Monthly Archives: October 2011

Volcker Rule – Proposed Regulations

Margaret E. Tahyar is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP.

This week, the Federal Banking Agencies released their proposed regulations implementing the Volcker Rule. Rather than prepare a traditional law firm summary, we have prepared two sets of slides – one that graphically maps the key restrictions on proprietary trading and another that maps the key restrictions on relationships with hedge funds or private equity funds. Each set of slides includes an annex providing a deeper dive into the quantitative metrics, market making and compliance requirements. We hope the slides will allow readers to visualize the structure of the Volcker Rule, making it easier to understand and analyze.

Interactive versions of the flowcharts are available at, which is part of the Davis Polk Portal. As we develop additional features for the flowcharts, we will upload them to this site. To view or print PDF versions of the flowcharts and annexes, click below:

Proprietary Trading: Summary Version (20 pages), With Annexes (82 pages)
Hedge/PE Funds: Summary Version (21 pages), With Annexes (32 pages)

The Most Influential People in Corporate Governance

A review of the most recent Directorship 100 list – a list of the most influential people in corporate governance put together each year by Directorship magazine – indicates that individuals affiliated with Harvard Law School and its Program on Corporate Governance play a central role in the corporate governance landscape.

This year’s Directorship 100 list includes forty individuals who are Harvard Law School faculty or fellows, guest contributors to the Forum on Corporate Governance and Financial Regulation, and/or Harvard Law School alumni. The “Harvard Forty” (with graduation year in parenthesis for those who are HLS alumni) are as follows:

The full Directorship 100 list is available here.

A Two-Pronged Approach to Reforming International Corporate Taxes in the U.S

Editor’s Note: Robert Pozen is a senior lecturer at Harvard Business School and a senior fellow at the Brookings Institution. This post is based on an article that first appeared in Tax Notes International, which is available (including footnotes) here.

The current system for taxing the income of controlled foreign subsidiaries of U.S. corporations — foreign-source income — makes no sense for U.S. multinational companies or the U.S. Treasury. In theory, foreign-source income is taxed at the standard U.S. corporate tax rate of 35 percent; in practice, Treasury generally receives no taxes on foreign-source income as long as it is held overseas. In fact, U.S. corporations now hold abroad an estimated $1.5 trillion in cash, which the current system encourages them to deploy by acquiring foreign companies and building overseas facilities.

In response, some U.S. multinationals are lobbying for a tax holiday on repatriation of their foreign-source income, similar to the one enacted in 2004. Such a tax holiday would reduce the effective tax rate on those repatriations to 5.25 percent for a limited time period, for example one year. This proposal for another tax holiday is reportedly gathering steam in some circles of liberal Democrats.

Another tax holiday for repatriated foreign profits would be a transition to nowhere. It does not address the fundamental problems of the current tax system. Indeed, it reinforces the incentives for U.S. multinationals to keep their foreign profits in overseas accounts — waiting for the next tax holiday.


Nonprofit Boards: Size, Performance and Managerial Incentives

The following post comes to us from Rajesh Aggarwal of the Department of Finance at the University of Minnesota; Mark Evans of the Department of Accounting at Indiana University; and Dhananjay Nanda, Professor of Accounting at the University of Miami.

In the paper, Nonprofit Boards: Size, Performance and Managerial Incentives, forthcoming in the Journal of Accounting and Economics as published by Elsevier, we study the relation between a nonprofit organization’s board of directors and the number of programs or objectives it pursues, its performance and its manager’s incentives. We posit that board membership is only conferred on directors that bring assets that are valuable to the nonprofit. However, the conferred control rights allow the directors to use the organization to pursue their own objectives. We hypothesize that directorship is only granted when the value of a director’s asset exceeds the cost of accommodating their objective. Consequently, we predict that board size is positively related to the number of objectives a nonprofit pursues, its performance in raising and spending funds, and inversely related to its managers’ incentives.


Present and Future Challenges for the Banking Industry and the FDIC

Editor’s Note: Martin Gruenberg is Acting Chairman of the Federal Deposit Insurance Corporation. This post is based on Chairman Gruenberg’s remarks to the American Banker Regulatory Symposium, available here.

Condition of the Banking Industry

The FDIC and the banking industry are only now emerging from the most severe financial crisis since the 1930s. The latest data, released by the FDIC in its Quarterly Banking Profile last month, indicate that banks have continued to make gradual but steady progress in recovering from the financial market turmoil and severe recession that unfolded from 2007 through 2009.

The economic recovery, now entering its third year, has been marked by continued distress in real estate markets and a slow, painful process of balance-sheet repair by households, financial institutions, small businesses, and, now, governments at all levels. The result has not only been sub-par growth compared with previous recoveries, but also a persistent uncertainty about the future prospects for the economy, for jobs, and for the banking industry.

All of these trends are, of course, of concern to policymakers and to the public. The FDIC remains alert to these challenges going forward.


Broker-Dealers Respond to Dodd-Frank and FINRA

The following post comes to us from Michael Patterson, Principal, Financial Services at Ernst & Young LLP, and is based on an Ernst & Young publication.

We recently conducted a survey of broker-dealer compliance officers to gather perspectives and practices around new regulatory initiatives and amendments that will likely have a material impact on financial institutions: the Dodd-Frank Act and FINRA’s know-your customer (KYC) and suitability rules.

We thought it would be useful to understand how firms and their compliance functions are responding.

The survey consisted of 12 questions focused on 4 specific initiatives:

  • 1. The uniform fiduciary standard under Dodd-Frank Title IX
  • 2. Regulation of the over-the-counter (OTC) derivatives markets under Dodd-Frank Title VII
  • 3. The Volcker Rule regulating proprietary trading under Dodd-Frank Title VI
  • 4. FINRA’s new KYC and suitability rules (FINRA Rules 2090 and 2111)


Institutional Investors: The Next Frontier in Corporate Governance

Ben W. Heineman, Jr. is a former GE senior vice president for law and public affairs and a senior fellow at Harvard University’s schools of law and government. Stephen M. Davis is the Executive Director of Yale University School of Management’s Millstein Center for Corporate Governance and Performance. This post is based on a paper by Mr. Heineman and Mr. Davis, available here or here.

Although institutional investors play a major role in our public equity markets, far less is known about the governance of those investor entities than about investee corporations. These investors are critical to individuals, equity markets, publicly held companies, the economy — and to the troubling (and conceptually difficult) issue of good versus bad short-termism in investor and investee behavior. Put simply, the fundamental issue is whether institutional investors are part of the problem or part of the solution within the current state of market capitalism. By institutional investors we mean, at a minimum, pension funds, mutual funds, insurance companies, hedge funds and endowments of non-profit entities like universities and foundations. Recent developments in public policy treat shareholders (primarily institutional investors) as part of the “solution.” The Dodd-Frank Act in the United States and the Stewardship Code in the United Kingdom, for instance, essentially place big bets that institutions can and will police the market with new powers and responsibilities. While this is a worthy objective, it rests on unexamined and unsophisticated assumptions.

In a new paper, Are Institutional Investors Part of the Problem or Part of the Solution?, we attempt to outline major descriptive and prescriptive issues relating to these institutional investors (the paper is available from Yale’s Millstein Center here, and from the Committee for Economic Development here). We call for much greater intellectual and institutional effort in addressing these vital but under-analyzed questions. Set out below is the essence of our argument for much more sophisticated analysis of the governance of institutional investors — based on development of much more robust data bases about the critical elements of investor governance and performance.


Complexity, Innovation and the Regulation of Modern Financial Markets

The following post comes to us from Daniel Awrey of the University of Oxford Faculty of Law.

The working paper, Complexity, Innovation and the Regulation of Modern Financial Markets, which was recently made publicly available on SSRN, was motivated by two observations.

First, the perfect market assumptions underpinning the canonical theories of financial economics – modern portfolio theory; the Modigliani and Miller capital structure irrelevancy principle; the capital asset pricing model, and the efficient market hypothesis – are increasingly unreflective of how many modern financial markets work in practice.  More specifically, these theories share a common and highly stylized view of financial markets, one characterized by perfect information, the absence of transaction costs and rational market participants.  Yet in reality, of course, financial markets rarely (if ever) strictly conform to these assumptions.  Information is costly and unevenly distributed; transaction costs are pervasive, and market participants frequently exhibit cognitive biases and bounded rationality.  Despite these seemingly uncontroversial facts, however, the empirically (con)testable assumptions of conventional financial theory have been transformed into the central articles of faith of the ideology of modern finance: the foundations of a widely held belief in the self-correcting nature of markets and their consequent optimality as mechanisms for the allocation of society’s resources.


Bankruptcy Court Decision May Impact Claims Trading and Plan Negotiation

The following post is based on a Davis Polk & Wardwell LLP client newsletter by Damian Schaible, Donald Bernstein, and Marshall S. Huebner from the Insolvency and Restructuring Practice at Davis Polk.

On September 13, 2011, Judge Mary Walrath of the United States Bankruptcy Court for the District of Delaware surprised many parties in interest and observers of the case by issuing an opinion denying confirmation of the modified proposed plan of reorganization of Washington Mutual, Inc. (“WMI”) and its affiliated debtors. The modified plan incorporated certain changes Judge Walrath had indicated were necessary in a January 2011 opinion denying confirmation of a prior version of the plan, and many expected that these changes would be sufficient to ensure confirmation of the modified plan. Although the decision turned primarily on the rate of post-petition interest awarded to certain creditors of WMI, the Court’s extensive discussion of allegations of “insider trading” raised against certain claims purchasers is likely to attract the most attention. Judge Walrath’s findings on these allegations may have a significant impact on claims trading and negotiation dynamics in complex chapter 11 cases going forward.


Say on Pay Drives Compensation Program Changes

Matteo Tonello is Director of Corporate Governance for The Conference Board, Inc. This post is based on a Conference Board Director Note by Russell Miller and Yonat Assayag of ClearBridge Compensation Group.

The arrival of say-on-pay (SOP) votes has renewed the focus of directors and senior management on striking the right balance between designing an effective executive compensation program that supports the company’s strategic business objectives and one that is sensitive to shareholder perspectives. As a result, many companies made changes to their compensation programs this year, aimed at enhancing the relationship between pay and performance in preparation for their first SOP votes. This report examines the changes made by some Fortune 500 companies and includes recommendations for companies to consider in their 2012 compensation decision-making.

An analysis of the first 100 proxy filings by Fortune 500 companies (First 100) subject to shareholder advisory votes under the Dodd-Frank Wall Street Reform and Consumer Protection Act demonstrates some of the real effects SOP has had on executive compensation. [1] A key learning from those filings is that companies that perform and successfully demonstrate that their pay programs support and drive performance are more likely to win shareholder SOP votes.


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