Monthly Archives: July 2011

What Corporate Managers Should Know About the SEC Whistleblower Rules

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, July 10, 2011
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The following post comes to us from William Gleeson, a corporate and securities partner at K&L Gates LLP.

The SEC whistleblower rules, adopted by the SEC under Section 21F of the Securities Exchange Act pursuant to a mandate in the Dodd-Frank Wall Street Reform and Consumer Protection Act, provide for the payment of bounties or awards to whistleblowers. Under the SEC whistleblower rules, a bounty or award will be payable to eligible whistleblowers who provide “original information” concerning a violation of federal securities laws that leads to a successful enforcement action in a covered judicial or administrative action, or a “related action,” by the SEC or other specified agencies, resulting in monetary sanctions (fines or penalties, disgorgement, and/or interest on the disgorged amounts) of at least $1 million. Bounty awards are mandatory if the foregoing criteria are met. Eligible whistleblowers can receive between 10 – 30% of the monetary sanctions actually recovered.

For the most part, the SEC whistleblower rules deal with definitions and the operation of the rules, such as who is eligible be a whistleblower, what information qualifies as “original information,” what is meant by “leads to a successful enforcement action,” and procedures for applying for, and the awarding of, whistleblower bounties, as well as how to appeal such awards. These are matters that companies that may be the subject of whistleblower complaints largely have no control over and no role in.

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An Inflection Point: The SEC and the Current Financial Reform Landscape

Posted by Luis A. Aguilar, Commissioner, U.S. Securities and Exchange Commission, on
Saturday, July 9, 2011
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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 Social Investment Forum 2011 Conference; the complete remarks 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.

I would like to discuss some of the SEC’s new responsibilities under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act), and some of the challenges I see going forward.

Commission Action Required By The Dodd-Frank Act

First, I would like to discuss how the SEC has been impacted by the Dodd-Frank Act. The legislation closed various gaps in regulation and significantly expanded the Commission’s jurisdiction and workload. In the near term, the Dodd-Frank Act requires the SEC to promulgate over 100 new regulations, create five new offices, and undertake about 20 studies. To say this is a significant undertaking is a massive understatement. The SEC is currently right in the middle of this process.

The Dodd-Frank Act will also have a long-term and permanent impact on the SEC. For example, the Dodd-Frank Act charges the Commission with on-going oversight responsibilities on the previously unregulated over-the-counter derivatives market. The Commission’s new responsibilities include direct regulation of participants such as security-based swaps dealers, venues such as swap execution facilities, warehouses such as swap data repositories, and clearing agencies set up as central counterparties. In addition to regulating the derivatives market, the Commission has also been given the responsibility for the oversight of hedge fund advisers, and new responsibilities for the registration of municipal advisers.

These new responsibilities are necessary; but by the same token, although the Dodd-Frank Act significantly increased the Commission’s workload, it did not fundamentally address the resources that will be available to the SEC to meet the challenges of the increased workload.

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Do VCs Use Inside Rounds to Dilute Founders?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, July 8, 2011
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The following post comes to us from Brian Broughman of the Maurer School of Law at Indiana University, Bloomington, and Jesse Fried, Professor of Law at Harvard Law School.

In our paper, Do VCs Use Inside Rounds to Dilute Founders? Some Evidence from Silicon Valley, recently made publicly available on SSRN, Brian Broughman and I examine the role of inside financing rounds in VC-backed firms.

VCs typically invest through several rounds of financing. Each round is separately negotiated and priced. A subsequent (“follow-on”) round of financing could be provided by either (a) the firm’s existing VC investors exclusively (an inside round) or (b) a group led by a VC fund that did not invest in the startup’s earlier rounds (an outside round). Historically, most follow-on financings were structured as outside rounds, in part to mitigate conflict between the entrepreneur and existing VCs over the value of the firm. In recent years, however, more than half of follow-on rounds have been structured as inside rounds.

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If the Delaware Court of Chancery Got Airgas Right, Professor Bebchuk’s Op-Ed Got it Wrong

Posted by Stanley Keller, Edwards Angell Palmer & Dodge LLP, on
Thursday, July 7, 2011
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Stanley Keller is partner of Edwards Angell Palmer Dodge LLP. This post discussing the Airgas case references an op-ed by Professor Lucian Bebchuk, available here. A paper from the Program on Corporate Governance discussing the case is available here, and more posts about the case can be found here. 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.

I wrote my comment “Delaware Court of Chancery Gets Airgas Right” (posted on the HLS Forum on March 1, 2011) before reading Professor Lucian Bebchuk’s op-ed “An Antidote for the Corporate Poison Pill” that was published in The Wall Street Journal on February 24, 2011. As such, my comment did not address Professor Bebchuk’s op-ed directly, but rather served as a counterpoint, providing another point of view. In this comment, I offer a more direct response to Professor Bebchuk’s op-ed.

The fundamental difference between Professor Bebchuk and me stems from Professor Bebchuk’s applying Athenian democracy principles to corporate governance (or, if you will, the French Revolution approach) while I favor a more Platonic representative structure (the American Revolution approach). My approach recognizes the central role of directors in corporate change-of-control transactions, regardless of their form, balanced by imposition of fiduciary duty obligations that are subject to court review. No such balance exists if unfettered power is given to shareholders, who have no such fiduciary duties as a check, whose access to information, no matter how robust the disclosure, is likely to be more limited than the board’s, and whose actions often can be controlled by a subset of shareholders with a short-term perspective.

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July 2011 Dodd-Frank Rulemaking Progress Report

Posted by Margaret E. Tahyar, Davis Polk & Wardwell LLP, on
Thursday, July 7, 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. Other posts about the Dodd-Frank Act are available here.

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

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Banking Entity Trading Under the Volcker Rule

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, July 6, 2011
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The following post comes to us from Christopher Laursen, Vice President, NERA Economic Consulting and Co-Regional Director, Professional Risk Managers’ International Association’s (PRMIA) Washington, DC Chapter.

Looking back to the fall of 2007, it is clear from SEC filings that significant financial company losses resulted from proprietary positions booked in trading accounts. More specifically, a large amount of trading losses came from holdings of mortgage-backed and asset-backed bonds that had been afforded high credit ratings (e.g., AAA) by Nationally Recognized Statistical Rating Organizations (NRSROs). Rapid mark-to-market losses on these and other trading positions contributed significantly to the financial crisis and ultimately led legislators to develop the Volcker Rule, section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

With the Volcker Rule, legislators aim to reduce banking entity exposure to proprietary trading and thereby enhance bank’s ability to maintain their more traditional functions during market crises. The Rule, depending on how it is interpreted and enforced by regulators, has the potential to significantly change the scope and scale of proprietary trading within federally insured depositories and their affiliates.

This article discusses the relevant background of the Volcker Rule trading restrictions and offers insights on likely regulatory interpretations and banking entity responses. Specifically, the article addresses the designation of customer-initiated trades, increased expectations related to trading risk systems and limits, and the identification of material conflicts of interest.

The original article can be found at the following link on NERA’s website: http://www.nera.com/67_7328.htm.

Can the Treasury Exempt its Own Companies from Tax? The $45 Billion GM NOL Carryforward

Posted by Mark Ramseyer, Harvard Law School, on
Tuesday, July 5, 2011
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Mark Ramseyer is a Professor of Japanese Legal Studies at Harvard Law School.

Year after year, General Motors lost money – enormous sums of money. It designed cars. It built cars. But no one wanted to buy the cars it designed and built. Over time, it accumulated huge operating losses (“net operating losses,” or NOLs). The tax code let GM carry forward these NOLs into the future. It let the firm save them for that day in the future when it would once again sell cars that people wanted.

The day never came. Instead, in June 2009 GM (or “Old GM”) declared bankruptcy. It filed under Chapter 11 of the Bankruptcy Code and sold its assets to a new shell (New GM) in a transaction under Sec. 363 of the Code. Old GM’s shareholders were not part of New GM, and the firm’s creditors took stock: the US Treasury, the auto unions, and Canada swapped debt claims against Old GM for equity stakes in New GM. With 61 percent, the Treasury took the largest share among this group. Other Old GM creditors acquired a 10 percent stake in New GM as well. In the fall of 2010, Treasury re-sold a large amount of its New GM shares to the public, and cut its share to 26%.

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Lessons of the Financial Crisis: The Dangers of Short-Termism

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, July 4, 2011
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Editor’s Note: Sheila Bair is the Chairman of the Federal Deposit Insurance Corporation. This post is based on Chairman Bair’s remarks to the National Press Club, available here.

As I prepare to close out my term, I cannot help reflect on the challenges we have faced over the past five years and some of the lessons we have learned in the process. Our nation has suffered its most serious financial crisis and economic downturn since the Great Depression. The after effects will be felt for years to come.

There are many causes of this crisis, some of which I will address in my remarks today. But, in my opinion, the overarching lesson of the crisis is the pervasive short-term thinking that helped to bring it about. Short-termism is a serious and growing problem in both business and government. I would like to devote my remarks to explaining what I mean by this, and discussing how I think it plays into the policy challenges arising from the crisis.

The Challenge Posed by Short-Termism

What is short-termism, and why does it arise? Short-termism refers to the long-observed tendency – which we all share, to one degree or another – to unduly discount outcomes that occur far in the future.

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The Information Content of Annual Earnings Announcements and Mandatory Adoption of IFRS

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, July 4, 2011
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The following post comes to us from Wayne Landsman, Professor of Accounting at the University of North Carolina at Chapel Hill; Edward Maydew, Professor of Accounting at the University of North Carolina at Chapel Hill; and Jacob Thornock of the Department of Accounting at the University of Washington.

In the paper, The Information Content of Annual Earnings Announcements and Mandatory Adoption of IFRS, forthcoming in the Journal of Accounting & Economics as published by Elsevier, we examine whether the information content of earnings announcements increased in countries that mandated adoption of IFRS compared to countries that retained domestic accounting standards. We address this research question using a sample of 20,517 earnings announcements from 16 countries that mandated adoption of IFRS and 11 countries that retained domestic accounting standards. We measure information content of earning announcements based on abnormal trading volume and return volatility around firms’ earnings announcements.

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Elevating Board Performance

Posted by Simon Wong, Northwestern University School of Law, on
Sunday, July 3, 2011
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Simon Wong is a Partner at Governance for Owners, an Adjunct Professor of Law at the Northwestern University School of Law, and a Visiting Fellow at the London School of Economics and Political Science.

The global financial crisis has prompted debate once again on how to improve the effectiveness of the board of directors at listed companies. Despite considerable reforms over the past two decades, boards – particularly at financial institutions – have been criticized recently for failing to properly guide strategy, oversee risk management, structure executive pay, manage succession planning, and carry out other essential tasks.

This article argues that the lack of attention to behavioral and functional considerations – such as director mindset, board operating context, and evolving human dynamics – has hampered the board’s effectiveness.

To reach their potential, the article recommends that – alongside establishing core building blocks such as appropriate board size, well-functioning committees, proficient company secretarial support, and professionally-administered board evaluation – boards and their members focus on the following:

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