Yearly Archives: 2012

Citigroup: A Symbol of Board Resurgence?

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, November 5, 2012
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Editor’s Note: 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. This post is based on an article that appeared in the Harvard Business Review online.

At the center of the corporate wreckage of the past fifteen years — the accounting scandals, the outright fraud, the environmental disasters, the financial meltdown — sits the boards of directors. Their failure to choose the right CEO and to provide appropriate oversight on core risks and opportunities has, in my view, reflected a broad failure of the corporate governance movement and its reliance on directors to effectively to oversee the corporation and its business leaders.

Yet, the recent fall of Vikram Pandit, Citigroup CEO, underscores a basic truth: Independent boards of directors are still the best mechanism — or the least worst one — for holding business leaders accountable, even if many boards have failed in their attempts to do this, often in spectacular fashion.

Much of the Citigroup commentary has focused on the behind-the-scenes campaign of Citigroup board chair William O’Neil to oust Pandit and his stark ultimatum during a one-on-one confrontation: resign now, resign at the end of the year, or be fired.

Many have criticized O’Neil for his ham-handedness, saying this was rude to Pandit, demoralizing to essential Citi leaders, lacking in clear public rationale. A minority, however, has said such CEO separations are invariably messy, bringing to mind Lady MacBeth’s advice to her husband about murdering the king: “If it were done when ’tis done, then ’twere well, It were done quickly.”

But the tactics surrounding the decision should not obscure the potential importance of the decision itself. Are boards of directors now more than in the past focusing on their fundamental task — critically evaluating the leadership and the management of the CEO? Are they now much less hesitant to force changes at the top of the corporation due to performance on fundamentals, not just scandal or stock price variation?

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The New Era of Swaps Market Reform

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, November 5, 2012
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Editor’s Note: Gary Gensler is chairman of the Commodity Futures Trading Commission. This post is based on Chairman Gensler’s remarks before the George Washington University Center for Law, Economics and Finance Conference, available here.

The days of the opaque swaps market are ending. On October 12, 2012, we are shifting to a new era of transparency and commonsense rules of the road for the swaps market.

New Era — Swaps Market Reform Becomes a Reality

During the Great Depression, President Roosevelt and Congress put in place similar rules to bring transparency to the securities and futures markets, and protect investors from fraud, manipulation and other abuses.

These critical reforms of the 1930s are at the foundation of our strong capital markets and many decades of economic growth.

Swaps emerged in the 1980s to provide producers and merchants a means to lock in the price of commodities, interest rates and currency rates. Our economy benefits from a well-functioning swaps market, as it’s essential that companies have the ability to manage their risks.

The swaps marketplace, however, has lacked the necessary transparency to best benefit Main Street businesses and common-sense rules to protect the public.

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Mutual Fund Sales Notice Fees

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, November 5, 2012
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The following post comes to us from David M. Geffen, counsel at Dechert LLP who specializes in working with investment companies and their investment advisers.

My recent article, Mutual Fund Sales Notice Fees: Are a Handful of States Unconstitutionally Exacting $200 Million Each Year?, forthcoming in the Hastings Constitutional Law Quarterly, describes the political compromise struck in 1996 between Congress and state securities regulators. That year, Congress enacted the National Securities Markets Improvement Act of 1996 (NSMIA), which effected multiple changes to the federal securities laws to promote efficiency and capital formation by eliminating overlapping federal and state securities regulations.

With respect to mutual funds, NSMIA resolved the problem of overlapping regulation by preempting state substantive regulation and registration requirements of mutual funds, thereby providing for exclusive federal jurisdiction over the contents of a mutual fund’s prospectus and operation of each fund. NSMIA was welcomed by the mutual fund industry because it eliminated the “crazy quilt” of regulation that had made registration of mutual fund shares unnecessarily cumbersome—in some cases leading mutual funds to restrict their fund offerings to residents of certain states.

However, in order to secure the acquiescence of the states and secure NSMIA’s enactment, NSMIA preserved state authority to require mutual funds to file sales reports and to pay state filing fees based on those sales in connection with the sales reports. A handful of states have taken unfair advantage of this fee loophole.

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Middle Market Private Equity Buyer/Public Target M&A Deal Study

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, November 4, 2012
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The following post comes to us from John Pollack and David Rosewater, partners focusing on mergers & acquisitions at Schulte Roth & Zabel LLP. This post is based on the Schulte Roth & Zabel Middle Market PE Buyer/Public Target M&A Deal Study; the full publication, including appendices, is available here.

Overview

We regularly conduct studies on private equity buyer acquisitions of U.S. public companies with equity values greater than $500 million (“large market” deals) to monitor market practice reflected by these high-profile transactions. Recognizing the importance of M&A activity in the $100 million to $500 million target equity value range (“middle market” deals), we are commencing a new deal study that identifies “market practice” involving private equity buyer acquisitions of U.S. public companies in the middle market. We also compare our findings for middle market deals to our findings for large market deals. During the period from January 2010 to June 30, 2012, there were a total of 36 middle market deals and 43 large market deals that met our parameters.

Part One

Key Observations: Market Practice and Trends in the Middle Market

  • 1. Activity in the middle market is down year over year. Only 5 deals were signed in 1H 2012 compared to 11 in 1H 2011, a decrease of 55%. Mean equity values of deals in 1H 2012 rose 21% when compared to 1H 2011. The year started with no activity — all of the 1H 2012 deals were signed in the second quarter. (See Chart 1.)

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Deciphering Chaos

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Saturday, November 3, 2012
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Editor’s Note: Bart Chilton is a Commissioner at the U.S. Commodity Futures Trading Commission. This post is based on Commissioner Chilton’s remarks before the High-Frequency Trading Leaders Forum in Chicago, IL, available here.

Wayne’s World

How many people here are not from Chicago or the Chicagoland area? It’s great to see you here. For those of you from the area, we all know the city of Aurora—the second largest city in Illinois. Most of you, and I’m sure a lot of others here, recall the movie Wayne’s World based upon the Saturday Night Live sketch? From a location near to us now, in that Aurora basement, long-haired Wayne Campbell and Garth Algar (played by the comedic masters Mike Myers and Dana Carvey) filmed their weekly low budget public-access Cable 10 television show, Wayne’s World. At the beginning and end of their show, and at various points Wayne plays a chord on his Fender Stratocaster and the duo sing, “Wayne’s World, Wayne’s World, party time, excellent.” That’s their “go to” when they get excited or there is a lull in conversation.

Well, there won’t be too many lulls in our conversation today, and I really am very excited to be with you—party time, excellent.

So, game on! Before we talk technology and about those wily high frequency cheetah traders—those fast, fast, fast speed traders out there nearly all of the time trying to scoop up micro dollars in milliseconds, I want to speak about Dodd-Frank.

The Status Gladys

It doesn’t matter if you’re an algo trader, a cheetah, a pit trader, an investor or a consumer—you want to know the rules of the road when it comes to financial reform.

It has been four years since the economy tanked and more than two years since Dodd-Frank became law. There are almost 400 rules to craft under Dodd-Frank. Overall, the regulators working to implement the new law have been slow. Most of the rules were to be completed within a year. That means the law called for almost everything to be completed by July of 2011. Of the 398 regulations that need to be finalized, only 131 are done. That’s a mere 33 percent. We’re not worthy. We’re not worthy.

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SEC’s Role in Enforcing the Federal Securities Laws

Posted by Wayne M. Carlin, Wachtell, Lipton, Rosen & Katz, on
Friday, November 2, 2012
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Wayne Carlin is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Carlin, John F. Savarese, David A. Katz, David B. Anders, and Theodore A. Levine.

In a recent speech at the Securities Enforcement Forum, SEC Commissioner Luis Aguilar called for, among other things, increased enforcement activity against individuals, with more frequent use of Officer and Director bars, monitoring of recidivists through post-enforcement monitoring mechanisms such as access to phone and bank records and income tax returns, and passage of the SEC Penalties Act, which would allow the SEC to impose significantly harsher monetary penalties on individuals and institutions. We certainly understand the desire to rethink the SEC’s enforcement priorities, particularly in light of recent criticism of the agency. But we are concerned that this speech reflects an unwarranted blurring of the line that should separate the role of criminal prosecutors from that of the SEC.

The SEC is an independent regulatory agency whose mission has long been understood to be protecting investors and fashioning appropriate remedial action in the public interest — through deterrence of future wrongdoing and improvement of business conduct. When violations of the federal securities laws reflect willful conduct warranting punishment for wrongdoers, prosecutors should — and do — play the central role in seeking criminal prosecution. The SEC, by contrast, is not charged with enforcing criminal laws and its enforcement attorneys are not prosecutors.

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A Theory of Empty Voting and Hidden Ownership

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, November 2, 2012
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The following post comes to us from Jordan M. Barry, Associate Professor of Law at the University of San Diego School of Law, John William Hatfield, Assistant Professor of Political Economy at the Stanford Graduate School of Business; and Scott Duke Kominers, Research Scholar at the Becker Friedman Institute for Research in Economics at the University of Chicago.

In our recent paper, On Derivatives Markets and Social Welfare: A Theory of Empty Voting and Hidden Ownership, we build and explore a formal theoretical framework to understand interactions between derivatives markets and shareholder voting behavior.

Ownership of stock in a corporation entails two types of rights with respect to that corporation. First, shareholders have economic ownership rights that entitle them to share in corporate profits. Second, they have certain legal rights of control over the corporation. These economic and control rights come bound together with each share of stock, but they can be separated, or decoupled. Decoupling can result in empty voting, in which an actor’s voting interest in a corporation is larger than her economic interest. It can also lead to hidden ownership, in which an actor’s economic interest in a corporation exceeds her voting interest. Decoupling raises a host of concerns because it turns the conventional logic for granting shareholders voting rights—their economic interest in the corporation—on its head. (See references here.)

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SEC Legal Bulletin on Shareholder Proposals

Posted by Richard J. Sandler, Davis Polk & Wardwell LLP, on
Thursday, November 1, 2012
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Richard J. Sandler is a partner at Davis Polk & Wardwell LLP and co-head of the firm’s global corporate governance group. This post is based on a Davis Polk client memorandum.

The SEC recently issued Staff Legal Bulletin No. 14G providing additional guidance on shareholder proposals submitted to companies pursuant to Rule 14a-8. The guidance is in response to several issues that came up during the 2012 proxy season.

Proof of ownership

In a prior bulletin, SLB No.14F, the SEC had reconsidered its view as to who constitutes a “record holder” for purposes of Rule 14a-8 and indicated that only DTC participants may provide adequate proof of ownership for shareholder proponents. Consistent with its no-action letter decisions during 2012, the Staff indicated in this bulletin that it would also view ownership letters from affiliates of DTC participants as satisfying the proof of ownership requirement.

Also, the Staff indicated that a shareholder who holds securities through a securities intermediary that is not a broker or a bank can satisfy Rule 14a-8’s documentation requirement by submitting a proof of ownership letter from that securities intermediary. If the securities intermediary is not a DTC participant or an affiliate of a DTC participant, then the shareholder will also need to obtain a proof of ownership letter from the DTC participant, or an affiliate of the DTC participant, that can verify the holdings of the securities intermediary.

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A Simple Tax Proposal to Improve Financial Stability

Posted by Ivo Welch, UCLA, on
Thursday, November 1, 2012
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Ivo Welch is the J. Fred Weston Chair in Finance and Distinguished Professor of Finance at UCLA.

It is hard to imagine a financial crisis that is not ultimately caused by creditors who had taken on too much debt. Debt is the root cause of most corporate financial failures and, if a snowball effect sets in, the root cause of financial system failure. Of course, debt also has advantages. Without debt, many privately and socially valuable projects could never be undertaken. Still, it is our current tax system that has pushed our economy to be too levered. Now is the time to address the problem—before it will again be too late.

From a creditor’s perspective, the two key advantages of debt are the tax deductibility of interest payments and the ability of lenders to foreclose on non-performing borrowers (which makes it in their interest to extend credit to begin with). Although both factors contribute greatly to the incentives of the borrower to take on debt, there is one important difference between them: the tax deductibility of debt is not socially valuable.

To explain this issue, let’s abstract away from the beneficial real effects of debt and consider only the tax component. In an ideal world, taxes should not change the decisions of borrowers and lenders. They would take exactly the same projects and the same financing that they would take on in the absence of taxes. At first glance, one might argue that the tax distortions of leverage are not so bad, because the interest deductibility of the borrower is offset by the interest taxation of the lender. But this “wash argument” is wrong. It ignores the fact that capitalist markets are really good at allocating goods to their best use. In this case, it means that the economy will develop in ways that many lenders end up being in low tax brackets (such as pension funds or foreign holders) ,while many borrowers end up being in high tax brackets (such as high-income households or corporations). The end result will be not only that the aggregate tax income is negative, but that debt is taken on by borrowed primarily to reduce income taxes and not because debt has a socially productive value.

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A Capital Market, Corporate Law Approach to Creditor Conduct

Posted by Mark Roe, Harvard Law School, on
Wednesday, October 31, 2012
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Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law.

Earlier in October, Federico Cenzi Venezze and I posted “A Capital Market, Corporate Law Approach to Creditor Conduct” up on SSRN. Michigan Law Review is scheduled to publish the article in their next volume.

In this article, we focus on the problem of creditor conduct in distressed firms — for which policymakers ought to have the economically-sensible repositioning of the distressed firm as a central goal. This problem has vexed courts for decades, without coming to a stable doctrinal resolution. It’s easy to see why developing an appropriate rule here has been difficult to achieve: A rule that facilitates creditor operational intervention going beyond ordinary collection on a defaulted loan can induce creditors to intervene perniciously, to shift value to themselves. But a rule that confines creditors to no more than collecting their debt can allow failed managers to continue mismanaging the distressed firm, with the only real alternative to the failed incumbent management — the creditor — being paralyzed by unclear and inconsistent judicial doctrine.

The article proceeds in four steps. For the first step, we show that existing doctrines do not address themselves to facilitating efficacious management of the failing firms. Yet with corporate and economic volatility as important as ever, courts should seek to make doctrine here more functionally-oriented than it now is.

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