Monthly Archives: February 2012

LLC Controlling Member Fiduciary Liabilities

Chancellor William Chandler is a partner at Wilson Sonsini Goodrich & Rosati, and former Chancellor of the Delaware Court of Chancery. This post is based on a WSGR Alert by Chancellor Chandler and Ryan McLeod. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Last month, the Delaware Court of Chancery issued an important post-trial decision that held the majority and managing member of an LLC liable for breaches of fiduciary duty in connection with the member’s management and eventual purchase of the company. The opinion unequivocally shows that the Court of Chancery considers Delaware’s LLC Act to impose default fiduciary obligations analogous to those in the corporate context absent a clear expression otherwise in the LLC agreement.


Lessons Learned: The Inaugural Year of Say-on-Pay

Anne Sheehan is Director of Corporate Governance at the California State Teachers’ Retirement System.

One thing is for certain: Pay is unique at every company. There are as many iterations of pay as there are companies in America. This uniqueness makes our job as shareholders very challenging. For the most part, we must rely on the members of compensation committees to develop the compensation philosophy and structure in order to incentivize management and align their interests with those of shareholders. We believe that poorly structured pay packages harm shareholder value by unfairly enriching executives at the expense of owners – the shareholders. On the other hand, a well aligned compensation package motivates executives to perform at their best. This benefits all shareholders.

There have been many changes this proxy season and although the evaluation of compensation is still a challenge, we have learned a few things along the way. Given the unique nature of compensation, CalSTRS tried to evaluate pay holistically at every company. We not only looked at the alignment between pay practices and the performance of the companies, but also corporate peer groups, problematic pay practices, and disclosures.


Spin-offs and Reverse Morris Trusts

Daniel Wolf is a partner at Kirkland & Ellis LLP focusing on mergers and acquisitions. This post is based on a Kirkland & Ellis M&A Update by Mr. Wolf, Sara B. Zablotney, and David B. Feirstein.

Even with the recent slowdown in M&A activity, spin-offs have been among the transactions of choice in the past year. With everyone from economic mainstays like ConocoPhillips and Kraft to high-profile new players like TripAdvisor engaging in separation deals in the latest round of deconsolidation, it is an opportune time for dealmakers to consider the general implications of a spin-off on transformational corporate merger activity and certain structures that may allow for a combination of the two.

Corporations engage in spin-offs for a variety of business and financial reasons. A corporation’s goals can be accomplished without U.S. federal income tax to the distributing corporation and its stockholders so long as the transaction meets the requirements of Section 355 of the Internal Revenue Code.

Failure to meet these requirements either before or after the transaction can cause a spin-off to be taxable to the distributing parent company (in the form of corporate- level gain generally equal to the appreciated value of the spun-off subsidiary), to the distributing parent’s stockholders (in the form of dividend income equal to the value of the spun-off business), or both. These taxes can be prohibitively or even catastrophically expensive.


Ownership Dynamics with Large Shareholders

The following post comes to us from Marcelo Donelli and Borja Larrain, both of the Universidad Catolica de Chile, and Francisco Urzua of the Department of Finance at Tilburg University.

In our paper Ownership Dynamics with Large Shareholders: an Empirical Analysis, forthcoming in the Journal of Financial and Quantitative Analysis, we study ownership dynamics in a country where controlling shareholders are prevalent. We find that ownership structures are very persistent and that pyramidal structures are associated with less dispersion than other control structures. We also find that dilution is preceded by higher returns and predicts low returns in the future, which is a typical feature of market timing.

It is an established fact that ownership is typically dispersed in the US and the UK, but concentrated in the rest of the world. Yet, why is it that markets do not converge to the dispersed ownership paradigm of the US/UK? Why is it that approximately 20% of firms in the US and UK are tightly controlled, whereas 70% of firms in Continental Europe are tightly controlled? What prevents controlling shareholders from diluting their stakes in the firms they control? We aim to provide an answer to these questions by examining Chilean firms’ ownership dynamics in a 20 year period (1990-2009). We benefit from Chile’s unique features, such as improvements in the protection to minority shareholders, economy’s steep growth (per capita GDP more than doubled in PPP terms), markets’ booms and busts, and excellent data sources. Despite these unique features, what we learn sheds light on ownership dynamics in a number of different markets, as Chile is similar to other developed and emerging economies in terms of financial development, the overall level of ownership concentration, and protection to minority shareholders.


Bebchuk Wins Debate about the Contribution of Executive Pay to the Financial Crisis

Over the past two weeks, Lucian Bebchuk and René Stulz engaged in an online debate on the question: Has Executive Compensation Contributed to the Financial Crisis? Bebchuk supported a “yes” answer, and Stulz argued for a “no” answer. The debate, which was hosted by the World Bank’s All about Finance blog, was followed by a poll in which readers cast their votes. The votes are now in, and 79.9% of the votes were cast in support of the position supported by Bebchuk.

The opening statements by Bebchuk and Stulz are available here and here. The second-round responses by Bebchuk and Stulz are available here and here. The results of the readers’ poll are available here.

Quasi-Appraisal: The Unexplored Frontier of Stockholder Litigation?

The following post comes to us from Robert B. Schumer, chair of the Corporate Department at Paul, Weiss, Rifkind, Wharton & Garrison LLP, and is based on an article published in the M&A Journal by Mr. Schumer, Stephen P. Lamb, Justin G. Hamill, and Joseph L. Christensen; the article, including footnotes, is available here.

For buyers of public companies, an obscure but increasingly evident judicial remedy known as “quasi-appraisal” is fast becoming a source of concern. Quasi-appraisal – as its name suggests – is not quite what parties expect from M&A litigation and has the capacity to upset the familiar process accompanying the sale of a public company.

There are three primary types of M&A litigation: Pre-closing disclosure litigation, post-closing loyalty litigation and appraisal. Not every litigation fits neatly into one of these categories, but most do. Pre-closing disclosure litigation often culminates in the plaintiffs, the target company and the buyer agreeing to additional disclosures (and occasionally revisions in the transaction terms) in exchange for a class-wide release and a court-approved award of plaintiffs’ fees. In the absence of a pre-closing disclosure settlement, the second type of litigation may arise which is post-closing, class-action litigation alleging breaches of fiduciary duties (other than disclosure). Most often, such post-closing actions relate to transactions subject to entire fairness review, as, for example, when a controlling stockholder is involved. And finally, in cash-out mergers, stockholders can pursue a post-closing appraisal claim, a remedy that requires each individual stockholder wishing to pursue appraisal to dissent from the merger vote, refrain from accepting the merger consideration, and bear litigation costs. In an appraisal, dissenting stockholders also bear the risk that the court will appraise the stockholder’s shares at a lower value than the merger consideration.


Analyzing Aspects of Board Composition

David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. This post is based on an article by Mr. Katz and Laura A. McIntosh that first appeared in the New York Law Journal. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.

As the 2012 proxy season approaches, it appears that certain issues in board composition—the separation of the chairman and chief executive officer (CEO) roles (along with the related issue of the independence of the chairman) and board diversity—are likely to be more prominent this year. As boards consider these and other related corporate governance issues, directors should keep in mind that a corporate board is a complex creature, with company history, personal dynamics, and board structure all contributing to, or potentially undermining, the overall effectiveness of the board. No single factor in board composition will have the same significance at one company as it has at another; boards should seek to adopt best practices that will make them more effective, but this does not mean that governance structures such as the separation of chairman and CEO roles should be mandated. Directors facing pressure from activists should be counseled that it is the board’s right and responsibility to determine its own operation, and that it is the board’s duty to do so in a way that, in the business judgment of the directors, best serves the company and its shareholders.


Say on Pay Votes and CEO Compensation

Fabrizio Ferri is an Assistant Professor of Accounting at Columbia University. Work from the Program on Corporate Governance about executive compensation includes the book Pay without Performance and the article Paying for Long-Term Performance, both by Bebchuk and Fried.

As we begin to analyze the first proxy season under “say on pay” in the US, it may be useful to review the evidence from the UK experience with say on pay. In the study, Say on Pay Votes and CEO Compensation: Evidence from the UK, co-authored with David Maber of University of Southern California and forthcoming in the Review of Finance, we examine the impact of “say on pay” in the UK, the first country to adopt a mandatory, non-binding annual shareholder vote on executive pay.

We perform three sets of analyses. First, we examine the market reaction to the (largely unanticipated) announcement of say on pay regulation and find positive abnormal returns for firms with weak penalties for poor performance, e.g. firms with excess CEO pay combined with poor performance and firms with generous severance contracts, which can weaken penalties in the event of poor future performance.


Corporate Governance Practices for IPOs

Matteo Tonello is Director of Corporate Governance for The Conference Board, Inc. This post is based on a Conference Board Director Note by Richard Sandler and Elizabeth Weinstein of Davis Polk & Wardwell LLP, which was adapted from a Davis Polk memorandum, available here.

This report examines the corporate governance practices of 50 U.S. companies at the time of their initial public offerings (IPOs) and finds that pressure to update governance practices at larger companies has had only a limited effect on companies at the IPO stage.

To glean the governance practices of newly public companies, we analyze the prospectuses filed with the U.S. Securities and Exchange Commission by the 50 domestic companies with the largest IPOs (in terms of deal size) from January 1, 2009 through August 31, 2011. The deal size of the IPOs examined ranged from $132.0 million to $18.14 billion. [1]

Despite the growing pressure for seasoned issuers to use certain corporate governance provisions, corporate governance practices at the top 50 IPO companies examined remain in many ways unchanged from those of previous years (as shown by a nearly identical review of the top IPOs in the United States from 2007 to 2008). [2] The IPOs from both time frames show similar percentages for the use of classified boards, plurality voting in uncontested board elections, and fully independent audit committees. Far fewer recent IPO companies separated the role of CEO and chairman of the board—34 percent, compared with 52 percent from the previous sample.


Dutch Court Decision Impacts Global Securities Class Actions

The following post comes to us from Todd G. Cosenza, partner in the Litigation Department of Willkie Farr & Gallagher LLP, and is based on a Willkie memorandum by Mr. Cosenza and Antonio Yanez, Jr.

Recently, the Amsterdam Court of Appeal issued an important decision in the Converium case with implications for class action suits in the United States and internationally. The decision authorizes the use of the Dutch collective-settlement statute to settle disputes on a classwide, opt-out basis. Given that the U.S. Supreme Court’s decision in Morrison v. National Australian Bank significantly limited the extent to which claims by foreign investors can be settled in United States securities cases, the Amsterdam Court of Appeal’s decision is significant because it provides a practical mechanism for structuring global securities class action settlements through the use of the Dutch statute in concert with U.S. proceedings, particularly in cases involving a large number of European investors.


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