Monthly Archives: February 2012

“Financial Stability” Analysis in Bank M&A

H. Rodgin Cohen is a partner and senior chairman of Sullivan & Cromwell LLP focusing on acquisition, corporate governance, regulatory and securities law matters. This post is based on a Sullivan & Cromwell LLP publication.

A recent acquisition approval order of the Board of Governors of the Federal Reserve System (the “FRB”) provides the first analysis of the “financial stability” factor in Section 604(d) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). This section amended Section 3(c) of the Bank Holding Company Act of 1956 (“BHC Act”) to require the FRB, when evaluating a proposed bank acquisition, merger, or consolidation, to consider “the extent to which [the] proposed acquisition, merger, or consolidation would result in greater or more concentrated risks to the stability of the United States banking or financial system”. Section 604(e) of the Dodd-Frank Act similarly amended Section 4(j)(2) of the BHC Act to require the FRB to consider financial stability concerns when reviewing notices by bank holding companies to engage in nonbanking activities.

On December 23, 2011, the FRB issued an order (the “Order”) explaining its reasons for approving the acquisition of RBC Bank (USA) (“RBC Bank”) by The PNC Financial Services Group, Inc. (“PNC”). (The FRB announced its approval of the transaction on December 19, 2011 but, unusually, the Order was not released until several days later.) The Order constitutes the first articulation by the FRB of how it will analyze proposed transactions under the new financial stability factor. The FRB stated in the Order, however, that it expects to issue a notice of proposed rulemaking implementing this change to Section 3(c) of the BHC Act as well as other provisions of the Dodd-Frank Act that require the FRB to consider the effect on financial stability of other proposals by financial institutions, and that this will afford the public an opportunity to provide comments on how the FRB should take financial stability into account when reviewing applications and notices.


The Real Effects of Financial Markets

The following post comes to us from Alex Edmans and Itay Goldstein, both of the Department of Finance at the University of Pennsylvania, and Wei Jiang, Professor of Finance at Columbia University.

In our paper, The Real Effects of Financial Markets: The Impact of Prices on Takeovers, forthcoming in the Journal of Finance, we provide evidence on the real effect of financial markets. Using non-fundamental shocks to market prices — occurring due to non-discretionary trades by mutual funds that face liquidation pressure from investors’ outflows — as an instrumental variable, we show that market prices affect takeover activity. A non-fundamental decrease in the stock price creates a profit opportunity for acquirers, and increases the probability that the firm will be taken over. Using an instrument for price changes is essential for identifying this effect since market prices are endogenous and reflect the likelihood of an upcoming acquisition. This may explain the weak relationship between prices and takeover activity found by prior literature. By modeling the relationship between prices and takeovers as a simultaneous system that accounts for anticipation, and identifying using an instrument, we find a significantly stronger effect of prices on takeovers than previous research.


Strategic M&A, Spin-Offs, Hostile Transactions and Private Equity

Peter Atkins is a partner of corporate and securities law matters at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on a section from Skadden’s 2012 Insights, contributed by Thomas W. Greenberg.

Strategic M&A Continues to Drive Overall Deal Activity

The dollar value of announced M&A transactions involving U.S. targets rose by approximately 12 percent during 2011 compared with 2010, according to Dealogic data. However, the total number of announced transactions remained relatively flat, with activity levels at their highest in the first quarter of 2011 and slowing during the rest of the year amid increasing economic uncertainty and market volatility.

Strategic M&A was the primary driver of overall activity last year, with an increase in larger, billion-dollar-plus transactions compared to 2010. Strategic buyers — in particular, well-established investment grade companies that have substantial amounts of cash on their balance sheets, improving outlooks on future business performance and access to financing on favorable terms — looked to M&A as a way to generate growth faster than could be achieved organically in the current economic environment. Industry sectors that were particularly active in 2011 M&A transactions included pharmaceuticals/health care, energy/oil & gas, telecommunications/ technology, real estate, chemicals and financial services. Given the liquidity available to strategic buyers, we expect cash to continue to be the preferred form of consideration in acquisitions, although equity and mixed consideration will continue to be used in transformative combinations (including mergers of equals), transactions where the buyer faces leverage constraints and those in which the seller is unwilling to give up the opportunity to participate in the potential future upside of the combined company.


Negative Say on Pay Vote Litigation

Paul Rowe is a partner in the Litigation Department at Wachtell, Lipton, Rosen and Katz. This post is based on a Wachtell Lipton memorandum by Mr. Rowe, Edward D. Herlihy, Jeremy L. Goldstein, and Jasand Mock.

In a decision reaffirming directors’ authority to determine executive compensation, the United States District Court for the District of Oregon has ruled that a suit against bank directors arising out of a negative “say on pay” vote should be dismissed. The court determined that plaintiffs failed to raise a reasonable doubt that the challenged compensation was a reasonable exercise of the board’s business judgment. This is the first federal court decision to dismiss such an action, a number of which have been filed in state and federal courts across the country in the wake of the Dodd-Frank Act. Plumbers Local No. 137 Pension Fund v. Davis, Civ. No. 03:11-633-AC (Jan. 11, 2012).

At issue in Davis was a decision by the compensation committee of Umpqua Holdings Corporation to pay increased compensation to certain executive officers for 2010 — a year in which the bank’s performance had improved and met predetermined compensation targets, but total shareholder return was allegedly negative. In a subsequent advisory “say on pay” vote, a majority of the shares voted disapproved of the 2010 compensation. Plaintiffs claimed that it was unreasonable for the Umpqua board of directors to increase compensation and that the shareholder vote rejecting the compensation package was prima facie evidence that the board’s action was not in the corporation’s or shareholders’ best interest.


Recent Trends in Joint Venture Governance

The following post comes to us from Stephen I. Glover, partner and member of the Corporate Transactions Practice Group at Gibson, Dunn & Crutcher LLP, and is based on a Gibson Dunn client alert.

For the last decade, governance issues have been a priority at public companies and companies planning to go public. Recent joint venture activity reflects a carryover from the public company arena of this intense focus on improving governance. Venture partners are increasingly concentrating on developing and implementing governance best practices within their joint venture vehicles. This client alert provides a brief discussion of recent trends in joint venture governance.

Use of Public Company Governance Practices in Joint Ventures

Many joint venture planners are using or adapting governance practices developed by public companies to address public company governance concerns, including the following:


PCAOB Board Appointment Disregards Investor Interests

Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on a statement by Commissioner Aguilar regarding the appointment of Jeanette Franzel to the Public Company Accounting Oversight Board. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The Commission has failed to fulfill its legal obligation. It has appointed a member to the Public Company Accounting Oversight Board (“PCAOB”) who has no demonstrable record of investor advocacy. Thus, the Commission has failed to satisfy its basic statutory mandate to appoint an individual who, among other factors, has “a demonstrated commitment to the interests of investors.” [1] Accordingly, I do not support and must respectfully dissent for the reasons outlined below.

Congress established the PCAOB in response to scandalous audit failures, like Enron and WorldCom, that cost investors billions. In doing so, Congress entrusted this Commission with the significant responsibility of appointing the members of the PCAOB. In exercising this responsibility, the Commission is required to abide by the statutory criteria to appoint individuals “who have a demonstrated commitment to the interests of investors.” [2]


Payout Policy through the Financial Crisis

The following post comes to us from Eric Floyd, Nan Li, and Douglas Skinner, all of the Department of Accounting at the University of Chicago Booth School of Business.

Why managers pay dividends remains a puzzle. In our paper, Payout Policy through the Financial Crisis: The Growth of Repurchases and the Resilience of Dividends, which was recently made publicly available on SSRN, we report evidence on the payout policy of US financial and industrial firms over the past 30 years, including through the financial crisis, to shed new light on the why managers pay dividends. There are two specific goals. First, we investigate whether, as would be expected if share repurchases now dominate dividends as a means of paying cash to shareholders, managers used the financial crisis as a convenient excuse to stop paying dividends. Second, we use these data to provide new evidence on whether taxes, and in particular the Tax Relief Act of 2003 (which effectively eliminated the tax disadvantage of dividends) had a first order effect on payout policy.

We find that industrials and financials both increased payouts in the years prior to the crisis, at a pace that was impressive both in absolute terms and relative to earnings. Dividends reach a low point in 2002 but rebound thereafter. Although there is an increase in the fraction of dividend-payers immediately after the Tax Relief Act, we show that this is part of a broader increase in cash payouts that also includes a strong increase in repurchases. In the years after the Tax Relief Act there is no evidence of a shift in the mix of dividends and repurchases towards dividends—if anything, the reverse is true. Nor is there evidence of an increase in dividend payout ratios.


Say-on-Pay Lawsuits – Is This Time Different?

Keith L. Johnson heads the Institutional Investor Legal Services team at Reinhart Boerner Van Deuren s.c. This post is based on a Reinhart alert by Mr. Johnson and Kenneth B. Davis; the complete article is available here.

In the aftermath of the first proxy season of shareholder “say-on-pay” votes under the Dodd-Frank Act, shareholders have filed derivative suits against the boards of several of the companies failing to win majority approval. Many observers have been quick to dismiss the plaintiffs’ likelihood of success in these cases, given the well-established principle that decisions on compensation lie within the board’s business judgment. However, while a Georgia court, in the Beazer Homes USA litigation, relied on the business judgment rule to dismiss a say-on-pay shareholder derivative case, at roughly the same time a federal judge in Ohio reached the opposite conclusion, refusing to dismiss a say-on-pay suit involving Cincinnati Bell. [1] In light of these unfolding and conflicting developments, how should directors and compensation committees assess and respond to the risk of suit?

In our view, boards would be ill advised to take too much comfort in the belief that the business judgment rule will always be held to immunize compensation decisions from shareholder attack in the face of a substantial negative say-on-pay vote. The time might be coming for courts to start applying a stricter standard of review in these cases. Analysis of the rationale underlying the courts’ traditional deference to boards on compensation matters reveals that the unique circumstances presented by say-on-pay may lead to a different outcome.


Implementing the Volcker Rule

Editor’s Note: Martin Gruenberg is Acting Chairman of the Federal Deposit Insurance Corporation. This post is based on Chairman Gruenberg’s testimony before the House of Representatives Committee on Financial Services, available here.

Last November, the FDIC, jointly with the Federal Reserve Board of Governors (FRB), the Office of the Comptroller of the Currency (OCC), and the Securities and Exchange Commission (SEC), published a notice of proposed rulemaking (NPR) requesting public comment on a proposed regulation implementing the Volcker Rule requirements of the Dodd-Frank Act. On December 23, the four agencies extended the comment period for an additional 30 days until February 13, 2012. The comment period was extended as part of a coordinated interagency effort to allow interested persons more time to analyze the issues and prepare their comments, and to facilitate coordination of the rulemaking among the responsible agencies. In addition, on January 11, 2012, the Commodity Futures Trading Commission (CFTC) approved the issuance of its NPR to implement the Volcker Rule, with a substantially identical proposed rule text as the interagency NPR. We look forward to receiving comments on the NPR.

In recognition of the potential impacts that may arise from the proposed rule and its implementation, the Agencies have requested comments on whether the rule represents a balanced and effective approach in implementing the Volcker Rule or whether alternative approaches exist that would provide greater benefits or implement the statutory requirements with fewer costs. The FDIC is committed to developing a final rule that meets the objectives of the statute while preserving the ability of banking entities to perform important underwriting and market-making functions, including the ability to effectively carry out these functions in less-liquid markets.


White Collar and Regulatory Enforcement

Wayne Carlin is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum.

The last ten years have seen a continuous increase in white collar criminal and regulatory enforcement activity. 2011 was no exception, and we expect the trend to continue in 2012.

While not an entirely new phenomenon, the world of white collar and regulatory enforcement appears more politicized than ever. Corporations facing investigations in 2012 can expect extensive press scrutiny, serial leaks about the investigation, and, on occasion, parallel involvement of Congress and others at any stage of the matter. The credit a company can expect to receive for providing cooperation seems ever more uncertain, especially in cases receiving a high level of public focus, notwithstanding government protestations that cooperation will be rewarded. And, it is likely to get harder going forward to shepherd corporate resolutions of these kinds of cases through this politicized landscape. There is no simple solution to these challenges. But, as we discuss below, it remains critical for companies responding to multipronged investigations to keep clear lines of communication open with government investigators, to address questions candidly and with integrity, to correct identified problems promptly, and to build upon and strengthen investments made before the inquiry began in establishing a culture of compliance.


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