Monthly Archives: August 2011

SEC Adopts Large Trader Reporting Requirements

Lanny Schwartz is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum.

On July 26, 2011, the SEC adopted Rule 13h-1 under the Securities Exchange Act of 1934 to require large trader registration and reporting. [1] The rule requires persons who directly or indirectly exercise investment discretion and purchase or sell more than a specified amount of U.S.-listed stocks and options through a registered broker-dealer to register with the SEC as large traders. These large traders must obtain a unique identification number and provide it to their registered broker-dealers. Registered broker-dealers must comply with monitoring, recordkeeping and reporting requirements with respect to registered large traders and persons who such broker-dealers know or have reason to know are large traders.

The rule will effectively require the ultimate parent companies of groups that may be large traders on a group-wide basis to develop corporate systems to enable them to identify all of their affiliates that have investment discretion with respect to U.S.-listed stocks and options. In addition, they must gather and report facts about the businesses, trading activities, regulation and brokerage relationships of the group on a combined basis. Registered broker-dealers will need to enhance their recordkeeping and reporting capabilities (using the existing Electronic Blue Sheets system) regarding large trader activity in accounts they carry, and develop systems to identify accountholders who may be “Unidentified Large Traders.”


Moderate Decrease in Federal Securities Fraud Class Action Filings in First Half of 2011

John Gould is Senior Vice President at Cornerstone Research, and Joseph A. Grundfest is the W. A. Franke Professor of Law and Business at Stanford University Law School. This post is based on a report prepared by the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research, available here.

Federal securities class action activity decreased in the first six months of 2011, according to Securities Class Action Filings—2011 Mid-Year Assessment, a semiannual report prepared by the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research. A total of 94 federal securities fraud class actions were filed in the first half of the year, representing a 9.6 percent decrease from the 104 filings in the second half of 2010. This decline includes a drop in credit-crisis filings; there were just two such filings in the first half of 2011. Twenty-four filings related to Chinese reverse mergers accounted for 25.5 percent of all filings in the first half of 2011. There were 21 traditional M&A filings in the first half of 2011, which constituted 22.3 percent of all filings. Taken together, Chinese reverse mergers and traditional M&A filings constituted 47.9 percent of all securities fraud class action complaints filed during the last six months, up from 32.7 percent in the last six months of 2010.


Corporate Governance of LBOs

The following post comes to us from Francesca Cornelli of the Department of Finance at the London Business School and Oguzhan Karakas of the Department of Finance at Boston College.

In our paper, Corporate Governance of LBOs: The Role of Boards, which was recently made publicly available on SSRN, we study whether the success of private equity-backed firms is due to their superior corporate governance or instead due to financial engineering. We focus in particular on the role of boards in LBOs and look at changes in the board when a public company is taken private by a private equity group.

We construct a new data set, which follows the board composition and financial figures of all public to private transactions that took place in the UK between 1998 and 2003. Out of these 142 transactions, 88 have private equity sponsors and are thus identified as LBOs. The remaining transactions are either pure MBOs or other types, and are used as benchmarks. We track each company two or three years before the announcement of the buyout until the exit of private equity investors or until 2010, whichever is earlier.

We find that when a company goes private, fundamental shifts in board size and composition take place. The board size decreases on average by 15% and the presence of outside directors is drastically reduced, as they are replaced by individuals employed by the private equity sponsors. We also find evidence that the board size and presence of LBO sponsors on the board depend on the “style” or preferences of the private equity firm. Overall, the boards become more in line with the type of boards that the corporate governance literature would identify as exhibiting better corporate governance. We then set to find out what role these boards play.


Investigative Authorities of House and Senate Committees

The following post comes to us from Michael D. Bopp, Partner at Gibson, Dunn & Crutcher LLP and Chair of the firm’s Congressional Investigations Group, and is based on a Gibson Dunn Alert by Mr. Bopp and Mel Levine. This post discusses authorities of Congressional committees, which are described in a corresponding table from Gibson Dunn here.

Congress has inherent power to investigate and that power has been delegated to House and Senate Committees. Both House and Senate rules, for example, give standing committees the ability to issue subpoenas, hold hearings, and conduct investigations. [1] It can be a harrowing experience to receive a request for information or documents or for an interview or deposition from a congressional committee. But does it matter which committee the request comes from? Do committees all have the same investigative authorities or are there differences and, if so, do the differences matter?

In fact, it often does matter which committee is conducting the investigation as authorities can and do differ, and often the differences do matter.

Congressional committees have the power to issue subpoenas to compel witnesses to produce documents, testify at committee hearings, and, in some cases, appear for depositions. Although the Fifth Amendment likely applies in the context of a congressional investigation, [2] standing committees nevertheless may appeal to the full House or Senate to hold in contempt any witness who refuses to appear, answer questions, or produce documents. Congressional contempt authority may take one of three forms: inherent, civil, or criminal. Failure to adhere to committee rules during an investigation may thus have severe legal consequences.


2011 Mid-Year 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 an abridged version of a Gibson Dunn client alert; the full version, including footnotes, is available here.

I. Overview of the First Half of 2011

Robert Khuzami, the Director of the Division of Enforcement (the “Division”) of the SEC, recently took stock of the SEC’s accomplishments in the two years since he began his term. Specifically, he focused on the Division’s restructuring, calling it the “most significant” since the Division’s creation almost 40 years ago. In describing the restructuring, he noted that it was composed of many initiatives that were intended to achieve a series of common goals including: achieving a better understanding of the products, markets, transactions and practices policed by the Commission; identifying and terminating fraud and misconduct more quickly; increasing efficiency in the use of resources; and maximizing the Division’s deterrent impact by swiftly addressing threats as they develop and before they can permeate entire business lines or industries.

In order to achieve these goals, this Commission is marked by a continued willingness to take on risk in litigation, particularly in cases related to insider trading and to extend jurisdiction and remedies. The last six months have seen some significant victories in the SEC’s litigation efforts and accordingly, we expect the SEC to continue to pursue an aggressive strategy of filing cases against prominent defendants to demonstrate its vigor in investor protection. Highlights of the past six months include:

  • Finalizing the Whistleblower Rules of the Dodd-Frank Act;
  • The first use of a deferred prosecution agreement;
  • The first use of the authority granted under the Dodd-Frank Act to pursue penalties against unregistered persons in administrative proceedings;
  • Continued emphasis on cases related to the financial crisis;
  • Continued application of the Sarbanes-Oxley “clawback” remedy;
  • Continued focus on insider trading, particularly by persons employed by hedge funds; and
  • A warning to defense counsel to avoid conduct that is “questionable, or worse” in defending clients in SEC investigations.


Regulatory Capital Surcharge for Global Systemically Important Banks

H. Rodgin Cohen is partner and senior chairman, and Mark Welshimer is deputy managing partner of the Financial Institutions Group, at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell LLP publication.

On July 19, 2011, the Basel Committee on Banking Supervision (the “BCBS”) [1] issued a consultative document setting forth a requirement for a new common equity capital surcharge on certain global systemically important banks (“G-SIBs”). [2] A summary of the surcharge proposal was announced on June 25, 2010 in a short press release by the Group of Governors and Heads of Supervision of the BCBS. [3] The July 29 consultative document now describes the proposal in significantly more detail. The main elements of the surcharge proposal are as follows:

  • G-SIBs would be subject to an additional progressive Common Equity Tier 1 (“CET1”) surcharge, referred to in the consultative document as a “loss absorbency requirement” ranging from 1% to 3.5% over the Basel III 7% CET1 requirement.
  • The exact amount of the surcharge depends on a bank’s placement in one of five “buckets” (requiring a 1%, 1.5%, 2%, 2.5% and 3.5% surcharge, respectively) based on the bank’s global systemic importance under the proposal’s methodology.


State Ownership and Corporate Governance

The following post comes to us from Mariana Pargendler of the Fundação Getulio Vargas School of Law at São Paulo.

In the paper State Ownership and Corporate Governance, which was recently made publicly available on SSRN, I explore the role of the state as shareholder in the political economy of corporate governance. Although atypical in the United States, state ownership of listed companies is pervasive and growing elsewhere in the world. According to a recent survey, state-owned enterprises are now responsible for approximately one-fifth of global stock market value, which is more than two times the level observed just one decade ago.

There is a large literature exploring the potential inefficiencies of state control of enterprise, and a growing literature on the ways in which the law, and in particular corporate law, might be structured to limit those inefficiencies. In this paper, I look at the other side of the problem: what is the effect of state ownership on the structure of corporation and capital markets law, not just as it applies to state-controlled firms but as it applies in general to firms that are entirely privately owned? The latter issue is arguably as important as, or even more important than, the problem of controlling the inefficiencies of state ownership, but it has been almost entirely neglected.


Why CEO-to-Worker Pay Ratios Matter to Investors

Daniel Pedrotty is the Director of the AFL-CIO Office of Investment. This post is based on an AFL-CIO briefing paper available here.

Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires public companies to disclose the ratio of compensation between their CEO and their median employee. The Securities and Exchange Commission will propose regulations to implement this requirement later this year. In this briefing paper, the AFL-CIO Office of Investment argues why CEO-to-worker pay ratios matter to investors.

First of all, changes in CEO-to-worker pay ratios are a useful measure of growing CEO pay levels. In 1980, BusinessWeek magazine estimated that the top executives of the largest U.S. companies made 42 times the pay of factory workers. In 2010, the gap between CEO pay at S&P 500 companies and the median U.S. worker had soared to 343 times, according to the AFL-CIO’s Executive PayWatch website.

Secondly, CEO-to-worker pay ratio disclosure will help reduce CEO pay levels. Existing disclosure rules encourage setting CEO pay levels based on “peer group analysis” that has contributed to CEO pay inflation. Pay ratio disclosure will encourage Boards to also consider the relationship of CEO pay to other company employees. Companies with high pay ratios will have to explain and justify their ratio to their shareholders.


Limitations on Contributions Would Undercut Directors

David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. This post is based on an article by Mr. Katz and Laura A. McIntosh that first appeared in the New York Law Journal. This post references a paper from the Program on Corporate Governance by Lucian Bebchuk and Robert Jackson titled Corporate Political Speech: Who Decides?, discussed on the Forum here. A committee of law professors co-chaired by Bebchuk and Jackson recently submitted a rulemaking petition to the SEC concerning corporate political spending; that petition is discussed here.

In mid-July, the Shareholder Protection Act [1] was reintroduced into Congress, representing the latest attempt by shareholder activists to extend corporate governance requirements to cover political spending by corporations in the wake of last year’s Supreme Court decision in Citizens United v. Federal Election Commission. [2] If it were to be adopted and signed into law, the Shareholder Protection Act would create a formidable set of burdens for corporations that wish to make political-speech contributions, while exempting labor unions from its requirements. Just like a similar legislative initiative, the DISCLOSE Act of 2010 (also known as the Democracy Is Strengthened by Casting Light on Spending in Elections Act), [3] which failed to pass Congress, the Shareholder Protection Act is a poorly conceived concept from a corporate governance perspective.


The 2011 CEO Succession Report

Matteo Tonello is Director of Corporate Governance for The Conference Board, Inc. This post is based on a Conference Board report by Mr. Tonello and Jason Schloetzer of Georgetown University.

In our study, The 2011 CEO Succession Report, which The Conference Board recently released, we document 2009-2010 succession events regarding the chief executive officer of S&P 500 companies and analyze those events in the historical context of the last two decades.

The report is organized in four parts.

Part I: CEO Succession Trends illustrates year-by-year succession rates and examines specific aspects of the succession phenomenon, including the influence on firm performance on succession and the characteristics of the departing and incoming CEOs.

Part II: CEO Succession Practices details where boards assign responsibilities on leadership development, the role performed within the board by the retired CEO, and the extent of the disclosure to shareholders on these matters.

Part III: Notable Cases of CEO Succession (2009-2010) includes summaries of 10 episodes of CEO succession that made headlines in the past two years and that were carefully chosen to highlight key circumstances of the process.

Part IV: Shareholder Activism on CEO Succession Planning (2010-2011) reviews examples of companies that have recently faced shareholder pressure in this area.


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