Monthly Archives: April 2012

Separate Entity Doctrine for U.S. Branches of Foreign Banks

The following post comes to us from three law firms: Cleary Gottlieb Steen & Hamilton LLP; Davis Polk & Wardwell LLP; and Sullivan & Cromwell LLP. It is based on a white paper authored jointly by the three firms on the separate entity doctrine as applied to the U.S. branches of foreign headquartered (non-U.S.) banks. The hybrid treatment of the U.S. branches of foreign headquartered banks has become a subject of focus in the wake of the financial crisis and in light of the enactment of the Dodd-Frank Act. The white paper provides a summary of the regulatory treatment of U.S. branches of foreign headquartered banks under various U.S. legal regimes, and highlights the hybrid nature of such branches. The original white paper, including footnotes, is available here.

Although a branch of a bank is not a separate juridical entity from the bank of which it is a component, U.S. law treats branches as separate from the head office and other branches of a bank when such differentiation is appropriate for various purposes. Branches are a hybrid structure, at the same time both an integral part of the banks of which they are merely offices and separate legal entities for a number of U.S. regulatory and commercial law purposes. This feature of bank branches is a central tenet of federal banking statutes, and the law governing U.S. branches of foreign banks in particular.

At times the status of a U.S. branch of a foreign bank under a particular statutory scheme is explicit. Such is the case with the U.S. law treatment of U.S. branches of foreign banks in insolvency. As discussed below, U.S. law treats those branches virtually as separate entities in insolvency.

In other circumstances, a particular statute does not explicitly address the status of U.S. branches of foreign banks, and the treatment has to be arrived at through an analysis of the purpose of the statutory scheme. For example, as discussed below, after a long series of no-action letters, the Securities and Exchange Commission (“SEC”) issued interpretive guidance providing that securities issued or guaranteed by U.S. branches of a foreign bank (but not its non-U.S. branches) could rely on the exemption from registration afforded to securities issued or guaranteed by a bank under Section 3(a)(2) of the Securities Act of 1933 (“Securities Act”). Thus, U.S. branches can rely on the Section 3(a)(2) exemption while the bank itself is required to register to distribute its securities in the United States.

This paper will review the treatment of U.S. branches of foreign banks under a variety of statutory schemes and explore the rationale for that treatment.


FDIC Lawsuits Targeting Failed Financial Institutions

The following post comes to us from Narayanan Subramanian, principal at Cornerstone Research. This post is based on a Cornerstone Research publication by Katie Galley and Joe Schertler, available here.

As widely reported in the press, seizures of banks and thrifts by regulatory authorities began to subside in 2011. Throughout the year, 92 institutions were seized compared with 157 in 2010 and 140 in 2009. In contrast, Federal Deposit Insurance Corporation professional liability lawsuits targeting failed financial institutions began to increase in 2011. These are lawsuits in which the FDIC, as receiver for failed financial institutions, brings professional liability claims against directors and officers of those institutions and against other related parties, such as accounting firms, law firms, appraisal firms, or mortgage brokers.


From July 2, 2010, through January 27, 2012, the FDIC filed 21 lawsuits related to 20 failed institutions (two of the 21 lawsuits were associated with IndyMac Bank, F.S.B). Of the 21 lawsuits, two were filed in 2010, 16 in 2011, and three in January 2012. Aggregate damages claimed in the complaints totaled $1.98 billion.


Director Ownership, Governance, and Performance

The following post comes to us from Sanjai Bhagat, Professor of Finance at the University of Colorado at Boulder, and Brian Bolton of the Department of Finance at Portland State University.

In our paper, Director Ownership, Governance, and Performance, forthcoming in the Journal of Financial and Quantitative Analysis, we study the impact of SOX on the relationship between corporate governance and company performance. A significant part of SOX and other exchange requirements increase the role of independent board members. Given that prior academic research suggests there is no positive relationship between board independence and firm performance, the above regulatory efforts are especially notable.

We find a shift in the relationship between board independence and firm performance after 2002. Prior to 2002, we document a negative relationship between board independence and operating performance. After 2002, we find a positive relationship between independence and operating performance. We find this result is driven by firms that increase their number of independent directors. An event study provides independent evidence supportive of the above results – specifically, when a company goes from being non-compliant to being compliant with SOX’s board independence requirement, the market response is significantly positive. Why might SOX be related to this positive performance? SOX and the listing standards impose new responsibilities on firms’ directors, such as regular meetings of the independent directors, approval of director nominations by independent directors, and approval of CEO compensation by independent directors. As a consequence of these policies boards began including more independent directors, and, perhaps the independent directors became more engaged in the firm’s governance processes. For example, we find that firms with greater board independence (and stock ownership of board members) are less likely to engage in a value-destroying activity, namely, acquisitions.


Will the SEC Facilitate Shareholder Access to the Ballot Under Rule 14a-8?

Robert Jackson is associate professor of law at Columbia Law School. This post was coauthored with Gabriella Wertman, member of the Columbia Law School class of 2013. Work from the Program on Corporate Governance about shareholder voting includes Private Ordering and the Proxy Access Debate by Bebchuk and Hirst; a previous post on the SEC staff’s rulings on proxy access proposals under Rule 14a-8 is available here.

In the wake of Business Roundtable v. SEC, public company shareholders and boards have, for the first time, been using Rule 14a-8 to propose, and defend against, proxy access proposals. Earlier this month, the SEC staff released a series of no-action letters  addressing management requests to exclude shareholders’ proxy access proposals from the ballot. The staff has based these early rulings on their longstanding 14a-8 precedents, which were originally crafted to address proposals outside the proxy access context. The staff’s approach leaves open the possibility that management will be able to use these rules to exclude proxy access proposals in the future, endangering the viability of Rule 14a-8 as a means of facilitating private ordering in proxy access. Before next proxy season, the SEC should make clear that it will apply Rule 14a-8 in a way that will give investors a meaningful opportunity to adopt the proxy access rules that shareholders prefer.

Although the staff’s initial rulings addressed important preliminary questions raised by the use of Rule 14a-8 for facilitating proxy access, they were much more notable for their adherence to the staff’s existing precedents for evaluating shareholder proposals outside the proxy access context. This approach has convinced corporate counsel and their clients that the SEC will allow management to use these precedents to exclude proxy access proposals from the ballot. Unless the SEC reverses course, this approach will give management a systematic advantage that will prevent shareholders from adopting their preferred approach to proxy access.


Wal-Mart Bribery Case Raises Fundamental Governance Issues

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.

Wal-Mart appeared to commit virtually every governance sin in its handling of the Mexican bribery case, if the long, carefully reported New York Times story is true. The current Wal-Mart board of directors must get to the bottom of the bribery scheme in Mexico and the possible suppression by senior Wal-Mart leaders in Bentonville, Arkansas (the company’s global headquarters) of a full investigation.

In addition, the board must also review – and fix as necessary – the numerous company internal governing systems, processes and procedures that appear to have been non-existent or to have failed. And, most importantly, it must define the CEO’s core role as one which truly fuses high performance with high integrity, and does not exalt performance at the expense of integrity – and possibly discipline or remove the past CEO (still on the board) or the current CEO.

The essential allegations in the Times story are as follows:

For a substantial period before 2005, the CEO of Wal-Mart in Mexico and his chief lieutenants, including the Mexican general counsel and chief auditor, knowingly orchestrated bribes of Mexican officials to obtain building permits, zoning variances and environmental clearances, and also falsified records to hide these payments. When the lawyer in Mexico directly responsible for bribery payments had a change of heart and reported the scheme to Wal-Mart lawyers in the United States, those lawyers hired an independent firm which, after an initial look, recommended a major inquiry.


Arbitration Provisions in Corporate Governance Documents

The following post comes to us from Carl W. Schneider, special consultant to Ballard Spahr LLP and former special adviser to the SEC’s Division of Corporation Finance. This post is a summary of an article by Mr. Schneider that appeared in 26(3) INSIGHTS: The Corporate & Securities Law Advisor (Wolters Kluwer Law & Business, March 2012).

The financial press and blogs were abuzz in late January 2012 about the Securities Act of 1933 (Securities Act) registration statement filed by The Carlyle Group L.P. for its initial public offering. Its limited partnership agreement required all shareholder disputes with the partnership to be resolved by mandatory, binding and confidential arbitration. The provision included a prohibition against shareholders bringing class actions. Much of the discussion that was critical of the provision focused on the elimination of class actions and not on the pros and cons of arbitration as such.

According to published reports, the SEC advised Carlyle that it would not grant an acceleration order permitting the registration statement to become effective unless the arbitration provision was withdrawn. As a practical matter, Carlyle had no means to challenge the Commission and no practical alternative other than to withdraw its arbitration provision, which it did.

I object to the process by which the SEC killed Carlyle’s arbitration provision.


Financing-Motivated Acquisitions

The following post comes to us from Isil Erel, Yee Jin Jang, and Michael Weisbach, all of the Department of Finance at The Ohio State University.

In the paper, Financing-Motivated Acquisitions, which was recently made publicly available on SSRN, we evaluate the extent to which acquisitions lower financial constraints on a sample of 5,187 European acquisitions occurring between 2001 and 2008. Each of these targets remains a subsidiary of its new parent, so we can observe the target’s financial policies following the acquisition. We examine whether these post-acquisition financial policies reflect improved access to capital.

Managers often justify acquisitions with the logic that they can add value to targets by facilitating the target’s ability to invest efficiently. In addition to the operational synergies emphasized by the academic literature, financial synergies potentially come from the ability to use the acquirer’s assets to help finance the target’s investments more efficiently. However, examining this view empirically is difficult, since for most acquisitions, one cannot observe data on target firms on subsequent to being acquired. Because of disclosure requirements in European countries, we are able to construct a sample of European acquisitions containing financial data on target firms both before and after the acquisitions. We use this sample to test the hypothesis that financial synergies are one factor that motivates acquisitions.


Establishing a “Domestic Transaction” in Securities under Morrison

Brad Karp is chairman and partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss client memorandum.

In its 2010 decision in Morrison v. National Australia Bank, 130 S. Ct. 2869 (2010), the Supreme Court addressed whether Section 10(b) of the Securities Exchange Act applies to a securities transaction involving foreign investors, foreign issuers and/or securities traded on foreign exchanges. The Morrison decision curtailed the extraterritorial application of the federal securities laws by holding that Section 10(b) applies only to (a) transactions in securities listed on domestic exchanges or (b) domestic transactions in other securities.

In Absolute Activist Value Master Fund Ltd. v. Ficeto, et al., Docket No. 11-0221-cv (2d Cir. Mar. 1, 2012), the Second Circuit addressed for the first time what constitutes a “domestic transaction” in securities not listed on a U.S. exchange. The Court held that, to establish a domestic transaction in securities not listed on a U.S. exchange, plaintiffs must allege facts plausibly showing either that irrevocable liability was incurred or that title was transferred within the United States.

Plaintiffs in Absolute Activist were nine Cayman Island hedge funds (the “Funds”) that had engaged Absolute Capital Management Holdings (“ACM”) to act as their investment manager. Plaintiffs alleged in their complaint that the ACM management defendants engaged in a variation of a pump-and-dump scheme. Specifically, defendants were alleged to have caused the Funds to purchase billions of shares of U.S. penny stocks issued by thinly capitalized U.S. companies – stocks that defendants themselves also owned – and then to have traded those stocks among the Funds in a way that artificially drove up the share value. Defendants thereby were alleged to have profited both from the fees generated through the fraudulent trading activity and the profits they earned when they sold their shares of the penny stocks at a profit to the Funds.


Public Investors and the Risks of Non-Corporate Governance

The following post comes to us from Kimberly Gladman, Director of Research and Risk Analytics at GovernanceMetrics International, and is based on a GMI Ratings report by Ms. Gladman and Beth M. Young.

Companies whose initial public offerings (IPOs) take the form of limited partnerships (LPs), rather than corporations, may pose special risks to investors. LP owners do not have the same legal rights as corporate shareholders, and standards of director independence and fiduciary duty do not protect investors’ interests to the same degree. The governance disadvantages of LPs may not be reflected in IPO prices, but could lead to price declines if they are subsequently recognized by the market.

The Carlyle Controversy

U.S. alternative asset manager Carlyle Group stirred controversy recently when it announced it would go public as a limited partnership with very limited rights for public investors. Most strikingly, the company’s IPO documents initially contained a provision that would have forced investors who wanted to sue the company for any reason to resolve their disputes through private arbitration. Investors would have been barred from using the courts even for securities class actions alleging stock price manipulation and fraud. However, the mandatory arbitration provision did not pass muster with the Securities and Exchange Commission (SEC), which required its removal in order for the offering to proceed. Without that provision, Carlyle’s governance looks a lot like that of Fortress, Blackstone, KKR, Kinder Morgan Energy Partners, and other companies that have gone public in the last few years as LPs rather than corporations. So can Carlyle’s would-be investors set their minds at ease?


Contingent Consideration in Bridging Valuation Gaps

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 from Mr. Herlihy, David E. Shapiro, Matthew M. Guest, David M. Adlerstein, and Jenna E. Levine.

The recovering, but still uncertain, economy and real estate markets have led to diverging opinions and concerns over the future value of a target’s assets which might otherwise prevent agreement on transaction pricing. As discussed in prior memos, contingent consideration structures have for years been used to bridge differences between buyers and sellers in uncertain times. With the burgeoning trend of increased M&A activity involving smaller banks, it is important to remember that these structures, while requiring careful thought, can be useful in both small and large deals alike to creatively address pricing challenges.

Capital Bank Financial Corp.’s recently announced agreement to acquire Southern Community Financial Corporation is the third transaction in the last 18 months in which that acquiror has utilized a contingent value right, or CVR, as a portion of the consideration. The CVR provides the opportunity for additional value to Southern Community shareholders if the portfolio performance exceeds a designated benchmark, while allowing Capital Bank to limit its exposure if performance should deteriorate. It has a value determined by the performance of Southern Community’s legacy loan and foreclosed asset portfolio at the end of a five-year period. Payments under the CVR may range from zero to $1.30 per share in addition to the primary merger consideration of $2.875 per share. Any payments would only be made at the end of the five-year measurement period. The CVR was structured so as not to require registration with the SEC, avoiding not only the cost of registration but also the ongoing reporting requirements. Consequently, the CVR is not transferable, does not grant any voting or dividend rights, bears no stated rate of interest, and will not be certificated.


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