Yearly Archives: 2010

Collateral, Risk Management, and the Distribution of Debt Capacity

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, July 14, 2010
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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.

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Practical Implications of CNX Gas on Controlling Shareholder Acquisitions

Posted by Charles M. Nathan, Latham & Watkins LLP, on
Tuesday, July 13, 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 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.

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Restriction on Removing PCAOB Members Violates Separation of Powers

Posted by John F. Olson, Gibson, Dunn & Crutcher LLP and Georgetown Law Center, on
Monday, July 12, 2010
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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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Does the Stock Market Harm Investment Incentives?

Posted by Alexander Ljungqvist, New York University, on
Monday, July 12, 2010
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Alexander Ljungqvist is Professor of Finance at New York University.

In the paper, Does the Stock Market Harm Investment Incentives? which was recently made publicly available on SSRN, my co-authors, John Asker and Joan Farre-Mensa, and I examine whether the stock market harms investment incentives. The theory literature in economics and finance has long argued that the separation of ownership and control following a stock market listing can lead to agency problems between managers and dispersed stock market investors and hence to suboptimal investment decisions. The literature is divided on whether overinvestment (i.e., empire building) or underinvestment (due to rational short-termism) will result, or indeed whether effective corporate governance mechanisms can be devised to ensure investment does not suffer (Tirole (2001), Shleifer and Vishny (1997)).

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Investor Protection Provisions of the Dodd-Frank Act

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, July 11, 2010
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This post comes to us from Stephen J. Crimmins, a partner in the Washington, D.C. and New York offices of K&L Gates LLP, and is based on a memorandum by Mr. Crimmins, Kay A. Gordon and Matt T. Morley.  The effect of the Dodd-Frank Act on securities litigation and enforcement was discussed in this post.  Additional posts relating to the Dodd-Frank Act are available here.

The investor protection provisions of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, 111th Cong. (2010) promise to make major changes in the world of securities enforcement and regulation.  Thanks to Dodd-Frank, we will shortly see whistleblowers enticed by potentially lucrative bounties for reporting violations to a much larger and more powerful SEC.  In addition to seeing its budget likely double over the next five years, the SEC will benefit from relaxed proof standards in pursuing secondary actors, expanded jurisdiction over foreign cases, the ability to obtain penalty awards in SEC administrative cases, industry-wide bars for securities professionals, and the ability to subpoena trial witnesses nationally.  The SEC will also have the power to impose fiduciary standards on brokers, regulate short selling, restrict customer arbitration agreements, and engage in other extensive rulemaking.

With further changes in this area unlikely as the bill moves towards final enactment over the next few days, this alert reviews key provisions that will soon begin to impact investors, public companies, securities professionals and their counsel.

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Focusing the SEC’s Regulatory Agenda on Investors

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Saturday, July 10, 2010
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Editor’s Note: Mary Schapiro is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Schapiro’s recent remarks at the Stanford University Law School Directors College, which are available here. The views expressed in the post are those of Chairman Schapiro and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners or the Staff.

Having served on boards, I know how challenging the role of director is. But I also know what an important job it is – perhaps more so today than ever. We have learned again and again over the last several years that active, informed and independent boards are often the difference between companies that successfully emerge from economic downturns, and those that are unable to do so.

Of course, I gave up my two corporate board seats when I accepted my current job, but I can sincerely say that board service is one of the things I miss most.

Fortunately, since I arrived at the SEC 17 months ago, there hasn’t been much time to look back.

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The Financial Reform Act and Executive Pay

Posted by Joseph E. Bachelder III, Law Offices of Joseph E. Bachelder, on
Friday, July 9, 2010
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Joseph Bachelder is founder and senior partner of the Bachelder Law Firm. This post is based on an article by Mr. Bachelder that first appeared in the New York Law Journal. Additional posts relating to the Dodd-Frank Act are available here.

The House and Senate conferees on H.R. 4173, the Restoring American Financial Stability Act of 2010 (RAFSA), have been reviewing and reconciling differences between the House and Senate versions of RAFSA since early June. [1] The conference is based on the Senate version passed May 20. RAFSA covers, among other things, a broad range of issues relating to the financial industry as well as issues relating to publicly traded companies not limited to the financial industry. Within this broad range are, among others, issues concerning so-called systemic risk for our financial system, regulatory supervision, derivatives, hedging, consumer protections, credit rating agencies, corporate governance and executive compensation.

The following discussion is limited to the executive compensation provisions in RAFSA Title IX, Subtitle E. Since passage is expected to be based largely on the Senate version, the following discussion is based on that version (references at the beginning of each part are to the Senate version).

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The Impact of Financial Reform on Securities Litigation and Enforcement

Posted by Wayne M. Carlin, Wachtell, Lipton, Rosen & Katz, on
Friday, July 9, 2010
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Wayne Carlin is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Carlin, Peter C. Hein, Eric M. Roth and Olivia A. Maginley. Additional posts relating to the Dodd-Frank Act are available here.

In addition to many significant regulatory provisions, the conference report text of the proposed Dodd-Frank Wall Street Reform and Consumer Protection Act contains a number of provisions in Title IX (Investor Protections and Improvements to the Regulation of Securities) which, if enacted, would have a significant impact on securities litigation and enforcement. Other proposed provisions were considered and discarded during the conference committee process. The highlights of the conference report text as it now stands include:

Private Cause of Action for Aiding and Abetting Violations Rejected. Efforts by some lawmakers to overturn well-settled Supreme Court authority by creating a private cause of action for aiding and abetting violations of the Securities Exchange Act of 1934 proved unsuccessful. The conference report text, at Sections 929M-929O, instead augments the SEC’s existing authority to pursue civil enforcement actions alleging aiding and abetting of violations of the Exchange Act by lowering the requisite state of mind to encompass “reckless,” in addition to “knowing,” acts, and by empowering the SEC to pursue actions premised on “knowingly or recklessly” aiding or abetting violations of the Securities Act of 1933, the Investment Company Act of 1940 and the Investment Advisers Act of 1940. Section 929Z of the conference report text requires the Comptroller General to conduct a “study” analyzing the impact of authorizing a private right of action for aiding and abetting violations of the federal securities laws.

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Corporate Governance and Executive Compensation Provisions of the Dodd-Frank Act

Posted by David S. Huntington, Paul, Weiss, Rifkind, Wharton & Garrison LLP, on
Thursday, July 8, 2010

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David Huntington is a partner in the Capital Markets and Securities Group at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss client memo by Mr. Huntington, Mark S. Bergman, Lawrence I. Witdorchic and Frances Mi. Other memoranda on the corporate governance and executive compensation provisions of the Dodd-Frank Act by Forum contributors are available here (from Wachtell, Lipton, Rosen & Katz) and here (from Sullivan & Cromwell LLP); a chart summarizing those provisions by Forum contributors from Kirkland & Ellis LLP is available here. Additional posts relating to the Dodd-Frank Act are available here.

On June 25, 2010, a House and Senate conference committee negotiating the blueprint for the reform of the U.S. financial system agreed on text of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). The Act as embodied in the conference report is currently scheduled to be approved by Congress this week before being sent to President Obama for signature.

The Act includes a number of significant corporate governance and executive compensation provisions that will apply to all U.S. public companies. We discuss these measures below and will be covering other aspects of this legislation in separate client memoranda. A copy of the entire Act is available here; however, for ease of use, we have excerpted the relevant corporate governance and executive compensation provisions here.

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Collins Amendment Sets Minimum Capital Requirements

Posted by Margaret E. Tahyar, Davis Polk & Wardwell LLP, on
Thursday, July 8, 2010
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Margaret E. Tahyar is a partner and member of the New York Financial Institutions Group at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum by Ms. Tahyar, Daniel N. Budofsky, Luigi L. De Ghenghi, John L. Douglas, Randall D. Guynn, Arthur S. Long, and Reena Agrawal Sahni. Additional posts on the Dodd-Franks Act are available here.

The Collins Amendment, originally drafted by the FDIC staff and reflecting views held by Chairwoman Bair, imposes, over time, the leverage and risk-based standards currently applicable to U.S. insured depository institutions on U.S. bank holding companies, including U.S. intermediate holding companies of foreign banking organizations, thrift holding companies and systemically important nonbank financial companies. One of the effects of the Collins Amendment is to eliminate trust preferred securities as an element of Tier 1 capital. Implementing regulations must be issued no later than 18 months from the bill’s effective date. As with all changes in capital requirements, there are highly negotiated transition periods and grandfathering exemptions, which we describe below. Please see a more complete implementation timeline at the end of this memorandum.

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