Monthly Archives: November 2011

ISS Issues Policy Updates for 2012 Proxy Season

Holly Gregory is a Corporate Partner specializing in corporate governance at Weil, Gotshal & Manges LLP. This post is based on a Weil Gotshal Alert. The complete article, including the appendix, is available here.

On November 17, 2011, Institutional Shareholder Services Inc. (ISS) issued updates to its proxy voting policies applicable to shareholder meetings held on or after February 1, 2012. This Alert summarizes and discusses implications of those updates for US companies. The ISS proxy voting guidelines and the updates are available at

ISS is generally considered the most influential proxy advisor in the US. Recent studies have found that ISS is able to influence shareholder votes by 6% to 20%. [1] In preparing for 2012 annual meetings, corporate counsel, corporate secretaries, and directors (particularly those serving on compensation or nominating and governance committees) should review the ISS policy updates and consider how the changes may affect ISS’ evaluation of director re-elections, executive compensation matters, and other matters for shareholder vote. Note that for the 2012 proxy season, ISS has identified over 50 circumstances that may support a negative vote recommendation (either “against” or “withhold”) in uncontested director elections.


Equilibrium in the Initial Public Offerings Market

The following post comes to us from Jay Ritter, Professor of Finance at the University of Florida.

The critical review article, Equilibrium in the Initial Public Offerings Market, forthcoming in the Annual Review of Financial Economic,  focuses on selected topics dealing with initial public offerings (IPOs) of equity securities, emphasizing issues that are of current interest to academics, practitioners, and policymakers.

On average, the average first-day returns on IPOs in the U.S. and most other countries appear to be higher than they should be if companies were trying to maximize the amount of money being raised. I criticize the ability of popular asymmetric information-based models to explain the magnitude of the underpricing of IPOs that is observed. I suggest that the quantitative magnitude of underpricing can be explained with a market structure in which underwriters want to underprice excessively, issuers are focused on services bundled with underwriting rather than on maximizing the offer proceeds, and there is limited competition between underwriters. I explain why competition is limited, in spite of the existence of dozens of underwriters competing for deals.


The Corporate Shareholder’s Vote and Its Political Economy

Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law. Work from the Program on Corporate Governance about shareholder voting includes Private Ordering and the Proxy Access Debate by Bebchuk and Hirst; more posts about proxy access are available here. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

At the Columbia Law School conference on the Delaware Chancery Court this November, I summarized my recent working paper The Corporate Shareholder’s Vote and Its Political Economy, in Delaware and in Washington. I discuss this paper below. Related work includes Delaware’s Competition, Delaware’s Politics, and Delaware and Washington as Corporate Lawmakers.

Shareholder power to effectively nominate, contest, and elect the company’s board of directors became core to the corporate governance reform agenda in the past decade, as corporate scandal and financial stress put business failures and scandals into headlines and onto policymakers’ agendas. As is well known to corporate analysts, the incentive structure in corporate elections typically keeps shareholders passive, and incumbent boards largely control the electoral process, usually nominating and electing themselves or their chosen successors. Contested corporate elections are exceedingly rare. But shareholder power to directly place their nomination for a majority of the board in the company-paid-for voting documents, as the SEC has pushed toward, could revolutionize American corporate governance by sharply shifting authority away from insiders, boards, and corporate managements. During the past decade, the SEC proposed, withdrew, and then promulgated rules that would shift the control of some corporate election machinery, to elect a minority of the board, away from insiders and into shareholders’ hands. Then, in July 2011, the D.C. Circuit Court of Appeals struck down the most aggressive of the SEC’s rules.


FINRA Proposed Rule on Private Placements

The following post comes to us from Robert E. Buckholz, Jr., partner at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication.

In January 2011, FINRA proposed to amend Rule 5122 (“Private Placements of Securities Issued by Members”) so that its disclosure and filing requirements, which currently apply only to private placements of securities issued by a FINRA member or a “control entity” of a member, would apply to all private placements, including those of unaffiliated issuers, covered by the rule. [1] On October 18, 2011 and in response to comments on the January proposal, FINRA withdrew its proposal to amend Rule 5122 and instead submitted new proposed Rule 5123 (“Private Placements of Securities”) to the Securities and Exchange Commission for adoption. [2] Rule 5122 would remain unchanged.

Proposed Rule 5123 would prohibit members and persons associated with a member from offering or selling a security in reliance on an exemption from registration under the Securities Act of 1933 (which the proposed rule defines as a “private placement”), or from participating in the preparation of a private placement memorandum, term sheet or other disclosure document in connection with such a private placement, unless the member or associated person provides to each investor, prior to sale, information about the anticipated use of the offering proceeds and the amount and type of offering compensation and expenses. This required information must be included in a private placement memorandum or term sheet or, if none is prepared, in a separate disclosure document. Although the rule’s definition of “private placement” is literally quite broad, it is unclear whether FINRA intends the rule to apply outside the context of non-public offerings generally effected pursuant to Section 4(2) or Regulation D.


Investment Cycles and Startup Innovation

The following post comes to us from Ramana Nanda and Matthew Rhodes-Kropf, both of the Entrepreneurial Management Unit at Harvard Business School.

In our paper, Investment Cycles and Startup Innovation, which was recently made publicly available on SSRN, we examine how the environment in which a new venture was first funded relates to their ultimate outcome. New firms that surround the creation and commercialization of new technologies have the potential to have profound effects on the economy. The creation of these new firms and their funding is highly cyclical (Gompers et al. (2008)). Conventional wisdom associates the top of these cycles with negative attributes. In this view, an excess supply of capital is associated with money chasing deals, a lower discipline of external finance, and a belief that this leads to worse ventures receiving funding in hot markets.

However, the evidence in our paper suggests another, possibly simultaneous, phenomenon. We find that firms that are funded in “hot” times are more likely to fail but create more value if they succeed. This pattern could arise if in “hot” times more novel firms are funded. Our results provide a new but intuitive way to think about the differences in project choice across the cycle. Since the financial results we present cannot distinguish between more innovative versus simply riskier investments, we also present direct evidence on the quantity and quality of patents produced by firms funded at different times in the cycle. Our results suggest that firms funded at the top of the market produce more patents and receive more citations than firms funded in less heady times. This indicates that a more innovative firm is funded during “hot” markets.


2012 Proxy Season: Audit Firm Rotation

The following post comes to us from Sean DiSomma, Senior Vice President at Alliance Advisors LLC, and is based on an Alliance Advisors whitepaper by Shirley Westcott.

In the wake of the financial crisis, regulators and shareholder activists alike have been revisiting the issue of auditor independence with a view towards requiring companies to periodically rotate their outside audit firms.

The United Brotherhood of Carpenters is filing resolutions for 2012 asking companies to establish a policy that at least every seven years the audit firm rotates off the engagement for a minimum of three years. The Carpenters argue that mandatory auditor rotation would improve the integrity of the audit and ensure the independence of the audit firm’s work.

Three of the targeted companies with early annual meetings—Deere, Hewlett-Packard and Walt Disney—are seeking no-action relief on ordinary business grounds. Although the SEC has historically allowed companies to omit shareholder resolutions limiting auditor tenure, the Commission may take into account whether recent regulatory initiatives have elevated the issue to a policy matter engendering widespread public debate.


Say-on-Pay and the Business Judgment Rule

Edward Greene is a partner at Cleary Gottlieb Steen & Hamilton LLP focusing on corporate law matters. This post is based on a Cleary Gottlieb Alert Memorandum; the full version of the memo, including omitted footnotes, is available here.

Over 40 companies received negative say-on-pay advisory votes in 2011, the first year for those votes under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”). Despite the advisory nature of the votes and the Act’s helpful language that they are not intended to affect director fiduciary duties, at least ten derivative lawsuits have been filed after failed votes. Two present an interesting contrast insofar as they address the “business judgment rule” and the requirement of pre-suit demand in the context of executive compensation. The first involves Cincinnati Bell and was brought in federal court in Ohio under Ohio law. It is the only such suit to survive a motion to dismiss to date. The other is a case involving Beazer Homes, which was dismissed by a Georgia state court applying Delaware law. We believe that the Cincinnati Bell case is inconsistent with the historical application of the business judgment rule and that Beazer Homes will ultimately prove the majority approach. Nonetheless, the cases bear consideration for what they suggest about the importance of process in making compensation decisions.


Compliance and Ethics in Risk Management

Editor’s Note: The following post comes to us from Carlo V. di Florio, Director, Office of Compliance Inspections and Examination at the U.S. Securities and Exchange Commission. This post is based on a recent speech by Mr. di Florio at the NSCP National Meeting, available here. The views expressed in the post are those of Mr. di Florio and do not necessarily reflect those of the Securities and Exchange Commission.

Today I would like to address two related topics that are growing in importance: the heightened role of ethics in an effective regulatory compliance program, and the role of both ethics and compliance in enterprise risk management. The views that I express here today are of course my own and do not necessarily reflect the views of the Commission or of my colleagues on the staff of the Commission.

In the course of discussing these two topics, I would like to explore with you the following propositions:

  • 1. Ethics is fundamental to the securities laws, and I believe ethical culture objectives should be central to an effective regulatory compliance program.
  • 2. Leading standards have recognized the centrality of ethics and have explicitly integrated ethics into the elements of effective compliance and enterprise risk management.
  • 3. Organizations are making meaningful changes to embraced this trend and implement leading practices to make their regulatory compliance and risk management programs more effective.


On the Regulation of Investment Advisory Services

The following post comes to us from James Angel of the Department of Finance at Georgetown University.

In the paper, On the Regulation of Investment Advisory Services: Where Do We Go from Here?, which was recently made publicly available on SSRN, I examine the regulation of investment advisory services. A controversy has arisen over the regulation of investment advisers in the United States. Traditionally, larger registered investment advisers (RIAs) have been regulated by the SEC and smaller ones by the states. The Investment Advisers Act of 1940 severely restricts the ability of RIAs to engage in principal trades with their customers. Brokers, on the other hand, are regulated by a self-regulatory organization, FINRA, as well as by the SEC. Brokers may engage in principal trades with their customers as long as the advice is merely “incidental” to their other activities. In recent years, the boundaries between RIAs and brokers have become blurred as brokers offer more advisory services, and there is substantial confusion among consumers as to the differences between brokers and RIAs.

In a study mandated under §914 of Dodd-Frank, the SEC documented that it is examining RIAs at a rate of approximately once every eleven years, and recommended the study of additional means to increase the frequency of examinations including user fees to fund more examinations by the SEC, or requiring RIAs to become part of a self-regulatory organization (SRO). It should be noted that the SEC has assigned fewer employees to its Office of Compliance, Inspections, and Enforcement (OCIE) in 2010 than in 2004, despite an increase in overall FTE over this period. This SEC diversion of resources presumably reflects its belief that RIA examinations are less important than other SEC activities.


2012 Proxy Season Developments: SEC Legal Bulletin and ISS Guidelines

Editor’s Note: James Morphy is a partner at Sullivan & Cromwell LLP specializing in mergers & acquisitions and corporate governance. This post is based on a Sullivan & Cromwell publication.

As issuers and shareholders look ahead to the 2012 proxy season, they should be aware of recent publications by the SEC’s Division of Corporation Finance with regard to Rule 14a-8 process issues and Institutional Shareholder Services with regard to potential voting recommendations on shareholder proposals.

SEC Staff Legal Bulletin No. 14F, issued on October 18, 2011, provides important new guidance on a number of topics that have led to confusion in recent years among issuers and shareholders participating in the Rule 14a-8 shareholder proposal process, including proof of share ownership for beneficial owners, submission of revised proposals, and withdrawal of a proposal submitted by multiple proponents.

On the same day, ISS, the influential proxy advisory firm, released proposed updates to its proxy voting guidelines for 2012. The proposed updates address topics such as company responses to last year’s say-on-pay votes and say-on-pay frequency votes, evaluation of executive pay practices, and recommendations on proxy access proposals. The proposed changes to the policy on evaluating executive pay include a new methodology that uses quantitative one-, three- and five-year comparisons of pay and stock performance together with a qualitative review, as needed.


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