped from a high of $600 million in 2000 to a symbolic $1 per year in 2004 and 2005. Interestingly, the option grant turned out to be worthless due to a fall in Apple’s stock price, but the value of Jobs’ stock holdings increased by $465 million from 2003 to 2005. Second, Fossil’s Kosta Kartsotis himself initiated that his pay be cut from $255,000 to nearly zero in 2005. He and his brother Tom (Fossil’s founder and chairman of the board) owned about 30% of Fossil’s shares at that time. Clearly, neither outlier fits the story that independent boards are able to prevent CEOs from extracting rents in the form of excessive pay.

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