Yearly Archives: 2011

Say-on-Pay and the Business Judgment Rule

Posted by Edward F. Greene, Cleary Gottlieb Steen & Hamilton LLP, on
Saturday, November 26, 2011
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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 Memorandum; the full version of the memo, including omitted footnotes, is available here.

Over 40 companies received negative say-on-pay advisory votes in 2011, the first year for those votes under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”). Despite the advisory nature of the votes and the Act’s helpful language that they are not intended to affect director fiduciary duties, at least ten derivative lawsuits have been filed after failed votes. Two present an interesting contrast insofar as they address the “business judgment rule” and the requirement of pre-suit demand in the context of executive compensation. The first involves Cincinnati Bell and was brought in federal court in Ohio under Ohio law. It is the only such suit to survive a motion to dismiss to date. The other is a case involving Beazer Homes, which was dismissed by a Georgia state court applying Delaware law. We believe that the Cincinnati Bell case is inconsistent with the historical application of the business judgment rule and that Beazer Homes will ultimately prove the majority approach. Nonetheless, the cases bear consideration for what they suggest about the importance of process in making compensation decisions.

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Compliance and Ethics in Risk Management

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Friday, November 25, 2011
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Editor’s Note: The following post comes to us from Carlo V. di Florio, Director, Office of Compliance Inspections and Examination at the U.S. Securities and Exchange Commission. This post is based on a recent speech by Mr. di Florio at the NSCP National Meeting, available here. The views expressed in the post are those of Mr. di Florio and do not necessarily reflect those of the Securities and Exchange Commission.

Today I would like to address two related topics that are growing in importance: the heightened role of ethics in an effective regulatory compliance program, and the role of both ethics and compliance in enterprise risk management. The views that I express here today are of course my own and do not necessarily reflect the views of the Commission or of my colleagues on the staff of the Commission.

In the course of discussing these two topics, I would like to explore with you the following propositions:

  • 1. Ethics is fundamental to the securities laws, and I believe ethical culture objectives should be central to an effective regulatory compliance program.
  • 2. Leading standards have recognized the centrality of ethics and have explicitly integrated ethics into the elements of effective compliance and enterprise risk management.
  • 3. Organizations are making meaningful changes to embraced this trend and implement leading practices to make their regulatory compliance and risk management programs more effective.

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On the Regulation of Investment Advisory Services

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, November 25, 2011
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The following post comes to us from James Angel of the Department of Finance at Georgetown University.

In the paper, On the Regulation of Investment Advisory Services: Where Do We Go from Here?, which was recently made publicly available on SSRN, I examine the regulation of investment advisory services. A controversy has arisen over the regulation of investment advisers in the United States. Traditionally, larger registered investment advisers (RIAs) have been regulated by the SEC and smaller ones by the states. The Investment Advisers Act of 1940 severely restricts the ability of RIAs to engage in principal trades with their customers. Brokers, on the other hand, are regulated by a self-regulatory organization, FINRA, as well as by the SEC. Brokers may engage in principal trades with their customers as long as the advice is merely “incidental” to their other activities. In recent years, the boundaries between RIAs and brokers have become blurred as brokers offer more advisory services, and there is substantial confusion among consumers as to the differences between brokers and RIAs.

In a study mandated under §914 of Dodd-Frank, the SEC documented that it is examining RIAs at a rate of approximately once every eleven years, and recommended the study of additional means to increase the frequency of examinations including user fees to fund more examinations by the SEC, or requiring RIAs to become part of a self-regulatory organization (SRO). It should be noted that the SEC has assigned fewer employees to its Office of Compliance, Inspections, and Enforcement (OCIE) in 2010 than in 2004, despite an increase in overall FTE over this period. This SEC diversion of resources presumably reflects its belief that RIA examinations are less important than other SEC activities.

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2012 Proxy Season Developments: SEC Legal Bulletin and ISS Guidelines

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, November 23, 2011
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Editor’s Note: James Morphy is a partner at Sullivan & Cromwell LLP specializing in mergers & acquisitions and corporate governance. This post is based on a Sullivan & Cromwell publication.

As issuers and shareholders look ahead to the 2012 proxy season, they should be aware of recent publications by the SEC’s Division of Corporation Finance with regard to Rule 14a-8 process issues and Institutional Shareholder Services with regard to potential voting recommendations on shareholder proposals.

SEC Staff Legal Bulletin No. 14F, issued on October 18, 2011, provides important new guidance on a number of topics that have led to confusion in recent years among issuers and shareholders participating in the Rule 14a-8 shareholder proposal process, including proof of share ownership for beneficial owners, submission of revised proposals, and withdrawal of a proposal submitted by multiple proponents.

On the same day, ISS, the influential proxy advisory firm, released proposed updates to its proxy voting guidelines for 2012. The proposed updates address topics such as company responses to last year’s say-on-pay votes and say-on-pay frequency votes, evaluation of executive pay practices, and recommendations on proxy access proposals. The proposed changes to the policy on evaluating executive pay include a new methodology that uses quantitative one-, three- and five-year comparisons of pay and stock performance together with a qualitative review, as needed.

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The Reliability of Voluntary Disclosures: Evidence from Hedge Funds

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, November 23, 2011
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The following post comes to us from Andrew Patton of the Department of Economics at Duke University, and Tarun Ramadorai and Michael Streatfield, both of the Saïd Business School.

In the paper, The Reliability of Voluntary Disclosures: Evidence from Hedge Funds, which was recently made publicly available on SSRN, we examine the reliability of these voluntary disclosures by hedge funds, by tracking changes to statements of performance in the publicly available hedge fund databases recorded at different points in time between 2007 and 2011. In each vintage of these databases, hedge funds provide information on their performance from the time they began reporting to the database until the most recent period. We find evidence that in successive vintages of these databases, older performance records (pertaining to periods as far back as fifteen years) of hedge funds are routinely revised. This behavior is widespread: nearly 40% of the 18,382 hedge funds in our sample have revised their previous returns by at least 0.01% at least once, and over 20% of funds have revised a previous monthly return by at least 0.5%. While positive revisions are also commonplace, negative revisions are more likely and larger when they occur, i.e., on average, initially provided returns present a rosier picture of hedge fund performance than finally revised performance. Moreover, these revisions are not random. Indeed, we employ information on the characteristics and past performance of hedge funds to predict them. For example, funds in the Emerging Markets style are significantly more likely to have revised their histories of returns than Fixed Income funds, and larger funds, more volatile funds, and less liquid funds are all more likely to revise.

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Surveying Sponsor-Backed Going Private Transactions

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, November 22, 2011
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The following post comes to us from Douglas P. Warner, partner and co-head of the Hedge Fund practice at Weil, Gotshal & Manges LLP, and discusses a Weil survey, available here.

Weil, Gotshal & Manges LLP recently conducted our fifth annual survey of sponsor-backed going private transactions. Weil surveyed 60 sponsor-backed going private transactions announced from January 1, 2010 through December 31, 2010 with a transaction value (i.e., enterprise value) of at least $100 million (excluding target companies that were real estate investment trusts).

Thirty-nine of the surveyed transactions in 2010 involved a target company in the United States, thirteen involved a target company in Europe and eight involved a target company in Asia-Pacific. The publicly available information for certain surveyed transactions did not disclose all data points covered by our survey; therefore, the charts and graphs in this survey may not reflect information from all surveyed transactions.

With a significant rebound in the availability of debt financing for new acquisitions, 2010 was a strong year for sponsor-backed going private transactions in the United States. Thirty-nine sponsor-backed going private transactions in the United States were announced over the course of 2010.

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A Changing Landscape: The MiFID II Legislative Proposal

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, November 22, 2011
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Editor’s Note: Barnabas Reynolds is head of the global Financial Institutions Advisory & Financial Regulatory Group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by Mr. Reynolds, Azad Ali, Mehran Massih, Thomas A. Donegan, and Anna Doyle; the complete publication, including omitted footnotes, is available here.

On 20 October 2011, the European Commission published its long-awaited legislative proposal to revise the Markets in Financial Instruments Directive (better known by its acronym MiFID). The proposal is divided into two parts, a Directive and a Regulation, both of which are expected to enter into force in 2013. Financial institutions and users of financial services will now need to prepare to negotiate a wider regulatory perimeter, which captures previously unregulated and more weakly regulated business areas. Pre-trade and post-trade transparency will apply to a broader scope of instruments. Firms should also be aware of the wider interventionist powers for EU and national regulators under contemplation.

Introduction

The original Markets in Financial Instruments Directive (“MiFID”) came into force almost four years ago, in November 2007. MiFID was intended to enhance investor protection, improve cross-border market access and promote competition in the financial markets across the EU. Although MiFID has arguably achieved some of these aims, it is widely considered that the regime requires updating to reflect the lessons of the financial crisis and developments in the markets. The terms of MiFID itself anticipate a review in any event. However, the financial crisis has undoubtedly led to a far more wide-ranging proposal than might otherwise have been expected.

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CEO Inside Debt Holdings and the Riskiness of Firm Investment and Financial Policies

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, November 21, 2011
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The following post comes to us from Cory Cassell, Shawn Huang, Juan Manuel Sanchez, and Michael Stuart, all of the Department of Accounting at the University of Arkansas.

In the paper, Seeking Safety: The Relation Between CEO Inside Debt Holdings and the Riskiness of Firm Investment and Financial Policies, forthcoming in the Journal of Financial Economics, we investigate whether CEOs with large inside debt holdings protect the value of their holdings by implementing less risky investment and financial policies. The recent near-collapse of global financial markets led to renewed scrutiny of executive compensation practices by journalists, academicians, politicians, and regulators.  Much of the scrutiny focused on alleged excesses in the compensation packages of the executives deemed (at least partially) responsible for the economic turmoil (e.g., Karaian, 2008; Rappeport, 2008; McCann, 2009). However, the financial crisis also highlighted the vulnerability of certain components of firm-specific executive wealth during times of financial distress as several prominent chief executive officers (CEOs) surrendered significant portions of their inside debt holdings (pension benefits and/or deferred compensation) when their firms failed during the crisis. Inside debt holdings are at risk because they generally represent unsecured and unfunded liabilities of the firm, rendering these executive holdings sensitive to default risk similar to that faced by other outside creditors (Sundaram and Yermack, 2007; Edmans and Liu, 2011).

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Corporate Governance and Shareholder Activism in 2011

Posted by James R. Copland, Manhattan Institute, on
Sunday, November 20, 2011
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James R. Copland is the director of the Manhattan Institute’s Center for Legal Policy. This post is based on the executive summary of report from the Proxy Monitor project; the full report is available here.

In recent years, a small number of activist shareholders have increasingly sought to use their equity stock holdings to exert influence over business management. Proponents of “shareholder democracy” have successfully pushed shareholder proposals offered for votes at the annual meetings of public corporations that change the manner in which directors are elected and in which shareholders can force corporate action outside those annual meetings. Proponents of “corporate social responsibility” have pushed companies to change their behavior with a clear interest in pursuing policy goals rather than share-price maximization. Critics of management’s pay levels have pushed for shareholder advisory votes on executive compensation—a practice borrowed from Britain but unheard of in the United States a decade ago—and such “say on pay” votes are now mandated under federal law by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Academics and investors alike have debated shareholder activism generally and these proposals specifically; but to date, hard data have generally not been publicly available about this phenomenon. To fill in this informational gap and to uncover and analyze trends in this aspect of shareholder activism and its influence over corporate governance, the Manhattan Institute launched its Proxy Monitor project. The ProxyMonitor.org database assembles information on the 150 largest corporations (by revenues, as ranked by Fortune magazine) and currently includes searchable and sortable information on every shareholder proposal submitted at each company from 2008 through August 1, 2011. (Earlier years’ proposals, and a broader data set of companies, will be added to the database in the months ahead.)

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Delaware Court Upholds Board Discretion in Setting Compensation Practices

Posted by Paul Rowe, Wachtell, Lipton, Rosen & Katz, on
Saturday, November 19, 2011
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Paul Rowe is a Partner in the Litigation Department at Wachtell, Lipton, Rosen and Katz. This post is based on a Wachtell Lipton memorandum by Mr. Rowe, Jeannemarie O’Brien, and Jeremy Goldstein. 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.

In dismissing a wide-ranging stockholder challenge to compensation practices at Goldman Sachs, the Delaware Court of Chancery has issued a strong reaffirmation of traditional principles of the common law of executive compensation.  The decision emphasizes that boards are free to encourage and reward risk-taking by employees and that Delaware law protects directors who adopt compensation programs in good faith.  In re The Goldman Sachs Group, Inc. Shareholder Litigation (Oct. 12, 2011).

Shareholders of Goldman Sachs brought suit on a variety of theories, claiming that Goldman’s compensation policies, which emphasized net revenues, rewarded employees with bonuses for taking risks but failed to penalize them for losing money; that the directors allocated too much of the firm’s resources to individual compensation versus investment in the business; that while the firm adopted a “pay for performance” philosophy, actual pay practices failed to align stockholder and employee interests; and that the board should have known that the effect of the compensation practices was to encourage employees to engage in risky and/or unlawful conduct using corporate assets.  In dismissing the claims, the Court relied on basic principles of Delaware law.

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