Monthly Archives: September 2011

SEC Concept Release on Use of Derivatives by Investment Companies

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. Press releases about the concept releases and proposed rule described below are available here and here.

On August 31, 2011, the SEC issued (i) a concept release (the “Derivatives Concept Release”) soliciting public comment on the use of derivatives by registered investment companies under the Investment Company Act of 1940 (the “ICA”); (ii) an advance notice of proposed rulemaking on the treatment of asset-backed issuers under the ICA (the “Proposed Rule”); and (iii) a concept release (the “Mortgage Concept Release”) seeking public comment regarding the ICA status of companies engaged in the business of acquiring mortgages and mortgage-related instruments.

A brief summary of key topics in each release is below.


Capital Market Consequences of Managers’ Voluntary Disclosure Styles

The following post comes to us from Holly Yang of the Department of Accounting at the University of Pennsylvania.

In the paper, Capital Market Consequences of Managers’ Voluntary Disclosure Styles, which is forthcoming in the Journal of Accounting and Economics, I examine the capital market consequences of managers establishing an individual disclosure style. While both neoclassical economic and agency theories suggest that managers’ individual preferences should not have an effect on corporate outcomes, several recent academic studies find that managers have styles of their own that they carry from one firm to the other. Anecdotal evidence also suggests that manager credibility matters to financial analysts, who penalize CEOs and CFOs that fail to effectively manage expectations. To the extent that these manager-specific “styles” affect investors’ perceptions of the manager’s overall reputation and credibility, investors should take this into consideration when responding to managers’ disclosure decisions.


International Corporate Governance Network Honors Bebchuk

Last week, at the 2011 annual meeting held in Paris of the International Corporate Governance Network (ICGN), Professor Lucian Bebchuk received an ICGN award for excellence in corporate governance. ICGN awards are given annually in recognition of “exceptional achievements in the corporate governance field.”

According to the remarks delivered at the ceremony by the chair of the ICGN awards committee Richard Bennett, Bebchuk received the award “for the volume and quality of his research, particularly around executive compensation and the relationship of governance to value and firm performance. Over two decades this research has provided a base of integrity and learning for scholars, policy makers, and legislators.” Quoting a letter from Robert Monks, Bennett added that Bebchuk “is the epitome of honest, painstaking, unprejudiced analysis; he is in truth an academic icon” and that “[a]ll of us are in his debt.”

The ICGN is a global membership organization of over 500 leaders in corporate governance based in 50 countries. Information about the ICGN awards, and about the past recipients of such awards, is available here.

Court Rules Insolvent Delaware LLC Creditors Cannot Assert Derivative Claims

The following post comes to us from Mark S. Chehi, a partner in the Corporate Restructuring Group of Skadden, Arps, Slate, Meagher & Flom LLP, and is based on a Skadden, Arps memorandum by Mr. Chehi, Allison L. Land, Robert S. Saunders, and Robert A. Weber. 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.

In a recent en banc decision by the Delaware Supreme Court in CML V, LLC v. Bax, 2011 Del. LEXIS 480 (Del. Sept. 2, 2011), the Delaware Supreme Court held that creditors of a Delaware limited liability company (LLC) have no standing to assert derivative claims on behalf of an LLC, even if the LLC is insolvent. The ruling rests on the plain language of Section 18-1002 of the Delaware Limited Liability Company Act (the LLC Act), which expressly provides that only members and assignees of an interest in an LLC have standing to bring derivative claims in the right of the LLC.

The Delaware Supreme Court’s decision in Bax makes it clear that creditors of an insolvent Delaware LLC have lesser rights than creditors of an insolvent Delaware corporation because creditors of an insolvent Delaware corporation do “have standing to maintain derivative claims against directors on behalf of the corporation for breaches of fiduciary duties.” N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007) (“Gheewalla”). [1]


The SEC and Banks’ Loan Loss Reserve Policies

The following post comes to us from Paul Beck and Ganapathi Narayanamoorthy, both of the Department of Accountancy at the University of Illinois at Urbana-Champaign.

In our paper, Did the SEC Impact Banks’ Loan Loss Reserve Policies and Their Informativeness?, which was recently made publicly available on SSRN, we study the joint impact of the SEC’s intervention in bank regulation during the late 1990’s and earnings management. In contrast with traditional bank regulators who focused on understatement (adequacy) of banks’ loan loss reserves, the SEC was concerned with overstatement of loan loss reserves to manage reported income. The SEC’s intervention in banking regulation involved several initiatives. These included investigations of banks that were alleged to have overstated loan loss allowances, the issuance of loan loss guidance in Staff Accounting Bulletin (SAB) 102, and pressuring traditional bank regulators belonging to the Federal Financial Institutions Examination Council (FFIEC 2001) to issue a policy statement affirming SAB 102 guidance. The SAB 102 loan loss guidance requires bank holding companies to use a consistent methodology that can be justified vis-à-vis actual loan loss (charge-off) rates and also imposes responsibility on bank examiners and financial statement auditors to evaluate controls over the loan loss estimation process.


Proxy Season 2011: A Tipping Point for Social and Environmental Issues?

The following post comes to us from Heidi Welsh, Executive Director at the Sustainable Investments Institute (Si2), with input from Tim Smith, Senior Vice President at Walden Asset Management, and was adapted from the executive summary of a longer report on the results of the 2011 proxy season published by Si2.

It doesn’t take a majority to make a revolution, particularly when old paradigms have developed deep fault lines. A significant and growing portion of investors think the companies they own need to take more proactive, transparent action on a broad range of social, environmental and governance issues, to protect long-term shareholder value. One measure of support for this view is the global group of 870 investors who manage more than $25 trillion and have signed on to the UN Principles for Responsible Investment. Another is the Carbon Disclosure Project, which now boasts support from investors with $71 trillion of AUM and presses companies to disclose how they are reducing their carbon footprints. Clearly there is an explosion of involvement by investors—“shareowners,” not just passive shareholders—who work to integrate ESG issues into their investment decisions and engagements with companies.

Additional hard evidence of sentiment favoring reform comes from the recently concluded 2011 proxy season, which arguably marks a new tipping point for social and environmental issues. Active shareowners now are voting their convictions more than ever, sending a strong message to company managements and boards. This analysis focuses on the spring “proxy season“ results as one strong indicator of the expansion of investor interest and support for company evolution to higher levels of corporate responsibility.


Say-on-Pay Under Dodd-Frank

Joseph Bachelder is founder and senior partner of the Bachelder Law Firm. This post is based on an article that first appeared in the New York Law Journal by Mr. Bachelder, with assistance from David T. Ling and Andy Tsang.

Say-on-pay has completed most of its first proxy season under the Dodd-Frank Wall Street Reform and Consumer Protection Act. [1] For this purpose, say-on-pay means a non-binding vote by shareholders of a publicly traded company pursuant to Dodd-Frank Section 951 to approve or disapprove the executive compensation program at that company. [2]

During the 2011 proxy season so far approximately 40 companies in the Russell 3000 have reported that a majority of their shareholder votes disapproved of the executive pay program at the company. This represents about 2 percent of the approximately 2,300 companies in the Russell 3000 that have had say-on-pay votes so far during the 2011 proxy season. [3] At another approximately 130 companies, between 30 percent and 50 percent of votes cast were negative votes or abstained. (Abstentions were very few.) Thus, during the 2011 proxy season so far, approximately 170 companies in the Russell 3000 had less than 70 percent of votes cast in favor of the company’s pay programs. [4]


Making Banks Transparent

The following post comes to us from Robert P. Bartlett III, Assistant Professor of Law at the University of California, Berkeley.

In the paper, Making Banks Transparent, forthcoming in the Vanderbilt Law Review, I propose a mandatory disclosure regime designed to make the credit risk residing on the balance sheets of financial institutions more transparent to the marketplace than is presently the case. As the Financial Crisis and the more recent European sovereign debt crisis each illustrated, U.S. financial institutions represent uniquely opaque organizations for investors in capital markets. Although bank regulatory policy has long sought to promote market discipline of banks through enhanced public disclosure, bank regulatory disclosures are notoriously lacking in granular, position-level information concerning their credit investments due largely to conflicting concerns about protecting the confidentiality of a bank’s proprietary investment strategies and customer information. When particular market sectors experience distress, investors are thus forced to speculate as to which institutions might be exposed, potentially causing significant disruptions in credit markets and contributing to systemic risk. Together with the failure of bank regulators to monitor bank risk-taking prior to the Financial Crisis, these concerns have prompted renewed calls for making financial institutions more transparent.


SEC Action Needed to Fulfill the Promise of Citizens United

Editor’s Note: John Coates is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School. Taylor Lincoln is Research Director at Congress Watch. More information about the SEC petition mentioned below is available here; more posts about corporate political spending are available here.

As we note in a recent op-ed in the Washington Post, the Supreme Court’s Citizens United decision to let corporations spend unlimited sums in federal elections was premised on a pair of promises: Corporations would disclose expenditures, and shareholders would police such spending.

Those promises remain unfulfilled: of the more than $300 million spent by outside groups in 2010, nearly half was spent by groups that revealed nothing about their funders, double the total spending by outside groups in 2006, as shown in analyses by the Center for Responsive Politics.

The best chance to fulfill those promises may now rest with the SEC, which was recently petitioned to begin a rule-making process to require disclosure of political activity by corporations.

Contrary to consensus views, SEC action may benefit owners of affected firms. In a new report, we estimate industry-adjusted price-to-book ratios of 80 companies in the S&P 500 that have policies calling for disclosure of electioneering. After controlling for size, leverage, research and development, growth and political activity, we find disclosing companies had 7.5 percent higher ratios than other S&P 500 companies in 2010.


September 2011 Dodd-Frank Rulemaking Progress Report

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 September Davis Polk Dodd-Frank Progress Report, is the sixth 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.

In this report:

  • No New Deadlines. No new rulemaking requirements were due in August.
  • 9 Requirements Met, 3 Proposed. Four deadlines that had been previously missed were met, and five with future deadlines were finalized. Two of the proposed rules, one from the SEC and one from the Federal Reserve, appear as missed requirements as their deadlines have passed.
  • Bank Regulators. Although August was a quiet month for the Bank Regulators, they are expected to take action on several key items in the coming months, including issuing rules regarding resolution plans and implementation of the Volcker Rule.
  • CFPB Begins Rulemaking. The CFPB finalized its first 5 rules in late July. None had a statutory deadline.
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