Monthly Archives: November 2011

Harvard Convenes the Institutional Investors Roundtable

The Harvard Institutional Investors Roundtable will convene tomorrow. The event will bring together prominent members of the institutional investor world to discuss a number of related issues concerning shareholder voting.

During the morning sessions, the roundtable discussion will focus on lessons from the first year of advisory votes on executives compensation and on how institutions should vote on compensation arrangements in the future. During the second half of the day, the roundtable discussion will focus on majority voting and withhold votes, as well as on the reporting of proxy votes to beneficiaries. The event will start with a keynote talk by and discussion with Larry Summers.

The event, which is co-organized by Lucian Bebchuk and Robert Pozen, is jointly sponsored by the Harvard Law School Program on Institutional Investors, the Harvard Law School Program on Corporate Governance, Harvard Business School, and the Harvard Kennedy School Center for Business and Government, and supported by the Investment Company Institute.

Participants in the Harvard Institutional Investors Roundtable will include:

  • F. Gregory Ahern, Chief Public Communications Officer, Investment Company Institute (ICI)
  • Joe Bachelder, Founder and Senior Partner, The Law Offices of Joseph E. Bachelder
  • Lucian A. Bebchuk, William J. Friedman and Alicia Townsend Friedman Professor of Law, Economics, and Finance; Director, Program on Corporate Governance, Harvard Law School
  • Bo Becker, Assistant Professor, Harvard Business School
  • Allison Bennington, Partner and General Counsel, ValueAct Capital
  • Kenneth A. Bertsch, President and CEO, Society of Corporate Secretaries and Governance Professionals
  • Glenn Booraem, Principle and Fund Controller, Vanguard
  • Carol Bowie, Executive Director, Institutional Shareholder Services Inc. (ISS)
  • Richard C. Breeden, Chairman, Breeden Capital Management
  • Jay Chaudhuri, General Counsel and Senior Policy Advisor, North Carolina Department of State Treasurer
  • Robert C. Clark, Harvard Distinguished Service Professor, Harvard Law School
  • John C. Coates IV, John F. Cogan, Jr. Professor of Law and Economics, Harvard Law School
  • Jack Cogan, Non-Executive Chairman, Pioneer Investment Management USA, Inc.
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November 2011 Dodd-Frank Rulemaking Progress Report

The following post comes to us from Margaret E. Tahyar and Gabriel D. Rosenberg of 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 November Davis Polk Dodd-Frank Progress Report, is the eighth 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:

  • 37 New Deadlines – The Halfway Point. The 37 rulemaking deadlines due in October bring the number to date up to 200 – half of the 400 total required by the statute. To this point, only 23% of the rules due have been finalized.
  • 10 Requirements Met, 30 Proposed, 37 Missed. A number of rulemakings were proposed or finalized this month, including:
    • Proposed Volcker Rule Regulations – The FDIC, Federal Reserve, OCC and SEC released a coordinated proposed rule to implement the Volcker Rule. The CFTC has not yet released its proposed rule.
    • FSOC Re-Proposal on SIFI Designation – The FSOC re-proposed a rule, along with guidance, on designation of nonbank financial companies as “systemically important.”
    • SEC Proposed Rule on Registration – The SEC issued a proposed rule on registration of security-based swap dealers and major security-based swap participants.
    • CFTC Proposal on Effective Date for Swap Regulation – The CFTC issued a proposed rule that would extend the latest date for its temporary Title VII relief until July 2012.
    • CFTC Final Rule on Position Limits – The CFTC approved a final rule on position limits.
    • CFTC Final Rule on DCOs – The CFTC approved a final rule on regulation of derivatives clearing organizations, combining several proposals into one 485-page final rule release.

The Effect of Enforcement on Timely Loss Recognition

The following post comes to us from Sudarshan Jayaraman of the Department of Accounting at Washington University in Saint Louis.

In the paper, The Effect of Enforcement on Timely Loss Recognition: Evidence from Insider Trading Laws, forthcoming in the Journal of Accounting and Economics as published by Elsevier, I examine how first-time enforcement of insider trading laws affects the extent of timely loss recognition (TLR) in financial statements. A growing literature examines how cross-country variation in institutional characteristics shape financial reporting outcomes (e.g., Ball et al. 2000; 2003; Ball and Shivakumar 2005, Bushman and Piotroski 2006, Hail and Leuz 2006). These studies find that variation in the demand for accounting information in contracts drives differences in the quality of financial reporting across countries. As the usefulness of accounting information in contracts depends on how well these contracts are enforced, the effectiveness of enforcement of securities laws is an important determinant of reporting quality.

I use the first-time enforcement of insider trading laws across sixteen countries as a shock to enforcement and examine its influence on TLR. Prior studies (e.g., Bekaert and Harvey 1997, 2000; Bhattacharya and Daouk 2002; Daouk et al. 2006) provide evidence that first-time enforcement of insider trading laws results in an overall increase in the level of enforcement of securities laws and property rights. Countries that enforce these laws for the first time follow it up with several initiatives designed to sustain the increased level of enforcement. These result in improvements in sovereign credit ratings and greater lending by foreign investors – the ones more likely to rely on financial statements for monitoring (Ball et al. 2000; Leuz et al. 2009).

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How Conflicts of Interest Thwart Institutional Investor Stewardship

Editor’s Note: Simon Wong is a Partner at Governance for Owners, an Adjunct Professor of Law at the Northwestern University School of Law, and a Visiting Fellow at the London School of Economics and Political Science. This post is based on an article by Mr. Wong that appeared in Butterworths Journal of International Banking and Financial Law, which is available here.

In its recent green paper, the European Commission expressed concern about the effects of conflicts of interest on institutional investors’ willingness and ability to engage investee companies actively on corporate governance matters. Given the pervasiveness of asset manager conflicts and their adverse impact on shareholder engagement and voting behaviour, the remedies pursued must venture beyond the EC’s proposal of requiring ‘independence of the asset manager’s governing body’.

Three Layers of Conflicts

Conflicts of interest at investment firms arise at three levels – institution, individual, and group – all of which pose risks to effective stewardship by institutional investors.

Institutional conflicts

Institutionally, the core conflict of interest pertains to asset managers’ unwillingness to actively engage and hold the boards and management of investee companies accountable because they fear losing corporate business. In reality, the risk of commercial harm varies by market. In the UK, for example, companies do not usually retaliate by withholding business when investment managers vote against management’s proposals. Nonetheless, the occasional veiled threat – such as when the company secretary of a UK manufacturer reminded a fund manager who was intending to vote against the company’s remuneration report that his firm was bidding for an investment mandate from the corporation’s pension plan – may be enough to make investment houses hesitate about embracing stewardship.

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Reacting to Shareholder Proxy Access Proposals

The following post comes to us from Robert K. Morris, partner at Reed Smith LLP, and is based on a Reed Smith White Paper by Mr. Morris. Related work on proxy access by the Program on Corporate Governance includes Private Ordering and the Proxy Access Debate by Bebchuk and Hirst, and the proceedings of The Harvard Law School Proxy Access Roundtable.

This year, as a result of recent amendments to SEC rules, shareholder proponents can require companies for the first time to allow shareholders to vote on the company’s proxy card for proposals to amend the bylaws to facilitate contested elections for directors. If approved, these proposals (“proxy access” proposals) would require a company in the future to permit voting on the company’s proxy card for persons that shareholders nominate for election as directors, thus enabling shareholders to mount contested elections at minimal cost.

The deadline for requesting inclusion of proposals in company proxy materials for the spring meeting season is in November. To assist companies in considering possible responses to these proposals, this paper will discuss:

  • the historically varying and current terms of the “election exclusion” in Rule 14a-8(i)(8);
  • the likelihood of receiving a proxy access proposal;
  • possible procedural grounds for excluding a proxy access proposal from the company’s proxy statement; and
  • a possible state corporation law basis for excluding a proxy access proposal.

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Corporate Governance Development Framework

Editor’s Note: The following post comes to us from Darrin Hartzler, Manager of the Corporate Governance Unit in the Environment, Social and Governance Department at the International Finance Corporation.

IFC recently joined 28 other development finance institutions (DFIs) – with combined assets of approximately $852 billion – to launch the Corporate Governance Development Framework. This new initiative provides DFIs with a common set of tools to evaluate the governance of their client companies, many of whom work in some of the world’s most challenging markets.

The framework helps DFIs strengthen their due diligence processes and work with their clients to improve weak areas in their corporate governance. By adopting a common approach, signatory DFIs will set consistent standards for corporate governance and common expectations from clients.

Corporate governance helps companies operate more efficiently, gain access to capital, and safeguard against corruption and mismanagement. It makes companies more accountable and transparent to investors and enables them to respond to legitimate stakeholder concerns, such as responsible environmental and social practices. As providers of financing to companies in emerging markets, DFIs play a significant role in promoting good corporate governance across a broad range of regions and sectors. Our hope is that by working together, we can help make corporate governance a cornerstone of sustainable development.

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Final “Living Wills” Requirements for Large Financial Institutions

Editor’s Note: Bradley Sabel is a partner at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by Gregg L. Rozansky.

A major step in the prevention of future financial bailouts has been taken by Federal bank supervisors with the adoption on October 17 and September 13 of final joint regulations requiring a resolution plan (or “living will”) for the largest financial institutions active in the United States. Preparation of these plans will constitute a major undertaking for the institutions with consequences and ramifications that will continue to evolve over time. The following provides the background of the new regulations, the requirements that the regulations impose, tips for compliance, and possible difficulties to be faced as the process unfolds.

The Federal Deposit Insurance Corporation (the “FDIC”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve”) approved final resolution-plan regulations for the largest financial groups operating in the United States on September 13 and October 17, respectively. The FDIC also approved a final interim regulation requiring plans of FDIC-insured institutions with $50 billion or more in total assets. Both sets of requirements follow from previously issued proposals but include important clarifications and additional accommodations to the financial industry.

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2011-2012 ISS Policy Survey

Editor’s Note: Carol Bowie is Head of Compensation Research Development at Institutional Shareholder Services Inc. This post is based on the key findings of the complete ISS Policy Survey, available here.

Top Governance Issues

Executive compensation continues to be an American issue for a second straight year. Only for North America, a majority of both investor (60 percent) and issuer respondents (61 percent) cite the perennial issue of executive compensation as one of the top three governance topics for the coming year, similar to last year’s survey results.

On a global basis, investor respondents focused on board independence. Across every region, board independence was identified among the three most important governance topics by approximately 40 percent of investor respondents.

Issuers focus on risk oversight in North America and Europe. For issuers, the second most commonly cited topic in North America was risk oversight. In Europe, risk oversight was commonly cited along with board competence.

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Designation of Systemically Important Nonbank Financial Companies Under Dodd-Frank

Editor’s Note: H. Rodgin Cohen is a partner and senior chairman of Sullivan & Cromwell LLP focusing on acquisition, corporate governance, regulatory and securities law matters. This post is based on a Sullivan & Cromwell LLP publication; the full version, including footnotes, is available here.

On October 11, 2011, the Financial Stability Oversight Council unanimously approved a second notice of proposed rulemaking and related interpretive guidance under the Dodd-Frank Act regarding the designation of systemically important “nonbank financial companies.” The new proposal, which was published in today’s Federal Register, describes the manner in which the Council proposes to apply the relevant statutory standards and the processes and procedures it intends to employ in carrying out its authority to designate systemically important nonbank financial companies. These designated companies are required to comply with enhanced prudential standards and are subject to consolidated supervision by the Board of Governors of the Federal Reserve System. Comments on the Council’s proposal are due by December 19, 2011.

Among the nonbank financial companies potentially subject to a systemically important designation by the Council are savings and loan holding companies, insurance companies, private equity firms, hedge funds, asset management companies, financial guarantors, and other U.S. and non-U.S. nonbank companies deemed to be “engaged primarily” in activities that are financial in nature.

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Leadership in the Fund Industry

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 by Mr. Pozen and Theresa Hamacher, president of NICSA, which was published in the Financial Analysts Journal. That article is based on research for The Fund Industry: How Your Money Is Managed (John Wiley & Sons, 2011).

What is the critical factor for success in the U.S. mutual fund industry? Is it top-ranked investment performance, innovative products, or pervasive distribution? In our view, it is none of these factors, despite their obvious importance. Instead, the best predictors of success in the U.S. fund business are the focus and organization of the fund sponsor. We believe that the most successful managers over the next decade will be organizations with two characteristics: dedication primarily to asset management and control by investment professionals. Our view is based on research for the book The Fund Industry: How Your Money Is Managed (Pozen and Hamacher 2011).

Dedicated asset managers—firms deriving a majority of their revenues from investment management—dominate the industry, as shown in Table 1. The table ranks U.S. fund families by assets under management in 1990, 2000, and 2010 and shows dedicated asset managers in boldface. At the end of 2010, 8 of the top 10 firms were dedicated to investment management, as were 14 of the top 25 firms. Dedicated firms have held this dominant position for the past 20 years; in 1990, 13 of the top 25 firms were dedicated to asset management, only 1 fewer than in 2010.

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