Monthly Archives: February 2011

Computerization and the Abacus: Reputation, Trust, and Fiduciary Duties in Investment Banking

Editor’s Note: Steven Davidoff is a Professor of Law at the University of Connecticut. This post is based on a paper by Mr. Davidoff, William J. Wilhelm, Jr. of the University of Virginia, and Alan D. Morrison of the University of Oxford.

In our essay Computerization and the Abacus: Reputation, Trust, and Fiduciary Duties in Investment Banking, recently posted to the SSRN, we analyze the 2007 synthetic collateralized debt obligation transaction, ABACUS 2007-AC1 SPV (ABACUS) and the subsequent SEC civil complaint against Goldman Sachs in connection with the ABACUS transaction. We use this analysis as a touchstone to examine the debate over whether to impose fiduciary duties or other heightened regulation upon investment bank/counter-party transactions, the subject of a recently released SEC study (available here).


2010 Year-End Securities Enforcement Update

Mark Schonfeld is a litigation partner at Gibson, Dunn & Crutcher LLP and Co-Chair of the firm’s Securities Enforcement Practice Group. This post is based on a Gibson Dunn client alert.

I. Overview of 2010

The year 2010 has been a watershed year for securities enforcement. The Dodd-Frank Wall Street Reform and Consumer Protection Act gave the SEC additional enforcement powers, while also bringing additional market participants under SEC registration and potentially elevating the standards of conduct for other securities professionals. At the same time, the SEC, working closely with criminal prosecutors, continued to pursue insider trading investigations based on recorded conversations and cooperating witnesses. In addition, the reorganization of the Enforcement Division into specialized units has started to yield enforcement actions in areas of priority. By all accounts, the heightened enforcement reflected this year will continue for the foreseeable future, putting a premium on the ability of in-house compliance programs to adapt to the changing regulatory landscape.


Capital-Market Effects of Securities Regulation

Christian Leuz is the Joseph Sondheimer Professor of International Economics, Finance and Accounting at the University of Chicago.

In the paper, Capital-Market Effects of Securities Regulation: The Role of Implementation and Enforcement, which was recently made publicly available on SSRN, my co-authors (Hans Christensen of the University of Chicago and Luzi Hail of the University of Pennsylvania) and I examine capital-market effects of changes in securities regulation. We focus on two key EU capital-market directives pertaining to market abuse and transparency regulation. As there were prior EU directives and national laws banning insider trading and requiring financial reporting, the two directives can be viewed as tightening and harmonizing existing EU securities regulation, particularly its enforcement. We use this setting to highlight that implementation and enforcement of regulation play an important role for regulatory outcomes. Our empirical identification strategy exploits the staggered implementation of the two directives across EU countries. This feature allows us to control for general market movements and other potentially confounding events that occurred within and outside the EU over the sample period.


Summary of the Volcker Rule Study – Hedge Funds and Private Equity Funds

Randall Guynn is head of the Financial Institutions Group at Davis Polk & Wardwell LLP. This post is based on a client memorandum by Mr. Guynn, Yukako Kawata and Alex Young-Anglim.

The study by the Financial Stability Oversight Council (“FSOC”) [1] of the funds portion of the Volcker Rule includes useful findings and recommendations on the definitions of “hedge funds,” “private equity funds” and “banking entities,” but leaves a number of important questions unanswered. To provide an idea of the number and nature of important questions left unanswered, we have attached a chart that maps the recommendations proposed by the Securities Industry and Financial Markets Association (“SIFMA”) [2] to the actual recommendations made in the FSOC study. [3]


Forum Selection Bylaw Clause Rejected by Court

This post comes to us from Adam M. Turteltaub, a partner in the Corporate and Financial Services Department of Willkie Farr & Gallagher LLP, and is based on a Willkie client memorandum by Mr. Turteltaub, Robert B. Stebbins and Jennifer E. Wade.

In a matter of first impression, the United States Federal District Court for the Northern District of California recently denied motions to dismiss a derivative action for improper venue, finding the forum selection clause in the corporate bylaws of a Delaware corporation to be unenforceable.  The decision in Galaviz v. Berg, No. 10-cv-3392, slip op. (N.D. Cal. Jan. 3, 2011), calls into question the ability of corporations to effectively mandate a chosen forum for the resolution of intra-company disputes.

The plaintiffs in Galaviz brought a claim in the Federal District Court for the Northern District of California against the directors of Oracle Corporation (“Oracle”) alleging that each director is individually liable for breach of fiduciary duty and abuse of control in connection with certain actions allegedly taken by Oracle from 1998 to 2006.


CFOs versus CEOs: Equity Incentives and Crashes

The following post comes to us from Jeong-Bon Kim, Professor of Accountancy at City University of Hong Kong; Yinghua Li of the Accounting Department at Purdue University; and Liandong Zhang of the Department of Accountancy at City University of Hong Kong.

In the study, CFOs versus CEOs: Equity Incentives and Crashes, forthcoming in the Journal of Financial Economics, we examine the impact of executive equity incentives on a firm’s stock price crash risk. Based on a recent theoretical study by Benmelech, Kandel, and Veronesi (2010), we argue that equity incentives motivate managers to conceal bad news about growth opportunities and to choose sub-optimal investment policies to support the pretense. The accumulation of bad news within a firm leads to a severe overvaluation and a subsequent crash in the stock price.


Final SEC Rules on Say-on-Pay Voting and Disclosures

Editor’s Note: This post comes to us from John J. Cannon, a partner in the Executive Compensation and Employee Benefits Group at Shearman & Sterling LLP, and is based on a Shearman & Sterling Client Memorandum by Mr. Cannon, Jeffrey Crandall, Kenneth Laverriere, Doreen Lilienfeld and Linda Rappaport. An earlier post by Lucian Bebchuk and Robert Jackson on the SEC rule concerning say-on-pay voting is available here.

The Securities and Exchange Commission released final rules implementing the say-on-pay provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act on January 25, 2011. [1]

The Dodd-Frank Act requires (1) a non-binding shareholder vote on executive compensation, (2) a non-binding shareholder vote on the frequency of the say-on-pay vote, (3) disclosure of “golden parachute” arrangements in connection with specified change in control transactions, and (4) a non-binding shareholder vote on golden parachute arrangements in connection with these change in control transactions.


SEC Study on the Fiduciary Duty of Investment Advisers and Broker-Dealers

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 by Ms. Nazareth, Gerard Citera, Robert L.D. Colby, Lanny A. Schwartz and David L. Portilla.

General Observations

Background. On January 21, 2011, the Securities and Exchange Commission (the “SEC” or “Commission”) released its much anticipated staff study on the effectiveness of the standards of care required of broker-dealers and investment advisers providing personalized investment advice about securities to retail customers (the “Study”). As required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the Study also considered whether there are regulatory gaps, shortcomings or overlaps that should be addressed by rulemaking.


Delaware Confirms Fairness of Third-Party Transaction with Controlled Company

William Savitt is a partner in the Litigation Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Savitt and Ryan A. McLeod. 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 post-trial decision, the Delaware Court of Chancery upheld as entirely fair the third-party acquisition of a controlled company in which the controlling shareholder received consideration that differed from that provided to the public minority. In re John Q. Hammons Hotels Inc. S’holder Litig., C.A. No. 758-CC (Del. Ch. Jan. 14, 2011).

The matter arose from the 2005 sale of John Q. Hammons Hotels, Inc., a publicly traded company controlled by John Hammons. In the transaction, the public shareholders were cashed out at a substantial premium while Hammons himself received an ongoing preferred equity interest and other contractual rights. In an important decision earlier in the case, the Chancellor ruled that with proper planning such a transaction may be reviewed under the deferential business judgment rule, but held that the Hammons transaction would nevertheless be subject to the plaintiff-friendly “entire fairness” test due to the lack of sufficient procedural safeguards.


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