Monthly Archives: April 2011

Comments on the SEC’s Proposal for Beneficial Ownership Reporting and Security-Based Swaps

Theodore Mirvis is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum.

Recently we filed a comment letter with the Securities and Exchange Commission regarding its proposal to readopt existing rules to preserve the “status quo” with respect to the treatment of security-based swaps under the beneficial ownership reporting rules. Our letter reiterates our belief, as reflected in the rulemaking petition we filed In March with the Commission, that modernization of the beneficial ownership reporting rules is needed in order to compel timely, accurate and complete disclosure of the accumulation of control stakes in public companies. We urge the Commission to undertake a complete overhaul of the rules as promptly as reasonably practicable. Chief among the failings in need of correction are the outdated ten-day reporting window and the overly narrow definition of “beneficial ownership,” which excludes a host of derivative products commonly used by investors to acquire the characteristics of ownership while currently evading reporting requirements.


The Supreme Court Considers Loss Causation at Time of Class Certification

The following post comes to us from Jonathan K. Youngwood, a partner in the Litigation Department at Simpson Thacher & Bartlett LLP, and is based on a Simpson Thacher report by Mr. Youngwood and Christopher R. Kelly. Oral arguments in the Supreme Court case discussed below, Erica P. John Fund, Inc. v. Halliburton Co., are available here.

The Supreme Court heard oral arguments recently in Erica P. John Fund, Inc. v. Halliburton Co., No. 09-1403, a private securities fraud case in which the Court is expected to address whether a class may be certified even where plaintiffs fail to establish that the alleged misstatements had an impact on the price of the securities at issue. The Court’s decision will likely resolve a split concerning whether courts should require plaintiffs to prove loss causation at the time of class certification. The Fifth Circuit in Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007), has expressly allowed defendants to rebut the fraud-on-the-market presumption by disproving loss causation at the class certification stage. The Third and Seventh Circuits have explicitly rejected the Fifth Circuit’s approach in In re DVI, Inc., Sec. Litig., No. 08-8033, 08-8045, 2011 WL 1125926 (3d Cir. Mar. 29, 2011), and Schleicher v. Wendt, 618 F.3d 679 (7th Cir. 2010), respectively. The Second Circuit also rejected analyzing loss causation as a class certification requirement in In re Salomon Analyst Metromedia Litig., 544 F.3d 474 (2d Cir. 2008).


Mergers, Spin-offs, and Employee Incentives

The following post comes to us from Paolo Fulghieri, Professor of Finance at the University of North Carolina, and Merih Sevilir of the Finance Department at Indiana University.

Many mergers are driven by the desire to reduce competition in the product market and to develop new products to enter into new markets. In our paper, Mergers, Spin-offs, and Employee Incentives, forthcoming in The Review of Financial Studies, we argue that these two motives may be in conflict with each other in that mergers reducing product market competition have a negative effect on employee incentives to innovate and develop new products.

On one hand, mergers reduce the product market competition and increase expected payoffs from employee innovations. On the other hand, by reducing the number of firms in the product market, mergers limit employee ability to go from one firm to another with a negative effect on incentives. Moreover, mergers create internal competition between the employees of the post-merger firm, with an additional negative effect on incentives to innovate. When the negative effects of the merger on incentives are sufficiently large, firms are better off competing in the product market and competing for employee human capital rather than merging and eliminating competition. In other words, firms prefer not to merge and bear competition in the product market to maintain stronger employee incentives. In this way, our paper is consistent with the recent concerns voiced in the context of the AT&T and T-mobile merger, whereby practitioners have suggested that it will hamper incentives to innovate, as we argue in this paper.


The Volcker Rule and Goldman Sachs

Andrew Tuch is a Fellow of the Program on Corporate Governance and a John M. Olin Fellow at Harvard Law School, as well as a senior lecturer in the Faculty of Law at the University of Sydney.

In its recently issued report, Wall Street and the Financial Crisis: Anatomy of a Financial Collapse, the Senate Permanent Subcommittee on Investigations considered the conduct of Goldman Sachs in several transactions, including the ABACUS 2007-AC1 collateralized debt obligation. The report “examines Goldman’s conduct in the context of the law prevailing in 2007,” [1] and it asserts that the Volcker Rule provisions of the Dodd-Frank Act, “if well implemented, will protect market participants from the self-dealing that contributed to the financial crisis.” [2] But what justification exists for the conflict of interest restrictions in the Volcker Rule provisions, and how would the Volcker Rule provisions have applied to the ABACUS CDO had the provisions been in force at the time?

In my paper, Conflicted Gatekeepers: The Volcker Rule and Goldman Sachs, I consider the conflict of interest restrictions in the Volcker Rule provisions. These provisions, namely Sections 619 and 621 of the Dodd-Frank Act, purport to impose fiduciary-like standards on banks in their arm’s length relationships with sophisticated counterparties. Section 619 generally prohibits banks from engaging in proprietary trading and affiliating with certain private funds; it permits some activities as exceptions to this general prohibition, but subjects such activities to the requirement that they not give rise to material conflicts of interest, including conflicts between banks and their “counterparties.” Section 621 purports to ban material conflicts of interest between banks (in their capacity as underwriters) and investors in offerings of asset-backed securities.


The Destructive Ambiguity of Federal Proxy Access

Jill Fisch is a Professor of Law at the University of Pennsylvania. The Program on Corporate Governance has issued several papers concerning proxy access, including Private Ordering and the Proxy Access Debate and The Harvard Law School Proxy Access Roundtable.

The paper, The Destructive Ambiguity of Federal Proxy Access, forthcoming in the Emory Law Journal, demonstrates the tension between the federal requirements for the exercise of shareholder nominating rights and the state law principles upon which the SEC purports to ground those rights. The paper unpacks the ambiguities in the SEC’s conception of which shareholders should nominate director candidates. And it highlights the ambiguity resulting from the SEC’s failure to confront, in adopting its rule, the appropriate allocation of power between shareholders and management and the effects of proxy access on that balance.

Under U.S. corporate law, the shareholders elect the board of directors. In most cases, however, those shareholders do not nominate director candidates. Instead, the nominating committee of the board chooses a slate of candidates, and those candidates are submitted to the shareholders for approval. Absent the infrequent phenomenon of an election contest, shareholders do not participate in the nomination process.


What Board Members Should Know About Communicating Corporate Social Responsibility

Matteo Tonello is Director of Corporate Governance for The Conference Board, Inc. This post is based on a Conference Board Director Note by Shuili Du, C.B. Bhattacharya and Sankar Sen.

Since creating stakeholder awareness is a key prerequisite for reaping the strategic benefits of any business initiative, it is imperative for board members and senior executives instituting a social responsibility program to have a deeper understanding of the key issues related to CSR communication. This report discusses what to communicate (i.e., message content) and where (i.e., message channel), as well as the major factors (internal and external to the organization) that affect the effectiveness of CSR communications.

Corporate social responsibility (CSR), defined broadly as “a commitment to improve [societal] well-being through discretionary business practices and contributions of corporate resources,” occupies a prominent place on the global corporate agenda in today’s socially conscious market environment. [1] More than ever, companies are devoting substantial resources to various social and environmental initiatives—ranging from community outreach and neutralizing their carbon footprint to socially responsible business practices in employment, sourcing, product design, and manufacturing.


The Effect of Managerial Traits on Corporate Financial Policies

The following post comes to us from Ulrike Malmendier of the Economics Department at the University of California, Berkeley, Geoffrey Tate of the Finance Department at UCLA, and Jon Yan of Stanford University.

In our forthcoming Journal of Finance paper, Overconfidence and Early-life Experiences: The Effect of Managerial Traits on Corporate Financial Policies, we provide evidence that managers’ beliefs and early-life experiences significantly affect financial policies, above and beyond traditional market-, industry-, and firm-level determinants of capital structure. We begin by using personal portfolio choices of CEOs to measure their beliefs about the future performance of their own companies. We focus on CEOs who persistently exercise their executive stock options late relative to a rational diversification benchmark. We consider several interpretations of such behavior — including positive inside information — and show that it is most consistent with CEO overconfidence. We also verify our measure of revealed beliefs by confirming that such CEOs are disproportionately characterized by the business press as “confident” or “optimistic,” rather than “reliable,” “cautious,” “practical,” “conservative,” “frugal,” or “steady.”


The Loss Absorbency Requirement and “Contingent Capital” Under Basel III

The following post comes to us from Gregg Rozansky, counsel in the Financial Institutions Advisory & Financial Regulatory Group of Shearman & Sterling LLP, and is based on a Shearman & Sterling client publication; this publication previously appeared in Reuters EuroWatch.

The Basel Committee on Banking Supervision recently finalized minimum requirements for regulatory capital instruments under Basel III. For internationally active banks, these include a requirement that so-called Tier 1 instruments other than common stock as well as all Tier 2 instruments include a feature requiring a “write-off” or conversion into common stock. The requirement is one of several important international developments that have broadened interest in bank-issued contingent capital securities.

Under the Basel III contingent capital requirement, the home country supervisor of an internationally active bank would have the authority to trigger a write-off or a conversion of non-common Tier 1 and Tier 2 instruments issued by the bank. A trigger event may be declared as deemed necessary to help prevent the issuer from becoming insolvent. For purposes of Basel III, non-common Tier 1 capital instruments generally consist of perpetual preferred stock and perpetual debt instruments where the issuer has complete discretion to cancel distributions/payments on the instrument. Tier 2 capital mainly consists of subordinated debt with a minimum original maturity of at least five years.


Facilitating Real Capital Formation

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 Council of Institutional Investors Spring Meeting; the complete remarks, including footnotes, 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 talk about capital formation. For over 30 years, I advised many clients as to their capital raising efforts in order to grow their businesses, and I worked with institutions that held significant stakes in companies who grew their operations by making better products, and selling more of them.

I have been growing increasingly concerned about the discussion that is taking place in our country regarding capital formation. This discussion seems to confuse the singular act of capital raising with the much broader concept of capital formation. Moreover, this discussion fails to take into account the importance of disclosure in helping investors assess risks and make informed investment decisions. Disclosure leads to an informed investor – and informed investors are ones who will make investment decisions that collectively, in the aggregate, will yield productive benefits and growth to the real economy.

I know you understand exactly what I mean. The Council is an association of members who have a long-term stake in the U.S economy. You are self-described as the “patient capital” of the markets because, in general, you have “30-year investment horizons and heavy use of indexing strategies.” You understand that for most investments to make money, the company generally requires organic or strategic growth over a period of time.

I share this long-term view.


Optimal Capital Structure

This post comes to us from Jules van Binsbergen of the Department of Finance at Northwestern University and Stanford University, John Graham, Professor of Finance at Duke University, and Jie Yang of the Department of Finance at Georgetown University.

In our paper, Optimal Capital Structure, which was recently made publicly available on SSRN, we develop a method that can be used to determine optimal capital structure for any given firm. Being able to make specific, firm-by-firm debt policy recommendations is an important addition to the current state of affairs. Though much progress has been made in capital structure research, traditional approaches neither explicitly separate out the benefits and costs of debt to facilitate estimation optimal debt ratios, nor precisely quantify the cost of suboptimal leverage.


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