Monthly Archives: January 2012

Defending a Strong Volcker Rule

Editor’s Note: Senator Jeffrey Merkley (D-Oregon) is a member of the Senate Banking Committee.

Three years ago we were standing in the aftermath of the greatest financial implosion since 1929. High stakes gambling and risky bets gone bad on Wall Street had left our financial system near collapse and our economy in shambles.  This crisis had many causes—all man-made.

The Volcker Rule, as embodied in Merkley-Levin provisions of the Dodd-Frank Act, is a critical part of the effort to put in place financial rules of the road that will prevent another crisis like the one we experienced in 2008.

Put simply, the Volcker Rule takes deposit-taking, loan-making banks out of the hedge fund business. While hedge funds have their place in capital allocation, that place is not in commercial loan-making banks subsidized by FDIC insurance and the Fed discount window.  The reason is simple:  our banking system and our economy do better if the periodic bad bets of hedge funds blow up only the hedge funds and not our lending system that fuels economic growth and job creation.


CFTC Swap Reporting Regime Rules

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; the full memo, including an appendix, is available here.

The CFTC has adopted two final rules — a Swap Data Reporting Rule and a Real-Time Reporting Rule — that, in less than a fully coordinated manner, establish the new Dodd-Frank Act reporting regime for swaps. [1] The rules require market participants to report a host of swap information upon execution or shortly thereafter to a swap data repository (“SDR”), which is then responsible for disseminating a portion of that information to the public. Updated information for a given swap must be reported to the same SDR throughout the life of the swap.

The methods by which the swap information is reported to the SDR and the time allotted for such reporting depend on the counterparties to the swap, the type of swap and whether the swap is large enough to qualify as a block trade or large notional off-facility swap. The rules also require market participants to maintain records concerning swaps and to ensure the timely retrievability of records. The rules will go into effect in stages based on the type of market participant and asset class, beginning no earlier than July 7, 2012.


Tightening the Limits on Big US Banks

Bradley Sabel is a partner at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by Mr. Sabel, Donald N. Lamson, and Gregg L. Rozansky.

The Federal Reserve on December 20 issued its proposal to implement heightened prudential requirements for the largest US financial institutions as a result of the ongoing financial crisis. These institutions will have to design and implement compliance, recordkeeping and reporting procedures for the new standards in addition to the multitude of new restrictions imposed by such reforms as the Volcker Rule. The following summarizes the new proposal, identifies the portions applicable to various types of covered financial institutions and outlines the various requirements applicable to each type. Covered institutions may take some solace, though perhaps not much, in the fact that many of the requirements are consistent with emerging international standards for supervision of large financial companies.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) requires that the Board of Governors of the Federal Reserve System (“Federal Reserve”) impose enhanced supervisory requirements on the largest bank holding companies – in general, those with at least $50 billion, but with respect to certain requirements, those with at least $10 billion assets – and those nonbank financial companies designated as requiring supervision as though they were bank holding companies. [1] The Federal Reserve’s proposal (the “Proposal”) provides detail on how several of the requirements would be implemented. [2] Comments are due by March 31, 2012.


Do Managers Do Good With Other Peoples’ Money?

The following post comes to us from Ing-Haw Cheng of the Department of Finance at the University of Michigan; Harrison Hong, Professor of Economics at Princeton University; and Kelly Shue of the Department of Finance at the University of Chicago.

In our paper, Do Managers Do Good with Other Peoples’ Money?, which was recently made publicly available on SSRN, we test the hypothesis that corporate social responsibility is due to agency problems using two quasi-experiments. First, we use the 2003 Dividend Tax Cut as a quasi-experiment that increased the marginal cost of pet projects or perks for managers, especially for firms with low insider ownership. In our model, managers with low ownership stakes invest more in pet projects (which we will also call perks consumption) and are not at their first-best levels of capital investment. Their marginal cost to engaging in a dollar of perk spending is the after-corporate-tax marginal product of capital. In contrast, managers with high ownership stakes are closer to their first-best levels of investment, or already at their first-bests, so their marginal cost to a dollar of perk spending is paying dividends and getting the risk-free rate, which is of course lower than the after-corporate-tax marginal product of capital.


Accelerated Equity Awards for Departing Executives Lose Favor

The following post comes to us from Scott Zdrazil, First Vice President and Director of Corporate Governance for Amalgamated Bank.

Hewlett-Packard’s announcement that it will no longer accelerate the vesting of equity grants for departing executives is the latest victory in a new push by active investors to limit such generous exit packages (a Wall Street Journal story about the announcement is available here).

The drive began in 2010 when Amalgamated Bank’s LongView Funds filed shareholder proposals at several companies urging them to back away from the long-standing practice of accelerating awards of restricted stock or stock options when an executive departs after a change in control or even without such a change. (Pro rata vesting would be allowed under these proposals.)

The LongView Funds argued that these equity awards were intended to be performance-based, and multi-million dollar awards that disregard vesting requirements have nothing to do with performance. The value of accelerated awards can often dwarf the amount paid in terms of the “base pay plus bonus” components of a severance agreement. Eight-figure payouts are not uncommon.


Noteworthy 2011 Delaware Court Decisions

Francis G.X. Pileggi is Member-in-Charge of the Wilmington office of Eckert Seamans Cherin & Mellott, LLC and publisher of the Delaware Corporate and Commercial Litigation Blog. This post is based on an article by Mr. Pileggi and Kevin F. Brady of Connolly Bove Lodge & Hutz LLP. This post is part of the Delaware law series, which is co-sponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

This is the seventh year that we are providing an annual review of key Delaware corporate and commercial decisions. During 2011, we reviewed and summarized approximately 200 decisions from Delaware’s Supreme Court and Court of Chancery on corporate and commercial issues. Among the decisions with the most far-reaching application and importance during 2011 include those that we are highlighting in this short overview. We are providing links to the more complete blog summaries, and the actual court rulings, for each of the cases that we highlight below.

Top Five Cases from 2011

We begin with the Top Five Cases on corporate and commercial law from Delaware for 2011 and we are glad to see that at least four of them have some support from the bench as these were the cases that four Vice Chancellors highlighted as important decisions in a recent panel presentation that they presented in New York City in early November 2011. Those cases were the following: In Re: OPENLANE Shareholders Litigation; In Re: Smurfit Stone Container Corp. Shareholder Litigation; In Re: Southern Peru Copper Corp. Shareholder Litigation and Air Products and Chemicals, Inc. v. Airgas Inc., and Kahn v. Kolberg Kravis Roberts & Co., L.P.


Mergers and Acquisitions in 2012

Adam Emmerich is a partner in the corporate department at Wachtell, Lipton, Rosen & Katz focusing primarily on mergers and acquisitions and securities law matters. This post is based on a Wachtell Lipton firm memorandum.

As we enter 2012 and as the U.S. economy continues to stabilize, there appears to be a growing sense of optimism about further recovery in the M&A market. During the first half of 2011, the M&A market continued a resurgence that began in the latter part of 2010, with higher aggregate deal value than had been seen since before the financial crisis. Though worldwide M&A activity declined in the second half of 2011, reflecting uncertainties regarding the volatile global financial climate, it has continued at a relatively strong pace, and a number of significant transactions have recently been announced, including Kinder Morgan’s $38 billion acquisition of El Paso, United Technologies’ $18 billion acquisition of Goodrich, and Gilead’s $11 billion acquisition of Pharmasset.


Why Do CEOs Survive Corporate Storms?

The following post comes to us from Messod Daniel Beneish, Professor of Accounting at Indiana University Bloomington; Cassandra Marshall of the Department of Finance at the University of Richmond, and Jun Yang of the Department of Finance at Indiana University Bloomington.

In our paper Why Do CEOs Survive Corporate Storms? Collusive Directors, Costly Replacement, and Legal Jeopardy, which was recently made publicly available on SSRN, we consider new explanations for the puzzling result that a majority of misreporting CEOs retain their jobs.  We extend the literature by investigating the role of directors’ both personal and reputational incentives in the CEO retention decision.  Overall, our analysis improves our understanding of the CEO retention decision by 30 to 40% relative to a benchmark model based on the severity of the misreporting, the firm’s performance and risk characteristics, and traditional measures of the strength of corporate governance.

We show that two types of personal benefits make conventionally independent directors less likely to remove CEOs: loss avoidance on equity-contingent wealth and increased compensation. First, we find that in firms where independent directors emulate CEOs’ trading behavior and also engage in abnormal insider selling over the misreporting period, CEOs are 13.6% more likely to be retained.  We view independent directors’ trading as suggestive of collusion because, like CEOs and other executive directors, they personally benefit by selling their equity at inflated prices during the period over which earnings are misreported.  To the extent that the misreporting sustains the firm’s overvaluation, the fact that directors engage in abnormal selling suggests they have access to negative information about the firm that they do not reveal to shareholders.  We posit that independent directors prefer not to attract attention to their own abnormal selling.  Thus, even though dismissing the CEO could enhance shareholder value by restoring credibility, directors whose trading actions align with those of CEOs have weaker incentives to replace the CEO.


Considerations for Public Company Directors in the 2012 Proxy Season

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.

The past year has been one of change and challenge for public companies and their boards, as companies have moved to implement “say-on-pay” and other provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). With the 2012 proxy season on the horizon, public companies and their directors will continue to feel the impact of Dodd-Frank as the Securities and Exchange Commission (“SEC”) proceeds with its ongoing efforts to implement the law. At the same time, public companies and their boards are operating in an environment where the balance of power between boards and shareholders continues to shift. The traditional, board-centric model of corporate governance continues to gravitate toward a paradigm that includes an increased role for shareholders. Activist shareholders are seeking greater participation in companies’ governance and operations, and they are exerting increased pressure on companies to adopt so-called corporate governance “best practices.”


Creative TruPS 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, Richard K. Kim, Nicholas G. Demmo, Patricia A. Robinson, and Brandon C. Price.

With the phase out of Tier 1 capital treatment for trust preferred securities (TruPS) mandated by Dodd Frank slated to begin January 1, 2013, financial institutions have been active in considering potential strategies to replace outstanding TruPS with other forms of regulatory capital. Last week, Huntington Bancshares completed a novel exchange offer for several specified series of outstanding TruPS. In the offer, Huntington exchanged outstanding floating-rate TruPS for a new series of floating-rate non-cumulative perpetual preferred stock, which – unlike the TruPS – will not lose Tier 1 treatment under Dodd Frank and will also continue to be recognized as a Tier 1 instrument under Basel III.

Huntington’s exchange offer involved four different series of TruPS and the offer was tailored to each series, including through the use of additional cash consideration for two of the series and by employing a waterfall of acceptance priority levels among the four series in the event that the offering was oversubscribed. By conducting the exchange as a registered offering rather than relying on the exchange provisions under Section 3(a)(9) of the Securities Act of 1933, Huntington was able to employ a dealer manager to solicit TruPS holders in an effort to maximize participation. Note, however, that while Huntington’s exchange offer was completed in the scheduled time frame, the SEC must declare an exchange offer registration statement effective prior to closing, and the SEC review process can risk a delayed closing. Under the securities laws, the offer must be open to all holders and must remain open for at least 20 business days.


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