Monthly Archives: December 2011

Economic Analysis in ERISA Litigation over Fiduciary Duties

The following post comes to us from Dr. John Montgomery, Senior Vice President with NERA Economic Consulting, and is based on a NERA publication by Dr. Montgomery which previously appeared in the July, August, and September 2011 issues of the Employment Law Strategist.

In the past decade, numerous lawsuits have been brought under ERISA against the fiduciaries and sponsors of 401(k) and other defined contribution retirement plans. Many of these lawsuits have been pled as class actions on behalf of all or many participants of the plan. The most common lawsuits have involved declines in the value of employer stock offered in the plans and allegations that decisions to maintain employer stock in the plans were imprudent. There have also been some lawsuits over other investment options, as well as lawsuits over the management of collateral from securities lending programs run by plan trustees. Another substantial category of litigation has involved allegations of excessive fees. Many of these cases, both investments and fees, have also involved allegedly inadequate disclosure of information to plan participants.

Economic analysis plays an important role in many of these cases. The purpose of this paper is to discuss some of the important economic issues that arise in ERISA litigation, both in establishing liability and in calculating damages.

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Federal Reserve Proposes Enhanced Prudential Standards and Early Remediation Requirements

Margaret E. Tahyar is a partner in Davis Polk & Wardwell LLP’s Financial Institutions Group. This post is based on a Davis Polk publication by Ms. Tahyar, Luigi L. De Ghenghi and other Davis Polk attorneys; the full version is available here.

The Federal Reserve has released proposed rules to implement the enhanced supervisory and prudential requirements in Sections 165 and 166 of the Dodd-Frank Act. These proposed rules represent the Federal Reserve’s primary effort, one and a half years after the enactment of Dodd-Frank, to put in place prudential standards that will govern the largest bank holding companies in the United States and any nonbank financial firm designated in the future as systemically important and subject to Federal Reserve oversight. Our memorandum, Federal Reserve Proposes Enhanced Prudential Standards and Early Remediation Requirements For Large BHCs and Nonbank SIFIs, describes the Federal Reserve’s proposal.

Of particular interest, the Federal Reserve is proposing, for the first time, to formally limit the consolidated exposures that a large BHC or nonbank SIFI, together with its subsidiaries, may have to any other counterparty at 25% of its capital and surplus, and to limit such exposures between the very largest institutions to 10% of capital and surplus. In addition, the Federal Reserve is proposing, for the first time, to require large BHCs and nonbank SIFIs to comply with a formal regulatory liquidity standard. While these proposed rules are consistent with Dodd-Frank’s requirements, and in some cases tie in with international regulatory efforts, they represent a new chapter in the regulation of large banks and non-bank financial institutions and efforts to reduce systemic risk. The proposed rules, however, defer rulemaking on several important topics to a future release. For example, despite press reports, the proposed rules do not contain the Basel Committee’s G-SIB surcharge but instead state that the Federal Reserve will implement the surcharge by 2014, with it taking effect between 2016 and 2019.

The full memorandum is available here.

Do They Do It for the Money?

The following post comes to us from Utpal Bhattacharya of the Department of Finance at Indiana University and Cassandra Marshall of the Department of Finance at the University of Richmond.

In our paper, “Do They Do It for the Money?” forthcoming in the Journal of Corporate Finance, we explore the motives for committing white collar crimes such as insider trading. The idea for the paper germinated when speaking with a prosecutor in the celebrated Enron case several years ago. He remarked that “they do it because they think they can get away with it.” We were skeptical. Being financial economists, our prior was that the strongest motivation for individuals to commit insider trading was for monetary gain.

In terms of anecdotes, the prosecutor seemed to be right. In 2001, Martha Stewart was charged in a civil case for insider trading. She avoided losses of $45,673, which was a paltry 1.7% of her $2,704,403 in legal compensation from (MSO) in 2001, and a miniscule .007% of her $650 million net worth at the time. Mark Cuban had a net worth of $1.3 billion when he was first charged with insider trading for avoiding losses of $750,000 in 2004. Don Tyson was one of the “Forbes Top 1,000 Richest” back in 1992 when he was convicted for making illegal trading profits of only $46,125.

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Federal Reserve Capital Plan and Stress Test Requirements

Mark J. Welshimer is the deputy managing partner of the Financial Institutions Group at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication; the full version, including footnotes, is available here.

On November 22, 2011, the Board of Governors of the Federal Reserve System (the “Board”) published a final rule (the “Final CCAR Rule”) requiring most bank holding companies (“BHCs”) with $50 billion or more of total consolidated assets (“Covered BHCs”) to submit annual capital plans, with their related stress test requirements, to the appropriate Federal Reserve Bank and to generally obtain regulatory approval before making capital distributions, which include dividends and purchases of capital securities and instruments. The Final CCAR Rule expands the capital plan requirements from 19 to 34 BHCs, including, for the first time, foreign-owned BHCs. In addition, the Board released (i) two sets of instructions (the “Instructions”) that provide guidance on compliance with capital requirements in the Final CCAR Rule, one for Covered BHCs that did not participate in the 2011 Comprehensive Capital Analysis and Review (“CCAR” and such BHCs, the “non-CCAR BHCs”) and another for the 19 Covered BHCs that participated in the 2011 CCAR (the “CCAR BHCs”) and (ii) the data templates (namely, the FR Y- 14A and FR Y-14Q) that will be used to collect data from the CCAR BHCs to support the data collection contemplated by the Final CCAR Rule. The Final CCAR Rule generally incorporates the core features of the Board’s June 17, 2011 proposal regarding capital planning (the “Proposed CCAR Rule”).

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The Corporate Governance, Cash Holdings, and Economic Performance of Japanese Companies

The following post comes to us from Meng Li and Douglas Skinner, both of the Booth School of Business at the University of Chicago, and Kazuo Kato of the Osaka University of Economics.

In our paper, Is Japan Really a “Buy”? The Corporate Governance, Cash Holdings, and Economic Performance of Japanese Companies, which was recently made publicly available on SSRN, we investigate whether the governance practices of Japanese companies, as manifested in their holdings of cash, have improved over the past two decades, and whether any such improvements translate into improved economic performance. We find that, in general, some of the differences between Japanese and U.S. companies that were evident during the 1990s have become less pronounced over the past 10 years but that important differences remain. While overall levels of cash holdings are now roughly the same for U.S. and Japanese companies, when we condition on firm characteristics we find that Japanese firms still hold substantially more cash than U.S. firms. We do find, however, that regressions of the determinants of firms’ cash holdings developed using U.S. data (e.g., Opler et al., 1999; Bates et al., 2009) fit Japanese firms better in the 2000s than in the 1990s, suggesting that Japanese managers now pay more attention to the economic determinants of their firms’ cash holdings, consistent with improved governance.

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Key Issues for Directors 2012

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton firm memorandum by Mr. Lipton. A longer Wachtell Lipton memo discussing issues for boards in 2012 is available here.

For a number of years, as the new year approached, I have prepared a one-page list of the key issues for boards of directors that are newly emerging or will be especially important in the coming year. Each year, the legal rules and aspirational best practices for corporate governance matters, as well as the demands of activist shareholders seeking to influence boards of directors, have increased. So too have the demands of the public with respect to health, safety, environmental and other socio-political issues. In The Spotlight on Boards, I have published a list of the roles and responsibilities that boards today are expected to fulfill. Looking forward to 2012, it is clear that in addition to satisfying these expectations, the key issues that boards will need to address include:

  • 1. Working with management to navigate the dramatic changes in the domestic and world-wide economic, social and political conditions, in order to remain competitive and successful.
  • 2. Coping with the increase in regulations and changes in the general perception of business that have followed the financial crisis. Once it was said, “The business of America is business.” Today, it could be said, “The business of America is government, and a dysfunctional government at that.”

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Proposed Rules Ease Compliance with Loss Trafficking Rules

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; the complete publication, including footnotes, is available here.

Under Section 382 of the Internal Revenue Code, a corporation’s use of net operating losses is limited if there is an “ownership change.” On November 22, 2011, the Department of Treasury issued a Notice of Proposed Rulemaking (the “Notice”) containing proposed regulations (the “Proposed Regulations”) intended to lessen the compliance burden on taxpayers determining whether an ownership change has occurred for these purposes. The Proposed Regulations are based upon and take into account comments received in respect of Notice 2010-49, which announced an IRS study on easing the compliance burden of tracking less-than-5% shareholders for these purposes.

Under the Proposed Regulations, taxpayers no longer have to separately track:

  • certain secondary transfers to a public owner;
  • certain small redemptions; and
  • certain shifts of ownership among small shareholders that indirectly hold shares of a corporation that has net operating losses or related tax attributes.

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Takeover Discipline and Asset Tangibility

The following post comes to us from Julien Sauvagnat of the Toulouse School of Economics.

In the paper, Takeover Discipline and Asset Tangibility, which was recently made publicly available on SSRN, I examine whether takeover discipline has a different effect in tangible and intangible firms. The empirical evidence is strong that firms with external good governance perform on average better. A recent literature, starting with Gompers, Ishii and Metrick (2003), shows that firms with less takeover defenses have higher firm value and equity returns. However, we know less about the type of firms or industries in which takeover vulnerability matters relatively more. In this line of research, Giroud and Mueller (2010, 2011) show that firms in non-competitive industries benefit more from high takeover vulnerability than do firms in competitive industries. Cremers and Nair (2005) find that higher takeover vulnerability is associated with higher performance only when the quality of internal governance, proxied by public pension fund and blockholder ownership, is high.

I show that higher takeover vulnerability is associated with higher performance only in intangible firms. My favorite explanation is that debt already disciplines managers in tangible firms. In contrast, debt is not an appropriate disciplinary mechanism for intangible firms. Intangible firms have low liquidation values and low asset redeployability, and therefore, they might prefer to avoid debt and delegate monitoring to the market for corporate control.

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Disclosure Obligations in Capital Restructurings

Edward Herlihy is a partner and co-chairman of the Executive Committee at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Herlihy and Matthew M. Guest.

Recently, the SEC instituted a cease-and-desist order against Fifth Third Bancorp in connection with its redemption of trust preferred securities (TruPS) in May 2011. The SEC charged that in effecting the redemption Fifth Third “selectively disclosed,” in violation of Regulation FD, that it would redeem a class of its TruPS for about $25 per share.  At the time the securities were trading at about $26.50 per share.  The SEC stated Fifth Third did not issue a Form 8-K or other public notice of the redemption until it became aware that investors who appeared to have learned of the redemption had been selling the securities to buyers who appeared to be unaware of the redemption.  Fifth Third, which compensated harmed investors and agreed to adoption and implementation of various additional policies and procedures, settled the SEC’s enforcement action without admitting or denying the allegations.

Fifth Third’s early redemption of their TruPS in May 2011 was triggered through Dodd-Frank’s phasing out of Tier 1 Capital treatment for TruPS generally.  As indicated in our July 2010 client memorandum “Potential Opportunities for Issuers of Trust Preferred Securities under the Collins Amendment,” bank holding companies have taken the opportunity presented by Dodd-Frank to redeem relatively costly TruPS under the regulatory capital provisions of their particular issuances where applicable.  As noted in that memo, employing this redemption strategy requires careful coordination with regulators and consideration of all applicable circumstances, importantly including disclosure obligations.

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The Role of the Board in Accelerating the Adoption of Integrated Reporting

Matteo Tonello is Director of Corporate Governance for The Conference Board, Inc. This post is based on a Conference Board Director Note by Robert G. Eccles and George Serafeim of Harvard Business School, which was adapted from a book chapter in CSR Index, available here.

This report examines the concept of integrated reporting and its current state of adoption around the globe. It also discusses the benefits to both companies and society and recommends ways boards can help their organizations accelerate the implementation of integrated reporting.

Interest in and adoption of integrated reporting regarding a company’s financial and environmental, social, and governance (ESG) performance is growing rapidly. Although still largely a voluntary practice in most countries, it already is (South Africa) or soon will be (France) required of all listed companies. The European Union is poised to mandate ESG (environmental, social, and governance) reporting within the next year, a significant step toward mandated integrated reporting. The first company to issue an integrated report, nearly 10 years ago, was the Danish bio-industrial products company, Novozymes. Natura Cosméticos, a Brazilian cosmetics and fragrances company, issued its first integrated report in 2003. The Danish diabetes care company Novo Nordisk did so the next year.

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