Monthly Archives: October 2011

Delaware Court’s New Chancellor Provides Guidance on M&A

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, October 5, 2011
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The following post comes to us from Bradley W. Voss, partner in the Commercial Litigation Practice Group of Pepper Hamilton LLP, and is based on a Pepper Hamilton publication. 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.

During a recent hearing on a motion to expedite litigation involving Validus Holdings’s hostile bid to acquire Transatlantic Holdings, Judge Leo E. Strine, Jr., recently promoted to Chancellor of the Delaware Court of Chancery, made several observations worthy of note by deal lawyers, bankers, and corporate litigators.

Banker Conflicts and Fairness Opinions

Validus’s hostile takeover bid came after Transatlantic signed a friendly deal with Allied World. In the process leading to the Allied World agreement, Transatlantic was advised by Goldman Sachs. Apparently in response to a potential Goldman conflict, Transatlantic obtained a fairness opinion from another bank. Chancellor Strine said, “I don’t understand the idea of a banker running a process … and not having to back it up with a fairness opinion. It in no way addresses the conflict for the person who plays the operative role to not actually have to put the fairness opinion on the line. In fact, it would seem more vital when someone acts in a conflicted basis to make them render a fairness opinion.” Where one banker performs important tasks like “testing the market” and “giving strategic advice,” Chancellor Strine thought it “a very strange cure” to a conflict to hand off the job of giving a fairness opinion to another banker who is not compensated as highly. Referencing Smith v. Van Gorkom, Chancellor Strine emphasized the importance of financial advisors in deals and that “conflicts of interest” in the deal process are “taken seriously.”

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Agency Costs in the Era of Economic Crisis

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, October 5, 2011
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The following post comes to us from Mira Ganor of The University of Texas School of Law.

In the paper, Agency Costs in the Era of Economic Crisis – The Enhanced Connection between CEO Compensation and Corporate Cash Holdings, which was recently made publicly available on SSRN, I examine the evolution of the practice of cash hoarding following the Great Recession. The results suggest that managerial behavior, as evidenced by the elasticity of cash holdings as a function of total director compensation, has changed significantly in 2008 with economically meaningful implications. The effect was somewhat diminished the following year, which may be attributed to the growth and stimulus of the second half of 2009, but peaked again in 2010. In particular, I find that following the Great Recession managerial compensation has become positively correlated with the level of corporate cash holdings, suggesting that agency costs contribute to cash retention in times of financial distress.

It is possible that high managerial compensation influences the managers to be more risk averse and thus affects the managers’ decision to retain cash. Since diversified shareholders are likely to be less risk averse than the managers at times of financial crisis, when it is harder to find a comparable alternative job and the probability of complete failure increases, it may well be that the cash hoarding practice is at a suboptimal level and comes at the expense of shareholder value. Thus, the influence of the size of the managerial compensation on the manager’s risk tolerance should be taken into account when evaluating managerial pay.

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For Directors, A Wake-Up Call from Down Under

Posted by David A. Katz, Wachtell, Lipton, Rosen & Katz, on
Tuesday, October 4, 2011
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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.

Earlier this summer, the Federal Court of Australia handed down an important corporate law decision that would appear to have a substantial impact on the way that the statutorily defined responsibilities of directors are understood in Australia. [1] In Australian Securities and Investments Commission v. Healey, the entire board of directors (consisting of seven non-executive directors and the chief executive officer) was found to have breached its duty in failing to notice a significant error in the financial statements, an error that also went uncorrected by the outside auditors and internal employees. The directors were subject to possible financial penalties and bans as a result of the decision, though in the penalty phase of the case, the court determined that the liability judgment itself, with its associated embarrassment and reputational damage, was adequate punishment and deterrence. [2] Though the case involved interpretation of an Australian corporation law statute and was necessarily fact-specific, nonetheless it is worth careful scrutiny, as it serves as a powerful reminder to directors that their role is an active one and, further, may signal the direction in which the understanding of the role of directors generally could be headed.

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Proposed American Jobs Act Would Tax Carried Interest Tax as Ordinary Income

Posted by David S. Huntington, Paul, Weiss, Rifkind, Wharton & Garrison LLP, on
Tuesday, October 4, 2011
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David Huntington is a partner in the Capital Markets and Securities Group at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss client memorandum.

On September 12, 2011, the Obama administration submitted statutory language for the proposed American Jobs Act to Congress. The Administration’s proposal contains a number of revenue offsets, including an updated proposal to tax carried interest as ordinary income. The carried interest proposal is similar to and based on earlier versions of the proposed legislation that have passed the House of Representatives a number of times over the past several years, but have not passed the Senate. The Administration’s proposal, however, makes some significant changes as compared to earlier versions.

In General. The legislation continues to recharacterize carried interest income and gain as ordinary income, and would apply to interests in traditional hedge funds, private equity funds, venture capital funds, and real estate funds that were the focus of the original legislation. It would also continue to treat gain on the sale of such interests as ordinary income.

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Director Histories and the Pattern of Acquisitions

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, October 3, 2011
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The following post comes to us from Peter Rousseau, Professor of Economics at Vanderbilt University, and Caleb Stroup of the Department of Economics at Vanderbilt University.

It is well-known in finance and economics that firms possess private information about their own fundamental values. In our paper, Director Histories and the Pattern of Acquisitions, which was recently made publicly available on SSRN, we contribute to this literature by examining, in the context of the market for corporate control, how the transmission of non-public information about potential targets influences mergers and acquisitions. This is interesting because, despite extensive research on the determinants of acquisitions, we can still only imperfectly predict which firms will choose to initiate acquisitions and, for those that do, how they choose among potential targets.

We capture a potential acquirer’s exposure to target-specific non-public information by tracking the service histories of its directors over time. If a current director was formerly on the board of another firm, we say that the two firms have an historical interlock. We treat these directed firm-pair interlocks as containing information about the firm where the current director once served, and estimate the impact of this information on the decision to initiate an acquisition of that firm. Our main results indicate that a given firm is about five times more likely to initiate an acquisition of a historically-interlocked target than some other unlinked firm.

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SEC Concept Release on Use of Derivatives by Funds

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, October 3, 2011
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The following post comes to us from David Gilberg, partner at Sullivan & Cromwell LLP, and is based on a Sullivan & Cromwell publication.

The Securities and Exchange Commission recently published a concept release and request for comments (the “Release”) on a wide range of issues relating to the use of derivatives by investment companies regulated under the Investment Company Act of 1940, including mutual funds, closed-end funds, exchange-traded funds and business development companies (collectively, “funds”).

The stated purpose of the Release is to assist in the SEC’s evaluation of whether the current regulatory framework, as it applies to funds’ use of derivatives, continues to fulfill the purposes and policies underlying the Act and is consistent with investor protection. The SEC states that it intends to use the comments it receives to help determine whether regulatory initiatives or guidance are necessary to improve the current regulatory regime and the specific nature of any such initiatives.

The Release solicits broad public comment and comprehensive information on any matters that may be relevant to the use of derivatives by funds, and it focuses particular attention, and requests specific comment, on issues relating to:

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Fixing the Watchdog: Evaluating and Improving the SEC

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, October 2, 2011
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Editor’s Note: Mary Schapiro is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Schapiro’s testimony before the U.S. House of Representatives Committee on Financial Services, which is available here. The views expressed in the post are those of Chairman Schapiro and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

I would like to discuss the organizational assessment of the Securities and Exchange Commission recently performed by the Boston Consulting Group, Inc. (BCG). [1] The study was mandated by Section 967 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). My testimony will discuss the specifics of the BCG report and our plans for following up on the report’s many recommendations, and also briefly discuss the two pieces of legislation included in the Committee’s invitation letter concerning the SEC’s organization and method of promulgating rules and issuing orders.

When I arrived at the SEC two years ago, the agency was reeling from a variety of economic events and mission failures that had severely harmed the ability of the agency to achieve its mission of protecting investors, maintaining fair and orderly markets, and facilitating capital formation. Reform was needed across the agency, and we immediately initiated decisive and comprehensive steps to reform the way the Commission operates. We brought in new leadership and senior management in virtually every office (including the Commission’s first Chief Operating Officer and Chief Compliance Officer), revitalized and restructured our enforcement and examination operations, revamped our handling of tips and complaints, took steps to break down internal silos and create a culture of collaboration, improved our risk assessment capabilities, recruited more staff with specialized expertise and real world experience, expanded our training, and, through rulemaking and leveraging of public accounting firms’ efforts, enhanced safeguards for investors’ assets, among other things. Our goal throughout these many changes has been to create a more vigilant, agile and responsive organization to perform the critical mission of the agency.

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Due Diligence Considerations for Nominees

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, October 1, 2011
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The following post comes to us from Ackneil M. Muldrow, partner focusing on merger and acquisition transactions at Akin Gump Strauss Hauer & Feld LLP, and is based on an article by Mr. Muldrow and Louis Kacyn of Egon Zehnder International which originally appeared in Thomson Reuters Accelus “Business Law Currents” publication.

When individuals are approached to join the board of directors of a public or private company, they are often thrilled by the opportunity to provide strategic guidance and advice to a new business enterprise, build new relationships with board members and perhaps transition to a new point in their careers.  However, it is rare for a nominee to complete adequate and systematic due diligence on the prospective company and the members of its board of directors prior to joining.

The premise of this article is simple: due diligence should be a two-way endeavor, undertaken by the company as well as the nominee.  This article provides practical advice for prospective nominees regarding the more refined issues they should consider and the questions they should ask prior to joining a board. With these inquiries significant considerations may be identified and then used in a nominee’s decision calculus.

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