Monthly Archives: July 2011

“Exclusivity” — Not As Preclusive As It Sounds?

Posted by David Fox, Kirkland & Ellis LLP, on
Sunday, July 31, 2011
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David Fox is a partner at Kirkland & Ellis LLP, focusing on complex mergers and acquisitions as a member of that firm’s Corporate Group. This post is based on a Kirkland & Ellis M&A Update by Mr. Fox and Daniel Wolf.

During the course of early-stage negotiations, exclusivity provisions are often used to protect the time and economic investment being made in the potential transaction by ensuring that the counterparty deals only with the named party for a stated period. In a recent appellate decision in the First Circuit, the court applied a surprisingly narrow reading of the scope of what appeared to be a very broad exclusivity provision, offering a cautionary note to dealmakers as they draft such terms.

Gemini, a private equity firm, signed a preliminary outline of terms to finance the acquisition by AmeriPark of a competitor (Mile Hi). While the rest of the term sheet was expressly non-binding, the paragraphs entitled “Exclusivity” and “Confidentiality” were agreed to be binding. The exclusivity provision, which was coterminous with the separate exclusivity arrangement between Mile Hi and AmeriPark, stated, in relevant part, that AmeriPark “agrees not to discuss this opportunity or reach any agreement with any person or entity regarding financing for this Transaction or the pursuit of any sale or major other financing”. During the exclusivity period, AmeriPark abandoned its discussions with Gemini and instead held talks with a large AmeriPark shareholder (Greenfield) and then the sole shareholder of Mile Hi about financing the acquisition, eventually completing the acquisition using the seller financing.

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IRS Issues Proposed Regulations Under Section 162(m) to Clarify Performance-Based Exception

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, July 30, 2011
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The following post comes to us from Scott P. Spector, a Partner in the Corporate Group and Chair of the Executive Compensation and Employee Benefits Group at Fenwick & West LLP, and is based on an Executive Compensation Alert by Fenwick.

Section 162(m) of the Internal Revenue Code, denies a tax deduction to a public company if compensation paid to certain individuals (known as “covered employees”) exceeds one million dollars for the taxable year. A “covered employee” is defined as a public company’s chief executive officer and its three other most highly compensated officers (excluding the CFO) whose compensation is required by the SEC to be disclosed for a given year. However, the deduction limit is subject to certain exemptions, including compensation that is “performance-based” within the meaning of Section 162(m), and certain equity awards granted under an equity incentive plan that existed prior to a company becoming public.

Proposed Regulations

On June 23, 2011 the Internal Revenue Service (“IRS”) issued proposed regulations to clarify the existing regulations of Section 162(m) with respect to stock-based compensation plans and the exception to the $1 million limit for qualified performance-based compensation.

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The Votes Are In — Deconstructing the 2011 Say on Pay Vote

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, July 29, 2011
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The following post comes to us from Michael R. Littenberg, a partner at Schulte Roth & Zabel LLP, and is based on Schulte Roth & Zabel white paper by Mr. Littenberg, Farzad F. Damania and Justin M. Neidig.

For most public companies, the 2011 annual meeting season is now over, and the first mandatory say on pay vote is behind them. Thus far, more than 2200 of the Russell 3000 companies have held say on pay votes in 2011. This White Paper analyzes the results of this year’s say on pay vote across several metrics.

An Overview of Say on Pay

As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Section 14A(a) was added to the Securities Exchange Act of 1934. Pursuant to Section 14A(a) and the rules thereunder subsequently adopted by the SEC, beginning with the 2011 proxy season, most domestic public companies are required to conduct say on pay (SOP) and say on frequency (SOF) votes.

Under the SOP requirement, companies must submit named executive officer (NEO) compensation to a non-binding, or advisory, shareholder vote at least once every three years, as determined by the board.

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The Economics of Credit Default Swaps

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, July 29, 2011
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The following post comes to us from Robert Jarrow, Professor of Finance at Cornell University.

Credit default swaps (CDS) are term insurance contracts written on the notional value of an outstanding bond. In the paper, The Economics of Credit Default Swaps, forthcoming in the Annual Review of Financial Economics, I study the economics of CDS using the economics of insurance literature as a basis for analysis. The first CDS were traded by JP Morgan in 1995. Since that time, CDS trading has grown dramatically. CDS contracts trade in the over-the-counter derivatives markets which is only loosely regulated. The CDS market exhibited exponential growth between 2001 and 2007. At its 2007 peak, total outstanding notional for CDS was over 62 trillion dollars. After the crisis, however, these numbers have halved to just over 30 trillion dollars in 2009. Most of this change in outstanding notional has occurred through “portfolio compression” as demanded by the regulators where long and short credit derivative positions on the same underlying credit entity held by the same institution are netted. The reduction is not due to decreased trading activity in CDS. This assertion is supported by the relatively stable outstanding notional of equity and interest rate and currency derivatives over this same time span.

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Hype and Reality in the Dodd-Frank Whistleblower Rules

Posted by John F. Savarese, Wachtell, Lipton, Rosen & Katz, on
Thursday, July 28, 2011
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John Savarese is a partner in the Litigation Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Savarese and Jonathan M. Moses. This post is part of a series following the first anniversary of the Dodd-Frank Act which was July 21, 2011, other Dodd-Frank posts are available here.

A lot of commentators, including many law firms, have recently issued dire warnings concerning the final whistleblower rules adopted by the SEC on May 25 pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act. Some of the more extreme observations have expressed fears that companies’ internal compliance programs will be undermined and have recommended top-to-bottom revamping of internal compliance systems. Believing that at least some of this commentary may be overblown, we thought it might be appropriate to take a deep breath and examine what is real and what is hype.

First, it is important to remember what has not changed: the new rules still permit and indeed encourage both privately held and publicly traded companies to continue doing what most have been doing for years: (1) actively encouraging all employees to report potential compliance violations to the company, either by directly reporting any concerns to supervisors, legal, compliance or audit personnel, or by using confidential hotline, website or ombudsmen mechanisms; (2) assuring all employees who step forward that they will not be terminated or otherwise discriminated or retaliated against for raising good faith compliance concerns; (3) examining, in a responsible and appropriate way, all reported potential compliance issues; and (4) taking reasonable corrective measures, including changing business practices and systems, imposing discipline, and when appropriate, reporting the issue to regulators. While it would have been better, as we and others previously stated (see our prior memo here), for the SEC to have fully respected those programs by requiring whistleblowers to first make an internal report, this does not mean that corporate compliance regimes have become obsolete. In fact, they have become even more important.

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Reflections on Dodd-Frank: A Look Back and a Look Forward

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, July 27, 2011
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Editor’s Note: The following post comes to us from Lee A. Meyerson, a Partner who heads the M&A Group and Financial Institutions Practice at Simpson Thacher & Bartlett LLP, and is based on the introduction of a Simpson Thacher compendium, available here. This post is part of a series following the first anniversary of the Dodd-Frank Act which was July 21, 2011, other Dodd-Frank posts are available here.

The impact of Dodd-Frank—like the U.S. financial industry it regulates—is greater than the sum of its parts. Dodd-Frank seeks to oversee and regulate financial markets as a whole, by increasing regulation of individual companies with the potential to compromise market stability, as well as implementing regulation of certain areas of the financial services sector previously not subject to federal supervision and regulation. Dodd-Frank also addresses consumer protection, through the creation of a new agency with broad consumer protection powers and new rules governing residential mortgage markets.

In comments regarding the impact of this historic legislation, Timothy Geithner, Secretary of the Department of Treasury, noted that “By almost any measure, the U.S. financial system is in much stronger shape” than it was prior to enactment of Dodd-Frank. [1] However, a huge amount of change still lies ahead. In the short run, uncertainty regarding the impact of Dodd- Frank on operations, capital and liquidity levels, costs and revenue, and increased litigation and enforcement risk, will continue to impact strategic decisions and valuations of financial institutions of all types and sizes. The long-term impact of the legislation is uncertain, although it could quite possibly usher in a new era of accelerated consolidation in the financial services industry.

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Accounting Conservatism, Going-Concern Horizon, and Earnings Informativeness

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, July 27, 2011
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The following post comes to us from Edward Owens of the Department of Accounting at the University of Rochester.

In the paper, Accounting Conservatism, Going-Concern Horizon, and Earnings Informativeness, which was recently made publicly available on SSRN, I examine how accounting conservatism shapes the relation between a firm’s going-concern status and the informativeness of its earnings for firm valuation. I extend earnings-persistence-based valuation theory to develop the study’s key insight that the difference between the earnings informativeness of a firm with a finite going-concern horizon and the earnings informativeness of a firm with an infinite going-concern horizon is a positive function of the proportion of capitalized value that is reflected in the earnings of future periods. Based on this insight, I predict that because of the asymmetric persistence implications of accounting conservatism, negative shocks to a firm’s assessed going-concern horizon diminish the informativeness of good news earnings but have no effect on the informativeness of bad news earnings. Using the setting of intra-industry bankruptcy to capture shocks to the market’s assessment of firms’ going-concern horizons, I provide empirical evidence consistent with my predictions.

This study makes several contributions to extant literature. First, my analysis and results provide additional insights into the dynamics of the going-concern assumption and firm valuation. In particular, I provide evidence that the negative relation between probability of bankruptcy and earnings informativeness is not symmetric across good and bad news realizations, as suggested implicitly by prior literature.

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Court Broadens Insider Trading Claims Under Delaware Law

Posted by Eduardo Gallardo, Gibson, Dunn & Crutcher LLP, on
Tuesday, July 26, 2011
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Eduardo Gallardo is a partner focusing on mergers and acquisitions at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn Client Alert by Jason J. Mendro, Adam H. Offenhartz, and Andrew S. Tulumello. 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.

Shareholders may state a derivative claim for insider trading without alleging injury to the company–so held the Delaware Supreme Court in an opinion it recently issued in Kahn v. Kolberg Kravis Roberts & Co., L.P., No. 436, 2010 (June 20, 2011) (“In re Primedia“). Following the In re Primedia decision, plaintiffs can be expected to rely increasingly on derivative actions as a means of pursuing insider trading claims. Although they would be subject to the requirements for asserting derivative claims, plaintiffs may exploit state law to evade many limitations that Congress has imposed on claims under the federal securities laws, including the heightened standard for pleading scienter under the Private Securities Litigation Reform Act of 1995. Significantly, derivative actions may not be removed to federal court under the Securities Litigation Uniform Standards Act of 1998.

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General Release — Handle with Caution

Posted by David Fox, Kirkland & Ellis LLP, on
Tuesday, July 26, 2011
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David Fox is a partner at Kirkland & Ellis LLP, focusing on complex mergers and acquisitions as a member of that firm’s Corporate Group. This post is based on a Kirkland & Ellis M&A Update by Mr. Fox and Daniel Wolf.

A recent decision by the highest court in New York highlights once again the broad finality of a general release given in a transactional context, even in cases where significant fraud is subsequently alleged. As we noted in a prior M&A Update, courts are reluctant to permit parties to circumvent the typically broad language of general releases by allowing the aggrieved party to argue that it really did not mean to release the claim being pursued despite the claim clearly falling within the literal words of the release.

The recent Court of Appeals decision arose out of a complicated set of transactions involving interests in various Latin American telecom businesses that culminated in a majority shareholder affiliated with Carlos Slim buying out the interests of minority shareholders. The sellers later alleged that they sold their interests at the agreed price only as a result of fraudulent information provided to them by the purchaser, resulting in an undervaluation of almost $1 billion. The purchaser asserted that all claims were barred by a broad release (“all manner of actions…whatsoever…future, actual or contingent…”) given by the sellers at the time the buyout was completed.

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One-Year Anniversary Dodd-Frank Rulemaking Progress Report

Posted by Margaret E. Tahyar, Davis Polk & Wardwell LLP, on
Monday, July 25, 2011
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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. This post is part of a series following the first anniversary of the Dodd-Frank Act which was July 21, 2011, other Dodd-Frank posts are available here.

This posting, the Davis Polk Dodd-Frank Rulemaking Progress Report, is the fifth 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.

Among the key elements of this Progress Report:

  • An analysis of rulemaking progress, which shows that regulators have completed 33, or 20%, of the 163 rulemakings due to date. Overall, regulators have completed 13% of all rulemaking requirements in Dodd-Frank.  Rules fulfilling 13 rulemaking requirements were finalized in July and 104 rulemaking deadlines were missed – 76 on July 16, 2011 and 28 on July 21, 2011.
  • A summary of study progress, which shows 7 missed studies to date.
  • A ranking of the most popular topics of discussion in the more than 1,700 meetings that have taken place between regulators and market participants since Dodd-Frank’s enactment.
  • A graphical representation of the GAO’s analysis of the $1.25 billion cost to regulators for Dodd-Frank implementation over the next two years.
  • A breakdown, organized by affected groups within financial firms, of the 1,081 specific tasks identified by Davis Polk from CFTC and SEC releases that are applicable to swap dealers and major swap participants.
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