Yearly Archives: 2011

The Re-Introduction of the Shareholder Protection Act

Editor’s Note: Lucian A. Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School. Robert J. Jackson, Jr. is Associate Professor of Law at Columbia Law School. Their paper, “Corporate Political Speech: Who Decides?”, is available here, and a previous Forum post discussing the paper is available here.

Several prominent members of the U.S. Senate and House of Representatives re-introduced yesterday the Shareholder Protection Act for debate. The bill would establish special corporate-governance rules for deciding when corporate resources may be spent on politics. Although it appears that the bill is unlikely to be adopted during this Congress, the approach it represents deserves consideration and support. In an article published last year in the Harvard Law Review, “Corporate Political Speech: Who Decides?,” we presented the case for such an approach. As we argued in “Corporate Political Speech,” political speech decisions are different from ordinary business decisions—and, thus, special rules are needed for deciding when a corporation may spend shareholder resources on politics.

The Shareholder Protection Act would establish a legal structure with three types of rules that apply when public companies wish to use corporate resources for political activity. These rules would require extensive disclosure, a role for independent directors, and shareholder approval.

First, the Shareholder Protection Act would require companies to disclose to shareholders each year both the amounts and recipients of the company’s spending on politics. Existing election law does not require disclosure of significant amounts of corporate spending on politics—especially contributions to intermediaries. Indeed, our article provided evidence indicating that five intermediaries who receive corporate contributions spent more than $130 million on lobbying and politics during the 2008 election cycle alone. Although the Act would mandate these disclosures by statute, the SEC currently has the authority to require disclosures of this type, and we urge the SEC to develop rules that would require that shareholders be given information on corporate political spending.

Second, the Act would require oversight of political spending by the board of directors. In our view, like other areas in which corporate law requires directors to take an active role in certain decisions—for instance, executive pay and financial audits—directors should be required to oversee corporate spending on politics. Because the interests of executives and shareholders may often diverge with respect to such spending, director oversight is especially desirable in this area. We also favor requiring directors to provide shareholders, in each year’s proxy statement, with a report explaining their choices and policies concerning the company’s spending on politics.

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What Should Be Done About the Private Money Market?

Morgan Ricks is a visiting assistant professor at Harvard Law School. This post is part of a series discussing articles appearing in the inaugural issue of the Harvard Business Law Review, which is published in partnership with the Harvard Law School Program on Corporate Governance.

What should be done about the private money market? It is widely recognized that this market was at the center of the recent financial crisis. Indeed, very nearly the entire emergency response to the financial crisis was aimed at stabilizing this market. Yet recent and proposed reform measures have done little to address this market squarely.

It is important to be precise about terminology. The term “private money market” refers to the multi-trillion dollar market for short-term IOUs that are neither issued by nor guaranteed by the federal government. This market includes repurchase agreements (“repo”), asset-backed commercial paper (“ABCP”), uninsured deposit obligations, and so-called Eurodollar obligations of foreign banks. It also includes the “shares” of money market mutual funds. (Contrary to widespread belief, commercial paper issued by non-financial firms is only a tiny fraction of the private money market—on the order of 2%. That is to say, the private money market is dominated by financial issuers, not commercial or industrial ones.)

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Supreme Court Limits the Power of Bankruptcy Courts to Hear Certain State Law Claims

Donald Bernstein and Marshall Huebner co-head the Insolvency and Restructuring Practice at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum which discusses the Supreme Court decision in Stern v. Marshall, which is available here.

Recently, the United States Supreme Court affirmed a 2010 ruling of the Ninth Circuit Court of Appeals and held that a bankruptcy court, as a non-Article III court, did not have the constitutional authority to decide a state law claim brought by a debtor against a creditor, even though the matter was part of the “core” statutory jurisdiction of the bankruptcy court. This significant decision limits the power of bankruptcy courts and may have wide-ranging implications, requiring certain types of claims to be decided in a non-bankruptcy forum, even where they are central to a debtor’s bankruptcy case.

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How the SEC Should Consider Possible Changes in Section 13(d) Rules

Lucian A. Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School, and Robert J. Jackson, Jr. is Associate Professor of Law at Columbia Law School. This post is based on the authors’ submission to the SEC available here. An earlier post describing the Wachtell, Lipton rulemaking petition to which this post refers is available here.

In a letter submitted yesterday to the Securities and Exchange Commission, we provide a detailed analysis of the policy issues relevant for the Commission’s ongoing examination of changes to its rules under Section 13(d) of the Securities Exchange Act of 1934. These rules, which govern share accumulation and disclosure by blockholders, are the subject of a recent rulemaking petition submitted by Wachtell, Lipton, Rosen and Katz, which proposes that the rules be tightened.

We argue that the Commission should not view the proposed tightening as merely “technical” changes needed to modernize its Section 13(d) rules. In our view, the proposed changes should be examined in the larger context of the beneficial role that outside blockholders play in American corporate governance and the broad set of rules that apply to such blockholders.

Our analysis proceeds in five steps. First, we describe the significant empirical evidence indicating that the accumulation and holding of outside blocks in public companies benefits shareholders by making incumbent directors and managers more accountable and thereby reducing agency costs and managerial slack.

Second, we explain that tightening the rules applicable to outside blockholders can be expected to reduce the returns to blockholders and thereby reduce the incidence and size of outside blocks—and, thus, blockholders’ investments in monitoring and engagement, which in turn may result in increased agency costs and managerial slack.

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The Change in Information Uncertainty and Acquirer Wealth Losses

The following post comes to us from Merle Erickson, Professor of Accounting at the University of Chicago; Shiing-Wu Wang of the Accounting Department at the University of Southern California; and X. Frank Zhang of Yale School of Management.

In this paper, The Change in Information Uncertainty and Acquirer Wealth Losses, forthcoming in the Review of Accounting Studies, we examine the possibility that the change in the acquiring firm’s information uncertainty is a factor contributing to acquiring firms’ long-term post-acquisition stock underperformance. By information uncertainty, we mean investors’ perceived uncertainty about a firm’s fundamentals, which captures the second moment of fundamentals. Prior literature focuses on the first moment of acquirer fundamentals. Uncertainty affects the discount rate (the cost of capital), which in turn influences stock price. Our discount rate theory offers an alternative explanation to the market’s mispricing of the acquirers’ fundamentals as a source of acquirers’ long-term underperformance. As suggested by standard finance theory, stock price responds to changes in either fundamentals or the discount rate. The prolonged integration process of M&As and complicated financial reporting issues are not fully anticipated ex ante and are likely to increase the uncertainty of the combined entity. An increase in acquirer’s uncertainty causes investors to demand a higher premium (higher cost of capital) to compensate for the rise in uncertainty/risk, which in turn results in acquirer stock price declines.

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What Corporate Managers Should Know About the SEC Whistleblower Rules

The following post comes to us from William Gleeson, a corporate and securities partner at K&L Gates LLP.

The SEC whistleblower rules, adopted by the SEC under Section 21F of the Securities Exchange Act pursuant to a mandate in the Dodd-Frank Wall Street Reform and Consumer Protection Act, provide for the payment of bounties or awards to whistleblowers. Under the SEC whistleblower rules, a bounty or award will be payable to eligible whistleblowers who provide “original information” concerning a violation of federal securities laws that leads to a successful enforcement action in a covered judicial or administrative action, or a “related action,” by the SEC or other specified agencies, resulting in monetary sanctions (fines or penalties, disgorgement, and/or interest on the disgorged amounts) of at least $1 million. Bounty awards are mandatory if the foregoing criteria are met. Eligible whistleblowers can receive between 10 – 30% of the monetary sanctions actually recovered.

For the most part, the SEC whistleblower rules deal with definitions and the operation of the rules, such as who is eligible be a whistleblower, what information qualifies as “original information,” what is meant by “leads to a successful enforcement action,” and procedures for applying for, and the awarding of, whistleblower bounties, as well as how to appeal such awards. These are matters that companies that may be the subject of whistleblower complaints largely have no control over and no role in.

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An Inflection Point: The SEC and the Current Financial Reform Landscape

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 the Social Investment Forum 2011 Conference; the complete remarks 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.

I would like to discuss some of the SEC’s new responsibilities under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act), and some of the challenges I see going forward.

Commission Action Required By The Dodd-Frank Act

First, I would like to discuss how the SEC has been impacted by the Dodd-Frank Act. The legislation closed various gaps in regulation and significantly expanded the Commission’s jurisdiction and workload. In the near term, the Dodd-Frank Act requires the SEC to promulgate over 100 new regulations, create five new offices, and undertake about 20 studies. To say this is a significant undertaking is a massive understatement. The SEC is currently right in the middle of this process.

The Dodd-Frank Act will also have a long-term and permanent impact on the SEC. For example, the Dodd-Frank Act charges the Commission with on-going oversight responsibilities on the previously unregulated over-the-counter derivatives market. The Commission’s new responsibilities include direct regulation of participants such as security-based swaps dealers, venues such as swap execution facilities, warehouses such as swap data repositories, and clearing agencies set up as central counterparties. In addition to regulating the derivatives market, the Commission has also been given the responsibility for the oversight of hedge fund advisers, and new responsibilities for the registration of municipal advisers.

These new responsibilities are necessary; but by the same token, although the Dodd-Frank Act significantly increased the Commission’s workload, it did not fundamentally address the resources that will be available to the SEC to meet the challenges of the increased workload.

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Do VCs Use Inside Rounds to Dilute Founders?

The following post comes to us from Brian Broughman of the Maurer School of Law at Indiana University, Bloomington, and Jesse Fried, Professor of Law at Harvard Law School.

In our paper, Do VCs Use Inside Rounds to Dilute Founders? Some Evidence from Silicon Valley, recently made publicly available on SSRN, Brian Broughman and I examine the role of inside financing rounds in VC-backed firms.

VCs typically invest through several rounds of financing. Each round is separately negotiated and priced. A subsequent (“follow-on”) round of financing could be provided by either (a) the firm’s existing VC investors exclusively (an inside round) or (b) a group led by a VC fund that did not invest in the startup’s earlier rounds (an outside round). Historically, most follow-on financings were structured as outside rounds, in part to mitigate conflict between the entrepreneur and existing VCs over the value of the firm. In recent years, however, more than half of follow-on rounds have been structured as inside rounds.

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If the Delaware Court of Chancery Got Airgas Right, Professor Bebchuk’s Op-Ed Got it Wrong

Stanley Keller is partner of Edwards Angell Palmer Dodge LLP. This post discussing the Airgas case references an op-ed by Professor Lucian Bebchuk, available here. A paper from the Program on Corporate Governance discussing the case is available here, and more posts about the case can be found here. This post is part of the Delaware law series, which is co-sponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

I wrote my comment “Delaware Court of Chancery Gets Airgas Right” (posted on the HLS Forum on March 1, 2011) before reading Professor Lucian Bebchuk’s op-ed “An Antidote for the Corporate Poison Pill” that was published in The Wall Street Journal on February 24, 2011. As such, my comment did not address Professor Bebchuk’s op-ed directly, but rather served as a counterpoint, providing another point of view. In this comment, I offer a more direct response to Professor Bebchuk’s op-ed.

The fundamental difference between Professor Bebchuk and me stems from Professor Bebchuk’s applying Athenian democracy principles to corporate governance (or, if you will, the French Revolution approach) while I favor a more Platonic representative structure (the American Revolution approach). My approach recognizes the central role of directors in corporate change-of-control transactions, regardless of their form, balanced by imposition of fiduciary duty obligations that are subject to court review. No such balance exists if unfettered power is given to shareholders, who have no such fiduciary duties as a check, whose access to information, no matter how robust the disclosure, is likely to be more limited than the board’s, and whose actions often can be controlled by a subset of shareholders with a short-term perspective.

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July 2011 Dodd-Frank Rulemaking Progress Report

Margaret E. Tahyar is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP. This post discusses a Davis Polk report which is available here. A post about the previous progress report is available here. Other posts about the Dodd-Frank Act are available here.

This posting, the Davis Polk Dodd-Frank Rulemaking Progress Report, is the fourth in a series of Davis Polk presentations that illustrate graphically the progress of the rulemaking work that has been done and is yet to occur under the Dodd-Frank Act. The Progress Report has been prepared using data from the Davis Polk Regulatory Tracker™, an online subscription service offered by Davis Polk to help market participants understand the Dodd-Frank Act and follow regulatory developments on a real-time basis.

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