Yearly Archives: 2012

UK Equity Markets and Long-term Decision Making

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, August 3, 2012
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The following post comes to us from John Kay, a visiting Professor of Economics at the London School of Economics and a Fellow of St John’s College, Oxford.

In June 2011, the Secretary of State for Business, Innovation and Skills asked me to review activity in UK equity markets and its impact on the long-term performance and governance of UK quoted companies. The Review’s principal concern has been to ask how well equity markets are achieving their core purposes: to enhance the performance of UK companies and to enable savers to benefit from the activity of these businesses through returns to direct and indirect ownership of shares in UK companies. More detail on the background to the Review, including its terms of reference and the Interim Report, can be found at www.bis.gov.uk/kayreview.

This final report details the findings of the Review. Overall we conclude that short-termism is a problem in UK equity markets, and that the principal causes are the decline of trust and the misalignment of incentives throughout the equity investment chain. These themes of trust and incentives are central to this report. We set out principles that are designed to provide a foundation for a long-term perspective in UK equity markets and describe the directions in which regulatory policy and market practice should move. These high level statements are supported by specific recommendations that are aimed at providing the first steps towards the re-establishment of equity markets that work well for their users.

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Securities Enforcement Update

Posted by Mark K. Schonfeld, Gibson, Dunn & Crutcher LLP, on
Thursday, August 2, 2012
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Mark Schonfeld is a litigation partner at Gibson, Dunn & Crutcher LLP and co-chair of the firm’s Securities Enforcement Practice Group. This post is based on a Gibson Dunn client alert; the full version, including footnotes, is available here.

I. Overview of the First Half of 2012

The first half of 2012 has shown a continuation of the SEC’s aggressive enforcement strategy even after a record-breaking fiscal year 2011 for the U.S. Securities and Exchange Commission (the “SEC” or “Commission”), which resulted in 735 enforcement actions and over $2.8 billion in penalties and disgorgement ordered. During the first six months of 2012, the SEC filed 110 actions in federal court against a collective 308 defendants. It appears, however, that the SEC is beginning to feel the resource costs of pursuing such cases over time. Specifically, the SEC recently disclosed that it is actively litigating approximately 90 cases, which is an increase of more than 50% in the past year. This recent surge in litigation may have been influenced by many factors, including the increased complexity in cases stemming from the financial crisis and a related increase in charges being filed against individuals. Protracted litigation will place an increasing drain on the agency’s limited resources. Nevertheless, as the current administration’s first term comes to a close and as conduct related to the financial crisis becomes more distant in time, we anticipate that the SEC will sustain its aggressive strategy of filing and, if necessary, litigating cases against prominent defendants in order to bolster public confidence in a vigorous enforcement of the securities laws.

Highlights of the past six months include:

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European Court Tightens Disclosure Rules

Posted by John F. Olson, Gibson, Dunn & Crutcher LLP and Georgetown Law Center, on
Wednesday, August 1, 2012
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John Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. This post is based on a Gibson Dunn alert by Philip Martinius.

On June 28, 2012, the European Court of Justice (“ECJ”) issued an important judgment that will have a significant impact on the disclosure of non-public, price-sensitive information (so-called “inside information”) by public companies listed on stock exchanges in the European Union (“EU”). The decision clarifies the definition of inside information in cases where the circumstances relevant to the disclosure develop over time, potentially involving several intermediate steps. The ruling is the latest in a string of court decisions concerning the spectacular departure of Daimler’s CEO in summer 2005 and the company’s allegedly late disclosure of this event.

The issue before the ECJ was whether Daimler had met its obligation to timely disclose inside information. Under EU and German law, each issuer of securities is obliged to disclose inside information if (i) the information is sufficiently precise, (ii) relates to circumstances which are not publicly known, (iii) relates to one or more issuers of securities (or the securities themselves) and (iv) the information would likely have a significant effect on the price of the securities if it became publicly known. Future circumstances may also constitute inside information if they are sufficiently likely to occur. Issuers can temporarily delay disclosure if certain conditions are met.

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Internal vs. External CEO Choice and the Structure of Compensation Contracts

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, August 1, 2012
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The following post comes to us from Frédéric Palomino of the Department of Economics at EDHEC Business School and Eloïc-Anil Peyrache of the Department of Economics and Decision Sciences at HEC Paris.

The dramatic and unprecedented increase in CEO pay in the 1980s and 1990s led to questioning the efficiency of CEO compensation packages. The debate concentrated first on the pay-performance sensitivity and then moved to the compensation level, given the observed widening gap between the pay level of executive officers and other employees. However, another important change regarding CEOs took place over the same period—their working experience prior to being appointed as a CEO. Increasingly, boards of directors have hired CEOs outside their firm.

In our paper, Internal vs. External CEO Choice and the Structure of Compensation Contracts, forthcoming in the Journal of Financial and Quantitative Analysis, we provide a rationale for the simultaneous increases in (i) CEO pay, (ii) use of equity in compensation schemes, and (iii) hiring of CEOs externally.

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Binding Shareholder Say-on-Pay Vote in UK

Posted by Edward F. Greene, Cleary Gottlieb Steen & Hamilton LLP, on
Tuesday, July 31, 2012
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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 footnotes, is available here.

In 2002, the UK began requiring an advisory shareholder vote on the annual executive and non-executive director compensation practices of UK-incorporated quoted companies (“UK Companies”). Eight years later, in July 2010, the US followed suit when President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), providing for an advisory say-on-pay vote for most large US public companies.

The UK government has now gone one step further by proposing to reform the approval process for director remuneration, including through the introduction of a binding shareholder vote for all UK Companies that must occur not less frequently than every three years. The new UK proposal does not stem from guidelines or mandates adopted by any European or other supra-national body. Rather, the proposal was the initiative of the UK government made at the national level in consultation with companies, shareholders, institutional investors and other interested parties. The UK approach, if ultimately implemented as expected, could be a powerful example for US investors seeking to drive change in executive compensation practices.

We discuss below the current state of say-on-pay in the US and the UK reforms.

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Duty to Disclose SEC Wells Notices Rejected by Judge

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, July 31, 2012
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The following post comes to us from Jonathan R. Tuttle, partner in the litigation department at Debevoise & Plimpton LLP, and is based on a Debevoise & Plimpton memorandum by Mr. Tuttle, Paul R. Berger, Matthew E. Kaplan, Alan H. Paley, and Colby A. Smith.

Judge Paul Crotty of the U.S. District Court for the Southern District of New York recently held that Goldman Sachs & Co. did not have a duty to publicly disclose the receipt of a Wells Notice from the Securities and Exchange Commission (“SEC”). Prior to this decision, no court had ever been asked to consider disclosure obligations with respect to Wells Notices. Going forward, this decision may inform companies’ consideration of whether and when to publicly disclose receipt of a Wells Notice.

The case, Richman v. Goldman Sachs Group, Inc., centered on allegations by class action plaintiffs against Goldman relating to the firm’s role in a synthetic collateralized debt obligation (“CDO”) called ABACUS 2007 AC-1 (“Abacus”). In January 2009, Goldman’s SEC filings disclosed ongoing governmental investigations related to the Abacus transaction. Between July 2009 and January 2010, the SEC issued Wells Notices to Goldman and two Goldman employees involved in the Abacus transaction, notifying them that Enforcement Division staff “intend[ed] to recommend an enforcement action.” The SEC filed a complaint against Goldman and one of its employees in April 2010, which Goldman settled for $550 million in July 2010. Plaintiffs alleged that Goldman’s failure to disclose its receipt of the Wells Notices was an actionable omission under Section 10(b) and Rule 10b-5 of the Exchange Act, and that Goldman had an affirmative legal obligation to disclose its receipt of the Wells Notices under applicable regulations.

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CFTC Proposes Cross-Border Guidance and Exemptive Order

Posted by Annette L. Nazareth, Davis Polk & Wardwell LLP, on
Monday, July 30, 2012
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Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP, and a former commissioner at the U.S. Securities and Exchange Commission. This post is based on a Davis Polk client memorandum.

On June 29, the CFTC released proposed interpretive guidance regarding the cross-border impact of the swap-related provisions of Title VII of the Dodd-Frank Act. [1] The CFTC also released a proposed exemptive order that would provide non-U.S. registered swap dealers (“SDs”) and major swap participants (“MSPs”) with temporary conditional exemptions from many swap-related Title VII requirements for one year, and permit SDs and MSPs that are U.S. persons (as defined below) to defer compliance with some requirements until January 2013. [2] Comments on the proposed interpretive guidance are due 45 days after it is published in the Federal Register and comments on the proposed exemptive order are due 30 days after it is published in the Federal Register, both of which are expected shortly.

The Proposed Guidance

The proposed guidance interprets the cross-border reach of Title VII’s swap provisions. The main impacts would be as follows:

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The Political Economy of International Financial Regulation

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, July 30, 2012
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The following post comes to us from Pierre-Hugues Verdier, Associate Professor of Law at University of Virginia.

In my paper, The Political Economy of International Financial Regulation, forthcoming in the Indiana Law Journal, I examine the current system of international financial regulation (IFR) from a historical and political perspective. In contrast with conventional theories of IFR, which see the current system of informal regulatory networks and non-binding standards as overall rational and efficient, I argue that historical path dependence and political economy play a major role in shaping outcomes in IFR. As a result, it produces mixed results—while it adequately addresses some international regulatory challenges, it is relatively ineffective at others, and avoids some altogether. This state of affairs has several important implications; perhaps most worrisome, it raises doubts that IFR can live up to the G-20’s ambitious post-crisis promises to address the international dimensions of systemic risk and moral hazard.

As readers of this blog will no doubt appreciate, there are substantial difficulties involved in developing a general account of IFR. The field is deeply fragmented, as international standards address a broad range of issues: accounting and disclosure rules, fraud, capital adequacy, prudential supervision, and cross-border resolution, to name but a few. All of these areas present different challenges and outcomes vary substantially across them. This being said, one recurrent feature of IFR is its informality. Instead of legally binding treaty obligations and formal international organizations, IFR relies almost exclusively on non-binding standards developed by networks of national regulators, such as the Basel Committee, IOSCO and IAIS. This feature is striking in comparison with many other areas of international governance where more formal mechanisms loom larger, such as trade, investment and the environment.

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The Parallel Universe of the Volcker Rule

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, July 29, 2012
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The following post comes to us from Charles Horn and Dwight Smith, partners focusing on bank regulatory matters at Morrison & Foerster LLP.

If timing is everything, this is not an auspicious time to argue against the Volcker Rule, given the recent London trading and investment misadventures of JPMorgan Chase. Predictably, there has been a hue and cry over this situation, and the bank regulators will be under heavy political pressure to toughen the Volcker Rule. In turn, the regulatory agencies probably will stiffen the Volcker Rule’s implementing regulations when they are adopted later this year (perhaps). For that reason, now is a good time to take a critical look at the Volcker Rule’s utility in improving regulatory oversight and preventing future financial crises.

In fact, the Volcker Rule continues to exist in a parallel universe that has little relation either to the recent financial crisis, the functional realities of the modern financial markets, or to the ongoing efforts to strengthen our financial system. Nothing that JPMorgan Chase, or any other too-big-to-fail bank, has or has not done changes that essential fact. Here is why:

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FASB Abandons Changes to Disclosure of Loss Contingencies

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, July 28, 2012
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The following post comes to us from Eric M. Roth, partner in the litigation department at Wachtell, Lipton, Rosen & Katz, and is based on a Wachtell Lipton memorandum by Mr. Roth and Peter C. Hein.

The Financial Accounting Standards Board (“FASB”) voted today to remove from its agenda its outstanding project aimed at modifying the accounting standards applicable to disclosure of loss contingencies.

As noted in prior memos, in 2008 (memo) and 2010 (memo) the FASB issued “Exposure Drafts” of proposed new accounting standards for loss contingencies, including litigation contingencies.  Numerous comments were submitted in response to the exposure drafts, many of which were opposed to enhanced requirements for loss contingency disclosures (memo).

Today’s vote by the FASB to remove this project from the Board’s agenda may reflect a view by the majority of the FASB Board that current requirements under Accounting Standards Codification 450 are sufficient, but the adequacy of corporate loss contingency disclosures may continue to be a subject of compliance and enforcement interest.  For example, as we have noted, the SEC has continued efforts to encourage companies to enhance their disclosure of litigation contingencies and, in particular, to provide estimates of both exposure in excess of established accruals and “reasonably possible” losses or range of losses in actions for which accruals have not been established, or to explain why such estimates cannot be provided (memo).

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