Monthly Archives: June 2011

Regulators Propose Swap Margin and Capital Rules

Posted by Annette L. Nazareth, Davis Polk & Wardwell LLP, on
Saturday, June 4, 2011
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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, Daniel N. Budofsky, Robert L.D. Colby, Lanny A. Schwartz and Gabriel D. Rosenberg.

On April 12, 2011, the U.S. banking regulators proposed rules regarding the capital and margin requirements applicable to uncleared swaps. In general, the proposed rules would not impose new capital requirements on bank swap entities. However, the proposed rules would require bank swap entities to collect initial and variation margin from counterparties, including, in some cases, end users. In addition, the proposed rules establish collateral eligibility and segregation requirements and methodologies for calculating initial and variation margin requirements. The proposed rules have an expansive approach to extraterritoriality, providing only a slender exception for certain wholly offshore transactions.

On the same day, the CFTC proposed rules governing margin requirements for uncleared swaps entered into by non-bank swap entities subject to its jurisdiction. Based upon the Fact Sheet and Q&As that were released by the CFTC, the CFTC’s proposal appears to be similar, but not identical, to the banking regulators’ proposal. The SEC has not yet released a proposal for capital or margin requirements for security-based swap entities.

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Managers Who Lack Style

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, June 3, 2011
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The following post comes to us from C. Edward Fee of the Finance Department at Michigan State University; Charles Hadlock, Professor of Finance at Michigan State University; and Joshua Pierce of the Finance Department at the University of South Carolina.

In the paper, Managers Who Lack Style: Evidence from Exogenous CEO Changes, which was recently made publicly available on SSRN, we study managerial style effects in firm decisions by examining exogenous CEO changes in a panel of 8,615 Compustat firms from 1990 to 2007. The hypothesis that managers have varying preferences or traits that affect their corporate decisions has a great deal of intuitive appeal and is implicit in many discussions of leadership. Prior empirical evidence lends support to this general hypothesis and suggests that managerial style effects play a substantive role in firms’ investment and financing choices. This raises the possibility that much of the unexplained variation in these and related choices is driven by the identities of a firm’s leaders rather than more traditional factors such as various economic tradeoffs.

While prior research on this issue has generated many interesting findings, a major weakness arises from the fact that endogenous leadership changes are used to identify style effects. In this paper we overcome this weakness by identifying a large set of exogenous CEO changes arising from deaths, health concerns, and, in some parts of the analysis, natural retirements. Quite surprisingly, we find no significant evidence of abnormal changes in asset growth, investment intensity, leverage, or profitability subsequent to exogenous CEO changes.

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Seventh Circuit Makes Life Tougher for Directors with Conflicts

Posted by Andrea Unterberger, Corporation Service Company, on
Thursday, June 2, 2011
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Andrea Unterberger is Vice President and Assistant General Counsel at Corporation Service Company (CSC). This post is by Ms. Unterberger, and Sandra E. Mayerson and Peter A. Zisser of Squire, Sanders & Dempsey LLP.

In CDX Liquidating Trust v. Venrock Assocs., et al., 2011 U.S. App. LEXIS 6390 (7th Cir. March 29, 2011), the United States Court of Appeals for the Seventh Circuit, reversing the District Court’s ruling, held under Delaware law that a director’s disclosure of a conflict, in and of itself, is insufficient to protect that director from liability for breach of the fiduciary duty of loyalty arising from that conflict.  Similarly, the other party to whom the conflicted director owes loyalty (under the right circumstances) can be held liable for aiding and abetting a breach of fiduciary duty.  Nor does the mere existence of independent directors shield these parties from liability.

In Venrock, the debtor (“Debtor”) was a company which manufactured internet modems. The founders received common stock.  Two venture capital firms (the “VCs”) received preferred stock in exchange for an investment made at the beginning of 2000.  A principal of one of the venture capital firms (the “VC Principal”) became a member of Debtor’s five-member board of directors (the “Board”) upon the firm’s investment.  In April 2000, the Board rebuffed a tentative offer to buy Debtor’s assets for $300 million.

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The Political Economy of Fraud on the Market

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, June 1, 2011
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The following post comes to us from William Bratton, Professor of Law of the University of Pennsylvania, and Michael Wachter, William B. Johnson Professor of Law and Economics at the University of Pennsylvania.

The fraud on the market class action no longer enjoys substantive academic support. The justifications traditionally advanced by its defenders—compensation for out-of-pocket loss and deterrence of fraud—are thought to have failed due to the action’s real world dependence on enterprise liability and issuer funding of settlements. The compensation justification collapses when considered from the point of view of different types of shareholders. Well-diversified shareholders’ receipts and payments of damages even out over time and amount to a wash before payment of litigation costs. The shareholders arguably in need of compensation, fundamental value investors who rely on published reports, are undercompensated due to pro rata distribution of settlement proceeds to all class members. The deterrence justification fails when enterprise liability is compared to alternative modes of enforcement. Actions against individual perpetrators would deter fraud more effectively than does enterprise liability. If, as the consensus view now has it, fraud on the market makes no policy sense, then its abolition would seem to be the next logical step. Yet most observers continue to accept it on the same ground cited by the Supreme Court in 1964 when it first implied a private right of action under the 1934 Act in J.I. Case v. Borak—a private enforcement supplement is needed in view of inadequate SEC resources. Restating, even a private enforcement supplement that makes no sense is better than no private enforcement supplement at all.

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